Refer to attach file
Part 1: Module 5: Hedging Interest Rate & FX Risk Hedging Problems (see Chapters 7 & 8, & Module 5 Lecture Notes, Power Points & Review Q&A) 1. It is April right now, and a U.S. Company is expecting to receive 5,000,000 Euros in June from its European customers and wants to hedge against a fall in the value of the Euro relative to the U.S. dollar when the Euros will be converted to U.S. dollars in June. At this time in April the spot exchange rate Euro was $1.1004 USD. The CME Group future settle rate for June Euro FX futures contacts at this time is listed as 1 Euro = $1.1056 USD, with each futures contract for 125,000 Euros per contract. a. What position and how many contracts should the financial manager get for the hedge? Explain why. (hint # contracts = Amount of Euros Hedging / 125,000 Euros per contract), Type of Position ____________ Why this Position ________________ Number of Contracts______ [ b. Suppose in June the spot rate for the Euro falls to $1.0004 USD and the futures settle rate falls to $1.0056 USD. Calculate the spot opportunity loss or gain for the company and the futures gain or loss. What is the net hedging result? Spot Opportunity Gain or Loss ____________________ Futures Gain or Loss ___________ Net Hedging Result ______________ (Hint: Gain – Loss) c. If the Euro had gone up instead of falling in June, would the U.S. Company have done better getting options on the Euro futures contracts instead for this hedge? Explain why or why not. Yes or No _____ Why___________________________________ 2. In April an insurance company portfolio manager has a diversified stock portfolio of $10,000,000 with a portfolio beta of 1 invested in S&P 500 stocks. The portfolio manager plans on selling the portfolio (with a Beta of )1 in June to be able to pay out funds to policyholders for annuities and is concerned about a potential fall in the S&P 500 index, so wants to hedge using the CME Group June contracts S&P Futures Contracts that at this time has an index price of 4447.75 (with a $250 multiplier x the index price to get the total price of the contract). a. What type of futures position should be taken to hedge against the stock market going down and how many future contracts are needed for this hedge? [Hint: # contracts = [Portfolio x Beta] /[ Futures Index Price x Multiplier]; recall The rounding rule for fractional contracts, round up if >.50) Type of Position _______________ Explain why __________________________ How many contracts should you get? Number of Contracts_______________ b. Suppose in June the value of the portfolio manager’s portfolio falls by 10% and the S&P500 futures contract index falls by 10% as well, what is the portfolio manager’s opportunity spot loss (gain) on the portfolio, and his futures gain (loss), and the net hedging result? Spot Loss _____________ Futures Gain ______________ Net Hedging Result ___________ 3. Mod. 5: Hedging with Interest Rate Futures (Chapter 8, pp. 191 to 193). [Hins: Formula for both Eurodollars and $ Price Eurodollar Futures] $ Price = $ Amount {1 – [(d x n)/360]} where d = discount yield as a fraction; and [n = maturity, usually 90 days] In April, a bank short-term investment manager has $10 million in 90-day T-bills that the bank plans to sell for its liquidity needs in December, and is worried about interest rates rising (i.e. T-bill prices falling) in the next few months. At this time the current (spot) T-bill rate is a discount yield is 0.502% for a 90-day T-bill. a. What is the $ price for the $ 10 million of T-bills in dollars? T-bill Price in Dollars ________ Suppose on the CME Group website, a June Eurodollar Futures contract gives has discount yield of 1.0875% for a $1 million, 90-day Eurodollar Futures contract. So the investment manager will get 10 contracts. b. What is the contract price for the 10 million Eurodollar Futures Contracts Eurodollar Futures Contracts Price in Dollars ______________ What type of Eurodollar futures contract should be purchased to hedge against a price fall in the spot position (i.e. interest rate rise) (long or short) and how many contracts should be purchased? Explain why. Long or Short _________________________________ Explain Why ______________________________________________ c. If in June the T-bill discount yield goes up by 50 basis points to 1.002%, and the Eurodollar Futures