LAst: Heaging tne batance sneet Janet Chilton and George Stephers had joined Wosld Trust Corporation. (WTC) a few years ago as trainers in the derivatives products group. Part of thair responsibilities was to explain to potential clients haw their derivatives services could help raanagement their risk exposures. A small depository institution, Eirst Savings Association, had recently contacted World Trust about hedging its ret worth agairst a porsible increase in interest rates. The financial gress was regularly speculating that the Federal Reserve would continue raising interest rates to hold down incigient inflation in the econ.amy. During its latest Board of Directors meeting, First Savings decided that the probability of a sigrificant increase in interest rates was sufficient to varrant the irrglernentation of a derivatives hedging strategy. However, the board wanted the selected dealer to clearly present its hedging plan at its next rmeeting the following month. A number of the hoard members expressed concern due to gast news stories of majoc blunders by derivatives dealers in groperly managing client risk. Janet and George collected the latest reports on the maturities of assets and liakilities held by First Savings. After checlaing the data, they agreed that First Savings did inciest face interest rate risk due to a positive maturity gap-that is, the maturity of assets exceeded the maturity of liabilities on average. They decided to set up a simgle example of this type of mismatch and gresent it to the Board of First Savings. Assume the institution made a oneyear loan at 10 percent with receigts of $1,000 (L. . ,its present value is $909.09 ). This loan is funded with 90-day CDs gaying 8 percent. Put together a schedule of receigts and gayments for the loan and CDs in each quarter for the upcoming year. Assume further that the date is September 15 and that you sell 13 -week T-bill futures in December, March, and June as a heige on the CDs. Calculate the grice of the T-ball futures ccntract using a 10 gercent discount rate. Assuming further that interent rates do not changs, shaw the results of First Savings gurchasing T-bills in the spot market and selling T-bills in the futures marlat on the delivery date. We are now ready to demonstrate the effects of an interest rate increase of 2 percent on the receipts and gayments associated vith the halance sheet and the futures heige strategy. Assume that interest rates increase after the first 90-day is soli at 8 gercent, such that all subserquent CDs must gay the higher interest rate of 10 percent. Assure also that First Savings has already sold T-hill futures for the upccoring year grior to the interest rate in arease and therefore has lodiced in its sales price. As a member of the staff at Warld Trust, you have been asked by Janet and George to show how the net receipts on the balance sheet an. A futures hedge are affected. In anticipation of their upccoring meeting with the board of First Savingis, they zlso want you to write up some short arswers to the following ruestions for distribution to the members of the board. W What is the present value of the net receipts if interent rates rise 2 percent? How does this change in net receipts conmare with the result assuming no change in interest rates - If interest rates declined rather than increased, what would be the effect on the balance sheet and futures hedge results? How might the bark use an option on a futures contract to achieve the same result? - What are the advantages of using the ogticn cn a futures contract over a futures contract alone? What is the disadvantage of the options agpoodh compared with using only a futures contract? - Finally, should Warld Trust sakk to pair a hedge contract to each individual asset or liability an the balance sheet of First Savings, or should it seek to look at the "big pisture" and hedge the overall riak of the balance sheet? LAst: Heaging tne batance sneet Janet Chilton and George Stephers had joined Wosld Trust Corporation. (WTC) a few years ago as trainers in the derivatives products group. Part of thair responsibilities was to explain to potential clients haw their derivatives services could help raanagement their risk exposures. A small depository institution, Eirst Savings Association, had recently contacted World Trust about hedging its ret worth agairst a porsible increase in interest rates. The financial gress was regularly speculating that the Federal Reserve would continue raising interest rates to hold down incigient inflation in the econ.amy. During its latest Board of Directors meeting, First Savings decided that the probability of a sigrificant increase in interest rates was sufficient to varrant the irrglernentation of a derivatives hedging strategy. However, the board wanted the selected dealer to clearly present its hedging plan at its next rmeeting the following month. A number of the hoard members expressed concern due to gast news stories of majoc blunders by derivatives dealers in groperly managing client risk. Janet and George collected the latest reports on the maturities of assets and liakilities held by First Savings. After checlaing the data, they agreed that First Savings did inciest face interest rate risk due to a positive maturity gap-that is, the maturity of assets exceeded the maturity of liabilities on average. They decided to set up a simgle example of this type of mismatch and gresent it to the Board of First Savings. Assume the institution made a oneyear loan at 10 percent with receigts of $1,000 (L. . ,its present value is $909.09 ). This loan is funded with 90-day CDs gaying 8 percent. Put together a schedule of receigts and gayments for the loan and CDs in each quarter for the upcoming year. Assume further that the date is September 15 and that you sell 13 -week T-bill futures in December, March, and June as a heige on the CDs. Calculate the grice of the T-ball futures ccntract using a 10 gercent discount rate. Assuming further that interent rates do not changs, shaw the results of First Savings gurchasing T-bills in the spot market and selling T-bills in the futures marlat on the delivery date. We are now ready to demonstrate the effects of an interest rate increase of 2 percent on the receipts and gayments associated vith the halance sheet and the futures heige strategy. Assume that interest rates increase after the first 90-day is soli at 8 gercent, such that all subserquent CDs must gay the higher interest rate of 10 percent. Assure also that First Savings has already sold T-hill futures for the upccoring year grior to the interest rate in arease and therefore has lodiced in its sales price. As a member of the staff at Warld Trust, you have been asked by Janet and George to show how the net receipts on the balance sheet an. A futures hedge are affected. In anticipation of their upccoring meeting with the board of First Savingis, they zlso want you to write up some short arswers to the following ruestions for distribution to the members of the board. W What is the present value of the net receipts if interent rates rise 2 percent? How does this change in net receipts conmare with the result assuming no change in interest rates - If interest rates declined rather than increased, what would be the effect on the balance sheet and futures hedge results? How might the bark use an option on a futures contract to achieve the same result? - What are the advantages of using the ogticn cn a futures contract over a futures contract alone? What is the disadvantage of the options agpoodh compared with using only a futures contract? - Finally, should Warld Trust sakk to pair a hedge contract to each individual asset or liability an the balance sheet of First Savings, or should it seek to look at the "big pisture" and hedge the overall riak of the balance sheet