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Unformatted text preview: UNIVERSITY OF ESSEX DEPARTMENT OF ECONOMICS Session 2011–12 R. E. Bailey EC372 Economics of Bond and Derivatives Markets Exercise 4: Futures Markets: III Applications 1. Your company has arranged to borrow £5m for six months beginning today. The interest rate for the first three months has been agreed but the rate for the second three months will be determined (in relation to the London Interbank Offered Rate, LIBOR) in three months time. Explain to your boss how short term interest futures could be used to hedge the interest rate risk. What considerations would determine whether you recommend that the hedge be undertaken? 2. A bank has agreed with one of its clients that six months from today the client will purchase a specified portfolio of shares from the bank, for which the client will pay a specified sum (i.e. fixed price per share) when the bank delivers the shares. The bank now instructs one of its traders to hedge the uncertainty incurred in the agreement with its client....
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