yield goes up by 50 basis points to 1.5875%, what is the new dollar price for the 1 mil. T-bills, and what is the new contract dollar price for the Eurodollar Futures Contract? New T-bill Price in $ Dollars _______________ New Eurodollar Futures Price in $ Dollars ____________ d. What is the loss or gain for respectively the T-bills and the Eurodollar Futures contract? What is the net hedging result? T-bill Spot Loss ____________ Eurodollar Futures Gain____________ Net Hedging Result __________________ Part 2: Module 6: Loan Analysis: Mini-case Cactus Rags, Inc. Loan Request: Cactus Rags, Inc. in Santa Fe, New Mexico operates retail stores in New Mexico, along with internet sales globally as well. The stores offer a large range of Western Santa Fe style clothes and other merchandise for men, women, and children. The owner of Cactus Rags, Rosalee Ramirez has operated the store successfully for the past ten years, and is requesting a $ 1million, 1 year seasonal working capital loan from Sierra Bonita Bank in Santa Fe to finance inventory and accounts receivables that will be paid back at the end of the year. As a credit analyst for the bank, you are asked to: Do a trend comparison analysis of the company’s solvency, stored liquidity, cash flow liquidity and performance trends for the current year compared to the previous year by looking at the following statements and answering the questions for each shown below based on the financial information on the spreadsheet posted in Module 6: “CactusRagsSpreadsheet.xls” Specifically answer the following questions. 1. Liquidity, Solvency, and Profitability Analysis: a. Looking at the Indirect Cash Flow Statement under Cash Flow from Operations, explain specifically why the firm’s net cash flow from operations is greater than the firm’s net income. If the Cash flow from Operations is expected to be similar next year, will the firm have sufficient CFO to pay back its loan at the end of the year if the loan is made? b. Looking at the Indirect Cash flow Statement under Cash Used for Investments and Cash Flow from Financing, explain how the firm used cash in investing, and explain why the firm used cash and raised cash under cash flow from financing, and what the net effect was for the firm’s change in its cash balance. c. Looking under Cash flow Liquidity, explain how the firm reduced its cash to cash conversion days, increasing its cash flow liquidity in the current year, by looking at the trend in days inventory, days accounts receivables, and days accounts payable. d. Looking at the firm’s current and quick ratios and debt to assets, and long-terms debt to asset ratio and Times Interest Earned Ratio trends, give your analysis of the trends in the firm’s solvency risk. e. Do a Dupont Analysis explaining why the firm’s ROE and ROA went up n the current year by examining the trends in the firm’s NPM, AU, and EM. Then go in more detail examining the reasons for the higher NPM by looking at the trends in the firm’s GPM and OPM, and the reasons for the higher AU by looking at the fixed asset turnover, days inventory, and days accounts receivable trends. Also discuss the asset, revenue, and expense growth rates. f. Calculate the Zeta Score for the current year for the company (see pages 228 to 229 of the text in Chapter 9) and the Review for Ex2 example. What does this reveal about the company’s solvency risk, where. Z = 1.2 WC + 1.4 RE + 3.3 OROA + 0.6 Equity + 0.999 AT · Note scores of about 2.675 are more like non-failed firms, while scores of 1.81 are more like failed firms. Firms in between these are in the zone of ignorance, not like failed firms, but not as strongly solvent as the 2.675 cutoff firms. where: WC = Working capital to total assets, where working capital = total current assets less total current liabilities excluding external debt RE = Retained earnings divided by total assets. OROA = Earnings before interest & taxes divided by Total Assets Equity = Total Equity divided by Total Debt AT = Asset Turnover = Total Revenues divided by Total Assets g. Summarize the strengths and weaknesses for the company based on your above analysis including what you found for the entire analysis including your analysis of liquidity, solvency, and financial performance, and give your assessment for whether the loan should be made, and the type of collateral to be used for