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UNIVERSITY COLLEGE DUBLIN

NATIONAL UNIVERSITY OF IRELAND, DUBLIN

MASTER OF SCIENCE (Singapore)

ADVANCED TREASURY MANAGEMENT (FIN4017S)

STUDY GUIDE

MSc 19/20 FT / Singapore

Copyright April 2015

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Authors: Dr. James Kwan (2015)

This manual was prepared for University College Dublin as a comprehensive support for

students completing the above mentioned Degree programme.

This publication may not be reproduced, in whole or in part without permission in from

University College Dublin.

Module Co-ordinator: Dr. James Kwan

Contact details

Office: 6733 1877

Email: james_kwan@singnet.com.sg

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TABLE OF CONTENTS

PAGE

Welcome message 4

1. INTRODUCTION 5 a. Background details 6 b. Module aims 6 c. Programme goals 7

2. MODULE OUTLINE 9 a. Module learning outcomes 9 b. Themes and topics 11 c. Learning supports 12

3. MODULE DELIVERY SCHEDULE 14 a. Session arrangements 14 b. Student engagement 15 c. Meeting hours arrangements 16

4. ASSESSMENT DETAILS 17 a. Module assessment components 18

i. Assignment 1 19 ii. Assignment 2 20

iii. Examination 21

5. GRADING 22 a. University grading policy 22 b. Grade descriptors for assessment components 23

6. CONCLUDING COMMENTS 28

APPENDICES 29

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Welcome message

I am writing to say how pleased I am that you have chosen the MSc (Finance) programme

offered by the National University of Ireland, Dublin. I feel honoured to be your lecturer to

share the knowledge of this challenging and exciting paper with you. You have made an

investment by sacrificing your precious time and money to join my class, and it is of

paramount importance to me to ensure that good intentions end up with good results.

This module will examine the main derivatives employed by MNEs in managing interest rate

risks and investments. You will be supplied with a module pack which contains lecture

handouts, practice questions, and additional readings relevant to the topics to be discussed.

Do be curious and seek to clarify your doubts during or after the lectures as you feel

necessary. There are no penalties for not knowing something during the class. But there are

penalties for not knowing the answers in the examination! Only by asking questions,

determine to understand the concepts thoroughly, apply the concepts by practising the

questions and be bold to make mistakes, then you can achieve your objective.

I am looking forward to meeting you soon.

Dr. James Kwan PhD Finance (UWA), MBR (UWA), MBA (Strathclyde), MBA Investment & Finance (Hull), BAcc (NTU), SDALT, FCA Singapore, FCPA (Aust.), FAIA (Acad), AMA (Aust.), MSID

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PART 1: INTRODUCTION

This Study Guide is designed to provide you with details of the module (FIN4017S:

Advanced Treasury Management), the learning outcomes, delivery and assessment

arrangements. The Study Guide consists of 6 parts.

Part 1 gives background details to the subject area are provided and the broad aims of the

module are set out.

Part 2 consists of the module outline. In this part the (a) module learning outcomes, (b) the

themes and topics to be explored are explained along with the (c) learning supports to be

used.

Part 3 gives details of the module delivery arrangements. It sets out the session

arrangements and the expectations in relation to your prior preparation and student

engagement.

Part 4 provides details of the assessment techniques used in this module explaining the

assessment components, their rationale.

Part 5 explains the UCD grading policy and grade descriptors drawing on the university

document are given for each assessment component (i) Assignment 1, (ii) Assignment 2 and

(iii) Examination (closed book).

Part 6 presents the concluding comments.

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Background details

a. Background to the Topic

From derivatives and investments to global markets, this course covers the application of

derivatives in managing interest rate risks, credit risk and investments. The topics covered in

this module allow students to gain valuable quantitative skills that are in high demand by

employers and also allow them to pursue a range of exciting careers in finance at an

international level. In addition, the topics covered will also enable students to further their

studies via PhD in Finance.

b. Module Aims

The aim of this module is to introduce the derivatives such as futures, options and swaps,

and it gives students opportunity to understand how the derivatives markets work, how they

can be used, and what determines prices in them. Among the topics covered in this module

are: futures markets and stock index futures; interest rate futures; options markets: calls and

puts, the Greeks; introduction to advanced equity derivatives and options strategies; interest

rate and foreign currency swaps; Value at risk; interest rate derivatives; and credit risk.

