Derivatived mentor for a small case (paid)

[joanne_peacemaker]

Hi,

I am a final year student at University and coming towards the end of my course. In terms of my expected degree, I am bordering between a first and a 2:1, with my final semester results awaited, therefore, I am trying to put my 100% into my final semester.

In this semester, I have a finance module which deals with treasury management. It is an introductory module and hence not too complex. I have been given a short case, wherein, I have to choose between various derivatives to hedge a cash market position against interest rate risk. I have to evaluate between the various hedging options available and then choose one.

I am looking for someone who would be willing to act as a mentor to me for this piece of work. I DO NOT expect anyone to do the work for me, as that would be wrong. However, I am looking for someone who would be happy to discuss the case with me and have a look at my work to give me some ideas, so that I can refine my work. If you believe you would be able to spare a few minutes of your time and have the knowledge of derivatives like FRA’s, Futures and Options, please drop me a PM and we can discuss this further. I will be happy to consider PAID MENTORING as long as it’s affordable and reasonable, although free would be great.

Thanks for Reading
Joanne

 

[grantx]

Joanne,

Ask your questions here. There are plenty of experts, and it's all free.

PM's, further discussions, payments - sounds sordid and furtive and undermines your credibilitity as a candidate for a first.

What is the "cash market position" you need to hedge - equities, fixed interest, forex?

Grant.

 

[grantx]

Sorry overlooked the reference to treasury management. Presumably you're talking about bonds and/or fx?

Grant.

 

[joanne_peacemaker]

Hi Grant,

Cash Market position = short term borrowings of £100m at LIBOR+3%

* The reason I mentioned "one on one" discussion was because, the answer is likely to be influenced by many external factors mentioned in the case, which may need some discussion.

Thanks for your help
Joanne

 

[grantx]

Joanne,

Do we have a term for the borrowings?

It is better in my opinion to have an open discussion because views generally differ between posters which is then subject to revision, correction, or a different solution. However, it is resolved in the end. Have faith.

I think I must sleep now.

Grant.

 

[Rhody Trader]

Well go on then. Spit it out. You've got us curious now. Reminds me of my own days in the classroom.

 

[sneo]

Couple of ways to do hedge that risk:
1. Sterling Libor Futures
2. Sterling FRA
3. Fixed/Float swap
4. option on Sterling Libor (the vanillas and the exotics)

probably you would need to talk about pros and cons on each way and what are the needs of the firm/user/victim of the ST borrowing.

like that others mentioned, wiser to do over for free. doubt its really necessary to have a paid mentor. the case situation is familiar and does sound like a typical John Hull text question.

 

[grantx]

Sneo,

Strange, whenever swaps are mentioned I've always get Hull's illustration in my mind.

Joanne, Interest rate swap example:

A pays interest at Libor + 3% on £100m (assume this a "floating rate", ie changes if Libor changes)
B pays interest at Libor + 4% on £100m (assume this is fixed)

A wants a fixed rate of interest, B wants a floating rate. So they agree to “swap” the interest differential, ie 1%:

A interest = £3m
B interest = £4m
So B pays the net difference which equals £1m.

Why should B be the net payer? His rate is higher based on credit rating, for example. By swapping to a floating rate he may also be gaining access to a lower floating rate he can achieve given his status. A wants a fixed rate to remove uncertainty/hedge against rate risk. The fixed rate of Libor + 4% may be lower than that achievable given her credit rating.

A very basic example.

Grant.

 

[joanne_peacemaker]

Hi Grant, Rhody, Sneo,

Thanks very much for such a great response. I have uploaded the case study on my server and PM'ed you a link, as I did not want to put the case study here, word to word.

My understanding of the question is this:

......................

I need to set-up my hedge from the 1/10/07 to 1/4/08 in order to cover the Interest Rate risk that may occur for the loan to be taken between 1/4/08 - 1/10/08. And then in the second part, analyse how efficient my hedge is, based on the rates that we have been provided for the 1st of April?

Would that be correct?

 

[joanne_peacemaker]

NB: If you want the case, pls let me know and I will post the link..

 

[sneo]

NB: If you want the case, pls let me know and I will post the link..

a link would be helpful.

 

[MrGecko]

am I too late to jump in on this one? If not, Joanne can you PM me everything I'm missing so i can catch up, and I'll have a look over the weekend

 

[joanne_peacemaker]

Hi,

Hopefully someone has read the case  ...As I am quite confused with the wording in the case. Starting with the FRA strategy, my assumption is that the strategy should be
..................
FRA Strategy:

On 1st Oct07
Borrow £60m for 12 months at 6.15375%
Invest £60m for 6 months at 6.26125%

Q1. In the case it says that “the short term borrowings had just been rolled over for a further 6 months”. Then in the very next paragraph, it says “that the borrowing being rolled over in 6 months time is being hedged”. I find these two statements contradictory and this is really confusing me about what is to be hedged and for what period.

My understanding is that, the company needs to borrow £60m between 1st April’08 and 1st Oct’08, therefore the hedge will be created on the 1st October;2007. This will be done using FRA, Futures, Options and Option with a cap. Then I have to justify which one if the best?

In the second part, then I take the LIBOR rate for April and evaluate the hedge efficiency, to show how good my decision really was.
Is my understanding correct?

Q2. The second thing that’s really confusing me is the rates. In the case it mentions that the company got a rate of LIBOR + 2%. Now does the +2% apply to my strategy? For e.g. in the above strategy should it be

Borrow £60m for 12 months at 6.15375%
Invest £60m for 6 months at 6.26125%

Or should it be

Borrow £60m for 12 months at 8.15375% (i.e. LIBOR + 2%)
Invest £60m for 6 months at 6.26125% (Also does the 2% apply on the investment rate also?)

Please help all you geniuses out there..I really need to get cracking..I am sure once I have a better understanding of the requirements of the case, It will all flow 

Thanks
Joanne