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AFM Treasury and advanced risk management

ACCA · Strategic Professional · 7 questions

Name: ____________________   Date: ____________

  1. Spot is $1.10 per euro. US interest is 5 percent and euro interest is 3 percent. By interest rate parity, the one year forward rate is closest to:

    • A $1.080 per euro
    • B $1.121 per euro
    • C $1.155 per euro
    • D $1.100 per euro

  2. A company with floating rate borrowing wishes to convert to fixed payments. It should enter an interest rate swap to:

    • A Pay fixed and receive floating
    • B Pay floating and receive fixed
    • C Buy a put option
    • D Sell a futures contract

  3. A company will borrow $10m in six months for six months. It uses three month futures contracts of $1m. The number of contracts is:

    • A 5
    • B 20
    • C 10
    • D 60

  4. Using a forward contract to hedge a currency receipt:

    • A Fixes the rate and removes both the downside and the upside
    • B Gives the right but not the obligation to exchange
    • C Gives upside if rates move favourably
    • D Has an up-front premium

  5. An increase in the volatility of the underlying asset, other things equal, will:

    • A Increase the value of both call and put options
    • B Decrease the value of a call option
    • C Decrease the value of a put option
    • D Have no effect on option values

  6. Basis risk in hedging with futures is the risk that:

    • A The counterparty defaults
    • B The futures price and the spot price do not move together exactly
    • C The contract is too small
    • D Margin payments are not made

  7. A company expects to receive $2m in three months. It is concerned the dollar will fall against its home currency. Which hedge could use money market borrowing?

    • A Buy a call on the home currency
    • B Borrow dollars now, convert them to the home currency and repay with the receipt
    • C Buy dollars forward
    • D Sell home currency forward

Answer key

1. B, 2. A, 3. B, 4. A, 5. A, 6. B, 7. B

  1. Forward = 1.10 x 1.05 / 1.03 = 1.1214. The currency with the higher interest rate trades at a forward discount.

  2. Receiving floating offsets the floating interest on the loan, and paying fixed leaves the net cost fixed.

  3. 10m / 1m x 6/3 = 20 contracts, sold to hedge a rise in rates.

  4. An option gives the right but not the obligation, and costs a premium. A forward is binding.

  5. More volatility increases the chance of a large favourable move, while the downside is limited to the premium.

  6. Hedges using futures may be imperfect because the spot and futures prices can change by different amounts.

  7. The money market hedge converts the future receipt into a known home currency amount today.