Please answer the following questions in detail, provide examples whenever applicable, provide in-text citations.
- Explain how companies can hedge risks in their operating costs by using each of the following instruments. Hypothetical examples are required.
- Futures and forward contracts
- Option contracts
- Swap contracts
- Buying one asset and selling another. What is the hedge ratio and how is it determined?
2. The websites of the major commodities exchanges provide futures prices. Calculate the annualized net convenience yield for a commodity of your choice. Retrieve the current risk free rate from the U.S. Government treasury site. (Note: You may need to use the futures price of a contract that is about to mature as your estimate of the current spot price.)
3. You can find spot and futures prices for a variety of equity indexes on www.wsj.com. Pick one and check whether it is fairly priced. You will need to do some research work to find the dividend yield on the index and the interest rate.
4. Define each of the following theories accompanied by equations. Hypothetical examples are required.
a. Interest rate parity.
b. Expectations theory of forward rates.
c. Purchasing power parity.
d. International capital market equilibrium (relationship of real and nominal interest rates in different countries).
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