The module draws on student prior learning and work experience and combines insights

from strategy, corporate finance, international trade and investment theory. The assessment

tasks for this module have been designed with this in mind as detailed later in the study

guide.

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c. Programme Goals

Programme Goal Learning Outcome Advanced Treasury and

Risk Management

Core Business

Knowledge

Our graduates will be

current in business

management theory and

practice.

Employ suitable business & theoretical models in business &

operational problem resolution

Exam

Use discipline specific information to make informed decisions

Exam

Communication Skills

Our graduates will be able

to prepare and present a

short presentation (oral

or written) on a current

business topic or issue.

Synthesise and summarize data / communicate outcomes to

stakeholders

Assignment 2

Select & use appropriate communication strategies to

communicate organizational challenges

Assignment 2

Analytical Skills

Our graduates will be able

to complete industry and

market analysis and

inform the design and

implementation of

appropriate competitive

strategies.

Undertake & present (in written or orally)a detailed analysis of a

core business industry situation

Assignment 2

Utilize appropriate on-line data bases to conduct research on

business environment issues and trends

Assignment 2

Interpret existing or original research using various tools to inform

decision-making

Assignment 1, Exam

Global Perspective and

Cultural Awareness

Our graduates will be able

to appreciate how

economic, political, social

and cultural factors

impact on business

management and related

areas.

Demonstrate an understanding of diverse business perspectives

Exam

Devise and develop plans, strategies and organizational

structures appropriate to operate in the global market place

Exam

Employ appropriate negotiation skills for working with individuals

across differing cultures

Exam

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Lifelong Learning

Our graduates will

possess the ability to

engage in continuous

learning throughout their

career.

Engage in collaborative learning by completing business projects

/assignments in teams

Draw on personal & colleagues cognitive & practical talents to

promote effective & ethical business practice

Assignment 2

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PART 2: MODULE OUTLINE

Module Title: Advanced Treasury Management

Module Code: FIN4017S

No. of ECTS: 7.5

Learning Outcomes

On completing the Advanced Treasury Management module, students should be able to:

provide practical illustrations of hedging various types of financial risk, such as

hedging using stock index futures and interest rate futures;

use of swaps in hedging interest rate and foreign exchange risk;

use of options for investments, static and dynamic portfolio insurance;

use of derivatives to hedge foreign exchange risk;

provide a detailed assessment of the techniques used by financial firms to measure

and monitor market risk (Value at risk)

apply derivatives other than swaps in managing interest rate risk;

appreciate how firms manage credit risk using credit derivatives

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Module Text:

Hull, J.C. (2012), Options, Futures and Other Derivatives, Pearson.

Other References:

Anderson (2006), Global Derivatives: A Strategic Risk Management Perspectives, FT Prentice Hall.

Buckley, A. (2012), International Finance, A Practical Perspective, Pearson.

Cuthbertson, K. & Nitzsche, D. (2001), Financial Engineering: Derivatives and Risk Management, Wiley.

Hull, J.C. (2011), Fundamentals of Futures and Options Markets, Pearson.

Kolb, R. & Overdahl, J.A. (2007), Futures, Options and Swaps, Wiley-Blackwell.

McDonald, R.L. (2013), Derivatives Market, Pearson.

Sundaram, R.K. & Das, S.R. (2011), Derivatives: Principles and Practice, McGraw-Hill.

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Themes and Topics

TOPIC 1

INTRODUCTION TO FUTURES AND OPTIONS

Overview of the futures and options markets

Mechanics of futures markets and hedging strategies using futures

Mechanics of options markets and trading strategies using options

TOPIC 2

BLACK-SCHOLES OPTION PRICING MODEL

Assumptions

Applications of BS model in investments (e.g. real options) and valuation of share options

Limitations

TOPIC 3

THE GREEKS

Delta, Theta, Gamma, Vega and Rho

TOPIC 4

INTEREST RATE RISK AND DERIVATIVES

Sources of interest rate risk

Derivatives used to hedge interest rate risk

TOPIC 5

SWAPS

Currency swap

Interest rate swap

Swaptions

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TOPIC 6

STOCK INDEX FUTURES, CREDIT RISK, VALUE AT RISK

Stock index futures

Credit risk

Value at risk

Learning Supports

For this module, please read the assigned chapters in the prescribed text and the additional

readings assigned (see list below).

