Data Analysis Set III Chapter 11 Problems 2, 3 (page 287) 2. A bank sells a “three against six” $3,000,000 FRA for a three-month period beginning three months from today and ending six months from today. The purpose of the FRA is to cover the interest rate risk caused by the maturity mismatch from having made a three-month Eurodollar loan and having accepted a six-month Eurodollar deposit. The agreement rate with the buyer is 5.5 percent. There are actually 92 days in the three- month FRA period. Assume that three months from today the settlement rate is 4 7/8 percent. Determine how much the FRA is worth and who pays who--the buyer pays the seller or the seller pays the buyer. Solution: Since the settlement rate is less than the agreement rate, the buyer pays the seller the absolute value of the FRA. The absolute value of the FRA is: $3,000,000 x [(.04875-.055) x 92/360]/[1 + (.04875 x 92/360)] = $3,000,000 x [-.001597/(1.012458)] = $4,732.05. 3. Assume the settlement rate in problem 2 is 6 1/8 percent. What is the solution now? Solution: Since the settlement rate is greater than the agreement rate, the seller pays the buyer the absolute value of the FRA. The absolute value of the FRA is: $3,000,000 x [(.06125-.055) x 92/360]/[1 + (.06125 x 92/360)] = $3,000,000 x [.001597/(1.015653)] = $4,717.16. Chapter 12 Problem 1 (page 311) 1. Your firm has just issued five-year floating-rate notes indexed to six-month U.S. dollar LIBOR plus 1/4%. What is the amount of the first coupon payment your firm will pay per U.S. $1,000 of face value, if six-month LIBOR is currently 7.2%? Solution: 0.5 x (.072 + .0025) x $1,000 = $37.25. Chapter 13 Problem 1 (page 335) 1. On the Milan bourse, Fiat stock closed at EUR5.84 per share on Thursday, March 3, 2005. Fiat trades as and ADR on the NYSE. One underlying Fiat share equals one ADR. On March 3, the $/EUR spot exchange rate was $1.3112/EUR1.00. a. At this exchange rate, what is the no-arbitrage U.S. dollar price of one ADR? b. By comparison, Fiat ADRs closed at $7.61. Do you think an arbitrage opportunity exists? Solution: a. The no-arbitrage ADR U.S. dollar price is: EUR5.84 x $1.3112 = $7.66. b. It is unlikely that an arbitrage opportunity exists after transaction costs. Additionally the slight difference in prices is likely accounted for by a difference in information contained in prices since the ADR market in New York closed several hours after the Milan bourse.