Interest Rate Risk Hedging and Basis Risk
47 Questions
0 Views

Choose a study mode

Play Quiz
Study Flashcards
Spaced Repetition
Chat to lesson

Podcast

Play an AI-generated podcast conversation about this lesson

Questions and Answers

What is the tick value of the three-month Euro futures contract?

  • €25 (correct)
  • €10
  • €50
  • €100

    • Which month has the highest call option premium for the three-month Euro futures?

  • December
  • June
  • March
  • September (correct)

    • What is one key disadvantage of using an interest rate collar for hedging?

  • It has no minimum return guarantee.
  • It is more expensive than options.
  • It may cap potential gains. (correct)
  • It eliminates all interest rate risk.

    • What impact does basis risk have on hedging strategies?

    <p>It introduces uncertainty into the effectiveness of a hedge.</p> Signup and view all the answers

    If Alecto Co is considering a hedging strategy for a €22,000,000 loan, which factor is most important in the recommendation?

    <p>Market interest rate trends</p> Signup and view all the answers

    In the context of Doric Co's proposals, what is a potential outcome of the leveraged management buyout for the parts division?

    <p>Continued growth in parts division cash flows</p> Signup and view all the answers

    What is the expected growth rate of after-tax cash flows for the new company after the leveraged management buyout?

    <p>3.5%</p> Signup and view all the answers

    Which strike price corresponds to the highest premium for put options in the March contract?

    <p>96.50</p> Signup and view all the answers

    Which of the following input variables are likely to be subject to change over the project's duration?

    <p>All of the above</p> Signup and view all the answers

    What percentage of the project's present value comes from tax shield and subsidy benefits?

    <p>Just over 40%</p> Signup and view all the answers

    How should Tramont Co approach the uncertainty associated with their project inputs?

    <p>Conduct sensitivity analysis to assess the impact of changes</p> Signup and view all the answers

    What could be a potential risk for Tramont Co relating to a change in government?

    <p>Loss of the tax shield and subsidy benefits</p> Signup and view all the answers

    What cultural factor should Tramont Co consider when establishing operations in Gamala?

    <p>The ability to match their systems to Gamalan culture</p> Signup and view all the answers

    What is a real option that Tramont Co should include in its analysis for the project?

    <p>Establishment in Gamala leading to follow-on projects</p> Signup and view all the answers

    What may not significantly impact the present value of the project if remittances are restricted?

    <p>The final year's operational cash flow</p> Signup and view all the answers

    What strategy should Tramont Co consider if they decide to close operations in the USA?

    <p>Assessing other alternatives and implications</p> Signup and view all the answers

    What is the main advantage of using a collar instead of uncovered options to hedge interest rate risk?

    <p>Lower cost</p> Signup and view all the answers

    What type of risk do shareholders holding well-diversified portfolios primarily face?

    <p>Systematic risk</p> Signup and view all the answers

    Which factor may influence whether diversification benefits arise from Tramont Co's investment in Gamala?

    <p>The size of the investment</p> Signup and view all the answers

    What happens to risk when a company diversifies into a market or system where shareholders do not invest?

    <p>Risk is reduced further</p> Signup and view all the answers

    Why might Tramont Co's shareholders benefit from the Gamalan investment?

    <p>If operations mirror local Gamalan companies</p> Signup and view all the answers

    What is the relationship between the premium paid and the premium received when using a collar for hedging?

    <p>The higher premium of the bought option is offset by the lower premium of the sold option</p> Signup and view all the answers

    What may not improve risk diversification for well-diversified shareholders?

    <p>Investing in similar markets</p> Signup and view all the answers

    What aspect will not directly impact Tramont Co’s corporate reputation?

    <p>The success of the financial report</p> Signup and view all the answers

    What is the total amount of funds needed for the management buy-out?

    <p>$286 million</p> Signup and view all the answers

    What is the estimated cash flow before interest payment after depreciation and tax?

    <p>$33.4 million</p> Signup and view all the answers

    How is the estimated value of the new company calculated based on perpetuity?

    <p>$461 million</p> Signup and view all the answers

    What is the estimated excess percentage of the new company’s value compared to the funds invested in the new venture?

    <p>61%</p> Signup and view all the answers

    What amount is assumed to cover current and non-current liabilities?

    <p>$280 million</p> Signup and view all the answers

    What assumption is made regarding future investments in non-current assets?

