FIN4480 International Risk Management Coursework 2019

Introduction

On 27th February 2019 UK company Mahoney Chemicals Plc signed a contract to supply polypropylene
fabrics to an American company. Under the financial terms of the agreement, Mahoney was set to
receive payment in three instalments of US dollars. The payments were set to occur on the following
dates:

1. $1.2 million on 27th March 2019

2. $2.3 million on 26th April 2019
3. $3.7 million on 26th June 2019

Mahoney also has US dollar-denominated trade debts and plans to use proceeds from the
polypropylene fabric sale to pay these suppliers. The company’s Treasury has budgeted for estimates
that 30% of the March payment to be held on account to pay creditors, 20% of the April payment and
50% of the June payment.

Two years ago (27th February 2017) Mahoney borrowed £156 million via a five-year floating-rate, non-
callable, note issue. The notes were sold at par (£100) and offer a coupon rate of £LIBOR plus 240
basis points. Interest is payable semi-annually on 27 th February and 27th August. The coupon rate is
based on the six-month £LIBOR at the start of each payment cycle.

Task 2: Interest Rate Risk Management

1. Calculate:

i. The prices of the zero-coupon bonds listed in Table 4

ii. The par coupon rates
iii. The six month and annualised forward rates from the current yields

2. Use the par coupon results to explain how Mahoney can use a swap to transform the remaining
interest payments on the loan from variable rate to fixed rate payments. Specify the swap rate
assuming the counterparty bank deals on the basis of a swap spread of +/- four basis points.

3. Compare the swap rate with the current variable rate on Mahoney’s debt and outline the terms of
the first settlement payment.

4. Explain the interest rate risk that Mahoney can hedge and discuss factors likely to influence the
decision, to hedge or not.

[The discussion should focus on the specific market circumstances that Mahoney is operating in
and not rely on general statements]
5. Show how the bank can protect its return by entering into forward rate agreements.

Market Data on 27th February 2019

GBP/USD Spot Rate (Bid-Ask Spread): $1.3316 - $1.3321

Table 1: Money Market Interest Rates (%)

One Month Three Month Six Month One Year
Sterling 0.73 - 0.83 0.83 - 0.93 0.94 - 1.09 1.07 - 1.22
Dollar 2.38 - 2.68 2.50 - 2.80 2.57 – 2.87 2.74 – 3.04

Table 2: Sterling LIBORs (%)

One Month Three Month Six Month One Year
0.729 0.860 0.995 1.136

Table 3: GBP/USD Currency Futures Prices (Contract Size £62,500)

Delivery Date Price ($ per £)
th
20 March 2019 1.3331
17th April 2019 1.3340
th
15 May 2019 1.3360
19th June 2019 1.3384
th
17 July 2019 1.3410

Table 4: Zero-Coupon Bond Yields

Maturity Date Yield (%)
th
27 August 2019 0.7590
27th February 2020 0.7690
27th August 2020 0.7726
27th February 2021 0.7808
27th August 2021 0.7927
27th February 2022 0.7999