Question #12
Reading: Reading 30 Pricing and Valuation of Forward Commitments
PDF File: Reading 30 Pricing and Valuation of Forward Commitments.pdf
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Question
The fixed-rate on a semiannual 2-year interest rate swap is closest to the:
Answer Choices:
A. coupon rate on a 2-year par bond with the same credit risk as the reference rate
B. coupon rate on a 2-year par bond with the same credit risk as the fixed-rate payer
C. current 180-day T-bill rate. The Isle of Nefer is a developing country with its stock and futures markets enjoying record trading volumes due to the influx of foreign funds. You are looking to invest in the stock and futures markets in the Isle of Nefer. The representative stock market index, Nefer Industrial Index (NII), is currently priced at 8,765 and the one year NII future contract is currently trading at 8,920. You have experience in using forward contracts but not futures. You discuss the possibility of investing in the Isle of Nefer using futures contract with your supervisor, Peter Filler, and he makes the following comments. Comment 1: "A futures contract will have positive value after marking to market if the future price is up on that day." Comment 2: "Given a quoted clean bond price of the CTD, when looking at a bond future the full price of the bond must be used which equals the clean price of the bond plus accrued interest. The futures price can then be calculated as:
Explanation
The fixed-rate on a swap is calculated using the yield curve for the floating rate reference.
Therefore, the fixed rate reflects the credit spread of that rate over the riskless rate of
return.
(Module 30.6, LOS 30.e)
Typesetting math: 100%
The Isle of Nefer is a developing country with its stock and futures markets enjoying record
trading volumes due to the influx of foreign funds. You are looking to invest in the stock and
futures markets in the Isle of Nefer. The representative stock market index, Nefer Industrial
Index (NII), is currently priced at 8,765 and the one year NII future contract is currently
trading at 8,920.
You have experience in using forward contracts but not futures. You discuss the possibility
of investing in the Isle of Nefer using futures contract with your supervisor, Peter Filler, and
he makes the following comments.
Comment
1:
"A futures contract will have positive value after marking to market if the
future price is up on that day."
Comment
2:
"Given a quoted clean bond price of the CTD, when looking at a bond future
the full price of the bond must be used which equals the clean price of the
bond plus accrued interest. The futures price can then be calculated as:
QFP = {(full price) × (1 + Rf)T + AIT – FVC)(1 / CF)
Where AIT = accrued interest at futures maturity, Rf = risk-free rate, FVC =
future value of coupon and CF = conversion factor
Peter Filler also suggests that you invest in Treasury bond futures. Exhibit 1 contains the
relevant information.
Exhibit 1
Price of underlying deliverable 16 year 5% Treasury bond (just paid coupon) $1,030
Expiration of Treasury bond futures contract
0.7 year
Conversion factor
1.08
Risk free rate
3.0 percent