Principles of Corporate Finance_ 12th Edition

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Chapter 26 Managing Risk 699


bre44380_ch26_673-706.indd 699 09/30/15 12:09 PM



  1. Convenience yield Calculate convenience yield for magnoosium scrap from the following
    information:


∙ Spot price: $2,550 per ton.


∙ Futures price: $2,408 for a one-year contract.


∙ Interest rate: 12%.


∙ Storage costs: $100 per year.



  1. Convenience yield Residents of the northeastern United States suffered record-setting low
    temperatures throughout November and December 2024. Spot prices of heating oil rose 25%,
    to over $7 a gallon.


a. What effect did this have on the net convenience yield and on the relationship between
futures and spot prices?


b. In late 2025 refiners and distributors were surprised by record-setting high temperatures.
What was the effect on net convenience yield and spot and futures prices for heating oil?



  1. Convenience yield After a record harvest, grain silos are full to the brim. Are storage costs
    likely to be high or low? What does this imply for the net convenience yield?

  2. Interest rate swaps A year ago a bank entered into a $50 million five-year interest rate
    swap. It agreed to pay company A each year a fixed rate of 6% and to receive in return LIBOR.
    When the bank entered into this swap, LIBOR was 5%, but now interest rates have risen, so on
    a four-year interest rate swap the bank could expect to pay 6½% and receive LIBOR.


a. Is the swap showing a profit or loss to the bank?


b. Suppose that at this point company A approaches the bank and asks to terminate the swap. If
there are four annual payments still remaining, how much should the bank charge A to terminate?



  1. Basis risk What is basis risk? In which of the following cases would you expect basis risk
    to be serious?


a. A broker owning a large block of Disney common stock hedges by selling index futures.


b. An lowa corn farmer hedges the selling price of her crop by selling Chicago corn futures.


c. An importer must pay 900 million euros in six months. He hedges by buying euros forward.



  1. Hedging You own a $1 million portfolio of aerospace stocks with a beta of 1.2. You are
    very enthusiastic about aerospace but uncertain about the prospects for the overall stock mar-
    ket. Explain how you could hedge out your market exposure by selling the market short. How
    much would you sell? How in practice would you go about “selling the market”?

  2. Futures hedging


a. Marshall Arts has just invested $1 million in long-term Treasury bonds. Marshall is con-
cerned about increasing volatility in interest rates. He decides to hedge using bond futures
contracts. Should he buy or sell such contracts?


b. The treasurer of Zeta Corporation plans to issue bonds in three months. She is also con-
cerned about interest rate volatility and wants to lock in the price at which her company
could sell 5% coupon bonds. How would she use bond futures contracts to hedge?


INTERMEDIATE



  1. Insurance Large businesses spend millions of dollars annually on insurance. Why? Should
    they insure against all risks or does insurance make more sense for some risks than others?

  2. Catastrophe bonds On some catastrophe bonds, payments are reduced if the claims
    against the issuer exceed a specified sum. In other cases payments are reduced only if claims
    against the entire industry exceed some sum. What are the advantages and disadvantages
    of the two structures? Which involves more basis risk? Which may create a problem of
    moral hazard?

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