4 questions.
Question 1:
As the manager of a medium-sized hedge fund, the recent fluctuations in the capital mar-
kets have attracted your attention. In particular, the prices of stocks and bonds have now
dropped to what you consider to be unprecedentedly attractive levels. Although you expect
the prices of these investments to rise in the near future, your hedge fund is currently
cash-constrained due to an unforeseen redemption wave;
“fire-selling” the best holdings in your portfolio is not a practical way to generate investable funds. Further, the next
round of incoming cash flows from new investor subscriptions and from the existing in-
vestments are not expected to occur for approximately three months.
a. Briefly explain the details of two investment strategies that employ derivative instru-
ments that would allow you to take advantage of the anticipated market rally.
b. What are the benefits and potential risk factors for undertaking these derivative
strategies in lieu of direct cash-oriented investments?
Question 2:
You are the chief financial officer of a large multinational company, and six months
from now you will be receiving a settlement payment of $50 million, which you plan to
invest in 10-year U.S. Treasury bonds. Your interest rate forecast indicates that the yield
curve will drop dramatically in the next two quarters. You are considering ways that you
can guard against the possible decline in interest rates before you have the funds avail-
able to invest.
a. Briefly describe the hedging strategy using the 10-year Treasury note futures contract
that would provide the best protection against this possible decline in yields.
b.Suppose that six months after you have entered into a futures contract as suggested in
Part a interest rates increases in the market actually increase substantially due to an unexpected change in monetary policy. Discuss how this increase in interest rates will
affect the futures position you entered into.
c.Discuss whether you would have been better off (1) with the hedge position or (2)
without the hedge position in this situation.
Question 3:
Techno-Logical Inc. is a smart-phone manufacturer and has issued a five-year discount
note in the amount of 160 million Japanese yen for procurement from its suppliers in
Japan. Techno-Logical wants to hedge its currency exposure and the firm’s financial di-
rector has the following suggestions.
(a) At-the-money Japanese yen call option contracts;
(b) Japanese yen forward contracts; or
(c) Japanese yen futures contracts.
Explain the exact way in which the company could use any of these products in their
hedging strategy, being sure to compare and contrast the advantages and disadvantages
of each.
Question 4:
Most money managers have a portion of their compensation tied to the performance of
the portfolios they manage. Explain how this arrangement can create an ethical dilemma
for the manager.