ONLINE CHAPTER
P23-9 Consider the following scenarios, determine how to hedge each scenario using bond futures and
comment on whether it would be appropriate to hedge the exposure.
a A bond portfolio manager will be paid a large bonus if her $10 million portfolio earns 6% in
the current fiscal year. She has done very well through the first nine months. However, she is
concerned that interest rates might increase over the next few months.
b The manager of a company is selling one of its warehouses. The deal will close in two
months. The manager plans to buy six-month Treasury notes when the company receives
payment for the warehouse space, but the manager is worried that interest rates might decline
in the next two months.
c Sam Blackwell plans to retire in a year. Upon retirement, he will be paid a lump sum based on the
value of the securities in his defined-contribution retirement plan. Sam’s portfolio consists largely
of Treasury bonds, and he is worried that interest rates will be increasing in the coming year.OPTIONS AND SWAPSP23-10 Chipman Products Company will suffer an increase in borrowing costs if the 13-week US Treasury
bill rate increases in the next six months. Chipman Products is willing to accept the risk of small
changes in the 13-week T-bill rate, but wishes to avoid the potential losses associated with
large changes. The company plans to hedge its risk exposure using an interest rate collar. If the
company buys a call option on the 13-week T-bill rate with a strike price of 60 and sells a put
option with a strike price of 50, describe how this strategy will limit the company’s exposure to
changes in the T-bill rate. The premium on the call is 0.75, and the premium on the put is 0.85.
What is the company’s profit (or loss) in the option market if the T-bill rate is 4.5% in five months?
If the T-bill rate is 5.5%? If the T-bill rate is 6.5%?
P23-11 Go to the CME Group Web site (http://www.cmegroup.com), and determine the contract
specifications for Dow Jones Industrial Average futures. (This is referred to as the Big Dow DJIA
($25) Futures contract.) Determine the current futures price for the next available contract month.
What would your profit or loss be if you bought one contract today, and the Dow Jones Industrial
Average increased by 100 points before the last settlement date?
P23-12 Company A, based in Switzerland, would like to borrow US$10 million at a fixed rate of interest.
Because the company is not well known, however, it has been unable to find a willing US lender.
Instead, the company can borrow SF17,825,000 at 11% per year for five years. Company B, based
in the United States, would like to borrow SF17,825,000 for five years at a fixed rate of interest.
It has not been able to find a Swiss lender. However, it has been offered a loan of US$10 million
at 9% per year. Five-year government bonds are yielding 9.5% and 8.5% in Switzerland and the
United States, respectively. Suggest a currency swap that would net the financial intermediary
0.5% per year.
P23-13 Citibank and ABM Company enter into a five-year interest rate swap with a notional principal
of $100 million and the following terms: every year for the next five years, ABM agrees to pay
Citibank 6% and receive from Citibank LIBOR. Using the following information about LIBOR at
the end of each of the next five years, determine the cash flows in the swap.Year LIBOR (%)
1 5.0
2 5.5
3 6.2
4 6.0
5 6.4P23-14 Based on the type of swap ABM entered into in the previous problem, what type of liabilities do
you think ABM has? Long-term or short-term?