ACCA P4 AFM

Advanced Financial Management

2022年 直播串讲（真题带练-1）
AFM Syllabus 大纲
 Part D
Corporate Reconstruction
& Reorganization
 CH11
Corporate Reconstruction &
Reorganization
CH11 Corporate Reconstruction & Reorganization (历年真题)
考点 考试频率 考题分布 分值
2017 Dec High K Q3(a) 21
2017 Dec Conejo Q1(b) 11
2017 Jun Chrysos Q1(b) 18
1. Ratio and performance appraisal 7 2017 Dec Eview Q2 (a) 17
2015 Dec Fluffort Q3（a） 12
2015 Jun Chawan Q2(b) 20
2014 Dec Kamala Q4(c) 14
2. Financial distress 1 2014 Jun Faoilean Q4 (b) 9
2018 Dec Q1 Opao (b) (c) (iii) +5,+7
2017 Dec Conejo Q1(b) 16
3. Financing Reconstruction 4
2017 Jun Chrysos Q1(b) 10
2015 Dec Flufftort Q3(b) 13
2019 Sep/Dec Q3 Newimber (a) +5
4. Demerger/spin-off/divest 3 2015 Dec Cigno Q1(a) 4
2013 Dec Nubo Q4 (b) 6
2017 Dec Eview Q2 (b) 8
2016 Jun Staple Q3(a) 19
5. Sell off 4
2015 Dec Cigno Q1(c) 6
2013 Dec Nubo Q4 (a) 7
2018 Dec Q1 Opao (a) +4
2015 Dec Cigno Q1(a) +4
6. MBO/LBO/MBI/Employee Buy Out 4
2015 Jun Bento Q3(a) 5+8
2013 Dec Nubo Q4 (b) 6
 经典考题（一）
Financial Performance evaluate
 2017 Sep/Dec Q3 (a) – High K

(a) Evaluate High K Co’s financial performance. You should

indicate in your discussion areas where further
information about High K Co would be helpful. Provide
relevant calculations for ratios and trends to support
your evaluation.
(10计算+11文字=21 marks)
2017 Sep/Dec Q3 (a)

Profitability
• Revenues from the different types of store and online sales have all increased this year, despite a drop in
store numbers. The increase may be largely due to the government-induced pre-election boom in
consumer expenditure, which appears unlikely to be sustained.
• Because the split of profits is not given, it is impossible to tell what has been the biggest contributor to
increased profit. Profit as well as revenue details for different types of store would be helpful, also profit
details for major product lines.
• Improvements in return on capital employed derive from increases in profit margins and asset turnover.
• The improvements in gross margins may be due to increased pressure being put on suppliers, in which
case they may not be sustainable because of government pressure.
• The increased sales per store employee figures certainly reflects a fall in staff numbers, improving
operating profit, although it could also be due to staff being better utilised or increased sales of higher
value items in larger stores.
• If staff numbers continue to be cut, however, this could result in poorer service to customers, leading
ultimately to decreased sales, so again it is questionable how much further High K Co can go.
• The asset turnover shows an improvement which partly reflects the increase in sales.
• There have been only limited movements in the portfolio of the larger stores last year. The fall in non-
current assets suggests an older, more depreciated, asset base. If there is no significant investment, this
will mean a continued fall in capital employed and improved asset turnover.
• However, in order to maintain their appeal to customers, older stores will need to be refurbished and
there is no information about refurbishment plans. Information about recent impairments in asset
values would also be helpful, as these may indicate future trading problems and issues with realising
values of assets sold.
2017 Sep/Dec Q3 (a)

Liquidity
• The current ratio has improved.
• But the higher cash balances have been partly reflected by higher current liabilities.
• The increase in current liabilities may be due to a deliberate policy of taking more credit
from suppliers, which the government may take measures to prevent. Being forced to pay
suppliers sooner will reduce cash available for short-term opportunities.
Gearing
• The gearing level in 2016 is below the 2014 level, but it would have fallen further.
• A fall in debt not been partly matched by a fall in High K Co’s share price.
• It seems surprising that High K Co’s debt levels fell during 2016 at a time of lower interest
rates. Possibly lenders were (rightly) sceptical about whether the cut in central bank lending
rate would be sustained and limited their fixed rate lending.
• Interest cover improved in 2016 and will improve further if High K Co makes use of revolving
credit facilities.
• However, when High K Co’s loans come up for renewal, terms available may not be as
favourable as those High K Co has currently.
2017 Sep/Dec Q3 (a)

Investors
• The increase in after-tax profits in 2015 and 2016 has not been matched by an increase in
share price, which has continued to fall.
• The price/earnings ratio has been falling from an admittedly artificially high level, and the
current level seems low despite earnings and dividends being higher.
• The stock market does not appear convinced by High K Co’s current strategy.
• Return to shareholders in 2016 has continued to rise, but this has been caused by a
significant % increase in dividend and hence increase in dividend yield.
• The continued fall in share price after the year end suggests that investors are sceptical 怀
疑 about whether this increase can be maintained
2017 Sep/Dec Q3 (a)

Revenue analysis
• Town centre stores
✓ High K Co has continued to close town centre stores, but closures have slowed recently and
revenue increased in 2016. This suggests High K Co may have selected wisely in choosing which
stores to keep open, although Dely Co believes there is no future for this type of store.
✓ Arguably though, town centre stores appeal to some customers who cannot easily get to out-of-
town stores. Town centre stores may also be convenient collection points for customers using
online click and collect facilities.
• Convenience stores
✓ High K Co has invested heavily in these since 2003. The figures in 2014 suggest it may have over-
extended itself or possibly suffered from competitive pressures and saturation of the market. The
2016 results show an improvement despite closures of what may have been the worst-
performing stores. The figures suggest Dely Co’s decision to close its convenience stores may be
premature, possibly offering High K Co the opportunity to take over some of its outlets.
✓ Maintaining its convenience store presence would also seem to be in line with High K Co’s
commitment to be responsive to customer needs.
✓ Profitability figures would be particularly helpful here, to assess the impact of rental
commitments under leases
 2017 Sep/Dec Q3 (a)

• Out-of-town stores
✓ Although the revenue per store for out-of-town stores has shown limited
improvement in 2016, this is less than might have been expected.
✓ The recent consumer boom would have been expected to benefit the out-of-town
stores particularly, because expenditure on the larger items which they sell is more
likely to be discretionary expenditure by consumers which will vary with the
business cycle.
✓ Where Dely Co sites its new out-of-town stores will also be a major issue for High K
Co, as it may find some of its best-performing stores face more competition.
✓ High K Co again may need to consider significant refurbishment expenditure to
improve the look of these stores and customer experience in them.
• Online sales
✓ Online sales have shown steady growth over the last few years, but it is difficult to
say how impressive High K Co’s performance is.
✓ Comparisons with competitors would be particularly important here, looking at
how results have changed over the years compared with the level of investment
made.
✓ It is also impossible to tell from the figures how much increases in online sales
have been at the expense of store sales.
2017 Sep/Dec Q3 (a)

Conclusion
• If High K Co’s share price is to improve, investors need it to make some sort
of definite decision about strategy the way its competitors have since its last
year end.
• What the chief executive has been saying about flexibility and keeping a
varied portfolio has not convinced investors.
• If High K Co is to maintain its competitive position, it may well have no choice
but to make a significant further investment in online operations.
• Possibly as well it could review where its competitor is closing convenience
stores, as it may be able to open, with limited investment, new stores in
locations with potential.
• However, it also must decide what to do about the large out-of-town stores,
as their performance is already stagnating and they are about to face
enhanced competition.
• High K Co will also need to determine its dividend policy, with maybe a level
of dividend which is considered the minimum acceptable to shareholders
allowed for in planning cash outflows.
 经典考题（二）
Financial restructuring
A. Financial restructuring scheme是否合理
B. Financial restructuring 前后的财报SOPF/SOPL/财务指标有什么变化
A. Evaluate a financial reconstruction scheme (精选必做题)

