FINISH task1 and 2 both
Assessed Course Work MSc. Finance and Investment: Financial Markets Practice.
MUST USE EXCEL
As the Corporate Treasurer of an oil company which is a constituent of the FTSE 1000 Index, you have been asked by the Board of Directors to provide solutions to two concerns that they have about the financial markets. One is that short-term interest rates will rise steadily over the next three years and the other is that the equity markets will fall over the next six months. Your company is rated ’single A’ by both Moody’s and Standard and Poor’s.
Your company has two, particularly pertinent risk exposures:
The first is that your company has issued £250,000,000 of Floating Rate Notes (FRNs) paying LIBOR plus 40 basis points. This FRN has five years to maturity and pays semi-annual coupons. A coupon is payable today, the next coupon has been set and is payable in 6 month time.
The second is that the final salary pension scheme is heavily invested in UK equities.
Financial Market Environments:
The Government Term Structure of interest rates:
0.5 Yrs. 1 Yrs. 1.5 Yrs. 2 Yrs. 2.5 Yrs. 3 Yrs. 3.5 Yrs. 4 Yrs. 4.5 Yrs 5 Yrs
5.2 5.5 5.7 6.0 6.1 6.25 5.5 5.75 5.85 6.0
Assume that banks generally have a credit rating of single A, and that the credit spread between the government term structure and the equivalent bank debt is 20 basis points.
The FTSE 100 index stands at 6500 and the volatility is 20%. For pricing equity index options assume that the annual dividend yield is 3.5%pa. For pricing equity index futures assume that the future value (expressed in index points) of dividends due over the next six months is 160 index points.
Tasks to be performed.
Task One: This work must be posted in studentcentral by 6/1/14
Using the information given above, you are required to:
Explain in detail how to price the FRN given in the scenario above. Illustrate your explanation by calculating the fair price of that FRN. Carry out your calculations using Excel and include the computer file with your assignment. In your calculations, you must assume that the market requires new FRNs issued today to have reset margin of 20 Basis Points in order to be priced at Par (100%).
Explain in detail how you would calculate the price of a Five-year swap that will hedge the reset risk in the above FRN. You should create a spreadsheet to calculate the price of the swap and include the computer file on a disc which should be submitted with your assignment.
Explain in detail how to use the interest rate swap that you have priced to hedge the reset risk in the FRN.
Task Two :
This work must be posted in studentcentral by 10/2/2014.
Explain the difference between Hedging and Insurance, and how using a futures contract or an option will enable you to manage the equity market risk in the pension fund portfolio. Illustrate your explanation by using the derivatives that you will price as indicated in the following sections.
Explain how you would calculate the arbitrage free price of a six-month futures contract on the FTSE 100 index. Pay particular attention to the assumptions underlying your pricing model.
Demonstrate the pricing of this futures contract by creating an Excel spreadsheet for the calculations. Include the computer file with your assignment.
Explain how you would calculate the arbitrage free price of a six-month, at-the-money, put option on the FTSE 100 index. Pay particular attention to the assumptions underlying your pricing model.
Demonstrate the pricing of this option by creating an Excel spreadsheet for the calculations. Include the computer file with your assignment.
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