Readings from Prescribed Text:

Chapters 1 - 7, 9-10, 14-15, 18, 21, 23, 34

Other Assigned Readings (essential):

The Greeks are coming by Steve Jay, Student Accountant, November/December 2001, pp. 28-39.

Application of Options Pricing to Firm Valuation by Bob Ryan, Student Accountant, November 2009.

The role of options in corporate finance by James Kwan

Swaps by Stewart Maugham, ACCA Students Newsletter, July 1999 pp.54-62.

How lenders set the rates by Bob Ryan, Student Accountant, August 2008, pp. 48-49.

The case for real option made simple by Raul Guerrero

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Students completing the Advanced Treasury Management module are expected to

participate in session discussions and learning activities and be familiar with recent

developments in the business world. To facilitate this, the following source materials are

useful:

o Journal of Applied Corporate Finance

o Pulses

o CFO Magazine

o The Straits Times

o The Financial Times

o Business Week

o Fortune

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PART 3: MODULE DELIVERY SCHEDULE

The module delivery relies on students ability to engage in prior preparation, to seek

confirmation and clarification as appropriate and to be actively engaged during the sessions.

Session Arrangements

Each student is expected to attend and be prepared for all sessions. Table 1 below outlines

the structure for the sessions.

Table 1: Module Delivery Schedule themes, readings, cases

No. Theme /Topic title Date / Time Text chapters *

1 Overview of Futures and Options

Markets

Tuesday Apr 21st

8.30am 11.30am

Wednesday Apr 22nd

8.30am 11.30am

Thursday Apr 23rd

8.30am 11.30am

Friday Apr 24th

8.30am 11.30am

Chapters 1, 2, 5, 9

2 - 4 Black-Scholes Option Pricing

Model

Real Options

Chapters 10, 14, 15

Chapter 34

5 The Greeks Thursday May 7th

8.30am 11.30am

Thursday May 7th

12pm 3pm

Monday May 11th

8.30am 11.30am

Thursday May 21st

8.30am 3pm

Friday May 22nd

8.30am 11.30am

Chapter 18

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Interest Rate Risk and Derivatives

Chapters 4 & 6

11&

12

Interest Rate and Currency Swaps Friday May 22nd

12pm 3pm

Thursday May 28th

8.30am 11.30am

Chapter 7

13-

14

Stock Index Futures Value at Risk (VaR) Credit Risk

Friday May 29th

8.30am 3pm

Chapter 3, 21, 23

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* Some chapters in the text are assigned for more than one theme.

Preparation Required in Advance of Sessions / Seminars

In addition to the Assignment 1, you are expected to have read the following topics in

advance of meeting the module coordinator / course lecturer at the seminars:

Chapters 1, 14

MSc modules are 10 ECTS the workload should reflect that fact. It is essential to set out the

schedule to that students can plan their learning activities, especially those who are aiming

to balance study and work demands. .

The readings detailed above have been assigned and students are expected to be fully

familiar with them. These readings are an important learning source and supplement the

session and text materials.

Student Engagement

During the sessions, students are expected to be able to discuss issues arising from the

assigned chapters and readings for the topics as scheduled above.

Session participation is a vital element in the design of this module. Therefore, all students

are expected to engage in class discussion and debate in order to facilitate the formation of

their critical judgements.

To support your learning, Powerpoint slides will be available which (on certain occasions)

may need to be upgraded / modified during or following the sessions depending on the

issues raised.

Meeting Hours Arrangement

I will be available on the date(s)/timing below should you wish to meet me individually to

discuss any aspect of this module.

7th May (Thu): 3pm 6pm

22nd May (Fri): 3pm 6pm

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29th May (Fri): 3pm 6pm

If you are not available during the abovementioned date(s)/timing, please feel free to contact

me via email for alternative arrangements for discussion.

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PART 4: ASSESSMENT DETAILS

Assessment is undertaken to establish the extent of student learning on completing a

module and according to Biggs and Tang1 (2009) it is the senior partner of teaching and

learning. This module has three assessment components with specific weightings and

marks awarded totalling 1002. The purpose of each assessment is as follows:

Assessment 1 aims to provide students an opportunity to apply what they have read up

prior to the face to face sessions. It is also designed to focus your learning in

preparation for the face to face sessions.

Assessment 2 is designed to allow students to apply what they have learned during the

face to face sessions.

