Risk Management

This document discusses risk management strategies for managing exchange rate and interest rate risks. It covers topics such as calculating forward rates, assessing the efficiency of future contract hedges, and protecting returns with forward rate agreements. The document also provides examples and calculations for better understanding.

Running head: RISK MANAGEMENT
Risk Management
Name of the Student:
Name of the University:
Authors Note:

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Table of Contents
1.i) Calculating the over the counter forward rates for each payment:......................................2
2) Showing how currency future hedges can affect the exchange rate uncertainty:..................3
3) Assessing the efficiency of the future contract hedges:.........................................................4
4) Showing how an arbitrageur could profit:.............................................................................5
5) Discussing the relevant merits for Mahoney of the over the counter and exchange traded
methods:.....................................................................................................................................5
1) Calculating the price for zero coupon bond listed:................................................................5
2) Specifying the swaps rates assuming the counterparty bank deals:.......................................6
3) Comparing the swap rates with the current variable rate:.....................................................6
Therefore, 0.56% will be benefited by using the fixed cost in comparison to the variable cost.
Therefore, entering the swap trade would benefit the organisation, as its overall debt
payments would be reduced due to the low level of interest rates.............................................7
4) Explaining the interest rate risk can hedge and discuss factors like to influence the decision
to hedge or not:...........................................................................................................................7
5) Stating how the bank can protect its return by entering into the forward rate agreements:. .8
References:...............................................................................................................................10

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Task 1: Exchange Rate Risk Management:
1.i) Calculating the over the counter forward rates for each payment:
Mahoney chemicals plc has high risk from the currency market, as the organisation is
set to receive payments in future. Moreover, the payments would be in dollars, which needs
to be converted in pounds, as it is the home currency of the company. Therefore, adequate
hedge can be conducted for reducing the negative impact on the currency exposure of
Mahoney. Hence, the following hedges are conducted for future payments that would be
received by Mahoney.
Payment in future
 $1.2 million on 27th March 2019
Buying $1.2 million using the present value method
¿ 1,200,000
¿¿
Buying the sterling 1,197,782.77 at (1/1.3321=0.75069)
= 1,197,782.77 x 0.75069
= 899,168.81
Opportunity cost = 899,168.81 x (1+ 0.83 %
365/28 )
= 899,741.32
One-month forward rate = £ 877,741.32
$ 1,200,000 =$ 0.749784434
 $2.3 million on 26th April 2019
Buying $2.3 million using the present value method

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¿ 2,300,000
¿ ¿
Buying the sterling 2,290,773.27 at (1/1.3321=0.75069)
= 2,290,773.27 x 0.75069
= 1,719,670.65
Opportunity cost = 1,719,670.65 x ( 1+ 0.93 %
365/58 )
= 1,722,211.99
three-month forward rate = £ 1,722,211.99
$ 2,300,000 =$ 0.748787824
 $3.7 million on 26th June 2019
Buying $3.7 million using the present value method
¿ 3,700,000
¿ ¿
Buying the sterling 3,668,832.25 at (1/1.3321=0.75069)
= 3,668,832.25 x 0.75069
= 2,754,171.80
Opportunity cost = 2,754,171.80 x (1+ 1.09%
365/119 )
= 2,763,959.29
Six-month forward rate = £ 2,763,959.29
$ 3,700,000 =$ 0.747016025
2) Showing how currency future hedges can affect the exchange rate uncertainty:
 The contract of 17th April 2019 can be purchased for the payment in 27th March 2019,
as the previous contract would be over before 7 days to maturity. Hence, the contract
payment of 1.3340 will be conducted at the month of April.

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 The contract of 15th May 2019 can be purchased for can be purchased for the payment
in 26th April 2019, as the previous contract would be over before 9 days to maturity.
Hence, the contract payment of 1.3360 will be conducted at the month of May.
 The contract of 17th July 2019 can be purchased for can be purchased for the payment
in 26th June 2019, as the previous contract would be over before 7 days to maturity.
Hence, the contract payment of 1.3410 will be conducted at the month of July.
3) Assessing the efficiency of the future contract hedges:
Amount in 27th March 2019 = $1.2 million
GBP/USD Spot rate = 1.3905
Appreciation of £ against $ = 1,200,000 x (1/1.3905)
Appreciation of £ against $ = 862,998.92
Gain on money market hedge = 899,741.32 – 862,998.92
Gain on money market hedge = 36,742.40
Future price = $1.3917
Contract price = 1.3340
Contract size = 19
Loss in future contract hedge = (1/1.3917) – (1/1.3340)
Loss in future contract hedge = -0.03108 x 19 x 62,500
Loss in future contract hedge = -37,295.43
Total loss = 36,742.40 - 37,295.43 = -533.03

