INTEGRATED MINI CASE HEDGING INTEREST RATE RISK WITH FUTURES VERSUS OPTIONS VERSUS SWAPS On January 4, 2018, an Fl has the following balance sheet (rates = 8 percent): Assets Liabilities/Equity A $450 m DA = 8 years DL = 4 years L $396 m E $ 54 m DGAP = [8 - (396/450)4] = 4.48 years > page 799 The Fl manager thinks rates will increase by 0.55 percent in the next three months. If this happens, the equity value will change by: AE = -[8 - 30 (4)]450 m = -$10.266,067 The Fl manager will hedge this interest rate risk with either futures contracts, option contracts, or swap contracts. If the Fl uses futures, it will select June T-bonds to hedge. The duration on the T-bonds underlying the contract is 14.5 years and the T-bond futures are selling at a price of $110.53125 per $100, or $110,531.25. T-bond futures rates, currently 5 percent, are expected to increase by 0.75 percent over the next three months. If the Fl uses options, it will buy puts on 15-year T- bonds futures with a June maturity, an exercise price of 109, and an option premium of 36/64 percent. The spot price on the T-bond underlying the option is $115.78125 per $100 of face value. The duration on the T-bonds underlying the options is 14.5 years and the delta of the put options is 0.85. Managers expect these T-bond rates to increase by 0.7 percent from 5.25 percent in the next three months. If the Fl uses swaps, a swap agent offers a swap involving DFixed = 8 years (based on the 15-year Treasury bond rate) and D Floating = 1 year (based on Treasury bills). If by April 4, 2018, balance sheet rates increase by 0.5 percent, futures rates by 0.7 percent, and T-bond rates underlying the option contracts by 0.66 percent, calculate the on- and off-balance-sheet cash flows to the Fl when using futures contracts, option contracts, and swap contracts as its hedge instrument. If by April 4, 2018, balance sheet rates actually fall by 0.25 percent, futures rates fall by 0.35 percent, and T-bond rates underlying the option contract fall by 0.34 percent, calculate the on- and off-balance-sheet cash flows to the Fl when using futures contracts, option contracts, and swap contracts as its hedge instrument. INTEGRATED MINI CASE HEDGING INTEREST RATE RISK WITH FUTURES VERSUS OPTIONS VERSUS SWAPS On January 4, 2018, an Fl has the following balance sheet (rates = 8 percent): Assets Liabilities/Equity A $450 m DA = 8 years DL = 4 years L $396 m E $ 54 m DGAP = [8 - (396/450)4] = 4.48 years > page 799 The Fl manager thinks rates will increase by 0.55 percent in the next three months. If this happens, the equity value will change by: AE = -[8 - 30 (4)]450 m = -$10.266,067 The Fl manager will hedge this interest rate risk with either futures contracts, option contracts, or swap contracts. If the Fl uses futures, it will select June T-bonds to hedge. The duration on the T-bonds underlying the contract is 14.5 years and the T-bond futures are selling at a price of $110.53125 per $100, or $110,531.25. T-bond futures rates, currently 5 percent, are expected to increase by 0.75 percent over the next three months. If the Fl uses options, it will buy puts on 15-year T- bonds futures with a June maturity, an exercise price of 109, and an option premium of 36/64 percent. The spot price on the T-bond underlying the option is $115.78125 per $100 of face value. The duration on the T-bonds underlying the options is 14.5 years and the delta of the put options is 0.85. Managers expect these T-bond rates to increase by 0.7 percent from 5.25 percent in the next three months. If the Fl uses swaps, a swap agent offers a swap involving DFixed = 8 years (based on the 15-year Treasury bond rate) and D Floating = 1 year (based on Treasury bills). If by April 4, 2018, balance sheet rates increase by 0.5 percent, futures rates by 0.7 percent, and T-bond rates underlying the option contracts by 0.66 percent, calculate the on- and off-balance-sheet cash flows to the Fl when using futures contracts, option contracts, and swap contracts as its hedge instrument. If by April 4, 2018, balance sheet rates actually fall by 0.25 percent, futures rates fall by 0.35 percent, and T-bond rates underlying the option contract fall by 0.34 percent, calculate the on- and off-balance-sheet cash flows to the Fl when using futures contracts, option contracts, and swap contracts as its hedge instrument