Example. BDJR Computers Global is a company that

manufactures a range of personal computers that are
sold to retailers, and also directly to individuals and
businesses through online sales.
Due to a number of technical problems the company’s
sales have fallen significantly over the last year
resulting in an operating loss of $160,000. The
company has, as a result, built up losses on its
retained earnings and there is a significant risk of
insolvency.
To avoid this, the company’s financial advisers have
proposed a scheme of reconstruction.
A. Evaluate a financial reconstruction scheme (精选必做题)
Statement of financial position at 31/12/20X9
$000 $000
Assets
Non-current assets: 1,100
Current assets:
Inventory 410
Receivables 220
Cash 25
Net Current Assets 665
Total assets 1,755
Equity and Liabilities
Share capital ($ 1 shares) 200
Retained earnings (50)
Total Equity 150
Non-current liabilities - Bank loan 1.200
Current liabilities
Payables 205
Overdraft 200
405
Total equity and liabilities 1,755
A. Evaluate a financial reconstruction scheme (精选必做题)

Notes:
(1) If the company was liquidated all of the assets could be
sold for their book values except for inventory. Following a
review it discovered that $220k of the inventory is obsolete
but the remainder could be sold for book value. In addition
$90k of the receivables is irrecoverable.
(2) To be successful a scheme of reconstruction would need
to raise $195k of cash to invest in new manufacturing
processes.
(3) Given the risk attached to the company any providers of
new equity capital will require a return of at least 18%.
(4) The current interest rates are 8% on the bank loan and 6%
on the overdraft. The bank loan is secured.
A. Evaluate a financial reconstruction scheme (精选必做题)

The following scheme of reconstruction is proposed:

(1) The nominal value of each existing share will be reduced
to 50c.
(2) Goodwin bank (who provide both the overdraft and loan)
will convert half of the overdraft and 1/3 of the loan into a
total of 200,000 new shares.
(3) New finance of $400k will be raised from a venture
capital company, PC ventures, who will buy new shares for
$1.25 per share. In addition to investing in the new
manufacturing process the finance will also be used to repay
the payables.
(4) Following the reconstruction it is expected that the
company will generate $320K of profit before interest and tax
per annum. Tax is payable at 28%. Assume no tax losses.
A. Evaluate a financial reconstruction scheme (精选必做题)

Require:
(a) Determine how much each of the original investors is
likely to get in the event of a liquidation.
(b) Following the reconstruction calculate the expected EPS,
and the return on equity to the venture capital company,
and advise as the whether the venture capital company is
likely to invest in BOJR computers.
(c) From the post-reconstruction EPS calculation above
calculate the effective return that the bank is likely to
receive on the capital converted into equity.
(d) Determine whether the existing ordinary shareholders,
and the bank, are likely to accept the scheme.
A. Evaluate a financial reconstruction scheme (精选必做题)

(a) Liquidation
Assuming that there are no liquidator’s fees, in the event of liquidation the distribution will be as follows:
Assets to distribute $000
Per SOFP 1,755
Less inventory write off (220)
Less receivables write off (90)
Net 1,445
Distribution:
Secured Bank Loan (1,200)
245
Unsecured
Payables 205
Overdraft 200
(405)
Note: (160)
(1) Unsecured creditors will only receive 245/405 =60% of the amount owing.
(2) Ordinary shareholders will receive nothing.
 A. Evaluate a financial reconstruction scheme (精选必做题)

(b) Post-reconstruction EPS

Earnings post-reconstruction $000
PBIT 320
Bank loan interest (2/3 × 1,200 × 8% ) (64)
Overdraft interest (1/2 × 200 × 6% ) (6)
PBT 250
Tax at 28% (70)
PAT 180

• Number of shares post-reconstruction

= 200,000 (existing s/h) + 200,000 (bank) + 320,000 (venture capitalist)
= 720,000
• Post-reconstruction forecast EPS
= 180 / 720 = 25c per share
• Return on equity to venture capital company
= 25c / 125c = 20%
➢ This is above the target required return of 18% and is therefore acceptable
to the venture capital company.
A. Evaluate a financial reconstruction scheme (精选必做题)

(c) Effective return to bank on converted capital

• Capital foregone
= (1/2 × 200,000) + (1/3 × 1,200,000) = $500,000
• Number of shares in exchange
= 200,000
• Earnings generated
= 200,000 × 25c = $50,000
• Return
= $50,000 ÷ $500,000 = 10%
A. Evaluate a financial reconstruction scheme (精选必做题)
(d) Acceptability of the Scheme
• Existing ordinary shareholders
✓ If the company is liquidated then the existing ordinary shareholders will
get nothing.
✓ In a reconstruction the existing ordinary shareholders will lose control
of the company (they will own 200/720 = 28% of the equity) , but they
are likely to earn 25c per new ordinary share. Based on the original
nominal value of each share this represents a return of 25c/$1 = 25%.
✓ Given the return that the providers of new capital are likely to receive
the scheme seems very generous to the existing shareholders.
✓ It is likely that the bank and the venture capital providers would want
the scheme to be amended so as to make it less generous to the
existing shareholders.
A. Evaluate a financial reconstruction scheme (精选必做题)

• Bank
✓ If the company is liquidated, the bank is likely to recover the full
amount of the secured loan but will only recover 60% of the
overdraft.
✓ Following the reconstruction the bank will only get a return of
10% on the capital converted into equity but will continue to
receive interest on the remaining loan and overdraft at the
existing rate.
✓ Given that 1/3 of the secured loan is converted into equity, and
the forecast return on this is only 2% more that the current loan
interest, this is unlikely to be acceptable to the bank.
 经典考题（二）
Financial restructuring
A. Financial restructuring scheme是否合理
B. Financial restructuring 前后的财报SOPF/SOPL/财务指标有什么变化
历年真题：Flufftort (2015 Sep/Dec Q3) - reconstruction
题号 考点 分值 难度
(a) SOFP after Share repurchase 4 marks ꙭ
SPL after Refinancing 4 marks
SOFP after Refinancing 4 marks
(b) Acceptance of refinancing scheme by 13marks
financial provider + assumptions
历年真题 Flufftort (2015 Sep/Dec Q3) - Reconstruction
历年真题 Flufftort (2015 Sep/Dec Q3) - Reconstruction
Flufftort (2015 Sep/Dec Q3) - Reconstruction
Flufftort (2015 Sep/Dec Q3) - Reconstruction
Flufftort (2015 Sep/Dec Q3) - Reconstruction
Flufftort (2015 Sep/Dec Q3) - Reconstruction
Flufftort (2015 Sep/Dec Q3) - Reconstruction
Flufftort (2015 Sep/Dec Q3) - Reconstruction
历年真题 Flufftort (2015 Sep/Dec Q3) - Reconstruction
(a) (i) Prepare a projected statement of financial position as at 30 June 2016, on the
assumption that Gupte VC exercises its rights and Gupte VC’s shares are
repurchased and cancelled by Flufftort Co. (4 marks)
(ii) Prepare a projected statement of financial position as at 30 June 2016 on the
assumption that the proposed refinancing and investment take place. (4 marks)
(iii) Prepare projected statements of profit or loss for the years ended 30 June
2017 and 30 June 2018 on the basis that the profit forecasts are correct. (4 marks)
(b) Evaluate whether the suggested refinancing scheme is likely to be agreed by
all finance providers. State clearly any assumptions which you make. (13 marks)
(b) Evaluate whether the suggested refinancing scheme is likely to be agreed by
all finance providers. State clearly any assumptions which you make. (13 marks)
(b) Evaluate whether the suggested refinancing scheme is likely to be agreed by all
finance providers. State clearly any assumptions which you make. (13 marks)
(b) Evaluate whether the suggested refinancing scheme is likely to be agreed by
all finance providers. State clearly any assumptions which you make. (13 marks)
(b) Evaluate whether the suggested refinancing scheme is likely to be agreed by
all finance providers. State clearly any assumptions which you make. (13 marks)
 经典考题（三）
Business re-organisation
Thank You
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 CH13
Hedging foreign exchange risk
Chapter13 Mind map

