# International Financial Management Oz Assignments

## Question 1 a

### Question 1 b

Future price converges to the spot price because the risk that was there of what will happen in the future is not there. Because of uncertainty of whether the price of a commodity will either fall or rise most people take caution against such risks. As time of expiration comes near the risk that the price might fall for the commodity help reduces completely because there is a surety. Also, future price is pushed to lower figure than spot price because there are more people who are willing to sell their commodity because of future risk of prices reducing than willing to buy but as expiration nears that risk is removed so many holds and waits for expiration time so this pushes the future price to be same as spot price (Gregoriou, G, 2008).

When this convergence fails an arbitrage, opportunity arises and one can take the advantage of the price difference. When the spot is below the future price one can buy the commodity in the cash market and sell it in the future market and make a risk-free profit. When the cash spot price is above the future price one can buy in the future market and sell it in the cash market and earn a risk-free profit. (Taylor, F. ed. ,2013).

### Question 2

Therefore, hedge ratio = -0.88= -0.7555

This means for every spot cash price unit held you trade 0.7555 of the future unit

The metric tons held by the customer = \$ 10,000,000/\$1,250 = 8,000 metric tons

So, the future position is

= 8,000*0.7555 = 6044 metric tons

Therefore, the contract to trade are

=6044/10 = 605 contracts

She should sell 605 future contracts.

### Part a

Fisher expects that a withdraw of \$ 10m will be done in the next four month and her concern is that to raise the \$ 10m required for withdraw more shares will need to be sold so a hedge of \$ 10 m should be got.

### Part c

Fisher should use future contact with expiration after the expected withdraw so it is December which is four months

Therefore

Q= (n/f) *β = 1.6(\$10,000,000/2100*250) = - 58.18 contracts

Therefore, to hedge the risk of \$ 10 million withdrawal fisher should sell 59 contact

 Date Cash market Future market Today Anticipated withdrawal of \$10m Sell 59 December S&P 500 future contracts Between current time and December Sell securities to meet portfolio demands Do a reverse trade to unwind the hedge as withdrawal is being made.

### Constructing a swap using a floating rate bond and a fixed rate bond

In this kind of a swap there are two payers floating rate payer and a fixed rate payer. For the floating rate payer, they have a liability that has an interest rate that is fluctuating and seeks to take advantage of the interest rate changes. This is typical to businesses with high interest rate sensitive assets which seeks to exchange with somebody who have a fixed interest rate. For a floating rate payer, expects that interest rate in future will decrease so he seeks to take advantage of that. On the other hand, a fixed rate payer expects the interest rate to rise but would like to have a fixed rate of payments. This is typical for business analysis with large amount of highly interest rate sensitive liabilities (Madura, J., 2011)

So, the fixed rate payer agrees to pay a certain pre-agreed interest rate per annum or semi annually depending on the maturity and the floating rate payer agrees to pay the let say six-month interest. (Kwok, Y.K., 2008)

Figure 1 floating rate, fixed rate swap (Treasury today,2006)

Part b

The fixed payment at the end of the period,

C=LN*I = \$ 100m *0.06*182/365

= \$ 2,991,780.82 million

PVfix= B (0.05) *C+B (0.1) *C+B (0.15) +B (0.2) *C+B (0.25) *C+B (0.3) *C+B (0.3) * LN

=(0.99+0.97+0.95+0.93+0.91+0.88)*2,991,780.82+0.88*100

= \$104.84

The floating rate loan is always equal to its par value at the payment dates

PVFloat= LN= \$ 100 million

so, the value of this swap is

= PVFloat-PVFix

= 100-104.84

= -\$4.84

Therefore, to enter in to the swap Fixed Towers will be paid \$ 4.84 million today.

#### Reference

1. Kolb. (2018). Future Prices. [online] Available at: http://www.blackwellpublishing.com/content/kolb5thedition/chapter_03_solution.pdf [Accessed 29 Sep. 2018].
2. Kolb, Robert W. and James Overdahl (2006) Understandingfutures markets.6th Ed.
3. Peter R.(2004) forward and future prices[Online] Available from:https://faculty.weatherhead.case.edu/ritchken/textbook/chapter2ps.pdf[Accessed 29th September 2018].
4. Kaufman, P.J(2013). Trading Systems and Research Methods (5th Ed.) John Wiley & Sons.
5. Gregoriou, G.N. ed. (2008) Encyclopedia of alternative investments. CRC Press.
6. Taylor, F. ed., (2013). Mastering the Commodities Markets: A step-by-step guide to the markets, products and their trading. Pearson UK.
7. Kolb. (2018). Using Future Prices. [online] Available at: http://www.blackwellpublishing.com/content/kolb5thedition/chapter_04_solution.pdf [Accessed 29 Sep. 2018].
8. Kolb. (2018). Stock index futures: introduction. [online] Available at: http://www.blackwellpublishing.com/content/kolb5thedition/chapter_07_solution.pdf [Accessed 29 Sep. 2018].
9. Kwok, Y.K., (2008)Mathematical models of financial derivatives. Springer.
10. Britten-Jones, M., (1998) Fixed income and interest rate derivative analysis. Elsevier.
11. Madura, J., (2011). International financial management. Cengage Learning.
12. Treasury today (2006) Interest rate risk – managing it with swaps. [online] Available at: http://treasurytoday.com/2006/04/interest-rate-risk-managing-it-with-swaps [Accessed 29 Sep. 2018]