Task 1: Bonds: Growth & Inflation
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.
Your points must cover the following:
Interest rates movement?
How does it affect inflation?
How does it affect the bonds market?
Further Description: Read and discuss the New York Times article. Use your own experience and knowledge to discuss whether the author is hinting at the right moves for prices and interest rates.
Task 2: Market Update
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 main 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 typically 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 emphasise mitigating the impact of adverse movements in interest rates. However, they also allow staff to consider 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 no margin requirements.
Requirements: Recommend a hedging strategy for the D27,000,000 investment, based on the treasury staff’s hedging choices if interest rates increase by 11% or decrease by 06%.
Support your answer with appropriate calculations and discussion.
