A firm has the following assets (in $ million) on its balance sheet: Cash: 3 Ger

Question

A firm has the following assets (in $ million) on its balance sheet:

Cash: 3

German Gvt. bonds (AAA rated) with maturity > 1 year: 5

Corporate Bonds Rated A: 4

Residential Mortgages: 18

U.S. Treasury Bonds (AAA rated) with maturity < 1 yr: 5

BBB-rated corporate bonds: 10

It also has off-balance sheet positions in derivatives as follows:

(a) A two-year forward contract on a foreign currency, currently worth $2 million, to buy foreign currency worth $50 million

(b) A long position in a six-month option on the S&P 500. The principal is $20 million and the current value is $4 million.

(c) A short position in a two-year swap involving oil. The principal is $30 million and the current value of the swap to the counter-party is $5 million.

Determine the risk-weighted value of the entire portfolio of the hedge fund under Basel

II with both netting and no netting.

Explanation / Answer

For a high-rated corporate bond, the relevant yield curve is that of HQM.

Approximate cost of borrowing = 5-year Yield on HQM Bond = 2.5% (Approx)

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