1) What are the main advantages, and disadvantages, to entering a futures hedge? Explain your answer with reference to a futures contract on wheat. Assume the current price is 400 cents per bushel and the futures price is 410 cents per bushel, and cover both the short and long positions. Provide enough details.
2) Explain the structure of each of the following types of swaps; what is exchanged between the parties?
a) interest rate swap
b) currency swap
c) equity swap
3) For each of the following situations, describe clearly the risk that you face and an appropriate futures hedging strategy to hedge that risk:
a. You own a portfolio of $20 million of equity securities.
b. You are an airline, and you expect to need to buy 20 million gallons of jet fuel in January of 2016.
c. You plan on borrowing 50 million in 12 months at LIBOR plus 50 basis points.
d. You are a yogurt manufacturer, and plan on buying 800,000 gallons of milk in the next 60 days.
4) Assume that you make a one year, $30 million notational principal, plain vanilla interest rate swap, with the fixed rate leg at 7%, paid quarterly on the basis of 90 days in the quarter, and 360 days in the year. The floating leg of the swap is based on LIBOR, and that the actual LIBOR rate for the preceding 4 quarters is 7.0%, 6.0%. 7.5% and 7.7%.
a) Calculate the net payments over the life of the swap, and identify who is responsible for making each payment.
b) What happens to the $30 million at the end of the swap?
5) Find the optimal stock index futures hedge ratio if the portfolio is worth $100,000,000, the beta of the portfolio is 1.15 and the S&P 500 futures price is 2,300 with a multiplier of 250. Show the structure of the hedge.
6) You hold a portfolio of stocks with a value of $1,000,000. You expect that you will be selling the stocks in the portfolio in one year. You are considering hedging your market risk by using the 1-yr S&P 500 Index Future. The price of the future is currently at 2,000. The multiplier for the future is 250; the margin requirement is 10% of the total futures position.
a) What side of the futures position will you take? Long or short, and why?
b) What is your initial cash flow?
c) If the price of the futures falls to 1,900, what will happen to your margin account?
d) If, in exactly one year, the futures contract is trading at 1,800 and your stock portfolio has fallen in value by 10%, what will be your overall profit?