question archive Monica Lewis, CFA, has been hired to review data on a series of forward contracts for a major client
Monica Lewis, CFA, has been hired to review data on a series of forward contracts for a major client
Subject:BusinessPrice: Bought3
Monica Lewis, CFA, has been hired to review data on a series of forward contracts for a major client. The client has asked for an analysis of a contract with each of the following characteristics: 1. A forward contract on a U.S. Treasury bond 2. A forward rate agreement (FRA) 3. A forward contract on a currency Information related to a forward contract on a U.S. Treasury bond: The Treasury bond carries a 6% coupon and has a current spot price of $1,071.77 (including accrued interest). A coupon has just been paid and the next coupon is expected in 183 days. The annual risk-free rate is 5%. The forward contract will mature in 195 days Information related to a forward rate agreement: The relevant contract is a 3 * 9 FRA (180-day loan, 90 days from now). The current annualized 90-day money market rate is 3.5% and the 270-day rate is 4.5%. Based on the best available forecast, the 180-day rate at the expiration of the contract is expected to be 4.2%. Information related to a forward contract on a currency: The risk-free rate in the U.S. is 5% and 4% in Switzerland. The current spot exchange rate is $0.8611 per Swiss France (SFr). The forward contract will mature in 200 days. A) Based on the information given, what initial price should Lewis recommend for a forward contract on the Treasury bond? (1 mark) B) Suppose that the price of the forward contract for the Treasury bond was negotiated off-market and the initial value of the contract was positive as a result. Which party makes a payment and when is the payment made? (0.5 marks) a. The short pays the long at the maturity of the contract. b. The long pays the short at the initiation of the contract. c. The long pays the short at the maturity of the contract. C) Suppose that instead of a forward contract on the Treasury bond, a similar futures contract was being considered. Which one of the following alternatives correctly gives the preference that an investor would have between a forward and a futures contract on the Treasury bond? (0.5 marks) It is impossible to say for certain because it depends on the correlation between the underlying asset and interest rates. b. The forward contract will be preferred to the futures contract. c. The futures contract will be preferred to the forward contract. a D) Based on the information given, what initial price should Lewis recommend for the 3 x 9 FRA? (1 mark) E) Based on the information given and assuming a notional principal of $10 million, what value should Lewis place on the 3 * 9 FRA at time of settlement? (1 mark) F) Based on the information given, what initial price should Lewis recommend for a forward contract on Swiss Francs based on a discrete time calculation? (1 mark)
