Treasury and Risk Management Assignment Questions

This assignment comprises two questions, designed to test students’ awareness on topics involving parity conditions and swap strategies.In Question 1, students are expected to utilise an exchange rate parity condition to conduct arbitrage transactions.For Question 2, students are required to formulate and implement a swap strategy and to evaluate the effectiveness of the strategy. Students are expected to write clearly and concisely, with appropriate in-text citations and references provided (Harvard system).

In both questions, the emphasis is on analytical thinking to assess the effectiveness and implications of the strategies. ?There is no word count requirement for Question 1, but must show the explainations of working step. And Word count requirement for Question2(d) = 400. Minimum number of references: 3.)

Bank B takes a bid-offer spread of 60 basis points. Currently, USD LIBOR is 7% per annum. 

(a) What total cost savings (basis points per half year) is available if initially XX borrows at a floating rate from its bank and YY borrows at a fixed rate from its bank. and then they enter into an interest rate swap? XX and YY agreed that a swap of fixed rate P% (per half year) against LIBOR is fair. 

(b) Assume that the swap between XX and YY requires floating rate payments at 6-month LIBOR. 

Design a swap that allocates 3/7 of the total cost savings to XX and the balance to YY. Draw the swap diagram. 
After the swap, what is XX's final fixed rate (per half year) on its loan? What is the fixed rate (P% per half year) does XX pay YY in the swap? What is YY's final floating rate (per half year) on its loan? 

(c) If LIBOR turns out to be 8.02 percent for the next swap settlement, calculate the swap settlement sum. What is the direction of settlement and why?

 
(d) Evaluate the level of default risk in interest rate swaps. Word count requirement for 2(d) = 400. Minimum number of references' 3. 

The following information is available to investors: 

-Spot rate Forward rate (3 months) New York interest rate (mid-rate) London interest rate (mid-rate) : £1 St 2550 - S1 2600 : £1 = S1.2300 - S1.2450 3 % per annum 5 % per annum .

1. Using the parity equation in the course material, test for interest rate parity between the United States and Britain over a 3-month period. Use the mid exchange rates. If panty is absent, find the panty forward (mid) rate. 

2. Conduct covered interest arbitrage to investigate the presence of arbitrage profits over a 3-month period. Assume the investor has £100,000 to either invest in a sterling deposit or to convert the sterling amount to US dollars If panty is absent, find the parity forward rate through the money market mechanism. 

3. Explain the difference in the parity forward rates in part 1 and part 2 above. 

There is no word count requirement for Question 1. 

Company XX can borrow USD 20 million at a fixed interest rate and at floating rates for 2 years from Bank A. XX would to borrow at fixed rates on a semi-annual basis. Bank A offers the following pricing schedule for 6-month US dollars LIBOR. where the rates are mid-rates: 

-Bank A's Pricing Schedule (2 years) for XX Fixed interest rate per annum Floating interest rate per annum 8 per cent USD LIBOR + 24 basis ooints 

-Bank A takes a bid-offer spread of 40 basis points. 

-Company YY can borrow USD 20 million at a fixed interest rate and at floating rates for 2 years from Bank B. YY would like to borrow at floating rates on a semi-annual basis. Bank B offers the following pricing schedule for 6-month US dollars LIBOR, also using mid-rates: