INDIVIDUAL ASSIGNMENT Case Solution And Analysis, HBR Case Study Solution & Analysis of Harvard Case Studies

INDIVIDUAL ASSIGNMENT Case Solution

Q1
a).
The interest rates expressed in actual/365 days count would be as follows:
Tenor Rate Start date End Date
0X3 0.004371788 1/11/2016 11/4/2016
0X6 0.004521336 1/12/2016 11/7/2016
0X9 0.004804515 1/13/2016 10/10/2016
0X12 0.005087694 1/14/2016 1/10/2017
0X15 0.005278711 1/15/2016 10/4/2017
0X18 0.005145385 1/16/2016 10/7/2017
0X21 0.005089925 1/17/2016 10/10/2017
0X24 0.005110507 1/18/2016 10/1/2018

b).
The annually compounded interest rate is as follows:
Formula: (1+1/n)^nt
Tenor Annually compounded interest rate Start date End Date Actual days
0X3 1.00071736 11/1/2016 11/4/2016 60
0X6 1.00259891 11/1/2016 11/7/2016 210
0X9 1.00394736 11/1/2016 10/10/2016 300
0X12 1.00795679 11/1/2016 1/10/2017 570
0X15 1.00651223 11/1/2016 10/4/2017 450
0X18 1.00762200 11/1/2016 10/7/2017 540
0X21 1.00880188 11/1/2016 10/10/2017 630
0X24 1.01010641 11/1/2016 10/1/2018 720

c).
The continuously compounded interest rate is as follows:
Formula = e^rt
Tenor Continuously Compounded Interest Rate Start date End Date Actual days
0X3 0.001953578 11/1/2016 11/4/2016 60
0X6 0.007071419 11/1/2016 11/7/2016 210
0X9 0.010734735 11/1/2016 10/10/2016 300
0X12 0.021598141 11/1/2016 1/10/2017 570
0X15 0.017691347 11/1/2016 10/4/2017 450
0X18 0.020693412 11/1/2016 10/7/2017 540
0X21 0.023882095 11/1/2016 10/10/2017 630
0X24 0.027404190 11/1/2016 10/1/2018 720

d).
The formula and the calculations are as follows:
Formula: FRA rate *(days/basis)/1+(reference rate*days/basis)
Tenor Rate Start date End Date Actual days
3x6 0.01036059 11/4/2016 11/7/2016 90
6x9 0.01572554 11/7/2016 10/10/2016 90
9x12 0.03163078 10/10/2016 10/1/2017 90
12x15 0.02590202 10/1/2017 10/4/2017 90
15x18 0.03029169 10/4/2017 10/7/2017 90
18x21 0.03496396 10/7/2017 10/10/2017 90
21x24 0.04012258 10/10/2017 10/1/2018 90

e)
The calculations using above formula are as follows:
Tenor Rate Actual days
3x12 0.0316442 90
12x24 0.0063352 90

Q2
a)
The forward contract for the US dollar invoice could be simply constructed by buying in a long position in the forward contract. The price to be locked in the forward contract for the delivery of the US dollars of amount equal to $ 120 million should be 1.4723 Canadian dollars per US dollar. This is the forward price for the September forward contracts, which has been computed in the excel spreadsheet.

Spot Rate 1.4181 C$/US$
Interest Rate in Canada 0.75%
Time to Maturity 5 Months

Forward Price 1.4723

The settlement of this forward contract would occur at the end of the settlement date of the contract which is September 1, 2016. In this case the buyer of the forward contract expects that the currency of US would appreciate therefore, long position has been taken in the forward contracts.
b).
Since the forward price is 5% high therefore, it should be the spot exchange rate at which the payment is expected to occur has been calculated by taking 105% of the forward price. There is certainly an arbitrage opportunity and in order to implement it, the following steps need to be followed:
 At the time of the maturity take a long position at the forward price for the given notional amount.
 At maturity sell the notional amount CAD$ at the prevailing spot rate as calculated.
 Close out the forward contract simultaneously.
 An arbitrage profit of about 0.046 US dollar million has been made as shown in the table below:
ARBITRAGE STRATEGY
Notional amount of trade 1.4181 CAD million
Spot Price 1.4181 C$/US$
Forward Price 1.4723 C$/US$

At Time=0 months
Take long position in forward at price 1.4723 C$/US$

At maturity=5 months
Expected Spot rate 1.5459 C$/US$
Sell Notional Amount to gain Dollars 0.91733 USD Million
Close forward contract 0.963 USD Million
Arbitrage profit 0.046 USD Million.............

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