Derivatives

Correct Answer: Enter into a pay-fixed, receive-floating interest rate swap on a notional amount of $150 million to hedge the fixed-income exposure, and simultaneously enter into currency forward contracts to sell EUR and buy JPY for the fund's international equity exposure, aligning the notional amounts with the respective exposures in each currency.

The most effective strategy for Crimson Asset Management to mitigate its portfolio risk would be to: 1. Enter into a pay-fixed, receive-floating interest rate swap on a notional amount of $150 million to hedge the fixed-income exposure. This strategy will protect the portfolio against the anticipated 100 basis point increase in interest rates over the next 12 months. 2. Simultaneously enter into currency forward contracts to sell EUR and buy JPY for the fund's international equity exposure, aligning the notional amounts with the respective exposures in each currency. This will help mitigate the currency risk associated with the fund's exposure to the euro and the Japanese yen, given the expected depreciation of the euro and appreciation of the yen based on the provided forward rates. The other strategies are less effective because: - Purchasing S&P 500 futures contracts would not fully hedge the U.S. equity exposure, as the portfolio may not perfectly match the S&P 500 index composition. Additionally, entering into a pay-floating, receive-fixed interest rate swap would not be appropriate given the expected rise in interest rates. - Entering into a pay-floating, receive-fixed interest rate swap would not effectively hedge the fixed-income exposure, as it would expose the portfolio to increased interest rate risk. Using S&P 500 index put options to hedge the U.S. equity exposure may be more expensive and less efficient compared to using futures contracts.

Correct Answer: The most appropriate hedging strategy for Sylvester Capital is to sell 400 S&P 500 futures contracts. This strategy would effectively offset the fund's $100 million long exposure to the S&P 500 index, as each contract has a notional value of $250,000. By selling futures contracts, the fund would benefit from any decline in the index value, offsetting potential losses in its long position.

The most appropriate hedging strategy for Sylvester Capital is to sell S&P 500 futures contracts. Here's why: 1. Sylvester Capital has a $100 million long position in the S&P 500 index, which they want to protect against potential market downturns over the next 3 months. 2. Each S&P 500 futures contract has a notional value of $250,000. To hedge the entire $100 million position, the fund would need to sell 400 futures contracts ($100 million / $250,000 per contract = 400 contracts). 3. By selling futures contracts, the fund would effectively offset its long exposure to the S&P 500 index. If the market declines, the losses in the long position would be compensated by the gains from the short futures position. The other two options are less suitable for the following reasons: - Buying put options would provide downside protection but would also incur a cost in the form of option premiums. The fund would need to purchase 10,000 contracts, which would be expensive and could significantly reduce the overall returns. - Entering a total return swap agreement would not directly hedge the fund's long position in the S&P 500 index. While it could mitigate downside risk, it would also introduce counterparty risk and may not provide the same level of protection as selling futures contracts. Therefore, selling S&P 500 futures contracts is the most appropriate hedging strategy for Sylvester Capital given their objectives and the available hedging instruments.

Correct Answer: Enter into a 5-year pay-fixed, receive-floating interest rate swap with a notional value of $150 million to hedge the interest rate risk of the corporate bond portfolio, and use a combination of 12-month currency forwards to sell GBP 100 million and buy CHF 100 million to hedge the currency exposure.

The most effective strategy for Vertex Capital to hedge its portfolio risk would be to: 1. Enter into a 5-year pay-fixed, receive-floating interest rate swap with a notional value of $150 million to hedge the interest rate risk of the corporate bond portfolio. This strategy effectively locks in the current interest rate for the bond portfolio, protecting against the expected 75 basis point rise in rates over the next 12 months. 2. Use a combination of 12-month currency forwards to sell GBP 100 million and buy CHF 100 million to hedge the currency exposure. This strategy locks in the forward exchange rates, protecting the portfolio against potential adverse currency fluctuations. The other strategies are less effective because: - Entering into a pay-floating, receive-fixed interest rate swap would expose the portfolio to the expected rise in interest rates, rather than hedging against it. - Using futures contracts to hedge the currency exposure introduces additional complexity and potential basis risk compared to using forward contracts. - Shorting U.S. Treasury futures to hedge the corporate bond portfolio's interest rate risk is less precise than using an interest rate swap, as the Treasury futures may not perfectly match the duration and credit risk of the corporate bonds.