1. On March 15, well before the current financial crisis, a hedge unit of Lehman
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Question
1. On March 15, well before the current financial crisis, a hedge unit of Lehman's sold a 6X12Forward Rate Agreement to Wells Fargo in the amount of $2 Billion at the rate of 5.25%. Onsettlement date, the tremors of the financial crisis have already been felt, and the 6-monthspot LIBOR was 6.75%.a. Determine the winner of the FRA on settlement date.b. Calculate the payoff of the contract on settlement date.c. If 4 months after origination a 2X8 FRA has a rate of 6.25%, calculate the value of the FRAthen, assuming that relevant 2-month spot LIBOR was 6.15 %.
2. On June 15, 08 Soros' Quantum Fund entered into a forward contract to sell 100,000 sharesof its stake in a privately held company at $140 each 90 days hence. 60 days after origination,a new 30-day forward contract sets the share forward price at $96. The risk free interest rateis 6%.a. Determine the winner of the derivative contract 60 days after origination.b. Calculate the value of the forward contract 60 days from its origination.c. Calculate the value of the contract if risk free rate decreases to 4%.
Explanation / Answer
1a) Lehman sold FRA means that Lehman shall receive 5.25% on the amount of $2 Billion for a period of 6 months and shall pay Libor on $2 Billion for a period of 6 months at the contract expiration . If libor is 6.75% after 6 months then Lehman ends paying up more due to high libor rate than receive fixed rate which is only 5.25% on the amount of $2 Billion for a period of 6 months.Thus the winner is the Wells Fargo.
b) the payoff of the contract on settlement date to Wells Fargo=(6.75%-5.25%)*(6/12)*($ 2000 million) =$ (.0675-.0525)*(6/12)*( 2000 million)=$ 15 million
2)a)The winner is the Soros' Quantum Fund as the short forward position on the stock of the fund gains from the decline in the price of the stock.
b)The value of forward contract(sell) after 60 days=140*100,000/(1.06)(30/360)
After 60 days an ofsetting contract of long 30-day forward contract to buy share at 96 has value
=96*100,000/(1.06)(30/360)
The value of the forward contract 60 days from its origination=140*100,000/(1.06)(30/360) - 96*100,000/(1.06)(30/360)
=44*100,000/(1.06)(30/360)
=$ 4378686.52
c)the value of the contract if risk free rate decreases to 4% 60 days from its origination =44*100,000/(1.04)(30/360)
= $ 4385642.55
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