Treasury & Risk Management

Treasury & Risk Management

1. Assignment 1

This assignment is designed to test students on Topic 1 and Topic 2 (Futures hedging).
Question 1 (10 marks)
A company uses an alternative energy source called Liquid X. The recent movements on the price of oil have caused volatility in the price of Liquid X and so the
company wishes to hedge its exposure to Liquid X. The price changes of liquid X have a 0.7 correlation with gasoline futures price changes.
The company will lose $500,000 for each 1 cent increase in the price per gallon of Liquid X over the next two months. Liquid X has a standard deviation that is 50%
greater than price changes in gasoline futures prices. Futures contracts on Liquid X are non-existent and the company uses gasoline futures to hedge its exposure to
Liquid X. Assume each gasoline futures contract is on 40,000 gallons.
Two months later, the price of Liquid X rose by 2 percent from US$2.50 per gallon.
Required:
a. What should be the hedge ratio in the use of gasoline futures to hedge its exposure?
b. What is the company’s exposure measured in gallons of Liquid X?
c. What position measured in gallons, what is the type of position should the company take in gasoline futures to hedge its exposure?
d. How many gasoline futures contracts should be traded in this hedging strategy?
e. After two months, what is the gain/loss in the spot market and the trading gain/loss on the futures contracts in part d?
(2 marks x 5 = 10 marks)
17

Question 2 (10 marks)

Global investors are not waiting for the Federal Reserve (Fed) to raise interest rates this
year. They are already betting that interest rates are going to increase in the U.S. this year,
the first in nearly a decade. According to CME Fed Watch (on 19 March 2015), the Fed’s
funds futures contracts suggest a 12 percent probability of a June rate hike, a 49 percent
probability of an increase in September, a 70 percent probability of a rate hike in October,
and an 79 percent of December rate hike. The history of the past three tightening cycles showed that the US dollar gains in the six to nine months preceding the first
interest rate hike over the cycle.
Required:
Discuss the impact of the market’s expectations of US interest rates on capital movements,
Asian currencies and global economic growth.
Note: Word count requirement is between 800 to 1,200 words. There must be a minimum of 4 references.

2. Assignment 2

This is designed to test students on designed to test students on Topic 7 (Mechanics of option markets) and on Topic 8 (Trading strategies involving options). Students
are expected to research on the consequences of a certain group’s decision on energy
production. The emphasis is on analytical thinking to assess the effectiveness and
implications of competitors’ hedging strategies.

Question 1 (10 marks)

You are presented with the following information on gold futures prices:
Delivery date (months) Futures price per ounce ($)
1 880
2 890
3 910
6 932
12 1008
The interest rate is 0.5 percent per month (compound basis). It costs $2 per ounce per month (payable for the whole period in advance) to store and insure gold. Each
futures contract covers 100 ounces of gold. The current price of gold is $873 per ounce.
Required:
a. Identify any arbitrage opportunities by inspecting each individual contract against the
spot price of gold today. Calculate the profit, if any, based on one gold futures
contract. (8 marks)
b. Describe any arbitrage opportunities by combining any two futures contracts. No
calculations are required here. (2 marks)

Question 2 (20 marks)

On 27 November 2014, Organization of Petroleum Exporting Countries (OPEC) members
met in Vienna to reject calls for drastic action to cut their oil output from 30 million barrels per day and rolled over this production figure. OPEC has continually
iterated that the
19 organization has no intention to meet again until June 2015. Market observers believe a cut in production at this meeting is even less likely than
at last November’s talks. Crude oil prices, as benchmarked by West Texas Intermediate (WTI) crude, have been falling since mid- June 2014 from the high of $107 per
barrel to a 6-year low of $42.02 per barrel on 18
March 2015.
Required:
a. Discuss the main reason for OPEC’s decision (up to June 2015) not to cut oil
production. (5 marks)
b. Using the WTI benchmark, discuss the effectiveness and implications of derivatives
hedging strategies of shale oil producers.. Your answer should use the WTI spot
price chart (from June 2014) to justify the types of options and futures strategies
employed by these producers. (15 marks)
Note: Word count requirement is between 1,000 to 1,500 words. There must be a minimum
of 10 references.
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