FIN 672, INTERNATIONAL FINANCIAL MANAGEMENT Exam 2

Q1. Veezee (VZ) issues a 2-year floating rate bond in the amount of $100M on which it pays (LIBOR6 – 0.5%) semi-annually. LIBOR6 refers to 6-month maturity London Interbank Offer Rate (LIBOR). First payment will be due on December 31, 2010. However, VZ would prefer a fixed rate payment. With this objective, it enters into a swap with Citibank as the intermediary swap bank. VZ agrees to pay Citibank an annual rate of 8% and in return will receive LIBOR from Citibank. All payments are made on a semi-annual basis.

A. In the above swap arrangement, what is the net fixed rate that VZ has to pay? (5 Points)
B. Suppose the LIBOR6 is realized at the end of 6-month periods as follows:

Dec 31,10
LIBOR6

Jun 30,11

Dec 31,11

Jun 30,12

Dec 31,12

7%

6%

8%

9%

5%

What will be the net interest payment of VZ for the principal of 100M on each of the dates shown in the above table? Of this amount, how much goes to Citibank? And how much to VZ’s bondholders as interest payment? Show your results by filling out the following table (send the completed table as a part of your answers): (10 Points)
LIBOR6
Dec 31,10

7%

June30,11

6%

Dec 31,11

8%

June30,12

9%

Dec 31,12

5%

Net pay to
Citibank

Pay to Bond holders

Net pay by VZ

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Q 2.

A US investor’s equally-weighted portfolio contains Intel (US stock) and Nestle (Swiss stock) with the following risk-return characteristics (10 Points):

Intel
Nestle

Exp. Return
Stand. Dev.
5% (in $-terms)
30% (in $-terms)
12% (in SF- terms) 19% (in SF-terms)

The dollar-denominated returns on the two stocks are correlated with a factor of 0.20. Swiss Franc is expected to depreciate against dollar by 4%. The standard deviation of the rate of change of $/SF spot exchange rate is 15%. In addition, the estimated correlation between SF-return on Nestle and the rate of change in exchange rate is 0.17.
A. What is the dollar return on the investor’s portfolio? (4 Points)
B. What is the standard deviation of the dollar return on the portfolio? (6 points)