FIN 4620 Futures and Forwards - Chapter Exercise 1) Hedging Interest Rate Risk With Forwards A bank holds a 15-year, face value $10 million bond that is priced at 104 with a YTM of 7%. The bond has a duration of eight years, and the bank plans to sell it after two months. The bank's market analyst predicts that interest rates will increase by 1% at the time of the desired sale. What is the exposure given the analyst's forecast given the formula? AP=-D x P x AR/(1+R) If the analyst is right, what will the spot price be in two months? Most other analysts are predicting no change in rates, so 2-month forward contracts for 15- year bonds are available at 104. How can the bank hedge against the expected change in interest rates with an opposing position in a forward contract? 2) Determining the Exposure A bank has the following balance sheet: millions Assets Assets Liabilities & Equity $150 Liabilities Equity $150 Total Liabilities and Equity $135 $15 Total Assets $150 The duration of the assets is six years and the duration of the liabilities is four years. The bank is expecting interest rates to fall from 10% to 9% over the next year. What is the expected change in net worth if the forecast is accurate? AE =-[DA-[(k)(DL)] [A] [AR/(1 + R)] What will be the change in net worth if interest rates increase 100 basis points? 3) Macrohedging With Futures - Short Hedge - # Units To Sell Village Bank has $240 million worth of assets with a duration of 14 years and liabilities worth $210 million with a duration of four years. In the interest of hedging interest rate risk, Village Bank is contemplating a macrohedge with T-Bond futures contracts now selling for 102-21. The T-Bond underlying the futures contract has a duration of nine years. If the spot and futures interest rates move together, how many futures contracts must Village Bank sell to fully hedge the balance sheet? N (D. -KD)A D. XP 4) Determining the Exposure Using the information from Exercise #2, if the existing interest rate on assets is 10% and the existing rate on liabilities is 6%, what will be the effect on net worth of a 1% increase in rates? AA = - [DA] [A] [ARA/(1+RA)] AND AL=-[D_] [L] [AR/(1 + RL)] 5) Hedging Credit Risk - Optional A bank lends $20,000,000 to a firm that has a credit rating of BB. The spread of a BB rated benchmark bond is 2.5% over the U.S. Treasury Bond of similar maturity. The bank sells a $20,000,000 one-year credit forward contract to an insurance company. At maturity, the spread of the benchmark bond against the Treasury bond is 3.1%, and the benchmark bond has a modified duration of 4 years. What is the amount of payment paid by the insurance company to the bank at the maturity of the credit forward contract? = (CST-CSF) * MD XA FIN 4620 Futures and Forwards - Chapter Exercise 1) Hedging Interest Rate Risk With Forwards A bank holds a 15-year, face value $10 million bond that is priced at 104 with a YTM of 7%. The bond has a duration of eight years, and the bank plans to sell it after two months. The bank's market analyst predicts that interest rates will increase by 1% at the time of the desired sale. What is the exposure given the analyst's forecast given the formula? AP=-D x P x AR/(1+R) If the analyst is right, what will the spot price be in two months? Most other analysts are predicting no change in rates, so 2-month forward contracts for 15- year bonds are available at 104. How can the bank hedge against the expected change in interest rates with an opposing position in a forward contract? 2) Determining the Exposure A bank has the following balance sheet: millions Assets Assets Liabilities & Equity $150 Liabilities Equity $150 Total Liabilities and Equity $135 $15 Total Assets $150 The duration of the assets is six years and the duration of the liabilities is four years. The bank is expecting interest rates to fall from 10% to 9% over the next year. What is the expected change in net worth if the forecast is accurate? AE =-[DA-[(k)(DL)] [A] [AR/(1 + R)] What will be the change in net worth if interest rates increase 100 basis points? 3) Macrohedging With Futures - Short Hedge - # Units To Sell Village Bank has $240 million worth of assets with a duration of 14 years and liabilities worth $210 million with a duration of four years. In the interest of hedging interest rate risk, Village Bank is contemplating a macrohedge with T-Bond futures contracts now selling for 102-21. The T-Bond underlying the futures contract has a duration of nine years. If the spot and futures interest rates move together, how many futures contracts must Village Bank sell to fully hedge the balance sheet? N (D. -KD)A D. XP 4) Determining the Exposure Using the information from Exercise #2, if the existing interest rate on assets is 10% and the existing rate on liabilities is 6%, what will be the effect on net worth of a 1% increase in rates? AA = - [DA] [A] [ARA/(1+RA)] AND AL=-[D_] [L] [AR/(1 + RL)] 5) Hedging Credit Risk - Optional A bank lends $20,000,000 to a firm that has a credit rating of BB. The spread of a BB rated benchmark bond is 2.5% over the U.S. Treasury Bond of similar maturity. The bank sells a $20,000,000 one-year credit forward contract to an insurance company. At maturity, the spread of the benchmark bond against the Treasury bond is 3.1%, and the benchmark bond has a modified duration of 4 years. What is the amount of payment paid by the insurance company to the bank at the maturity of the credit forward contract? = (CST-CSF) * MD XA