Practice Questions

Question 1

You are a Mutual Fund manager who is currently managing a portfolio of Malaysian equities worth
RM150 million with a beta of 1.70. However, you foresee that the stock market would have higher
market volatility due to the uncertainty over the outcome of the 15 th General Election. Thus, you would
like to hedge against the uncertainty of the market in the next month.

You have obtained the following information:

Bursa Malaysia KLCI Index : 1,487

1-month Bursa Malaysia KLCI Index : 1,498
Multiplier : RM50
Interest rate : 4% per annum
Dividend yield : 7% per annum
Initial margin : 20% per trade amount
Maintenance margin : 60% of the initial margin

Assume that the futures will expire at the end of the contract month, and the number of days per calendar
year is 360.
Note: Round your answers (number of contracts, and payoff figures) to the nearest number.

Required:

(a) Based on the information above, explain how to hedge against your risk exposure with an
appropriate strategy and determine the number of contracts needed. (5 marks)

Suggested answer Marks

A fall in the market price would be harmful to the portfolio of Malaysian 2
equities, short the KLCI index futures would be appropriate.
3
RM 150,000,000× 1.70
=3,430 contracts
50 ×1,487

(b) Assume that the KLCI Index decreases by 20%, compute the payoff based on your strategy in
part (a) above. (5 marks)

Suggested answer Marks

Action Today’s value Maturity’s value P/L (RM)

(RM) (RM)
Portfolio (150,000,000) 99,000,000 (51,000,000) 1
Short 3,430 256,907,000 (204,016,400) 52,890,600 1
contracts
Dividend 875,000 1
Nett 2,765,600 2
 Working
Today’s value:
Short 3,430 Bursa Malaysia KLCI futures: 3,430 x 1,498 x 50 =256,907,000

Maturity’s value:
Portfolio = 150,000,000 [1-0.2 X 1.70]= RM99,000,000
Bursa Malaysia KLCI futures=3,430 X (1,487 X 0.8) X 50 =204,016,400
Dividend =150,000,000 X 0.07 X 30/360 = 875,000

(c) Based on your futures position in part (a) above, fill in the table below and justify the price level
that you will receive a margin call: (9 marks)

Day 1-month Bursa Adjustment (RM) Balance (RM)

Malaysia KLCI
Index
0 1,498 51,381,400
1 1,480 3,087,000 54,468,400
2 1,510 (5,145,000) 49,323,400
3 1,470 6,860,000 56,183,400
4 1,400 12,005,000 68,188,400

Suggested answer Marks

Initial margin = 256,907,000X 0.2 = 51,381,400 1
Maintenance margin = 51,381,400 X 0.6 = 30,828,840 1

Price will receive margin call:

(1,498-A) X 50 X 3,430 = - (51,381,400 – 30,828,840) 2
(1,498- A) = -119.84
A = 1,498 + 119.84 = 1,617.84
You will not receive margin call in any day above because the price never rises 1
above 1,617.84.

From the table above:

(1,487-1,480) X 50 X 3,430 = 1,200,500
Day 1: Adjustment (0.5 marks); Balance (0.5 marks) 4
Day 2: Adjustment (0.5 marks); Balance (0.5 marks)
Day 3: Adjustment (0.5 marks); Balance (0.5 marks)
Day 4: Adjustment (0.5 marks); Balance (0.5 marks)

(d) Identity the THREE (3) players and their objectives in the derivatives market. (6 marks)

Suggested answer Marks

1) Hedger 1
Objective: To reduce the risk exposure 1
2) Arbitrageur 1
Objective: To profit from mispricing 1

3) Speculator 1
Objective: To trade based on expectation 1
Question 2

The following are the spot exchange rates of foreign currency pairs:

Forex pair Bid Offer

AUD/USD 0.6748 0.6761
EUR/GBP 0.8590 0.8607
AUD/JPY 93.86 94.05
EUR/JPY 144.56 144.85
USD/CAD 1.3375 1.3402

Required:

(a) Kelvin, a businessman from Australia, would like to transfer USD200,000 to his headquarters in
Australia.

Determine how much AUD will Kelvin receive in the current account of his headquarters for the
transfer above. (2 marks)

Suggested answer Marks

2
USD 200,000 /0.6761=AUD 295,814.23

(b) David, a tourist from Canada, would like to convert CAD3,000 to AUD for his trip expenditure in
Australia.

Determine how much AUD will David receive. (4 marks)

Suggested answer Marks

Convert CAD to USD 2
CAD 3,000
=USD 2,238.47
1.3402

Convert USD 2,238.47 to AUD 2

USD 2,238.47 /0.6761=AUD 3,310.86

(c) GPS Inc, a smart watch company in the United States, would like to import 10,000 pieces of
smart watches at a price of JPY27,820 each from Alikado Co.

Determine the amount in USD that GPS Inc. would need for the purchase. (6 marks)

Suggested answer Marks

10,000 X JPY 27,820 = JPY 278,200,000 2

JPY 278,200,000/ 93.86 = AUD 2,963,988.92 2

AUD 2,963,988.92 X 0.6761 = USD2,003,952.91 2

(d) Based on the above information, compute the bid rate and offer rate for EUR/AUD. (4 marks)

Suggested answer Marks

Bid rate
EUR/AUD = Bid EUR/JPY / Offer AUD/JPY = 144.56 / 94.05= 1.5371 2

Offer rate
EUR/AUD = Offer EUR/JPY X Bid AUD/JPY = 144.85 X 93.86 = 1.5433 2

(e) Explain THREE (3) types of interbank dealers in the foreign exchange market. (9 marks)

Suggested answer Marks

 The structural trader 1

 Structural traders (also referred to as “strategic dealers”) are those who 2

take long term or “structural” positions. Such positions are often sizeable
and as such highly risky in that the profits and losses can both be
substantial.

 Structural positions are taken by the more experienced dealers, including

Senior or Chief Dealers and Treasury Managers. Due to the natural of
their busy work schedules, they do not have time to “sit behind the desk”
to trade.

 As such these dealers take and “sit” on longer term positions.

 The positioner 1

 A positioner or a day-trader is a dealer who takes a slightly longer-term 2

view of the market.

 Unlike jobber, a positioner does not move quickly in and out of the
market, but “positions” himself with a view to profit from favourable
price movement.

 Positioner’s techniques evolves around studying the markets, looking at

charts, reading the news and deciding whether to go “long” or “short” in
a particular currency during the trading day.

 Unlike jobber, the positioner relies on less trading frequency, but goes
for bigger profit margins.
  The jobber or scalper 1

 Jobbers are mainly short-term traders who move in and out of the market
to reap a small profit. 2

 In general, a jobber cannot expect to make profit on every deal. Out of

10 trades, he may make profit on six or seven trades and lose on the
remaining three or four deals. But at the end of the day, his performance
is judged by the profits that he generates over a period of time.

1 mark for main point and 2 marks for any TWO (2) explanation above.

[Total: 25 marks]