Question 9 Danny McClaren is the CFO of Manchester United Jumpers & Jerseys, Plc, a manufacturer of casual knitwear. Manchester United has recently expanded its production facilities, and as a consequence has taken on 42 million in additional debt. This concerns McClaren because the debt has a 10-year maturity but carries a floating interest rate tied to LIBOR. Holding long-term floating-rate debt makes McClaren uncomfortable. To stabilize Manchester United’s finances, McClaren considers entering into a plain vanilla pay-fixed swap with Carling Housewares, Ltd., a manufacturer of plates, cups, flatware and other utensils for home entertaining. The swap would cover up to 40 million of Manchester United’s 42 million in debt. The floating rate payer would agree to pay 180-day LIBOR plus 50 basis points, and the fixed-rate payer would pay 4.0%. The swap would be based on a 360-day year and settle twice a year, at the end of each period. 180-day LIBOR is currently 3.0%, but forward market rates suggest that 180-day LIBOR is likely to increase. McClaren expects 180-day LIBOR to rise consistently for the next three years: 180-day LIBOR rate | (Current and expected) | | | Today | 3.00% | In 180 days | 3.25% | In 360 days | 3.50% | In 540 days | 4.50% | In 720 days | 5.50% | In 900 days | 6.00% | In 1,080 days | 6.25% |
Another possibility that McClaren is considering is putting on a collar. His swap broker, Chelsea Howard, assures McClaren that she could get him a zero-cost collar that would run all ten years with a floor at 2.50% and a cap at 4.50%. The collar would also have a notional amount of up to 40 million, use 180-day LIBOR, and settle semi-annually, at the end of each period. Howard tells McClaren, “If you buy a floor and sell a cap, you can keep your borrowing costs within the 2.50% - 4.50% range.” McClaren complains, “Yes, but the cost of the collar is prohibitive. I’d rather take the risk than know I’m losing all that money up front.” Since each approach has both its advantages and disadvantages, McClaren decides to split the difference. He does 20 million in the swap agreement with Carling Housewares and 20 million in the collar. Part 1) Which of the following statements about the following derivative options is most accurate? A) The buyer of a floor has a position similar to that of a buyer of a call on the benchmark rate. B) A cap is actually a portfolio of put options called caplets. C) A swap is a zero-sum game. D) An interest rate floor is an agreement in which one party aggress to pay the other when the benchmark rate rises above the rate specified in the contract.
Part 2) Regarding the statements made by Howard and McClaren about the potential collar: A) Howard’s statement is incorrect; McClaren’s statement is incorrect. B) Howard’s statement is correct; McClaren’s statement is correct. C) Howard’s statement is correct; McClaren’s statement is incorrect. D) Howard’s statement is incorrect; McClaren’s statement is correct.
Part 3) If McClaren’s expectations for LIBOR turn out to be correct, what will be Manchester United’s first payment on the collar? A) Pay 200,000 in 720 days. B) Receive 100,000 in 900 days. C) Receive 100,000 in 720 days. D) Pay 400,000 in 720 days. Part 4) After entering into the swap and the collar, McClaren wants to make sure his junior analyst, Jennifer Eggenton understands the transactions so that she can monitor Manchester United’s positions. McClaren asks Eggenton about plain vanilla interest rate swaps and she replies with four comments: Comment 1: At the conclusion of the swap, the notional principal is swapped between the counterparties. Comment 2: The counterparty with the pay-fixed side of the swap receives floating-rate interest payments. Comment 3: Interest payments are netted out and net interest is paid by the counterparty that owes interest to the counterparty due interest. Comment 4: The fixed rate payor can gain identical exposure by issuing a fixed-coupon bond and investing the proceeds in a floating-rate bond with the same maturity and payment dates. How many correct comments did Eggenton make? Eggenton made: A) 1 correct comment. B) 3 correct comments. C) 2 correct comments. D) No correct comments.
Part 5) If McClaren’s expectations for LIBOR turn out to be correct, what will be Manchester United’s payment on the swap 360 days from now? Manchester United:
A) receives 50,000.
B) pays 50,000. C) 0. D) pays 25,000.
Part 6) What do 180-day LIBOR rates need to do in order to make the swap arrangement more profitable for Manchester
United than the collar? A) Decline below 2.50%. B) Stay between 3.50% and 4.50%. C) Rise above 3.50%. D) Remain unchanged.
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发表于 2008-5-26 16:29
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