MN30067 Seminar 5 Interest Rate Risk Seminar Questions

MN30067 Seminar 5 Interest Rate Risk Seminar Questions

Q 1 A triple A rated company wishes to raise floating rate funds for five years. It is able to borrow on floating rate terms at Libor +1/4 and on fixed rate terms, for a straight bond issue for five years, at Treasuries plus 61 basis points. Treasuries are currently yielding 4.00 %. The company has been approached by its bank with a deal that would allow it to raise funds at Libor minus 10 basis points.

The bank has another customer rated triple B who is able to raise floating rate funds at Libor + 3/4 but who has to pay 6.15 for 5 year fixed rate funds. The triple B company wishes to raise fixed rate funds for five years.

Given the above information

i)  Say what the theory of comparative advantage is and illustrate it using the figures given above. 10 marks

ii)  Outline the transaction that the Bank has in mind and work out the benefit to each party. The Bank will want to see at least 20 basis points per annum.

40 marks

iii)  What are the advantages and disadvantages of the above transaction to each party? 10 marks

iv)  Why might the triple A rated company wish to raise floating rate funds even if it thinks interest rates might be rising? 10 marks

v)  What alternative strategies to the swap could you pursue and what are the problems and benefits of each? 30 marks

Q2

i)  Describe what is meant by ‘riding the yield curve’ and the risks that a bank or a company is running when they do so. 10 %.

ii)  You have a GBP1,000,000 receipt due in three months time which you intend to deposit for three months

a)  if the current six month interest rates are 4 7/16 – 4 5/16 and the current three month interest rates are 4 3/8 – 4 3/16, what is the forward-forward rate for the three month deposit (use the simple calculation). 10 %

b)  if you have FRA quotes as follows:

Period Rate

1-4  4 3/32 – 4 7/32

3-6 4 ¾ - 4 7/8

6-9  4 7/8 – 4 15/16

what would the compensation amount be and who would pay whom if on the deposit date in three months time the actual rate was 5%? 20%

iii)  The Sterling three month June futures contract has a quote of 95.49 and the current three month rate is 4.00 %

a)  What is the implied three month rate from June to September?

b)  If when you reverse your position the futures quote is 95 and the market three month rate is 4.5 % what is your net gain or loss?

iv)  Why would there be differences between the pricing on the forward –forward the FRA and a futures contract?