Assessment 3 (Examination) is the formal examination which aims to get insights on

your understanding of issues (theory and practice) addressed in the module.

Students are expected to complete all assignments ensuring that they are submitted by the

specified date. All submissions must be typed, be well laid out, written in an academic style

with appropriate headings (introduction, main part and concluding comments) and sections.

Please ensure that all submissions are entirely your own work for UCDs policy on

plagiarism click on the link below (please see Appendix 1 for further information on

Plagiarism and the policy on the Late Submission of Coursework):

http://www.ucd.ie/registry/academicsecretariat/plag_pol_proc.pdf

The weighting assigned for each component is shown in Table 2 below. (I = Individual; G =

Group)

Table 2 Assessment Components

Assessment components Weighting I / G

1. Assignment 1 20% I

2. Assignment 2 30% I

3. Examination 50% I

1 Biggs, J. and Tang, C. 2009, Teaching for Quality Learning at University, Maidenhead: Open

University/McGraw Hill. 2 As the Overseas Programme modules are worth 10 ECTS they should be graded out of 200 marks.

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Module Assessment Components

In the following pages, further details of each assessment component are presented along

with expectations in relation to prior preparation and completion.

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1. Assignment 1 (20%)

With reference to the literature and empirical studies, critically evaluate the strengths and weakness of the Black-Scholes option pricing model.

The aim of this assignment is to provide an opportunity for students to have a good

grasp of the Black-Scholes option pricing model and its strengths and weaknesses.

Students are expected to read beyond textbooks and able to apply the knowledge gain

from real life examples either from their working environment or/and case studies read.

Specifically, I would like to see students are able to demonstrate their competence in the

following areas:

Knowledge and understanding of key concepts

Analysis and level of argument

Extent of reading and academic references cited

Structure and presentation of the submission, writing style, appropriate

citations and referencing etc.

This assignment must be submitted on 5th May 2015 (Tuesday) by way of a hard copy

and via Blackboard. See Grade Descriptors on page 23.

Word limit: 2,000 words 10%

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2. Assignment 2 (30%)

Please refer to the extract of Singapore Airline Limited Annual Report 2013/14 provided

and write a report that covers the following issues:

(1) With reference to relevant literature and empirical studies, critically evaluate the

current risk management techniques employed by Olam International Limited with

respect to:

- jet fuel price risk

- foreign currency risk

- interest rate risk

- liquidity risk

(2) Are there any alternative ways to deal with the abovementioned risks and to what

extent do you think they will be more effective than the current techniques?

Word limit: 4,000 words 10%

This assignment must be submitted to your Programme Manager on 5th June 2015

(Friday) by way of a hard copy and via Blackboard. See Grade Descriptors on page 25.

Guidelines for All Assignments:

Assignments should be typed using 12 font size, Times New Roman font style and 1.5

line spacing. Students are strongly encouraged to adopt the Harvards style referencing

system for their references and in-text citations. Students should familiarize themselves

with the Universitys policy on the late submission of coursework.

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3. Examination (50%)

The examination will focus on module themes and the material covered in the text, assigned

readings, and class discussions. For this, students are expected to demonstrate their

understanding of theory and practice addressed throughout the module. The examination

question format will be designed to allow you show your understanding of the topics

discussed and also reveal your learning (new and prior). More specific guidelines regarding

the examination paper format and questions will be provided during the final session.

A recent past examination paper is included in Appendix 2 to this Study Guide, please be

prepared for slightly different style of question.

Examination

Date: 19th June 2014, Friday

Time: 2pm - 5pm

Duration: 3 hours

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PART 5: GRADING

This section of the Study Guide provides students with details of the UCD grading system

and also explains criterion referenced grading (UCD Policy). Under criterion referenced

grading, students are graded on the quality of their work without reference to other students

(norm referenced). For instance, the submission that meets the required guidelines in terms

of writing style, analysis, description and / or summary will be awarded according to the

standards set out. All students work is graded to indicate the standard attained using the

criterion referenced approach.

Table 3: UCD Grading System

Grade Description Grade Point

A +

A

A-

Excellent

4.2

4.0

3.8

B+

B

B-

Very good

3.6

3.4

3.2

C+

C

C-

Good

3.0

2.8

2.6

D+

D

D-

Acceptable

2.4

2.2

2.0

E Marginal 1.6

F Fail (unacceptable, no compensation) 1.0

G Fail (Wholly unacceptable; no compensation) 0.4

NG Fail (Wholly unacceptable; no relevant attempt)

0.0

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More specific grade descriptors are set out for your assessment components in the following

pages. Table 4 and 5 below provides descriptors for the Pre-Module Assignment and Main

Assignment respectively please read them prior to submitting your work.

