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Chapter 21 Problem 3 (a-e)

Chapter 21 Problem 3 (a-e)
June Klein CFA manages a $ 100 million ( market value ) US government bond portfolio for an institution, she anticipates a small parallel
shift in the yield curve and wants to fully hedge the portfolio against any such change
		PORTFOLIO AND TREASURY BOND FUTURES CONTRACT CHARACTERISTICS
Security	Modified Duration in (Years )	Basis point value	Conversion factor for Cheapest to deliver bond	Portfolio value / furture contract price
Portfolio	10
U.S Treasure bond	8
future contrac
a)- Discuss two reasons for using futures rather than selling bonds to hedge a bond portfolio. No calculation required
b)- Formulate Klein hedging strategy using only the futures contract shown .Calculate the number of futures contracts to implement the strategy. Show all calculations
c)- Determine how each of the following would have change in value if interest rates increase by 10 basis points as anticipated. Show all calculations
1)- The original portfolio
2)- The treasury bond futures position
3)- the newly hedged portfolio
d)- State 3 reasons why Klein hedging strategy might not fully portect the portfolio against interest rate risk
e)- Describe a zero -duration hedging strategyusing only government bond portfolio and options on U.S treasury bond futures contracts. No
calculation is required

Chapter 21 Problem 4 ( a-c)

Chapter 21 Problem 4 ( a-c)
A bond speculator currently has positions positions in two separate corporate bond portfolios: a long holding 1 and short holding in portfolio 2
All the bonds have the same credit quality. Other relevant information on these positions includes :
Portfolio	Bonds	Value Market (mil.)	Coupon rate	Compounding Frequency	Maturity ( Years)	Yield to maturity
1	A	6	0	Annual	3
	B	4	0	Annual	14
2	C	11.5	4.6	Annual	9
Treasury bond futures ( based on $ 100,000 face value of 20 -years T-bonds having an 8% smi- annual ) with a maturity exactly six months
from now are currently priced a 109- 24 with a corresponding yield to maturity of 7.081 percent. The yield betas between the futrues contract and Bonds A,B and C are 1.13, 1.03, 1.03 and 1.01 respectively. Finally, the modified duration for the T-bonds underlying the futures contract is 10.355 years
a)- calculate the modified duration ( expressed in years ) for each of the two bond portfolios. What will be the apporximate percentage change in the value of each if all yields increase by 60 basis points on an annual basis?
b)- Without performing the calculations, explain which of the porfolios will actually have its value impacted to the greatest extent ( in absolute
terms ) by the shift yields ( Hint: This explanation require knowledges of the concept of bond convexity )
c)- Assuming the bond speculator wants to hedge her net position, what is the optimal number of futures contracts that must be bought or sold ? Start by calculating the optimal hedge ratio between the futures contract and the two bond porfolios separately and then combine them.

Chapter 21 Problem ( 6 ( a-c)

Chapter 21 Problem ( 6 ( a-c)
As a relationship officer for a money-enter commercial bank, one of your corporate accounts has just approached you about one-year loan for $ 1000,000. The customer would pay a quarterly interest expense based on the prevailing
level of LIBOR at the beginning of each three- month period.						As is the bank's convention on all such loans, the amount of interest payment would then be paid at the end of the quarterly cycle when the new rate
You observe the following LIBOR yield curve in the cash market :
90-day LIBOR 4.60%
180-days LIBOR 4.75
270-day LIBOR 5.00
360-day LIBOR 5.30
a)- If 90 LIBOR rises to the levels " predicted : by the impled forward rates, what will the dollar level of the bank' interest receipt be at the end of each quarter during the one-year loan period ?
b)- If the bank wanted to hedge its exposure to failing LIBOR on this loan commitment, describe the sequence of transactions in the futures markets it could undertake.
c)- Assuming the yields inferred from the Eurodollar futures contract prices for the next three settlement periods are equal to the implied forward rates, calculate the annuity value that would leave the bank indifferent
between making the floating-rate loan and hedging it in the futures market and making a one-year fixed-rate loan Express this annuity value in both dollar and annual ( 360-day) percentage terms.

Chapter 21 Problem 9 (a- b)

Chapter 21 Problem 9 (a- b)
Alex Andrew who manages a $ 95 million large-capitalization U.S. equity porfolio, currently forecasts that equity markets will decline soon.
Andrew prefers to avoid the transaction costs of making sales but wants to hedge $ 15 million of the porfolio's current value using S&P 500 futures
Because Andrew realizes that his portfolio will not track the S&P 500 Index excactly, he performs a regression analysis on his actual porfolio returns
versus the S& P futrues returns over the past year. The regression analysis indicates a risk -minimizing beta of 0.8 with an R 2 of 0.2
Futures Contract Data
S&P 500 futures price		1000
S&P Index		999
S&P 500 index multiplier		250
a)- Calcluate the number of futres contracts required to hedge $ 18 million of Andrew's portfolio using the data shown. State whether the
hedge is long or short. Show all caculations.
b)- Identify two alternative methods (other than selling securities from the portfolio or suing futures) that replicate the strategy in Part a.
Contract each of these methods with the futures strategy

Chapter 21 Problem 10 (a-c)

Chapter 21 Problem 10 (a-c)
The treasurer of a middle market , import-export company has approached you for advice on how to best invest some of the firms's short -term one -year holding period.
The treasurer is currently considering two alternatives: (1) invest all the funds in a one-year U.S treasury bill offering a bonds equivalent yield of 4.25 percent, and ( 2) invest
all the funds in a Swiss government securty over the same horizon . Locking in the spot and forward currency exchanges in the FX market. A quick call to the bank's
FX desk gives you the following two-way currency exchange quotes.
		Swiss Francs per U.S. Dollar		U.S. Dollar per Swiss Franc (CHF)
	Spot		1.5035	0.6651
	1-Year CHF futures		0	0.6586
a)- Calculate the one- year bond equivalent yield for the Swiss government security that would support the interest rate
condition.
b)- Assuming that actual yeild on a one -year Swiss government bond is 5.50 percen, which strategy would leave the treasurer with the greatest retrun after one year ?
C- Describe the transactions that an arbitrageur could use to take advantage of this apparent mispricing, and calculate what the profit would be for a & 250, 000 transaction

Chapter 21 problem 11 (a-c)

Bonita Singer is a hedge fund manager specializing in futures arbritrage involving stock index contracts. She is investigatiing potential trading opportunities in S&P 500

stock index futrues to see if there are any indefficiencies that she can exploit. She knows that the S&P 500 stock index is currently trading at 1,100

a)- Assume that the treasury yield curve is flat at 3.2 percent and the annualized dividend yield on the S&P index is 1.8 percent. Using the cost of carry model, demonstrate

what the theoritical contract price should be for a futures position expiring six months from now

b)- Describe the set of transaction that Bonita would have to undertake to take advantage of an actual futres contract price that was substantially higher

or (2) substantially lower than theoritical value you establised in Part a

c)- Assuming that tota round-trip arbitrage transaction costs are $20 for the set trades described in part b, calculate the upper and lowe bounds for the theoritcal contract price such that abitrage trading would not be

profitable