Invoice In home currency

Hedge risk by internal Leading and lagging

techniques

Netting and matching

Chapter 13
Hedging foreign Forward contracts (FRA)
exchange risk
Money market hedge

Derivatives to hedge forex risk

Currency futures
(External techniques)

Currency options

Currency swaps
CH13 Hedging foreign exchange risk（历年真题）
主要考点 考试频率 考题分布 分值
Boullain 2020 Mar Q2(b) 1
Okan 2019 Sep/Dec Q1 (b) 1
Nutourne 2018 Dec Q2 (b) +7
1. Forward contract 7 Washi 2018 Sep Q1 (c)(i) 1
Lirio 2016 Jun Q1(b)(ii) 1+1
CMC 2014 Jun Q1(a) 1+1
Kenduri 2013 Jun Q3(a) 1+1

Boullain 2020 Mar Q2(b) 5

Nutourne 2018 Dec Q2 (a) 5+1
Washi 2018 Sep Q1 (c)(i) 3+1
2. Future 7 Adverane 2018 Jun Q4 (a) 5+1
Buryecs 2017 Jun Q3 (c) 5+2
Lirio 2016 Jun Q1(b)(ii) 4+1
CMC 2014 Jun Q1(a) 4+2

Boullain 2020 Mar Q2(b) 3

Nutourne 2018 Dec Q2 (a) 5+1
Washi 2018 Sep Q1 (c)(i) 3+1
3. option 6
Buryecs 2017 Jun Q3 (c) 5+2
Lirio 2016 Jun Q1(b)(ii) 4+2
CMC 2014 Jun Q1(a) 6+2
CH13 Hedging foreign exchange risk（历年真题）

主要考点 考试频率 近5年考题分布 分值

Okan 2019 Sep/Dec Q1 (b) 2

Nutourne 2018 Dec Q2 (c) 3+3
4. Money market hedge 4
Adverane 2018 Jun Q4 (a) 2
Kenduri 2013 Jun Q3(a) 2+1
5. Forex swap 1 Buryecs 2017 Jun Q3(a)(b) +6,12

Adverane 2018 Jun Q4 (a) 7+3

6. Netting 3 Armstrong 2015 Dec Q2(a) 8+3
Kenduri 2013 Jun Q3(b) 7+3
2 Foreign currency Exchange rate (Recap)

Example. UK Co. trade with foreign Co. from US , will receive US$.
Step 1 Determine use 低 rate / 高 rate ? (US$/£) 1.2200 – 1.2400
Spot ($ /£)

US$ £

Counter Base currency

Spot currency
rate
外币 本币
US$/£
c b 1.2200 – 1.2400
• You buy US$ from • You sell US$ to the
Step 2 Determine 乘 rate / 除 rate? the bank at this rate. bank at this rate.
• 计算得到前面的货币的值 – 乘 rate • Bank sell US$ at • Bank buy US$ at
lower bid price. higher offer price.
• 计算得到后面的货币的值 – 除 rate
YOU：买前用前，买后用后
2 Foreign currency Exchange rate (Recap)

Example. UK Co. trade with foreign Co. from US , will receive US$.
Step 1 Determine use 低 rate / 高 rate ? (US$/£) 1.2200 – 1.2400 必胜口诀一

Spot ($ /£) 1.2200 – 1.2400 £升值数变大/贬值数变小

US$ £ Bank bid offer

Counter Base currency 本币 低买£ 高卖£ 银行：低买高卖本币

Spot currency
Compan
rate
外币 本币 y 低卖£ 高买£ 必胜口诀二
本币
c b 企业：低买高卖外币
低买US$ 高卖US$ Buy low, sell high
外币
(收$少) (付$多) 拜拜了，say hi ^-^
Step 2 Determine 乘 rate / 除 rate? 必胜口诀三
• 计算得到前面的货币的值 – 乘 rate 企业：前乘后除
• 计算得到后面的货币的值 – 除 rate 必胜口诀四
企业：买前用前，买后用后
 2.3 Bilateral and multilateral netting and matching agreements

X, Y, and Z are three companies within the same UK based international

group. W is a company outside of the group. The following liabilities
have been identified for the forthcoming year:
payables Owed by Owed to Amount (millions)
X Y € 39
Y X ￡10
Y W $ 20
Z X ￥200
W X $ 15
W Z ￥100
Mid-market spot rates are : ￡1 = $2.00
￡1 = €1.50
￡1 = ￥250

Required:
Establish the net indebtedness that would require external hedging.
2 Bilateral and multilateral netting and matching agreements

X, Y, and Z are three companies within the same UK based international

group. W is a company outside of the group. The following liabilities have
been identified for the forthcoming year:
Owed by Owed to Amount (millions)
X Y € 39
Y X ￡10
Y W $ 20
Z X ￥200
Z Y € 15
W X $15
W Z ￥100
Mid-market spot rates are : £1 = $2.00
£1 = €1.50
£1 = ￥250
Required:
Establish the net indebtedness that would require external hedging.
Example answer

Step2 Total Owned by

(Payables)
Example answer
2.3 Netting and matching (历年真题-Homework) 历年真题
2010 Jun Q5 Mezza (b) +8

(b) Discuss the advantages and disadvantages of netting arrangements

with both group and non-group companies. (8 marks)

What is Netting?
• Netting is a mechanism whereby mutual indebtedness between group members
or between group members and other parties can be reduced.
Advantage
• The advantages of such an arrangement is that the number of currency
transactions can be minimised, saving transaction costs and focusing the
transaction risk onto a smaller set of transactions that can be more effectively
hedged.
• It may also be the case, if exchange controls are in place limiting currency flows
across borders, that balances can be offset, minimising overall exposure.
• Where group transactions occur with other companies the benefit of netting is
that the exposure is limited to the net amount reducing hedging costs and
counterparty risk.
 历年真题
2.3 Netting and matching (历年真题) 2010 Jun Q5 Mezza (b) +8

Disadvantages
• some jurisdictions do not allow netting arrangements, and there may be
taxation and other cross border issues to resolve.
• There will be costs in establishing the netting agreement and where third
parties are involved this may lead to re-invoicing or, in some cases, re-
contracting.
 必胜口诀二
3 Derivatives to hedge forex risk 企业：低买高卖外币
Buy low, sell high
3.1 Forward contracts (FRA) 拜拜了，say hi ^-^

• A forward contract allows a business to buy or sell a currency on a fixed 必胜口诀三

future date at a predetermined exchange rate.
企业：前乘后除 (前程无忧)
Example. UK Co. trade with foreign Co. from U.S
£ 100,000; US$ 250,000 必胜口诀四
3 Month Forward (US$/£) 1.2200 – 1.2400 企业：买前用前，买后用后