    <p>No additional investments needed</p> Signup and view all the answers

    What factor is stated as potentially influencing the value of the new company significantly?

    <p>The growth rate and cost of capital</p> Signup and view all the answers

    Through which methods might potential buyers be sought for the new company?

    <p>Open tender or through an intermediary</p> Signup and view all the answers

    Which of the following factors is not typically considered in evaluating a company's management?

    <p>Market share growth</p> Signup and view all the answers

    What financial aspect is included in evaluating a company's management performance?

    <p>Performance in achieving financial targets</p> Signup and view all the answers

    Which of the following is a potential implication of a change in government for a business?

    <p>Change in regulatory framework</p> Signup and view all the answers

    In a financial context, what does 'due diligence' primarily involve?

    <p>Investigating a company's financial health</p> Signup and view all the answers

    What is the primary benefit of risk diversification for a company?

    <p>Lower chances of total loss</p> Signup and view all the answers

    Which financial document would primarily include calculations related to gross redemption yield?

    <p>Bond valuation report</p> Signup and view all the answers

    What is a major disadvantage of using options for hedging?

    <p>Expensive premiums</p> Signup and view all the answers

    Which method is not typically recommended for hedging in financial markets?

    <p>Index fund investment</p> Signup and view all the answers

    In investment terms, what does 'terminal value' refer to?

    <p>Value of an investment at the end of its forecasting period</p> Signup and view all the answers

    When calculating funds required for a Management Buyout (MBO), which aspect is most critical?

    <p>Calculation of the business's value</p> Signup and view all the answers

    Which of the following best describes 'basis risk'?

    <p>The risk that a hedge will not move in line with the price of the hedged item</p> Signup and view all the answers

    What is considered a critical component of a report format in financial evaluations?

    <p>Clear structure and layout</p> Signup and view all the answers

    What is typically the primary objective of management succession planning?

    <p>Ensuring continuity in leadership</p> Signup and view all the answers

    The duration of a bond is used to measure what?

    <p>The sensitivity of the bond's price to changes in interest rates</p> Signup and view all the answers

    Which of the following is not a type of cash flow associated with a capital investment?

    <p>Depreciation expenses</p> Signup and view all the answers

    Study Notes

    Interest Rate Risk Hedging

    • Alecto Co. is considering hedging a €22,000,000 loan.
    • The company is considering using three-month Euro futures, options on Euro futures, or a collar.
    • An interest rate collar is a hedging strategy that involves buying a put option and selling a call option.
    • The main advantage of using a collar is that it is less expensive than using only options. A collar limits an investor’s potential losses and profits.
    • The main disadvantage is that a collar is a less flexible hedging strategy than an option.

    Understanding Basis Risk

    • Basis risk is the risk that the price of the underlying asset will not move in the same direction as the price of the hedging instrument, causing losses.
    • Basis risk can be mitigated by using a hedging instrument with a correlation to the underlying asset.

    Calculating Funds Needed For a Management Buy-Out

    • Doric Co. is considering closing its fridges division and continuing the parts division through a leveraged management buyout.
    • The funds needed for the management buyout are
      • €176 million for current and non-current liabilities
      • €60 million for shareholders
      • €50 million for the new venture.

    Evaluation Factors for a Leveraged Management Buyout

    • Potential buyers will need to be sought through open tender or through an intermediary.
    • Evaluation factors include:
      • Planning and control policies
      • Financial strategies
      • Management succession
      • Manager qualifications and experience
      • Performance in achieving financial and non-financial targets.

    Importance of Diversification

    • If a company diversifies into a new market or system, it may achieve risk reduction, even for shareholders with well-diversified portfolios.
    • The benefits of this depend on the size of the investment and the nature of the business operations undertaken in the new market or system.

    Studying That Suits You

    Use AI to generate personalized quizzes and flashcards to suit your learning preferences.

    Quiz Team

    Related Documents

    ACCA Advanced Financial Management PDF Past Paper

    Description

    This quiz explores key concepts in interest rate risk hedging strategies, including the use of Euro futures, options, and collars. It also delves into the implications of basis risk and how it can affect the effectiveness of hedging instruments. Ideal for finance students and professionals looking to enhance their risk management knowledge.

    More Like This

    Use Quizgecko on...
    Browser
    Open
    Browser
    Browser