Table 4: Grade Descriptors Assignment 1

Grade

Criteria

A3

Excellent A deep and systematic engagement with the assessment task, with consistently impressive demonstration of a comprehensive mastery of the subject matter, reflecting:

a deep and broad knowledge and critical insight as well as extensive reading;

a critical and comprehensive appreciation of the relevant literature or theoretical, technical or professional framework

an exceptional ability to organise, analyse and present arguments fluently and lucidly with a high level of critical analysis, amply supported by evidence, citation or quotation

a highly developed capacity for original, creative and logical thinking

B

Very Good A substantial engagement with the assessment task, demonstrating:

a thorough familiarity with the relevant literature or theoretical, technical or professional framework

well-developed capacity to analyse issues, organise material, present arguments clearly and cogently well supported by evidence, citation or quotation

some original insights and capacity for creative and logical thinking

C

Good An intellectually competent and factually sound answer with, marked by:

evidence of a reasonable familiarity with the relevant literature or theoretical, technical or professional framework

good developed arguments, but more statements of ideas

arguments or statements adequately but not well supported by evidence, citation or quotation

some critical awareness and analytical qualities

some evidence of capacity for original and logical thinking

D

Satisfactory An acceptable level of intellectual engagement with the assessment task showing:

some familiarity with the relevant literature or theoretical, technical or professional framework

mostly statements of ideas, with limited development of argument

limited use of evidence, citation or quotation

3 While the criteria detailed above refer to A NG grades (inclusive) only, please note that all bands will be used

(A+, A and A-; B+, B and B- etc) for grading assignments.

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limited critical awareness displayed

limited evidence of capacity for original and logical thinking

E Marginal A marginally acceptable piece of work showing: little familiarity with the relevant literature or theoretical, technical or

professional framework mostly statements of ideas, with no development of argument

very limited use of evidence, citation or quotation

no critical awareness displayed

no evidence of capacity for original and logical thinking

F Fail Little or no response to the assessment task with:

no knowledge of subject matter and lacks focus and structure

main points are not covered and clearly lack depth

no effort to apply knowledge to the task and lacks capacity or understanding displayed

G Fail An unacceptable piece of work that does not show: any familiarity with the relevant literature of

theoretical, technical or professional framework any development of argument

any use of evidence, citation or quotation

critical awareness displayed

any capacity for original and logical thinking

NG Fail A wholly unacceptable piece of work that does not address most or all the requirements in the assignment.

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Table 5: Grade Descriptors Assignment 2

Grade

Criteria

A4

Excellent A deep and systematic engagement with the assessment task, with consistently impressive demonstration of a comprehensive mastery of the subject matter, reflecting:

a deep and broad knowledge and critical insight as well as extensive reading;

a critical and comprehensive appreciation of the relevant literature or theoretical, technical or professional framework

an exceptional ability to organise, analyse and present arguments fluently and lucidly with a high level of critical analysis, amply supported by evidence, citation or quotation

a highly developed capacity for original, creative and logical thinking

B

Very Good A substantial engagement with the assessment task, demonstrating:

a thorough familiarity with the relevant literature or theoretical, technical or professional framework

well-developed capacity to analyse issues, organise material, present arguments clearly and cogently well supported by evidence, citation or quotation

some original insights and capacity for creative and logical thinking

C

Good An intellectually competent and factually sound answer with, marked by:

evidence of a reasonable familiarity with the relevant literature or theoretical, technical or professional framework

good developed arguments, but more statements of ideas

arguments or statements adequately but not well supported by evidence, citation or quotation

some critical awareness and analytical qualities

some evidence of capacity for original and logical thinking

D

Satisfactory An acceptable level of intellectual engagement with the assessment task showing:

some familiarity with the relevant literature or theoretical, technical or professional framework

mostly statements of ideas, with limited development of argument

limited use of evidence, citation or quotation

limited critical awareness displayed

limited evidence of capacity for original and logical thinking

4 While the criteria detailed above refer to A NG grades (inclusive) only, please note that all bands will be used

(A+, A and A-; B+, B and B- etc) for grading assignments.

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E Marginal A marginally acceptable piece of work showing: little familiarity with the relevant literature or theoretical, technical or

professional framework mostly statements of ideas, with no development of argument

very limited use of evidence, citation or quotation

no critical awareness displayed

no evidence of capacity for original and logical thinking

F Fail Little or no response to the assessment task with:

no knowledge of subject matter and lacks focus and structure

main points are not covered and clearly lack depth

no effort to apply knowledge to the task and lacks capacity or understanding displayed

no evidence of background reading

many major errors

unacceptable presentation with many errors

G Fail An unacceptable piece of work that does not show: any familiarity with the relevant literature or theoretical, technical or

professional framework any development of argument

any use of evidence, citation or quotation

critical awareness displayed

any capacity for original and logical thinking

NG Fail A wholly unacceptable piece of work that does not address most or all the requirements in the assignment.

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TABLE 6: Grade Descriptors Formal Closed Book Examination

Grade

Characteristics

A

Excellent The student has a very clear understanding of theory, concepts and issues relating to the subject and is able to evaluate conflicting interpretations of it to reach a novel, independent, personal resolution. The student is able to demonstrate relationships between knowledge or analysis derived from different contexts. The work demonstrates ability to communicate the material clearly, articulately and persuasively.

B

Very Good The student is able to demonstrate a good understanding of theory, concepts and issues relating to the subject and is able to provide a range of responses to the issues raised. The work is communicated clearly and effectively, using a logical, progressive structure.

C

Good The student demonstrates an understanding of the analytic framework developed in the course and a partial understanding of concepts and issues. The student is able to identify some key issues and is able to present a logical discussion, but with some conceptual errors or gaps between analysis and conclusions shortcoming. The work demonstrates the ability to communicate the material clearly through the appropriate format.

D

Satisfactory The student is able to demonstrate some understanding of the issues involved but does not demonstrate the ability to apply the analytical framework which had been developed in the course. The work demonstrates relatively weak arguments and evaluation offered generally supporting a simple single right answer.

E

Marginal The student demonstrates little understanding of the issues involved and does not demonstrate the ability to apply the analytical framework which had been developed in the course. The work demonstrates weak arguments and evaluation offered generally supporting a simple single right answer.

F

Fail The student demonstrates very little understanding of the issues involved and does not demonstrate the ability to apply the analytical framework which had been developed in the course. The answers provided are unacceptable and have not addressed the requirements stated in the questions.

G

Fail The student demonstrates no understanding of the issues involved nor demonstrates the ability to apply the analytical framework which had been developed in the course. The answers provided are totally unacceptable and have not addressed the requirements stated in the questions.

NG Fail A wholly unacceptable piece of work that does not address most or all the requirements in the exam

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PART 6: CONCLUDING COMMENTS

This Study Guide is designed to assist and guide your learning for this module. It is

important that you read it regularly and do so in conjunction with the core text, the assigned

readings and session materials. Should you need clarification on issues covered, please let

me know during the seminar sessions.

I hope you enjoy the module and wish you good luck with the rest of your study and for the

future.

Dr. James Kwan April 2015

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APPENDIX 1: IMPORTANT DOCUMENTS

You are advised to read the important documents before you commence your

studies on this module:

1. Guidelines for the Late Submission of Coursework

This document provides a detailed outline of the rules and regulations

surrounding the presentation, submission and marking of assignments. The

guidelines provided must be adhered at all times to avoid an unnecessary loss of

marks. Further details on

www.ucd.ie/registry/academicsecretariat/docs/latesub_po.pdf

2. A Briefing Document for Students on Academic Integrity and Plagiarism.

The University understands plagiarism to be the inclusion of another persons

writings or ideas or works, in any formally presented work (including essays,

theses, examinations, projects, laboratory reports, oral, poster or slide

presentations) which form part of the assessment requirements for a module or

programme of study, without due acknowledgement either wholly or in part of

the original source of the material through appropriate citation. Further details

please go to

www.ucd.ie/registry/academicsecretariat/docs/plagiarism_po.pdf

Plagiarism is a form of academic dishonesty. In any assignment, plagiarism

means that you have presented information or ideas belonging to someone else

falsely as being your own original thoughts on a subject.

All assessments/projects submitted must be the result of your own work.