(1) Exporter - 收 历年真题

Step1 确定rate (必胜口诀四、买前用前、买后用后) <Receipt>
Sell products to foreign customer –收US$ - 卖US$, 买GBP £ @ high rate 1.2400
2016 Jun Q1 Lirio 1+1
Step2 确定乘/除 (必胜口诀三、前乘后除)
卖US$250,000, 得到多少 £ ? 后除 $250,000/1.2400 2011 Jun Q2 Casasophia 1+1
需要£ 100,000, 要卖多少 US$? 前乘 £100,000*1.2400 <Payment>
2014 Jun Q1 CMC 1+1
(2) Importer - 付 2013 Jun Q3 Kenduri 1+1
Step1 确定rate (必胜口诀四、买前用前、买后用后)
buy foreign products -付US$ - 买US$ @ low rate 1.2200
Step2 确定乘/除 (必胜口诀三、前乘后除)
买US$250,000, 需要多少 £ ? 后除 $250,000/1.2200
有£ 100,000, 能买多少 US$? 前乘 £100,000*1.2200
3.1 Forward contracts (FRA)

• Three months forward

(1) 全值标价 USD/ GBP 1.2200 – 1.2400
• 和正常spot rate 的计算一样
(2) 基点标价 0.21 – 0.18 cents premium / 0.19 – 0.16 cents discount
• 银行常用基点标价, 基点是远期汇价和即期汇价的差额,
基点的单位是cents, 计算时要先除以100 换成 $
• Premium: FRA = spot – premium 必胜口诀五
(1) 除以100换成$, £
Premium 指前面的货币 (如，外币) appreciate升水/升值，后面货币 (如，本
(2) - premium; + discount 节能减排
币) 贬值，汇率下降
• Discount ：FRA = spot + discount
Discount 指前面的货币depreciate 贴水/贬值, 后面货币升水/升值，汇率上升

Example. UK Co. trade with foreign Co. from U.S

UK£ 100,000; US$ 250,000
Spot rate 1.2200 – 1.2400
3 Month Forward (USD/GBP)
0.21 – 0.18 cents premium (1)除以100换成$ (2) 减premium FRA(USD/GBP) 1.2179 – 1.2382
0.16 – 0.19 cents discount (1) 除以100换成$ (2) 加discount FRA(USD/GBP) 1.2216 – 1.2419
 3.1 Forward Example

Marcus is based in France has recently imported raw materials from the Required:
USA and has been invoiced for US$240,000, payable in three months’ time. Show how the company
In addition, it has also exported finished goods to Japan and Australia. can hedge its exposure to
The Japanese customer has been invoiced for US$69,000, payable in three foreign exchange risk
months' time, and the Australian customer has been invoiced for A$295, using:
000, payable in four months' time. (a) forward contracts
(b) money market
Current spot and forward rates are as follows:
US$.../1 Euro hedges
Spot: 0.9830 - 0.9850 and for each transaction,
3 months forward: 0.9520 - 0.9545 determine which is the
Euro.../1 A$ best hedging technique.
Spot: 1.8890 - 1.8920
4 months forward: 1.9510 - 1.9540
Current money market rates (pa) are as follows:
US$: 10.0% - 12.0%
A$: 14.0% - 16.0%
Euro: 11.5% - 13.0%
3.1 Forward Answer
Forward contracts
Current spot and forward rates are as follows:
US$.../1 Euro
3 months forward: 0.9520 - 0.9545
Euro.../1 A$
4 months forward: 1.9510 - 1.9540

1. US$ Exposure
Net payment of US$171,000 Buy US$171,000 3 moneys forward at a cost of US$0.9520/Euro
(240k-69k) in 3 months US$171,000 / 0.9520 = €179,622 payable in 3 months’ time.

2. AU$ Exposure
Net receipt of AU$295,000 Sell A$295,000 4 moneys forward at a cost of €1.9510/A$
in 4 months A$295,000*€1.9510/ A$=€575,545 receivable in 4 months’ time
 Money market hedge

Hedge

Exporter Importer

Export goods - Receive foreign currency Import goods - Pay foreign currency

本国：英国，本国货币为英镑 £ 本国：英国，本国货币为英镑 £

交易：出口货物，未来收外币 交易：进口货物，未来付外币
如，3个月后收美元$ 如，3个月后付美元$
担心：未来外币贬值，本币升值 担心：未来外币升值，本币贬值
如，担心3个月后美元贬值，英镑升值； 如，担心3个月后美元升值，英镑贬值；
则3个月后将收到的美元$换成英镑£， 则3个月后支付美元$货款时，将英镑£换成美元$，
所得到的英镑£变少 需支付的英镑£变多
目标：现在就锁定，未来能收到的本币 目标：现在就锁定，未来需支付的本币
如，今天就锁定，3个月后换美元$能得到的英镑£数 如，今天就锁定，3个月后换美元$所支付的英镑£数
额 额
 Money market hedge – Exporter

Exchange
UK (本国-英镑) US (外国-美元)
Rate $/£

4. Exchange into £ @ 1.9618 1.9618 3. Borrow $ 外币

$0.9867m / 1.9618= £0.5030m $? 0.9867m X (1+5.38% x
3/12)=$1m
Now
Interest
Deposit @5.5% x 3/12 Borrow @5.38% x 3/12
rate

5. Receipt of £ deposit Effective 1. Receipt $1m 有外汇风险

In $0.5030m x (1+ 5.50% x 3/12) = £ 0.51m rate 2. Pay loan ($1m)
3 months 1.9608 0 无外汇风险
 Money market hedge – Importer
Exchange
UK (本国-英镑) US (外国-美元)
rate
4. Exchange £ into $ @ 1.9612 3. Deposit $? m @ 5.31%
1.9612
£ ? 0.5032m x 1.9612 = $0.9869m $? 0.9869m X (1+5.31%x3/12)=$1m
Now
Interest
Borrow @5.59% x 3/12 Deposit @5.31% x 3/12
rate

5. Pay of £ borrowing Effective 1. Pay ($1m)有外汇风险

In $0.5032m x (1+ 5.59% x 3/12)
rate 2. Receive deposit $1m
= (£ 0.5106m)
3 months 1.9585 0 无外汇风险
 3.1 Forward Example

Marcus is based in France has recently imported raw materials from the Required:
USA and has been invoiced for US$240,000, payable in three months’ time. Show how the company
In addition, it has also exported finished goods to Japan and Australia. can hedge its exposure to
The Japanese customer has been invoiced for US$69,000, payable in three foreign exchange risk
months' time, and the Australian customer has been invoiced for A$295, using:
000, payable in four months' time. (a) forward contracts
(b) money market
Current spot and forward rates are as follows:
US$.../1 Euro hedges
Spot: 0.9830 - 0.9850 and for each transaction,
3 months forward: 0.9520 - 0.9545 determine which is the
Euro.../1 A$ best hedging technique.
Spot: 1.8890 - 1.8920
4 months forward: 1.9510 - 1.9540
Current money market rates (pa) are as follows:
US$: 10.0% - 12.0%
A$: 14.0% - 16.0%
Euro: 11.5% - 13.0%
 历年真题
3 Derivatives to hedge forex risk 2018 Mar Q4 Adverane 2
3.2 Money market hedge < receipt >

Exchange Euro.../1 A$:

Euro (本国-欧元) AUD (外国-澳元) Spot: 1.8890 - 1.8920
Rate
Current money market rates :
4. Exchange into @ 1.8890 1.8890 3. Borrow AU$ 外币
AU$280k *1.8890 =Euro 529k
Euro: 11.5% - 13.0%
$? 280X (1+16% x 4/12)=AUD295k
A$: 14.0% - 16.0%
Now

