Assessment Task

Learning Outcome (ULO)

Successful Completion of this assessment, students can:

ULO1- Develop and demonstrate knowledge of interest rate measurement, fixed income securities, forwards, futures, and options

ULO3 - Apply derivatives securities to risk management;

ULO4 - Develop and demonstrate effective communication skills, including the ability to clearly explain graphs, data, statistics and algebra,
in a manner appropriate for finance peers and academics.

Cross Hedging with Futures Contract and Derivative Securities Disaster

Question 1

Assessment objective: This question aims to assess your understanding of the concept of cross hedging with futures contract and calculation of optimal hedge ratio, optimal number of contract and hedge effectiveness (Topic 2 Learning Outcomes)

You are required to create an imaginary cross hedging scenario, collect appropriate data, and use the data to calculate the optimal hedge ratio, optimal number of contracts to be used and hedge effectiveness.

Your answer to this question should include the following items:

1. An overview of a hypothetical cross hedging scenario for a commodity (This includes parties involved in hedging, asset to be hedged, when to hedge, length of hedge period, reason(s) to hedge, etc).

2. Data collection: Collect your market data for the cross hedging problem from Global Financial Database accessible via Deakin Library. You are required to use at least 36 observations of weekly prices. Describe the data you collected (i.e., sample period, spot and futures price). Please note that the sample period should precede the hedge period. The raw data must be presented in an Excel spreadsheet embedded in the Appendix section of this report.

3. Suggest and describe a futures contract for cross hedging and the hedging strategy and provide justification(s) for your choice. The justification(s) should include the calculation of correlation between the historical spot price of the asset to be hedged and historical futures price. The hedge period should end in 2017. Calculate the optimal hedge ratio, optimal number of contracts to be used and hedge effectiveness. Describe how you calculate the optimal hedge ratio, number of contracts to be used, and hedge effectiveness. Interpret your calculation results and comment on the hedge effectiveness as part of the recommendation of selected futures contract.

Wherever appropriate, the summary of your calculation and/or results should be presented in the main text of your report. However, the data, detailed calculation and detailed results should be presented in the Excel spreadsheet, which must be embedded in the Appendix section of your report. You must properly reference (Harvard style) all sources of information used.

Important: You may refer to the cross hedging example in Chapter 3 of your textbook to help you create your own cross hedging scenario. However, your cross hedging scenario cannot be exactly the same as the one in your textbook. If you do so, a penalty will be applied.

Question 2

Assessment objective: This question aims to assess your understanding of the reason for derivatives usage. (Topic 1 Learning Outcomes)
Pick and describe one theoretical explanation of corporate hedging/derivatives usage for hedging purpose by companies. Then describe one study/article that empirically investigates the determinants of derivative usage/corporate hedging by companies in Australian or New Zealand market. To answer this question, you are expected to describe the study, including the sample of companies examined, types of derivative securities used, industries of the companies examined in the study and the factors affecting a company's decision to use derivatives for hedging. Also, describe and discuss the empirical results on the factors that determine the company's use of derivatives in relation to the theoretical explanation you have selected and described.

In attempting the above task, you are expected to use at least three academic references. You may use articles from academic journals or textbooks, but not Wikipedia, Investopedia or other non- academic Internet websites. You must properly reference (Harvard style) all sources of information used.

Question 3

Assessment objective: This question aims to assess your understanding of the uses of derivative securities and the damages it can bring if it is misused. (Topic 1 Learning Outcomes)

Derivative securities is used for risk management. However, it has often been blamed for causing huge losses for corporations, governments and investors. In fact, Warren Buffett in Berkshire Hathaway 2002 Annual Report stated that "In our view, however, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal."

You are required to identify one derivative disaster caused by the misuse of derivative securities. Provide a brief description of the background of the disaster, how the disaster happened, the type of derivative securities involved, and what was the original purpose of using the derivative securities. In your view, was the derivative securities to be blamed for causing huge losses? Provide justification(s) for your view. Describe the lessons that can be learned from the disaster.

In attempting the above task, you are expected to use at least three references. You may use articles from academic journals or textbooks or news articles, but not Wikipedia, Investopedia or other non- academic Internet websites. You must properly reference (Harvard style) all sources of information used.

Important: One derivative disaster (China Aviation Oil disaster) will be discussed in week 3 or 4 lecture. However, you are not allowed to use China Aviation Oil disaster in your answer to Question 3. If you do so, you will get a zero mark for Question 3.

3. Please note: 2 marks are allocated for referencing.