The answer for Q 28 is B or the Pac man defense strategy.
The answer for Q 28 is B or the Pac man defense strategy.
Q28 Ans B:
This takeover defense strategy is known as Pac man defense.
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Today's Question (Questions and answers provided by Knowledge Varsity)
Case Study
Swamp Telecom, a subsidiary of Dakshin Bharat RealEstate is involved in providing telecommunication services. The firm has agreed to take a floating rate loan of $100 million after 6 months, the maturity of the loan would be of 6 months. Mohnish Upadhaya is the finance manager of the firm and he is concerned that the interest rates will rise in the future, so he takes a position in a Forward Rate Agreement which expires in 6 month (180 days) and is based on 180 days LIBOR.
The current LIBOR term structure (spot rates) is given below
Term-----------Interest Rate
180 days---------------6%
360 days-------------- 7%
After 30 days of taking the position in the FRA, the interest rates have changed, below exhibit shows the interest rate.
Term-----------Interest Rate
150 days---------------6.5%
330 days---------------7.8%
Q29. Determine the rate that would be determined for the FRA and the nomenclature for the FRA?
Options----------------Rate-------------------Nomenclature
A----------------------------6%-----------------------------6 X 12 FRA
B---------------------------7.767%-------------------------6 X 12 FRA
C---------------------------7.855%-------------------------6 X 6 FRA
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The answer to the Q 29. is B according to my calculations.
Q29 Ans B:
Since the spot rates are given, we need to find the no-arbitrage forward rate. This forward rate would be the rate of FRA. For LIBOR based rates, we will use 30 days for a month and 360 days for a year, also since LIBOR is add-on yield we need to consider the simple interest during the calculations.
(1 + rate for 180 days) * (1 + forward rate for another 180 days) = (1 + rate for 360 days)
(1 + 0.06 * 180/360) * (1 + F * 180/360) = (1 = 0.07 * 360/360)
= 7.76699% or 7.767%
The nomenclature for the FRA comes from the no of days to expiry and the LIBOR Rate
FRA would be termed as 6 (months to expiry) X 12 (months to expiry + the month of LIBOR)
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Today's Question (Questions and answers provided by Knowledge Varsity)
Q30. The value of the FRA to Swamp telecom after 30 days of entering the contract is closest to? The FRA rate, when the contract was entered is 7.767%.
A. $1.07 mn
B. $2 mn
C. $1 mn
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I am not so sure about the choices for this Q 29. I am using my calculations and getting an answer of $429371.97.
Please provide explanation with clarification.
Ans 30 C:
Since the interest rates have changed (increased) the FRA would become more valuable to Swamp now. The best way to find out the value of the FRA is to determine the New FRA rate and from this we should be able to calculate the benefit it provides to Swamp. The method given in Institute book is somewhat cumbersome.
New FRA Rate:
(1 + rate for 150 days) * (1 + forward rate for another 180 days) = (1 + rate for 330 days)
=> (1+0.065*150/360) * (1 + Fnew * 180/360) = (1+0.078*360/360)
=> Fnew = 9.91481%
Now calculate the benefit due to the rate increase.
Benefit = (Fnew – F) * 180/360 * Notional Value = 2.14782% * 180/360 * $100 Mn
=> Benefit = $1,073,908
Please note that this benefit will be realized 330 days from now, so we need to discount this to the present.
PV of benefit = Benefit/ (1 + 330 day rate * 330/360) => $1,073,908/( 1 + 0.078*330/360)
=> PV of benefit = $1,002,247
Approximately we can say that the value of FRA is $1 mn to Swamp
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Today's Question (Questions and answers provided by Knowledge Varsity)
Case Study (Derivatives)
Omar Sheikh is a derivative analyst with Akbardeen advisors. He is advising a corporate client, Maanza Inc about the issuance of a Swap. Manza has a floating rate receivable for 2 years in which the payment are done every 6 month. Manza officials are concerned that the rate might decrease and hence they want to enter into the swap as a fixed rate receiver.
Below exhibit has the information on the LIBOR rates.
Period-----------Annual rate
180 days-------------4.5%
360 days--------------5%
540 days-------------5.5%
720 days--------------6%
Omar has gone through the current LIBOR rate and the expectation of Manza and advises them to enter into the swap as fixed rate receiver and pay LIBOR. The notional value of the swap is $100 million.
After 270 days have passed, Manza officials believe that due to international scenario, the floating rate will increase. Manza officials believe that the best way is to terminate the swap contract. Following are the current LIBOR rates
Period------------Annual rate
90 days------------------6%
270 days----------------7%
450 days---------------7.5%
Q31. Which of the following is closest to the fixed rate that Omar would suggest to Manza?
A. 1.5%
B. 5.5%
C. 5.72%
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As part of my calculations I did 1+ 0.078* 330/360, as 0.078 is the 330 day rate. However you have multiplied 0.078 by 360/360, which I guess caused the difference in our answers.
Q 31 Ans C:
We will arrive at the present value factors for the rates in the exhibit 1.
PV for 180 days = Z1 = $1/ (1 + 4.5% * 180/360) = 0.9780
Similarly, we will arrive at the other factor
Z2 = 0.9524
Z3 = 0.9238
Z4 = 0.8929
Fixed rate = (1 – Z4) / (Z1 + Z2 + Z3+ Z4)
=> (0.1071)/(3.747) = 2.86%
Or the annual rate will be 2.86 * 2 = 5.72%
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Today's Question (Questions and answers provided by Knowledge Varsity)
Q32. Which of the following is closest to the fixed rate at which Manza officials will be able to enter into an offsetting swap as a fixed rate payer?
A. 5.72%
B. 6.5%
C. 6.02%
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Ans 32: C
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