Deposit @11.5% Interest rate Borrow @16% x 4/12 Therefore

A$ borrowing rate = 16%*4/12
5. Receipt of £ deposit 1. Receipt AUD295k 有外汇风险 Euro investment rate = 11.5%*4/12
Euro 529k x (1+ 11.5% x 4/12) 2. Pay loan (AUD295k)
In = Euro 549k 0 无外汇风
4 months * Assume interest rates can simply
险
be time-apportioned.
 历年真题
3 Derivatives to hedge forex risk 2013 Jun Q3 Kenduri 2
3.2 Money market hedge < payment >

Exchan Current spot and forward rates

Euro (本国-欧元) ge US (外国-美元) US$/1 Euro :
rate Spot: 0.9830 - 0.9850
4. Exchange @ 0.9830 3. Deposit $? m @ 10% Current money market rates :
0.9830 US$: 10.0% - 12.0%
? Euro 170 * 0.9830 =$167k $167k ? X (1+10%x3/12)=$171k
Now Euro: 11.5% - 13.0%
Interes
Borrow @13% x 3/12 Deposit @10% x 3/12 Therefore
t rate
US investment rate = 10%*3/12
5. Pay of £ borrowing 1. Pay ($171k)有外汇风险 Euro borrowing rate = 13%*3/12
In
Euro 170 x (1+ 13% x 3/12) 2. Receive deposit $171k
3 months = (Euro 176k) 0 无外汇风险 * Assume interest rates can simply
be time-apportioned.
3 FRA & Money Market Hedge Example

Summary
FRA Money Market Hedge
US$ Payment €179,622 €175,230
AU$ Receipt €575,545 €549,319

Amount of payment of money market hedge €175,230 is

cheaper than the forward market hedge result €179,622,
therefore should be selected.

Forward has larger amount than received from the money

market hedge €549,319, we can conclude that the forward
market hedge gives the better outcome.
3 Derivatives to hedge forex risk
3.3 Currency Futures

• Currency future are contracts that fix the exchange rate for a set
amount of currency over a specified period of time (交易双方所签订
的一个在未来的某一日期根据协议价格交割标准数量外汇的合约).
• Buying the futures means receiving the contract currency
• Selling the futures means supplying the contract currency
How future works
• Background: in 3 months’ time the company is expected to
received US$(外币)/ pay US$ (外币)

3 months’ later
Now Received US$(外币)/ pay US$ (外币)
3. If exchange rate in spot market move against you,
1. Set up a future contract in 3 months time receive compensation profit.
2. Deposit a margin (保证 4. If exchange rate in spot market moved in favor of you,
金) in 3 months time pay out losses.
5. Net effect = fixed outcome (future rate)
3 Derivatives to hedge forex risk
3.3 Currency Futures

Future
Value of
price Contract size Tick size
one tick
quotation
US$/£ £62,500 £0.0001 $6.25
US$/€ €200,000 €0.0001 $20.00
US$/CHF CHF125,000 CHF0.0001 $12.50
US$/JPY Yen12.5 million JPY0.000001 $12.50

Currency of contract – CC 合约币种

• The CC is the currency in which the contract size is quoted
• 考试技巧：题目中contract size 是什么货币，CC就是什么
货币
3.3 Currency Futures
Set up hedge position

必胜口诀一

Importer: In 3 months pay $ — buy $, sell £

CC is $ CC is £
Buy $ future Sell £ future
Exporter: In 2 months receive $ — Sell $, buy £
CC is $ CC is £
Sell $ future Buy £ future
3.3 Currency Futures

Ticks
• i.e. a future contract is £125,000 (future contract 以 base
currency 标价).
• A tick is the smallest movement in the exchange rate, i.e. $/£ , 以
万分之一为单位 0.0001£.
• every unit of movement in future will give a company
• £125,000 x 0.0001£ = $12.5 profit or loss (tick 以counter
currency 体现), called tick size / value of 1 tick (最小波动价位).
• Example. 0.0030 movement in exchange rate is:
30 ticks * $12.5 = $375
 3.3 Currency Futures
必胜口诀二 “三三法则”

Future
时间轴 Now Settlement date
contract
maturity date
Step 1 : Set up the hedge by addressing Step 3: Calculate the impact of hedge
3 key questions • Calculate profit or loss in the futures market
• Buy or sell futures? by closing out the futures contracts
看CC, buy CC货币, buy future Now: sell future @ open rate 0.7300
sell CC 货币, sell future 4 month: buy future @ close rate 0.7328
• No. of contracts? loss (0.0028)
amount to hedge/contract size • Calculate the value of the transaction using the
尽量 under hedge + 剩下用FRA或spot
FRA or spot rate on the transaction date.
• Which expiry date ?
nearest maturity date after settlement date Spot 0.7337
超过交易日离的最近的 Overall impact 0.7309
Step 2: Contact the exchange. Pay the
initial margin
(保证金，考试不考虑)
3.3 Currency Futures
Example — 收外币/ close future price 已知/ complete hedge

It is 4 May and the treasurer of a Swiss company has identified a net receipt of US$2 million
on 10 June. These dollars will need to be converted into Swiss Francs (CHF).
The treasurer has decided to use Swiss Francs - US dollar futures contracts to hedge with
the following details:
• New York Board of Trade (NYBOT) options and futures exchange.
• Contract size $200,000.
• Prices given in Swiss francs per US dollar (i.e. $1=...)
• Tick size CHF20 per contract.
Expiry date Futures price
June 1.2200
Sep 1.2510
The spot rate on 4 May is 1.2160 CHF/$1.
Required:
Calculate the financial position using the relevant futures hedge, assuming that on 10
June the spot rate is 1.2750 CHF/$1；future rate is 1.2760 CHF/$1.
3.3 Currency Futures
必胜口诀二 “三三法则”

Future
时间轴 Now Settlement date
contract
maturity date
Step 1 : Set up the hedge by addressing Step 3: Calculate the impact of hedge
3 key questions • Calculate profit or loss in the futures market by closing out the
• Buy or sell futures? futures contracts
CC is $, receipt $ convert to CHF 4 May: sell future $ @ open rate 1.2200
Sell $, buy CHF, sell $ future 10 June: buy future $ @ close rate 1.2760
• No. of contracts? loss (0.0560)0.0560 x $0.2m x 10 = (112,000) loss
amount to hedge/contract size • Calculate the value of the transaction using the FRA or spot rate on
= $2m / $200,000
the transaction date.
= 10 contracts
• Which expiry date ? Spot 1.2750 1.2750 x $2m = 2550,000
nearest maturity date after settlement date Overall impact 1.2190 CHF2438,000
(transaction) date
June contract @ 1.2200 effective rate 1.2190 ≠ future rate 1.2200, Because close at 10 June, not 30
Step 2: Contact the exchange. Pay the June ,date not perfect hedge
initial margin
(保证金，考试不考虑)
3.3 Currency Futures

Basis
• Basis is the difference between the spot price and 0.7343
futures prices. In exam, assume basis reduce from Unexpired Basis
its opening value to zero in liner manner. Basis 0.0043 0.0043*(5-4)/5 =
0.0009
Basis = spot rate – future rate Basis =0
• Basis on the expiry date on the future contract is
0.7300
always 0.
Choose of future contract date
Now 4 5
• Choose the nearest maturity after the settlement
(transaction) date.
3.3 Currency Futures
Example. Euro Co. is expecting to receive $10m in 4 months, it wants to
translate into Euro.
Spot rate now (Euro/$) 0.7343 – 0.7355
Futures market $500,000 contract, price quoted as Euro/$
5 month expiry Euro/ $ 0.7300
Spot rate in 4 months (Euro/$) 0.7337-0.7366
Required: What is future rate in 4 months’ time, assume the basis
reduce to zero on liner manner. 方法二
(1) Receive $ and convert to Euro — sell $, buy Euro
(2) Contract CC is $ — sell $ future, buy Euro
0.7343

