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Derivatives and Alternative Investments - Assignment Example

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Derivatives and Alternative Investments

First, if management understands about the corporation’s risks better than shareholders, the corporation, not its stakeholders, can hedge. Subsequent, corporation could be capable to hedge at a lower cost. Corporate hedging can be justified if default costs are significant, since it reduces the possibility of default (Johnson, 2010). Lastly, if the corporation encounters progressive taxes, it can decrease tax accountabilities by hedging which steady corporate earnings. To calculate the appropriate number of bonds and equity futures that should be sold the following are considered and done. Bond estimation is a technique used to establish the predictable trading price of a bond. The anticipated trading value is computed by adding the total of the current values of all coupon costs to the current value of the par value (Johnson, 2010). German federal state bonds with a minimum issuing volume of EUR 1 billion. FDAX = opening price 8,218.50 Low price 8,164.00 High 8,259.00 Daily settlement price 8,197.50 Bond face value = € 1 000 000 000 Annual coupon rate = 3.723% Maturity in years = 1 year Market interest rate = 7.2% Future Bond Price = 3.723% * 1000 000 000 * 1-(1+7.2%)-10/7.2% + 1000000000/ (1+7.2%)10 =32,230,000*6.94 +1000000000/2.004 =223676200+499001996 =€ 722,678,196 Future Equity Present value = €50,000,000 Question 2 Interest rate swap amount = €5,000,000 Term: 5 year fixed rate payer The risks of the interest rate swap To explain the risks of the interest rate swaps position taken by the European asset manage the following are considered. In addition, the possibilities of hedging the scenario are also explained. Management decisions relating to a bank’s interest rate risk challenge should consider the risk or reward swap of interest rate risk positions. This is why the trade-off, in form of interest rate swaps, is necessary in this scenario (Corb, 2012). Management must compare the possible risk such as impact of unpleasant rate actions of an interest rate risk situation or approach against the possible reward (impact of positive rate movements).To assess the potential impact of interest rate danger on a corporation’s operations, a well-managed company will reflect on the affect on both its incomes (the profits or accounting viewpoint) and fundamental economic worth (the capital or economic perspective). Both perspectives must be evaluated to establish the full scope of a corporation’s interest rate risk vulnerability, particularly if the company has significant long-term or multipart interest rate risk positions (Corb, 2012). The current situation warranty interest rate swaps consideration so as to avert too much risk exposure. An interest rate swap is an accord by two entities(the European asset corporation and the central Bank) to swap or exchange floating rate interest compensations for fixed rate interest compensations and vice versa. It is significant for the European asset manager to appreciate that swaps are between corporations and not between personal investors; however, the outcome of these swaps may influence his/her job activities or the cost he/she may pay for a bond. The most ordinary kind of swap is a vanilla exchange in which fixed rate interest compensations are swapped for floating rate interest payments according to the London Interbank Offered Rate (LIBOR) (Corb, 2012). The London Interbank Offered Rate is the interest rate that financials institutions with high credit ratings from ratings organizations charge one another for ...Show more

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DERIVATIVES AND ALTERNATIVE INVESTMENTS by Code+ University name Date Question 1 The manager wants to hedge the interest rate risk on bonds to ascertain or dispute this it is necessary to consider why a firm should hedge or not…
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