Essay about Corporation Finance Final Exam Spring 2014

2049 WordsSep 30, 20149 Pages
1.What are conversion factors? Why were conversion factors developed? How do they impact on which bond is cheapest to deliver? Under what conditions would there be no cheapest to deliver? Explain in detail. The conversion factor, for any particular bond deliverable into a futures contract is a number by which the bond future delivery settlement price is multiplied, to arrive at the delivery price for that bond. Conversion factor relates all outstanding deliverable government bonds and notes in terms of the nominal 6% bond specified in the contract. The formula to find conversion factor is as follows: Conversion factors were developed by the CBOT in 1970's and was intended to compensate for the coupon and timing differences of…show more content…
It is the ratio of futures position relative to the spot position that minimizes the variance of the position. We can calculate the optimal hedge by multiplying the correlation between futures and spot with standard deviation of spot divided by the standard deviation of the future. 0.66 = future contract/ (200,000/100) Future contract = 1320 short contract. 5. Compare and contrast selling Eurodollar futures and being a fixed rate payer in a swap as a risk management technique. Explain in detail. Eurodollar futures are based off deposits of US dollars that are held within foreign banks or foreign branches. The yield on these contracts are usually baded off the London Interbank Offer Rate of LIBOR. At the time of settlement, the contracts are marked to the cash settlement price which is calculated as 100- the 90 day LIBOR rate. If we were to take out a loan with a variable rate, we could sell Eurodollar futures to lock in our interest payments. If interest rates were to rise, we would have to pay more to the bank we took the loan out from but would make up all the difference from the gains on the Eurodollar contract. Another way to mitigate interest rate risk from a variable rate loan would be to enter into a interest rate swap agreement. Unlike Eurobond futures, interest rate swaps are less standardized and are traded on the OTC market. The transfer of interest payments is also slightly different than Eurobond futures. If interest
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