方法一 Unexpired Basis

Basis 0.0043 0.0043*(5-4)/5 =
Now 4 months 5 months 0.0009
Basis =0
Spot 0.7343 0.7337
Future 0.7300 ？ 0.7328 0.7300

Basis 0.0043 ？ 0.0009 0

0.0043*1/5 Now 4 5
 3.3 Currency futures
Example — 收外币/ close future price 未知/ complete
hedge
Europe Co is expecting to receive $10m in 4 months' time, which it
wants to translate into €. Receive $, covert to €
The spot rate (quoted as €/$1) is： Need to Sell $, buy €

0.7343 — 0.7355
Futures market information：
$500,000 contracts, prices quoted as €/$1
CC is $, so sell $
2 month expiry 0.7335 future
5 month expiry 0.7300 Nearest maturity after
Required: transaction date is
5 month
Estimate the likely financial result of the hedge, assuming that the
spot rate in 4 months is expected to be 0.7337-0.7366 €/$1, and
that basis reduces to zero in a linear manner.
(1) Show the detail calculation of hedge by future Use 3 steps procedure
(2) Assess the overall impact of the future hedge Use lock in rate
 3.3 Currency Futures
必胜口诀二 “三三法则”
Future
时间轴 Now Settlement date
contract
maturity date
Step 1 : Set up the hedge by addressing 3 Step 3: Calculate the impact of hedge
key questions • Calculate profit or loss in the futures market
• Buy or sell futures? by closing out the futures contracts
看CC, buy CC货币, buy CC future Now: sell future @ open rate 0.7300
sell CC 货币, sell CC future 4 month: buy future @ close rate 0.7328
CC is $, sell $ future loss (0.0028)
• No. of contracts? • Calculate the value of the transaction using the
amount to hedge/contract size
spot rate on the transaction date.
尽量 under hedge + 剩下用FRA
No. of contract = $10m/ $500,000 =20 contract Spot 0.7337
• Which expiry date ? Overall impact 0.7309
nearest maturity date after transaction date超 0.7300 – (0.7337 – unexpired basis 0.0009) + 0.7337 = 0.7309
过交易日离的最近的
Expiry in 5 months Step 3: Calculate the impact of hedge use “lock-in”
Step 2: Contact the exchange. Pay the effective rate 必胜口诀
initial margin 三 future rate @ 0.7300
Opening
(保证金，考试不考虑) + unexpired basis @ 0.0009
0.7309
3.3 Currency Futures

(2) Assess the overall impact of the future hedge

Use lock -in effective rate
Effective exchange rate = Opening(current) future rate + unexpired basis
0.7309 = 0.7300 + 0.0009
€/$ 0.7309*$10m = € 7,309,000
Or,
Effective exchange rate = current spot rate – expired basis
3.3 Currency Futures
Basis risk
• Basis risk is the risk that the basis reduces in a non-linear
manner, making the forecast of unexpired basis on our
settlement date inaccurate.
• In order to try to manage basis risk, it is important that the
futures contract chosen is the one with the closest maturity
date to the actual transaction.
考试提醒
• 考试中，如果写 Assumption: 就assume basis reduces in
a linear manner
• 考试中，如果写 Limitation: 就写 basis may reduces in a
non-linear manner, there is potential that the forecasted
unexpired basis and lock-in rate is inaccurate.
3.3 Currency Futures

Advantage Disadvantage
Liquidity Imperfect hedge
Low credit risk Margin deposit requirement
Can be closed off before Basis risk
maturity
Legally binding contract
 历年真题
3.3 Currency Futures 2015 Jun Q4 Daikon (b) 3+7

• Margin
✓ Initial margin: when a future position is opened, the clearing
house requires that an initial margin be placed on deposit in a
margin account to act as a security against possible default.
✓ Maintenance margin: each client of the of future contract
should keep a minimum amount of deposit in their margin
account.
✓ Marking to market: at the end of each day, the Clearing house
calculates the daily profit or loss on the futures position. The
daily profit or loss is added or subtracted to the margin account
balance.
✓ Margin call: if the amount in the margin account to fall below
the maintenance margin, a margin call is made to the
investor ,requiring the investor to deposit extra funds to top-up
the margin account, call the margin variation.
✓ An inability to pay the variation margin causes default and
contract is closed.
3.4 Currency options
• Currency option
Currency option are contracts giving the holder the right but
not the obligation,
• to buy a fixed amount of currency at a fixed rate, for an
upfront fee (premium) — call option.
• sell a fixed amount of currency at a fixed rate, for an
upfront fee (premium) — put option.
• Over the counter options: currency option purchased
directly from merchant bank at fixed rate (European
option).
• Exchange traded options: currency option exchange at
market such as Philadelphia stock exchange.
PHLX US$/£ per £ option £31,250 (cents per £1)
Strike Calls Puts
price Apr May June Apr May June
1.9500 2.20 2.75 3.10 0.65 1.20 1.60
1.9750 0.88 1.45 1.85 1.70 2.40 2.85
2.0000 0.25 0.70 1.05 3.65 4.10 4.50
 3.4 Currency options 必胜口诀一 “四四法则”

Option
时间轴 Now Transaction maturity
data date
Step 1 : Set up hedge by addressing 4 key questions Step 3: Decide exercise or lapse by compare
• Buy call / put option? option price and spot rate
看CC, buy CC货币, buy call option
sell CC 货币, buy put option put option, sell @ exercise price $1.50/£
• No. of contracts? buy @ spot price $1.48/£
Amount to hedge / contract size, or Gain $0.20/£
(Amount to hedge*/ exercise price) / contract size
向下取整数 (Under hedge) 其余敞口用spot 或FRA
Gain in the option market, so exercise!
• Which expiry date ?
nearest maturity date after transaction date
超过交易日离的最近的 Step 4: calculate the net cash flows
• Which exercise price? (i.e CC is £) (1) Premium cost (X)
Buy $, sell £, premium is cost, so 减 (卖的少) 1.50 - premium (2) Gain/loss on exercise option X/0
Sell $, buy £, premium is cost, so 加(买花的多) 1.50 + premium
Step 2: Contact the exchange. Pay the upfront premium (3) Under hedge exchange @ spot/ FRA X
(手续费会产生cost) XX
手续费通常以cents标价，要先换算成$，£，etc.
Premium cost
= Premium * contract size * contract No.
3.4 Currency options
Example — 付外币
Pongo plc is a UK-based import-export company. It has an invoice,
which it is due to pay on 30 June, in respect of $350,000.
The company wishes to hedge its exposure to risk using traded
options. The current $/￡ spot rate is 1.5190 —1.5230.
On LIFFE, contract size is ￡25,000.
Exercise price ($/￡） June contracts
Calls Puts
1.45 8.95 10.20
1.50 6.80 12.40
Option premium are given in cents per ￡.
Assume that it is now the 31 March.
Spot rate is: $1.4810 - $1.4850 to ￡1 on June.
Required:
Calculate the cash flows in respect of the payment
3 Currency options – 付外币

Example 4. Pongo plc is a UK-based import-export company. It has

an invoice, which it is due to pay on 30 June, in respect of $350,000.
The company wishes to hedge its exposure to risk using traded
options. The current $/￡ spot rate is 1.5190 —1.5230.
On LIFFE, contract size is ￡25,000.
Exercise price ($/￡） June contracts
Calls Puts
1.45 8.95 10.20
1.50 6.80 12.40
Option premium are given in cents per ￡.
Assume that it is now the 31 March.
Spot rate is: $1.4810 - $1.4850 to ￡1 on June.
Required:
Calculate the cash flows in respect of the payment
3 Currency options –付外币
 历年真题 CMC (2014 Jun Q1) (a)

(a) Advise CMC Co on an appropriate hedging strategy to manage the

foreign exchange exposure of the US$ payment in four months’time.
Show all relevant calculations, including the number of contracts bought
or sold in the exchange-traded derivative markets. (15 marks)
历年真题：CMC (2014 Jun Q1) (a)

Current spot rate is US$1·0635 per CHF1.

