Question 3 Though Alpha Seekers Investments has a general preference for exchange-traded derivatives, the management of
Posted: Sun May 08, 2022 9:56 am
Question 3
Though Alpha Seekers Investments has a general preference for
exchange-traded derivatives, the management of Teachers Pension
Fund is interested in knowing more about the use of OTC derivatives
particularly forwards and Swaps for managing the risks of their
proposed investments in UK equities. Your line manager requires
your report to cover this too.
Required:
A) Explain the mechanics of a Basis Spread with
numerical example.
B) Illustrate the pricing of a hypothetical forward
contract on BT Group's stock and how it can be used to manage the
risk of the proposed investment. You will have to consider and
choose the required inputs and make reasonable assumptions wherever
required. Provide clear descriptions of all the steps in the
process and a conclusion.
C) Illustrate the pricing of a hypothetical swap
contract involving Teachers Pension Fund receiving Fixed GBP Rate
derived from GBP Libor[1] rate and paying the returns on BT Group's
stock; assume an investment of £2,500,000, payments made quarterly
for one year. For any missing Libor term rates, assume that the
term structure of interest rates is linear and upward sloping.
Provide detail descriptions of each step.
Though Alpha Seekers Investments has a general preference for
exchange-traded derivatives, the management of Teachers Pension
Fund is interested in knowing more about the use of OTC derivatives
particularly forwards and Swaps for managing the risks of their
proposed investments in UK equities. Your line manager requires
your report to cover this too.
Required:
A) Explain the mechanics of a Basis Spread with
numerical example.
B) Illustrate the pricing of a hypothetical forward
contract on BT Group's stock and how it can be used to manage the
risk of the proposed investment. You will have to consider and
choose the required inputs and make reasonable assumptions wherever
required. Provide clear descriptions of all the steps in the
process and a conclusion.
C) Illustrate the pricing of a hypothetical swap
contract involving Teachers Pension Fund receiving Fixed GBP Rate
derived from GBP Libor[1] rate and paying the returns on BT Group's
stock; assume an investment of £2,500,000, payments made quarterly
for one year. For any missing Libor term rates, assume that the
term structure of interest rates is linear and upward sloping.
Provide detail descriptions of each step.