Test

Derivatives (Prof. Ramesh Laxman)

Exercise 1

1. The USD Libor Curve and the INR zero curve are available in the embedded excel file in the sheets respectively marked INR and USD Libor. Given the USD/INR Spot rate is ruling at a price of 44.38/39 compute the forward price for maturity date of 23^rd July, 2011. Determine the forward price for bid and offer and indicate how the forward price would be quoted by the market participants in the interbank market.

USD Libor	12-Nov-10		12/Nov/10
s/n-o/n	0.22813	Beta 0	8.6559
1w	0.25281	Beta 1	-2.5497
2w	0.25313	Beta 2	-0.6222
1m	0.25781	Tau 1	2.4926
2m	0.27469	Beta 3	1.9969
3m	0.29563	Tau 2	1.0000
4m	0.35631	Maturity (Yrs)	12/Nov/10
5m	0.42856	0.0	6.11
6m	0.49669	0.5	6.65
7m	0.55450	1.0	6.99
8m	0.61113	1.5	7.20
9m	0.66063	2.0	7.35
10m	0.71894	2.5	7.45
11m	0.77975	3.0	7.53
12m	0.84306	3.5	7.60
		4.0	7.66
Today	23-Jul-11	4.5	7.71
Days	253	5.0	7.75
Weeks	36.1428571	5.5	7.80
		6.0	7.84
		6.5	7.88
		7.0	7.92
		7.5	7.95
		8.0	7.98
		8.5	8.01
		9.0	8.04
		9.5	8.07
		10.0	8.09
		10.5	8.11
		11.0	8.13
		11.5	8.16
		12.0	8.17
		12.5	8.19
		13.0	8.21
		13.5	8.22
		14.0	8.24
		14.5	8.25
		15.0	8.26
		15.5	8.28
		16.0	8.29
		16.5	8.30
		17.0	8.31
		17.5	8.32
		18.0	8.33
		18.5	8.34
		19.0	8.35
		19.5	8.35
		20.0	8.36
		20.5	8.37
		21.0	8.37
		21.5	8.38
		22.0	8.39
		22.5	8.39
		23.0	8.40
		23.5	8.40
		24.0	8.41
		24.5	8.41
		25.0	8.42
		25.5	8.42
		26.0	8.43
		26.5	8.43
		27.0	8.44
		27.5	8.44
		28.0	8.44
		28.5	8.45
		29.0	8.45
		29.5	8.46
		30.0	8.46

2. We go live to Reuters and take relevant information for spot, USD interest rates (Depo Rates) and INR rates and compute Forward rate for maturity of 23^rd December, 2010, the date for maturity of futures on USD in the Indian market. Compare the rate so computed with futures price and determine the difference. Compute estimated margins on the futures and ascertain whether the futures price difference is due to interest cost on margins.

3. Britania Industries uses wheat in its biscuit production. The past average monthly consumption in tons for the six months are as under

June 3.0

July 2.5

Aug 4.0

Sept 3.7

Oct 5.0

Nov 4.5

The company uses linear projection to estimate the consumption for the next six months. Using the Trend Function and including each months projection in the computation for subsequent months, determine the quantity to be consumed for Dec, Jan to March. For the estimated consumption determine how the company can use the futures market to hedge its purchase cost. Discuss the cash flow implications for the company assuming the initial margin to be 5% and the past one month trend will follow for the next one month. Can you think of any alternative to the hedging process? What problems would you face in using this hedge for the 4 months-that is from a practical implementation point of view. Would you consider a stack hedge.

4. P and G USA is planning to issue Commercial Paper of 90 days duration and roll them over for the next three quarters to fund one year fund requirement. If the requirement is for 100 M USD, determine the cost to the company of using this route as against the one year straight money. Considering that Libor is based on BBB risk, using P and G risk rating factor the spreads in the market when determining the cost to the company. Use Reuters to find out the rating currently prevailing.

5. Using the Australian futures exchange establish the unique feature of their 2 year and 10 year bond futures contract where the tick size keeps changing. Explain how and why it changes and how you will use the contract in hedging bond portfolio.