Answered step by step
Verified Expert Solution
Question
...
1 Approved Answer
An endowment has made a commitment to fund two initiatives as described below. As a hedge to these commitments, it entered into three forward contracts
- An endowment has made a commitment to fund two initiatives as described below. As a hedge to these commitments, it entered into three forward contracts with cash flows also described below.
- Initiative 1: $10 mil dollar per year for the next four years plus $100 mil in year 4
- Initiative 2: pay $100 mil in scholarships next year
- Forward Contract 1: Fund borrows $110 mil next year and repays the loan in year 4 locking in a 10% borrowing rate. In other words, the endowment receives $110 in year one and repays the loan in year 4 assuming a 10% annualized interest rate.
- Forward Contract 2: Fund borrows $10 mil in year 2 and repays the loan in year 4 locking in a 10% borrowing rate. In other words, the Fund receives $10 mil in year two and repays the loan in year 4 plus all accrued interest at 10% per year.
- Forward Contract 3: Fund borrows $10 mil in year 3 and repays the loan in year 4 locking in a 10% borrowing rate. In other words, the Fund receives $10 mil in year three and repays the loan in year 4 plus accrued interest at 10% per year.
The current value of the endowments assets are $1,190.91. The endowments CIO want to invest the assets in a fixed income portfolio so that the net equity has an interest rate exposure equal to that of a 2-year zero e.g. DMac = 2. The current term structure is flat at 10% for all maturities.
- (5 points) What is the present value of the liabilities? Hint: there is a long way and a short way to do this problem. To simplify your calculations, you should consider the net cash flows in each year of the initiatives and the forward contracts before you begin.
| Today | Year 1 | Year 2 | Year 3 | Year 4 |
Initiative 1 |
|
|
|
|
|
Initiative 2 |
|
|
|
|
|
Fwd Contract 1 |
|
|
|
|
|
Fwd Contract 2 |
|
|
|
|
|
Fwd Contract 3 |
|
|
|
|
|
|
|
|
|
|
|
- (5 points) What is the delta (dollar duration $) and Macaulay duration (DMac) of the endowments committed initiatives and three forward contracts?
- (5 points) What is the present value of the endowment less its committed initiatives and forward contracts?
- (5 points) What is the required Macaulay duration of the endowments fixed income assets in order to achieve the desired Macaulay duration of the net equity? (i.e. Equity DMac = 2).
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access with AI-Powered Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started