Assessment 2(Use spreadsheets)

1 Suppose that, under the terms of a swap, Citibank as a swap dealer has agreed to receive sixmonth

LIBOR and pay 7% per year on a notional principal of $50 million. The other side of the contract is Unilever. The payments are every six months. The swap has a remaining life of 1.25 years. The appropriate LIBOR discount rates for 3-month, 9-month, and 15-month maturities are 6.5%, 7%, and 7.5%, respectively. The LIBOR rate used for the next payment date was 6% per year. Describe the cash flows of the swap from Citibank’s perspective. Particularly, when is the next payment? How much are the next fixed payment and floating payment? What is the next net payment for Citibank?

2 Firm AA can borrow in the five-year fixed rate market at 5.26% and floating at six month LIBOR. Firm BBB can borrow in the five-year fixed rate market at 6.38% and floating at six month LIBOR plus 0.6%. A swap dealer can have a swap pricing schedule for AA and BBB. Now, AA pays LIBOR and receives 5.5% (through the dealer) while BBB pays 5.54% and receives LIBOR (through the dealer). Please explain why all three parties gains in this deal. How much each gains in this deal.

3 Suppose that Tesla Company wants to build an auto plant in Europe and VW Corporation wants to do the same in the United States. To open a factory, you need local currency. Often a manufacturer can more easily raise cash at home because it has relationships with local banks. Tesla and VW both plan to do this. Seeing a large spread between foreign exchange buying and selling rates, they decide to do the currency conversion via a currency swap. This is a generic fixed-for-fixed currency swap that involves regular exchange of fixed payments over the swap’s life. The automakers enter into a swap with a threeyear term on a principal of $200 million. The spot exchange rate is $2 for €1.66. The automakers exchange principals today. One pays $200 million and the other pays in Euro equivalent to $200 million. Assuming annual payments, Tesla pays VW 4 percent on the principal in Euro (you need to find the amount) and VW pays Tesla 6 percent on $200 million at the end of each year for three years. The companies are basically exchanging their borrowings. The swap ends after three yearly payments, and the principals are handed back. Please list the cash flows for both Tesla and VW from time 0 to the end of year 3. Specifically, at each time, which company pays dollars, which pays Euro, and how much.

4 Suppose that you buy a one-year forward contract on NetFlix (NFLX) stock. Unless noted otherwise, all computations are on a per stock basis. No cash changes hands today because the future price is the fair price. At maturity, you will receive one NFLX stock from the forward’s seller by paying him the forward price. The current price of NFLX is $508.90. The interest rate is 1%. What is the forward price?

5 The Cable One (CABO) stock price is $1846.10 today (April 22 2021), a newly written forward on CABO matures in 3 months (June 18 2021), and the continuously compounded interest rate is 1 percent per year. It is scheduled to pay a dividend of $2.50 on May 21 2021. What is the fair value forward price of the stock?

6 The S&P500 index is currently at 4163.50. The risk free rate is 1% and the dividend yield on the index is 2% per year. What is the futures price for a six months S&P 500 index contract?

7 The exchange rate between USD and GBP (Great British Pound) is $1.39 to £1. The current six-month interest rate in the US is 0.04% and the six-month interest rate in UK is 0.1125%. What is the forward price of the GBP for a 6-month forward contract?

8 Suppose I am obligated to buy a house from Mark in a year. I consider the obligation similar to a forward contract. The fair value of the house is $1 million today. Assume that today is April 30 2021. The property tax of $10,000 is due today and another $10,000 is due on November 1 2021. Mark will pay the tax. The property tax is like cost of carry in the forward contract. What is the fair value of the house in 1 year holding everything else constant? The interest rate is 1% per year.

9 Julie just bought a random length lumber futures contract. Suppose that the storage costs are 8% per year of the lumber. The current spot price is $1,291.80 per 1,000 board feet. One forward contract is for 110,000 board feet. The risk-free interest rate is 1 percent per year with continuous compounding. Find the forward price for one contract.

10 Suppose the spot price of oats (a pure consumption commodity) is $3.91 per bushel. There are no storage costs. The interest rate is 1 percent per year with continuous compounding. The actual quoted forward price is $3.70 per bushel for five months. Compute the implied convenience yield, y, of oats.

