Financial Markets and Institutions Report: Hedging and Swap Analysis

This report addresses a financial markets and institutions assignment focusing on risk management strategies for an Asian bank in response to rising interest rates. The solution analyzes the potential impact of interest rate changes on existing borrowers and bond holdings, proposing adjustments to lending norms and bond portfolio management. It also covers hedging strategies using futures contracts, determining whether to go short or long, and calculating the number of contracts needed for a macro hedge. The report includes detailed calculations to verify how changes in the futures position offset the changes in the cash balance sheet. Finally, the optimal swap value is determined, providing a comprehensive analysis of the financial instruments and strategies involved.

FINANCIAL MARKETS AND INSTITUTES
STUDENT ID:
[Pick the date]

Question 1
It is evident from the article that the interest rates are expected to rise. As a result, it would be
difficult for the existing borrowers to meet their debt obligations. In wake of the potential
increase in credit risk, I would alter the lending norms so that the businesses that are
vulnerable are given credit only if stringent screening criteria are met. Further, with respect to
the current borrowers, a watchlist would be created for the accounts which can potentially
default on the repayments and attempts would be made to recover the loan amount at the
earliest. Also, rising interest rates would have adverse impact on the prices of the bonds. As a
result, bond holdings would be trimmed and also the duration of the holdings would be made
short so as to reduce the adverse impact of higher interest rates on bond prices (Arnold,
2015).
Question 2
a) Hedging would involve assuming position that would offset the position taken under the
futures contract so as limit the underlying risk. Based on the relevant facts, it is evident
that for hedging their position the future contracts should be sold. With an increase in the
interest rate, the value of both the equity and future contract would decrease. However, it
is essential that the bank should proceed with buyback of future to ensure the gains by
balancing the decrease in equity (Brealey & Myers, 2016).
(b) Number of contracts which are necessary to fully hedge the bank needs to find.

(c) Change in the future position for change in the offset in the given cash balance sheet for
market interest rate change of plus 100 basis and minus 50 basis points
Increase in rates (100 basis points) would create the following change in cash balance sheet
position.
The sold contracts could be repurchased for a gain of $3,313,98625. The total of the above
two values will be the net gain of $41,258.98.
Decrease in rates (50 basis points) would create the following change in cash balance sheet
position.
The sold contracts could be repurchased for a gain of $1,656,993 The total of the above two
values will be the net gain of $20,629.49.
Question 3
Optimal swap value needs to be determined here.
NS =
( DA −k DL
A )
D¿−DFloating
Where,
NS =Optimal Swap=?
DA =Duration period of the assets=9 years

k =0.9
DL=Duration period of theliabilities=3 years
A=Total assets=$ 500 million
D¿=¿ duration period=6 years
DFloating=Floating duration period=2 years
Hence,
NS =
( DA −k DL
A )
D¿−DFloating
= ( 9−(0.9∗3)
500 )
6−2 =$ 785.5 million
Therefore, the optimal swap value would be $785.5 million.

References
Arnold,G. (2015). Corporate Financial Management (3rded.). Sydney: Financial Times
Management.
Brealey, R., & Myers, S., (2016). Principles of Corporate Finance (9thed.). New York:
McGraw –Hill.