Annual inflation rate in the USA is three times higher than Switzerland.
Exchange-traded currency futures Contract size CHF125,000 price quotation:
US$ per CHF1
3-month expiry 1·0647
6-month expiry 1·0659
 历年真题：CMC (2014 Jun Q1)

Exchange-traded currency options Contract size CHF125,000,

exercise price quotation: US$ per CHF1,
premium: cents per CHF1
Advice
Forward contracts minimise the payment and option contracts
would maximise the payment, with the payment arising from the
futures contracts in between these two. With the option contracts,
the exercise price of US$1·07/CHF1 gives the lower cost.
Although transaction costs are ignored, it should be noted that
with exchange-traded futures contracts, margins are required and
the contracts are marked-to-market daily.
It would therefore seem that the futures contracts and the option
contract with an exercise price of US$1·06/CHF1 should be
rejected.
The choice between forward contracts and the 1·07 options
depends on CMC Co’s attitude to risk. The forward rate is binding,
whereas option contracts give the company the choice to let the
option contract lapse if the CHF strengthens against the US$.
Observing the rates of inflation between the two countries and
the exchange-traded derivatives this is likely to be the case, but it
is not definite.
Moreover, the option rates need to move in favour considerably
before the option is beneficial to CMC Co, due to the high
premium payable. It would therefore seem that forward markets
should be selected to minimise the amount of payment, but CMC
Co should also bear in mind that the risk of default is higher with
forward contracts compared with exchange-traded contracts.
 历年真题
3.5 Forex swaps Buryecs 2017 Jun Q3 (b) (ii) 6+2

Characteristics
• In a forex swap, the parties agree to swap equivalent
amounts of currency for a period and then re-swap them at
the end of the period at an agreed swap rate. The swap rate
and amount of currency is agreed between the parties in
advance. Thus it is called a 'fixed rate/fixed rate’ swap.
• The main objectives of a forex swap are:
- To hedge against forex risk, possibly for a longer period than
is possible on the forward market.
- Access to capital markets, in which it may be impossible to
borrow directly.
• Forex swaps are especially useful dealing with countries
that have exchange controls and/or volatile exchange rates.
3.5 Forex swaps
A plc require an Initial investment of 100m pesos and is will be sold for
200m pesos in one year’s time.
The currency spot rate is 20 pesos/￡, and the government has offered a
forex swap at 20 pesos/ ￡.
A plc cannot borrow pesos directly and there is no forward market
available.
The estimated spot rate in one year is 40 pesos/ ￡.
Required:
Determined whether A plc should do nothing or hedge its exposure
using the forex swap.
With swap Yr 0 Yr1
(1) Buy 100m pesos @ pesos20/£ (£5m)
(2) Swap 100m pesos @ pesos 20/£ £5m
(3) Sell 100m pesos @ pesos 40/ £ £2.5m
(£5m) £7.5m

Without swap
(1) Buy 100m pesos @ pesos 20/ £ (£5m)
(2) Sell 200m pesos @ pesos 40/ £ £5m
(£5m) £5m
CH13 Hedging foreign exchange risk（精选必作题）
Ch14 Hedging interest rate risk
Chapter14 Mind map

1.Forward rate agreements 2.1Particular characteristics of

(FRAs) IRFs

2.2Steps of futures hedging

2.Interest rate futures (IRFs)
calculations

2.3 Basis in interest rate futures

Ch14 Hedging 3. Options on interest rate 3.2 Steps of options hedging

interest rate risk futures calculations

4.1 Terminology – Collars,

4. Collars
caps and floors

5. Interest rate swap

6. Options over swaps

(Swaptions)
CH14 Hedging interest rate risk（历年真题）

考点 考试频率 近5年考题分布 分值

Wardegul 2017 Dec Q4 (a) 2+1

1. FRA 3 Pault 2016 Dec Q4 (a) 11+1
Awan 2013 Dec Q2 (a) 2+1

Wardegul 2017 Dec Q4 (a) 6+1

2. Interest rate futures 3 Daikon 2015 Jun Q4 (a) 4+1
Awan 2013 Dec Q2 (a) 6+2

Armstrong 2015 Dec Q2 (b) 7+1

3. Interest rate options 2
Keshi 2014 Dec Q2 (a) 7+2
Wardegul 2017 Dec Q4 (a) 6+1
4. Option on futures 3 Daikon 2015 Jun Q4 (a) 4+1
Awan 2013 Dec Q2 (a) 4+3
Armstrong 2015 Dec Q2 (b) 5+1
5. Collars 2
Daikon 2015 Jun Q4 (a) 4+1
CH14 Hedging interest rate risk（历年真题）

考点 考试频率 近5年考题分布 分值

Pault 2016 Dec Q4 (a)(b)(c) 11+14

Moonstar 2015 Dec Q4 (a) 2+1
6. Interest rate swaps 4
Keshi 2014 Dec Q2 (a) 3+3
CMC 2014 Jun Q1(b) +6

7. Mark-to-market (future) 1 Daikon 2015 Jun Q4 (b) 3+3

Wardegul 2017 Dec Q4 (a) +3

8. Discussion on interest rate
3 Daikon 2015 Jun Q4 (b) +7
hedging methods
Awan 2013 Dec Q2 (a) +6
1 Forward rate agreements (FRAs)

• FRA is totally separate contractual agreement from the

loan itself and could be arranged with a completely
different bank.
• FRA are usually on amounts > $1m, enable you to hedge
for 1 month to 2years.
• FRA is over the counter instrument, they can be tailored to
the company’s precise requirements
• Decision rule:
✓ If borrowing money, a firm would buy an FRA
✓ If investing money, a firm would sell an FRA
 1 Forward rate agreements (FRAs)

• Usage: effectively fixes the rate of interest on a loan or

deposit.
• Terminology: FRA for a three-month loan/deposit starting
in five months' time is called a '5—8 FRA’ (or ’5v8 FRA’).

• Two rates are usually quoted, the higher one for borrowing
and the lower one for investing.
i.e. 2-5 FRA at 5.00% - 4.70%
 1 Forward rate agreements (FRAs)

• Hedging is achieved by a combination of an FRA with

the normal loan or deposit.
• Decision rule
(1) Borrowing (hedge against interest rate rises)
✓Buy a FRA from a bank or other market maker receive
compensation if rate rise
✓The firm will borrow the required sum on the target date,
contract at the market interest rate
(2) Depositing (hedge against interest rate fall)
✓Buy a FRA from a bank or other market maker receive
compensation if rate fall
✓The firm will deposit the required sum on the target date,
contract at the market interest rate
 1 Forward rate agreements (FRAs)

Example 1: It is now the 1st November 20X6. Enfield

Inc’s financial projections show an expected cash
deficit in two months' time of $8m, which will last for
approximately three months The treasurer is
concerned that interest rates may rise before the 1st
January 20X7, so he is considering using an FRA to fix
the interest rate.
The bank offers a 2 — 5 FRA at 5.00% — 4.70%.
Required：
Calculate the interest payable if in two months' time
the market rate is: (a) 7% or (b) 4%.
1 Forward rate agreements (FRAs)
 1 Forward rate agreements (FRAs)

• In this case, the co. is protected from a rise in

interest rates but is not able to benefit form a fall
in interest rates
• A FRA contract is hedges the Co. against both an
adverse and favorable movement
1 Forward rate agreements (FRAs)

How does the bank set interest rate for FRA ?

