6. Pico plc has borrowed heavily in euros and is worried about increasing interest rates in...

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6. Pico plc has borrowed heavily in euros and is worried aboutincreasing interest rates in the eurozone. The Finance Directorsuggests that Pico plc should sell futures on French bonds (knownas OATs or Obligations Assimilables du Trésor). a. Explain whyselling a futures contract on French bonds would reduce the effectof an increase in euro interest rates. b. Pico sells afutures contract on bonds for €1,010 calculate the daily paymentsand receipts on the futures contract given the following bondprices: Day 1 Day 2 Day 3 Day 4 Day 5 €1,010 €1,005 €1,001 €1,006€1,009 c. Explain why the market insists on dailysettlement. The Finance Director also offers twoalternatives: d. One alternative is to engage in an interest rateswap. Explain how this might work. e. The otheralternative is to purchase a PUT contract on euro denominatedbonds. Calculate the net profit or loss per unit on a put optioncontract with a strike price of €1,008 with a premium of €4.00 forthe following maturity prices: €985, €1,000, €1,015 and €1,020 f. Explain how the option contract in part e protectsagainst interest rate rises and how this form of protection differsfrom the futures contract.

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4.3 Ratings (596 Votes)

aInterest rates and bond prices are inversely related That isan increase in interest rates results in a fall in bond prices anda decrease in interest rates results in a rise in bond prices Bondprices and bond futures prices move together because theunderlying asset on the futures is the bond itselfThus if the interest rates increase the bond prices See Answer

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