Practice - Tribeca Case Scenario

Exhibit 1.

Equity Futures Data

S&P 500 E-Mini Futures One-Month Contract Price	US$3,000
S&P 500 E-Mini Futures Multiplier	US$50
FTSE IDX One-Month Futures Contract Price	£7,300
FTSE IDX Contract Multiplier	£10
UK Fund to FTSE Beta	1.1

Stuyvesant also wants to be prepared to answer general questions from the committee on the economy and financial markets. One member always asks her view on what the Federal Reserve Board (Fed) rate move is expected to be at the upcoming Federal Open Market Committee (FOMC) meeting. Stuyvesant prefers to infer the likely move from the market pricing of Fed funds futures. The current federal funds rate is 1.88%, and the Fed futures contract is priced at 98.33.

Which statement will Stuyvesant most likely make to the committee regarding expectations for the upcoming FOMC meeting? There is a(n):

1. A.84% probability of a 25 bp cut in the federal funds rate at the next meeting.

2. B.98% probability of a 25 bp hike in the federal funds rate at the next meeting.

3. C.100% probability of a 21 bp cut in the federal funds rate at the next meeting.

Stuyvesant plans to transition £10 million from a UK equity fund to a US$8 million US index fund, which have benchmarks of the FTSE 100 Index and S&P 500 Index, respectively.

The committee has been concerned that because of uncertainty surrounding Brexit, there could be downside risk to the UK fund, but the fund cannot be liquidated for one month.

Stuyvesant proposes using equity futures contracts to convert the FTSE equity risk into S&P 500 equity risk during the transition.

Her analysis, based on the data in Exhibit 1, focuses on the equity derivatives transactions because the currency risk is hedged separately as part of an overlay program.

Exhibit 1.

Equity Futures Data

S&P 500 E-Mini Futures One-Month Contract Price	US$3,000
S&P 500 E-Mini Futures Multiplier	US$50
FTSE IDX One-Month Futures Contract Price	£7,300
FTSE IDX Contract Multiplier	£10
UK Fund to FTSE Beta	1.1

Based on the data in Exhibit 2, what equity futures trades would Stuyvesant most likely implement to achieve her target equity risk exposures?

1. A.Sell 150 FTSE IDX futures contracts and buy 53 S&P 500 E-mini futures contracts.

2. B.Sell 110 FTSE IDX futures contracts and buy 74 S&P 500 E-mini futures contracts.

3. C.Sell 110 FTSE IDX futures contracts and buy 67 S&P 500 E-mini futures contracts.

US = 3000*50 = 150000

UK = 7300*10 = 73000

buy 8m / 150000 = 53

sell 10m / 73000 = 124.5 ?

wrong - should times 1.1, instead of / 1.1

meaning UK Fund is 1.1 beta to FTSE, you need more FTSE to hedge UK Fund as UK Fund moves 1.1 larger than FTSE

Tribeca Case Scenario

Chelsea Stuyvesant is treasurer of the Tribeca Company, where she is responsible for oversight of the defined benefit pension plan.

She uses a number of outside investment firms to manage equity and fixed-income strategies for the plan but also implements some trades on her own.

Her trades are focused on ensuring that asset allocation remains in line with the investment policy statement and that liabilities are hedged in a manner that reduces funded status volatility and therefore minimizes the impact on Tribeca’s financial results.

Stuyvesant is due to provide an update to the plan’s investment committee at an upcoming meeting and prepares several slides to illustrate her recent trades.

The fixed-income assets of the plan include US$10 million invested in one-year US Treasury bonds.

Stuyvesant’s evaluation of global bond and currency markets indicates that she can increase the yield on the portfolio by selling the Treasury bond position and buying Japanese government bonds of the same maturity.

The data she uses for her assessment show that the US bonds pay 1.75% and Japanese bonds pay –0.40% annualized.

She plans to fully hedge the currency risk. The YEN/USD spot rate is 106.85, the one-year YEN/USD forward rate is 104.15, and the one-year YEN/USD cross currency swap basis is –0.63.

Does Stuyvesant’s proposal to buy Japanese bonds most likely increase the yield on the portfolio?

1. A.Yes, it increases the yield.

2. B.No, because the yen appreciation does not compensate for the lower Japanese rate.

3. C.No, because paying the basis would further erode the return on the Japanese government bonds.

Solution

A is correct. Stuyvesant can sell US$10,000 converted at a spot rate of 106.85 to invest proceeds of ¥1,068,500 at –0.40%. After one year, the Japanese bonds are sold (1,068,500 × 0.9960 = 1,064,226.00) and converted at the forward rate of 104.15, for proceeds of US$10,218.20. The fund has earned 10,218.20/10,000 – 1 = 2.18%. The 2.18% yield is higher than the 1.75% she could have earned in US Treasury bills. The difference is due to the basis given a high demand for US dollars.

B is incorrect. The exchange rate reflects not only the interest rate differential implied by interest rate parity but also receiving the basis.

C is incorrect. Stuyvesant is actually receiving the basis for lending US dollars.

Swaps, Forwards, and Futures Strategies Learning Outcome

1. Demonstrate how interest rate swaps, forwards, and futures can be used to modify a portfolio’s risk and return

ChatGPT - https://chatgpt.com/c/3fd804b3-4ab2-435c-8ccf-88367c69e7c1

(only correct 2nd question, but explanation okay after adjustments)