• FRA rate are set by the bank by analyzing the

individual co.’s spot yield curve.
• Example 2. CO. A’s yield coved has been calculated
as
• Yr individual yield curve(%)
1 3.96
2 4.25
3 4.56
Using the Co.’s spot yield information, calculate the
rate of interest the bank would quote for a 24-36FRA.
2. Interest rate guarantees (Options on FRAs)
• An interest rate guarantee (IRG) is an option on an FRA and, protects the
company from adverse movements and allows it take advantage of
favorable movements.

• If borrowing money, a firm would buy an FRA, so a call option over FRAs
would be used.

• If investing money, a firm would sell an FRA, so a put option over FRAs
would be used.

• Decision rule:

✓ If adverse movement, exercise the option to exercise

✓ if favorable movement, allow the option to lapse.

2. Interest rate guarantees (Options on FRAs)

When to hedge using FRAs or IRGs

• If the company treasurer believes that interest rates
will rise, he will use an FRA, as it is the cheaper way
to hedge against the potential adverse movement.
• If the treasure is unsure which way interest rates will
move, he may be will to use IRG to be able to
benefit from a potential fall in interest rates, even
though it is more expensive.
3. Interest rate futures (IRFs)
• An interest rate futures contract fixes the interest rate on a future
loan or deposit.
• Two types of IRFs:
✓ Short-term interest rate futures (STIRS)
✓ Bond futures (settle by physical delivery)
• Future prices
✓ Interest rate future price are stated as (100-expected market
reference rate), so price of 95.5, imply an interest rate of 4.5%
• Basis = spot – future price (future price = spot – basis)
✓ [100 – spot rate of interest (i.e. LIBOR) ]– future price
✓ i.e. current LIBOR is 5%, future price is 95.50
Basis=(100-5%)-95.5=-0.50%
• Futures “lock in rate”
✓ 100 - (current futures price + unexpired basis on the transaction
date).
 3. Interest rate futures (IRFs)

步骤：Futures hedging calculations 必胜口诀

Step 1: Set up the hedge by addressing 3 key questions:
• Do we initially buy or sell futures? (borrow sell/ deposit buy)
• How many contracts? Loan or deposit amount Loan or deposit period in months
Numbers of contacts = ∗
Contract size Contract duration
• Which expiry date should be chosen?
Step 2: Contact the exchange. Pay the initial margin. Then wait
until the transaction/settlement date.
Step 3: Calculate profit or loss in the futures market by closing
out the futures contracts, ana calculate the value of the
transaction using the market rate of interest rate on the
transaction date.
3. Interest rate futures (IRFs)
4. Options on interest rate futures

Options on futures
• Traded options are options to buy or sell futures.
• call option: right to buy the futures contract.
• put option: right to sell the futures contract.
Choose call or put ? 必胜口诀
Cash market Deposits Loan
Futures market Buy futures contracts Sell futures contracts
Options market Buy calls Buy puts
Choose exercise prices and premium costs ? 必胜口诀
• Borrow：100- exercise price + premium (选最低值，最便宜)
• Invest: 100-exercise price – premium (选最高值，赚的多)
 4. Options on interest rate futures

计算步骤： 必胜口诀
Step 1: Set up the hedge by addressing 4 key questions
• Do we need call or putoptions?
• How many contracts?
• Which expiry date should be chosen?
• Which strike price/exercise price should be used?
Step 2: Contact the exchange. Pay the upfront premium. Then wait
until the transaction/settlement date.
Step 3: On the transaction date, compare the option price with the
prevailing market interest rate to determine 'whether the option
should be exerclsed of allowed to lapse.
Step 4: Calculate the net cash flows —beware that if the number of
contracts needed rounding, there will be some borrowing or deposit
at the prevailing market interest rate even if the option is exercised.
4. Options on interest rate futures

Example 4. It is now the 31st of July.

Tolhurst Co needs to borrow $10m in 1 month's time, for
a 6 month period. The current market interest rate is 5%.
The following information is available regarding $500,000
3-month September interest rate options:
Exercise price Call Put
94.50 1.39 -
94.75 1.02 0.18
95.00 0.65 0.65
95.25 0.21 1.12
Premia are quoted in %.
Required:
Calculate the result of the options hedge if the interest
rate has risen to 7.5% and if the September futures price
has moved to 93.00 in one month's time.
4. Options on interest rate futures
4. Options on interest rate futures

Example 5. Co A needs to borrow $5m for 6 months, starting in 4 months’ time on 1st August. The
current LIBOR rate is 3.50% but there is a risk that interest rates will change over the next few
months by up to 0.5% either way, so the company's treasurer is considering hedging the interest
payments using futures contracts or options. Chesterfield Co can borrow at 25 basis points
above the LIBOR rate.
Current futures/options information:
Futures ($500,000, 3 month contracts)
June 96.40 September 96.10 December 95.86
Options on futures (premia quoted as an annual percentages)
Exercise price Calls Puts
June Sept Dec June Sept Dec
96.40 0.155 0.260 0.320 0.305 0.360 0.445
Required:
• Estimate the likely financial position if Chesterfield Co hedges the interest rate risk using:
(a) futures contracts. (b) options over futures contracts.
• Recommend which method the company should use in this case.
4. Options on interest rate futures
4. Options on interest rate futures
 5. Collars 领子期权

• A company buys an option to protect against an

adverse movement whilst allowing it to take advantage
of a favourable movement in Interest rates.
• The option will be more expensive than a futures hedge.
The company must pay for the flexibility to take advantage
of a favourable movement.
• A collar is a way of achieving some flexibility at a lower cost
than a straightoption.
• Under a collar arrangement the company limits its ability to
take advantageof a favourable movement.
5. Collars 领子期权

必胜口诀
Loan interest Deposit interest

Buy put options - sets max cost Buy calls option - set min receipts

Sell call options - limits min cost Sell put options - limits max receipts
5. Collars 领子期权
5. Collars 领子期权

Example 6. A company wishes to borrow $10m on the 1st of March for three months
The company can borrow at LIBOR + a fixed margin of 2%. LIBOR is currently 8%.
It is keen to hedge using options, to prevent an increase in LIBOR rate causing the
borrowing rate to rise above the existing level. However, having made initial
enquiries, it has been discouraged by the cost of the option premium.
A member of its treasury team has suggested the use of a collar to reduce the premium
cost of the purchased option.
Market deta: Interest rate options
Calls Puts
Exercise price March June March June
92.00 0.80 0.77 0.20 0.22
93.00 0.15 0.12 0.60 0.70
Required:
Calculate the effective interest rate the company will pay using a collar if:
(a) LIBOR rises to 9.5% and futures prices move to 90.20.
(b) LIBOR falls to 4.5% and futures prices move to 96.10.
5. Collars 领子期权
 6. Interest rate swaps

• An interest rate swap is an agreement whereby the parties

agree to swap a floating stream of interest payments for a
fixed stream of interest payments and via versa. There is no
exchange of principal.
• Swaps can run for up to 30 years.
• Swaps can be used to hedge against an adverse
movement in interest rates.
• A swap can be used to obtain cheaper finance.
Example 8. Company X also wishes to raise $50m.
They would prefer to issue fixed rate debt and can
borrow for one year at 6% fixed or LIBOR + 80 points.

Company Y also wishes to raise $50m and to pay

interest at a floating rate. It can borrow for one year at
a fixed rate of 5% or at LIBOR + 50 points.

Required:
Calculate the effective swap rate for each company -
assum savings are split equally.
6. Interest rate swaps
Thank You
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