1 Suppose that, under the terms of a swap, Citibank as a swap dealer has agreed to receive sixmonth

LIBOR and pay 7% per year on a notional principal of $50 million. The other side of the contract is Unilever. The payments are every six months. The swap has a remaining life of 1.25 years. The appropriate LIBOR discount rates for 3-month, 9-month, and 15-month maturities are 6.5%, 7%, and 7.5%, respectively. The LIBOR rate used for the next payment date was 6% per year. Describe the cash flows of the swap from Citibank’s perspective. Particularly, when is the next payment? How much are the next fixed payment and floating payment? What is the next net payment for Citibank?

2 Firm AA can borrow in the five-year fixed rate market at 5.26% and floating at six month LIBOR. Firm BBB can borrow in the five-year fixed rate market at 6.38% and floating at six month LIBOR plus 0.6%. A swap dealer can have a swap pricing schedule for AA and BBB. Now, AA pays LIBOR and receives 5.5% (through the dealer) while BBB pays 5.54% and receives LIBOR (through the dealer). Please explain why all three parties gains in this deal. How much each gains in this deal.

3 Suppose that Tesla Company wants to build an auto plant in Europe and VW Corporation wants to do the same in the United States. To open a factory, you need local currency. Often a manufacturer can more easily raise cash at home because it has relationships with local banks. Tesla and VW both plan to do this. Seeing a large spread between foreign exchange buying and selling rates, they decide to do the currency conversion via a currency swap. This is a generic fixed-for-fixed currency swap that involves regular exchange of fixed payments over the swap’s life. The automakers enter into a swap with a threeyear term on a principal of $200 million. The spot exchange rate is $2 for €1.66. The automakers exchange principals today. One pays $200 million and the other pays in Euro equivalent to $200 million. Assuming annual payments, Tesla pays VW 4 percent on the principal in Euro (you need to find the amount) and VW pays Tesla 6 percent on $200 million at the end of each year for three years. The companies are basically exchanging their borrowings. The swap ends after three yearly payments, and the principals are handed back. Please list the cash flows for both Tesla and VW from time 0 to the end of year 3. Specifically, at each time, which company pays dollars, which pays Euro, and how much.

4 Suppose that you buy a one-year forward contract on NetFlix (NFLX) stock. Unless noted otherwise, all computations are on a per stock basis. No cash changes hands today because the future price is the fair price. At maturity, you will receive one NFLX stock from the forward’s seller by paying him the forward price. The current price of NFLX is $508.90. The interest rate is 1%. What is the forward price?

5 The Cable One (CABO) stock price is $1846.10 today (April 22 2021), a newly written forward on CABO matures in 3 months (June 18 2021), and the continuously compounded interest rate is 1 percent per year. It is scheduled to pay a dividend of $2.50 on May 21 2021. What is the fair value forward price of the stock?

6 The S&P500 index is currently at 4163.50. The risk free rate is 1% and the dividend yield on the index is 2% per year. What is the futures price for a six months S&P 500 index contract?

7 The exchange rate between USD and GBP (Great British Pound) is $1.39 to £1. The current six-month interest rate in the US is 0.04% and the six-month interest rate in UK is 0.1125%. What is the forward price of the GBP for a 6-month forward contract?

8 Suppose I am obligated to buy a house from Mark in a year. I consider the obligation similar to a forward contract. The fair value of the house is $1 million today. Assume that today is April 30 2021. The property tax of $10,000 is due today and another $10,000 is due on November 1 2021. Mark will pay the tax. The property tax is like cost of carry in the forward contract. What is the fair value of the house in 1 year holding everything else constant? The interest rate is 1% per year.

9 Julie just bought a random length lumber futures contract. Suppose that the storage costs are 8% per year of the lumber. The current spot price is $1,291.80 per 1,000 board feet. One forward contract is for 110,000 board feet. The risk-free interest rate is 1 percent per year with continuous compounding. Find the forward price for one contract.

10 Suppose the spot price of oats (a pure consumption commodity) is $3.91 per bushel. There are no storage costs. The interest rate is 1 percent per year with continuous compounding. The actual quoted forward price is $3.70 per bushel for five months. Compute the implied convenience yield, y, of oats.