TASK 1
Bonds: Growth & Inflation
Dear all students
Description: Read and discuss the New York Times article posted on your Moodle page. Use your own experience and knowledge to discuss whether the author is hinting at the right moves for prices and interest rates.
Interest rates movement?
How does it affect inflation?
How does it affect the bonds market?
500 words (3 sources)
TASK 2
Assessment:
Brief instructions and objectives of the task read the case and propose a hedging foreign exchange strategy
for the company.
Assignment Scenario
Interest Rate Risk Wonderworld Co has a newly acquired subsidiary in Algeria, where the local currency is
the dinar (D). The subsidiary expects to receive D27,000,000 and wants to invest the full amount. Assume it is
now 1 October 2017 and the subsidiary expects to receive the money on 31 January 2018. It wishes the
money to be invested for five months until 30 June 2018. Currently, the central bank base rate in Algeria is
42%, but Wonderworld Cos treasury team has seen predictions that the central bank base rate could
increase by up to 11% or fall by up to 06% between now and 31 January 2018. The treasury team believes
that Wonderworld Co can invest funds at the central bank base rate of less than 30 basis points. The treasury team
normally hedge interest rate exposure by using whichever of the following products is most appropriate:
Forward rate agreements (FRAs)
Interest rate futures
Options on interest rate futures
Treasury function guidelines emphasize the importance of mitigating the impact of adverse movements in
interest rates. However, they also allow staff to take into consideration upside risks associated with interest
rate exposure when deciding which instrument to use. A local bank in Algeria, with which Wonderworld Co
has not had any business relationship before, has offered the following
FRA rates: 49: 502% 510: 510% The treasury team has also obtained the following information about
exchange-traded Dinar futures and options:
Three-month D futures, D500,000 contract size Prices are quoted in basis points at 100 annual % yield:
December 2017 94.84 March 2018 94.78 June 2018 94.66 Options on three-month D futures, D500,000
contract size, option premiums are in annual %:
Call Put December March June December March June 0.417 0.545 0.678 94.25 0.071 0.094 0.155 0.078
0.098 0.160 95.25 0.393 0.529 0.664
It can be assumed that futures and options contracts are settled at the end of each month.
Basis can be assumed to diminish to zero at contract maturity at a constant rate, based on monthly time
intervals. It can also be assumed that there is no basis risk and there are no margin requirements.
Requirements: Recommend a hedging strategy for the D27,000,000 investment, based on the hedging
choices that treasury staff are considering if interest rates increase by 11% or decrease by 06%.
Support your answer with appropriate calculations and discussion.
