Assignment task:
Part I:
1. Describe the main short-term (less than one year) funding instruments available to cash flow managers in a bank or company.
2. In cash flow management, explain what is meant by the term netting. Outline the various procedures used by banks or firms which aid in the netting of cash flows within an organisation. Use appropriate examples in your answer.
Part II:
1. Explain what is meant by the terms (i) securitisation and (ii) mortgage backed security.
2. Suppose a US hedge fund manager currently has a leveraged position of €10 million and faces monthly interest payments until June 2019. Provide an interest rate risk management strategy for the hedge fund manager. Fully justify your answer.
3. Suppose a bank has sold an interest rate swap to pay 3 month euribor and receive 3.55% fixed on quarterly rollovers on €20 million notional principal. The swap has 11 months to maturity. The 2, 5, 8 and 11 month spot euribor rates are 3,2%, 3.35%, 3.45% and 3.85% respectively. The 3 month euribor rate at the last rollover date was 3.10%.
Calculate the current value of the swap. State whether the swap is in or out of the money for the bank.
Part III:
1. Distinguish between (i) transactions risk (ii) operational risk and {iii) translation risk as types of risk posed by fluctuations in exchange rates.
2. Forward FX contracts are very inflexible. You can't be certain about when the cash flow to be hedged will arise - if at all. Much of the time by the Forward expiry date the spot has moved in your favour and you wish you had not entered the forward in the first instance'. Describe some of the variations on forward contracts which provide greater flexibility.
3. In March, a US pension fund manager is long German government bonds. She's due to receive €2.5m in fixed coupons in June but is concerned about a weaker euro outlook. She needs to be sure about the USD value of the coupons because of the liabilities in the fund. The June euro currency future is 1.1650. Using examples of possible future spot levels in euro/dollar, describe fully how the fund manager can use the currency future to hedge her FX exposure.