The following statement must be included on the cover page of all

assignments submitted:

I declare that all materials included in this essay/report/project/dissertation is the end

result of my own work and that due acknowledgement have been given in the

bibliography and references to ALL sources be they printed, electronic or personal.

Signed: Student name/s, student number

Date:

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APPENDIX 2: Most recent Examination Paper

Note to Students: Providing a copy of this paper does not signify that future papers

will follow the exact same format. Further copies of past examination papers are

available in the Kaplan library.

SEMESTER 1 EXAMINATION 2014

Academic Year 2012/2013

MSc Finance (Singapore) 17th & 18th Intake

FIN4005S

Advanced Treasury Management Financial Engineering

Professor Jol Metais

Professor Don Bredin

Dr. James Kwan*

Time Allowed: 3 Hours

Instructions for Candidates

Section A: A compulsory questions carries 50 marks.

Section B: Answer any TWO questions (25 marks each)

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Section A (50%)

Question 1

Kaplan Technologies Co (KTC), a listed company based in Europe, has been involved in

manufacturing motor vehicle parts for many years. Although not involved in the production

of complicated engine components previously, KTC recently purchased the patent rights for

$2m to produce an innovative energy saving engine component which would cut carbon

based emissions from motor vehicles substantially.

KTC has spent $5m developing prototypes of the component and undertaking investigative

research studies. The research studies came to the conclusion that the component will have a

significant commercial potential for a period of five years, after which, newer components

would come into the market and the sales revenue from this component would fall to virtually

nil. The research studies have also found that in the first two years (the development phase)

there will be considerable training and development costs and fewer components will be

produced and sold. However, sales revenue is expected to grow rapidly in the following three

years (the commercial phase).

It is estimated that in the first year, the selling price would be $1,000 per component, the

variable costs would be $400 per component and the total direct fixed costs would be

$1,500,000. Thereafter, while the selling price is expected to increase by 8% per year, the

variable and fixed costs are expected to increase by 5% per year, for the next four years.

Training and development costs are expected to be 120% of the variable costs in the first

year, 40% in the second year and 10% in each of the following three years.

The estimated average number of engine components produced and sold per year is given

below.

Year 1 2 3 4 5

Units produced and sold 7,500 20,000 50,000 60,000 95,000

There is considerable uncertainty as to the exact quantity that could be produced and sold and

the estimated standard deviation of units produced and sold is expected to be as much as

30%.

Machinery costing $120,000,000 will need to be installed prior to commencement of the

component production. KTC has enough space in its factory to manufacture the components

and therefore will incur no additional rental costs. Tax allowable depreciation is available on

the machinery at 10% straight line basis. It can be assumed that, depending on the written

down value, a balancing adjustment will be made at the end of the project, when the

machinery is expected to be sold for $40m. KTC makes sufficient profits from its other

activities to take advantage of any tax loss relief available from this project.

Initially, KTC will require additional working capital for the project of 20% of the first years sales revenue. Thereafter every $1 increase in sales revenue will require a 10% increase in

working capital.

Although this would be a major undertaking for KTC, it is confident that it can raise the

finance required for the machinery and the first years working capital. The financing will be

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through a mixture of a rights issue and a bank loan, in the same proportion as the market

values of its current equity and debt capital. Any annual increase in working capital after the

first year will be financed by internally generated funds.

DCU Co, a company based in South-East Asia, has approached KTC with a proposal to

produce some of the parts required for the component at highly competitive rates. In

exchange, DCU Co would expect KTC to sign a five-year contract giving DCU Co the

exclusive production rights for the parts.

Singapore Innovations Co (SIC) is a listed company involved in the manufacture of

innovative engine components and engines for many years. As the worldwide demand for

energy saving products has increased, it has successfully developed and sold products

designed to reduce carbon emissions. SIC has offered to buy the production rights of the

component and the machinery from KTC for $113m after the development phase has been

completed in two-years time.

KTCs after-tax weighted average cost of capital has been stabilised at 12%. Tax rate applicable to KTC and SIC is 20%.

It can be assumed that tax is payable in the same year as the profits on which it is charged.

Required:

(a) Determine whether KTC should undertake the project of developing and

commercialising the innovative engine component before taking SICs offer into consideration. Show all relevant calculations. (15 marks)

(b) Determine the value of the above project if KTC takes SICs offer into consideration. Show all relevant calculations. (10 marks)

(c) Discuss the approach taken and the assumptions made for parts (a) and (b) above.