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4) Showing how an arbitrageur could profit:
Exchange rate = 1,000,000 × (1+ (2.38 %)
12 )=1,001,983.33
1,000,000 ×1.3316=1,331,600
Value of amount in future = 1,331,600 × (1+ 0.83 %
12 )=1,332,521.02
One-month forward rate = ( 1,332,521.02
1.3300 )=1,001,895.51
Arbitrage loss = 1,001,895.51−1,001,983.33=−87.83
5) Discussing the relevant merits for Mahoney of the over the counter and exchange
traded methods:
The analysis of the overall hedging strategies has directly helped in eliminating the
currency risk faced by the organisation. From the relevant evaluation, it can be detected that
that there was a loss from market hedge of -533.03. Moreover, the total future contract used
for the calculation is 19 instead of 19.20. The arbitrage calculation has also indicated a loss of
-87.83, due to the changes in the exchange rate. Therefore, borrowing the money would not
benefit the organisation (Bessis 2015).
Task 2: Interest Rate Risk Management:
1) Calculating the price for zero coupon bond listed:
Table 4: Zero-Coupon Bond Yields
Maturity
Date Yield (%) Bond price
27-Aug-19 0.76% 100.00
27-Feb-20 0.77% 100.00
27-Aug-20 0.77% 100.00
27-Feb-21 0.78% 100.00
27-Aug-21 0.79% 100.00
27-Feb-22 0.80% 100.00

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2) Specifying the swaps rates assuming the counterparty bank deals:
Particulars Value
LIBOR rate 6 month 0.9471%
Semiannual swap
rate 0.4736%
Swap rate spread 0.0200%
S 0.4936%
S1 0.4536%
Swaps can be used by Mahoney for adequately minimising the extra expenses and
save on the relevant interest payments, which needs to be conducted over time. Therefore,
using the swaps can be beneficial for Mahoney to minimise their expenses. The Par coupon
rate would only allow Mahoney to fix the relevant interest payments, while reduce the
implications of the variable interest rates.
3) Comparing the swap rates with the current variable rate:
Mahoney and the Bank Counterparty Swap
Period 1 2 3 4 5 6
Debt (%) -0.2367-0.9 −0.909
−0.9
−Libor1,1.5
−0.9
−Libor1.5,2
−0.9
−Libor2,2.5
−0.9
−Libor2.5,3
−0.9
Swap (%) -0.2367-0.4939 0.909
−0.4939
Libor1,1.5
−0.004939
Libor1.5,2
−0.004939
Libor2,2.5
−0.004939
Libor2.5,3
−0.004939
Net (%) -1.39357 -1.39357 -1.39357 -1.39357 -1.39357 -1.39357
Particulars Value
LIBOR rate 6 month 0.9471%

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Coupon rate 2.40%
Current payment in bond 3.35%
Fixed payment 2.78713%
Savings on payment 0.56%
Therefore, 0.56% will be benefited by using the fixed cost in comparison to the
variable cost. Therefore, entering the swap trade would benefit the organisation, as its overall
debt payments would be reduced due to the low level of interest rates.
4) Explaining the interest rate risk can hedge and discuss factors like to influence the
decision to hedge or not:
Mahoney and the Bank Counterparty Swap
Period 1 2 3 4 5 6
Debt (%) -0.2367-0.9 −0.909
−0.9
−Libor1,1.5
−0.9
−Libor1.5,2
−0.9
−Libor2,2.5
−0.9
−Libor2.5,3
−0.9
Swap (%) -0.2367-0.4939 0.909
−0.4939
Libor1,1.5
−0.004939
Libor1.5,2
−0.004939
Libor2,2.5
−0.004939
Libor2.5,3
−0.004939
Net (%) -1.39357 -1.39357 -1.39357 -1.39357 -1.39357 -1.39357
The calculation indicated that the annual loan interest on fixed loan is 2.78713%.
Moreover, the changes in the interest rate is cancelled with the Libor payments. Therefore, it
could be assumed that the company will benefits from the SWAP agreement, as total
reduction in interest rate is 0.56% (Hopkin 2018).

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5) Stating how the bank can protect its return by entering into the forward rate
agreements:
Mahoney and the Bank Counterparty Swap
Period 1 2 3 4 5 6
Swap
(%)
0.4939
−0.2367
*
0.4939−Libor0.5,10.4939
−Libor0.5,1
0.4939
−Libor0.5,1
0.4939
−Libor0.5,1
0.4939
−Libor0.5,1
FRA
(%)
0 Libor0.5,1−0.3413Libor0.5,1−0.4075Libor0.5,1−0.4668Libor0.5,1−0.5254Libor0.5,1−0.5799
Net
(%)
0.256865 0.152265 0.086065 0.026765 -0.031835 -0.086335
Net
Cash
(£)
25686.5 15226.5 8606.5 2676.5 -3183.5 -8633.5
¿ 0.256865
( 1+ 0.7590 ) 0.5 + 0.152265
( 1+0.7690 )1 + 0.086065
( 1+0.7726 ) 1.5 + 0.026765
( 1+0.7808 ) 2 − 0.031835
( 1+ 0.7627 ) 2.5 − 0.086335
( 1+ 0.7999 ) 3
¿ 0.2559+0.1511+0.0851+0.0264−0.0312−0.0843=0.4029=40.29 basis points
Therefore, profit of 40.29 basis point is generated in three years.

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References:
Bessis, J., 2015. Risk management in banking. John Wiley & Sons.
Hopkin, P., 2018. Fundamentals of risk management: understanding, evaluating and
implementing effective risk management. Kogan Page Publishers.