(9 marks)

(d) Discuss possible implications of KTC entering into a contractual agreement with

DCU Co. Include in the discussion suggestions of how any negative impact may be

reduced. (6 marks)

(e) Explain three different types of real options and illustrate with examples on how each

type of option assist companies in evaluating long-term projects. (10 marks)

(Total: 50 marks)

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Section B: Answer ANY TWO questions (50%)

Question 2

UWA is a long established airline and it owns 42 planes that provide airline services between

54 different airports in 8 countries. The company has grown quickly in the last four years to

become the second largest airline in Europe.

One of the main risks UWA is exposed to changes in oil prices as these represent 21% of the

expenditure of UWA and they change suddenly with significant movements. UWA, in

common with other airlines, takes fixed price bookings for seats for aircraft weeks and

sometimes months in advance, providing a situation of fixed income but potentially variable

costs. UWA needs some method of estimating risk of the amount it will pay for aviation fuel

in its cash flows and probability.

The management accountant of UWA has provided the following information:

(i) Paying $10 million in one months time for aviation fuel has a mean of zero and a standard deviation of $200,000.

(ii) Expected cash flows with associated probabilities for the next 12 months given no changes in expected risks are:

Cash flows $ Probability

6 million 0.2

10 million 0.5

14 million 0.3

Required:

Explain three different methods of financial risk management, making a recommendation

regarding which method should be used by UWA in determining the price to be paid for

aviation fuel.

You should use the data given in the question to support your analysis as far as possible.

(25 marks)

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Question 3

Strathclyde Ltd is expected to receiving $48m on 1 August 2014, which will be invested until

it is required for a large project on 1 December 2014. With the appointment of the new chief

at Federal Reserve and the uncertainty in the US economy, the company is of the opinion that

it is likely that interest rates will fluctuate significantly over the coming months, albeit it is

difficult to predict whether they will increase or decrease.

Strathclyde Ltds CFO wants to hedge the company against adverse movements in interest rates using one of the following derivative products:

Forward rate agreement (FRAs);

Interest rate futures; or

Options on interest rate futures.

Strathclyde can invest funds at the relevant inter-bank rate less 20 basis points. The current

inter-bank rate is 4.09%. However, the CFO is of the opinion that interest rates could increase

or decrease by as much as 0.9% over the coming months.

The following information and quotes are provided from an appropriate exchange on $

futures and options. Margin requirements can be ignored.

Three-month $ futures, $2 million contract size.

Prices are quoted in basis points at 100 annual yield

June 2014: 94.80

September 2014: 94.76

December 2014: 94.69

Options on three-month $ futures, $2 million contract size, option premiums are in annual %

Calls Puts

Exercise June September December June September December

94.50 0342 0432 0523 0090 0119 0271

95.00 0097 0121 0289 0312 0417 0520

CBCO Bank has offered the following FRA rates to Strathclyde Ltd:

1 v 7: 4.37%

3 v 4: 4.78%

3 v 7: 4.82%

4 v 7: 4.87%

It can be assumed that settlement for the futures and options contracts is at the end of the

month and that basis diminishes to zero at contract maturity at a constant rate, based on

monthly time intervals. Assume further that it is 1 May 2014 now.

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Required:

(a) Based on the three hedging choices Strathclyde is considering, recommend a hedging

strategy for the $48m investment, if interest rates increase or decrease by 0.9%.

Support your answer with appropriate calculations and discussion. (20 marks)

(b) A member of Strathclyde Ltds treasury team has suggested that if option contracts are purchased to hedge against the interest rate movements, then the number of

contracts purchased should be determined by a hedge ratio based on the delta value of

the option.

Discuss how the delta value of an option could be used in determining the number of

contracts purchased. (5 marks)

(Total: 25 marks)

Question 4

The following five-year loan interest rates are available to Lancaster Ltd, an AA credit rated

company, and to Edinburgh Ltd, a BBB rated company.

Fixed rate Floating rate

Lancaster 6.75% LIBOR + 0.50%

Edinburgh 7.50% LIBOR + 0.90%

A bank is willing to act as an intermediary to facilitate a five-year swap, for an upfront fee of

$25,000 and an annual fee of 0.10% of the swap value. Both of these fees are payable by each

of the companies. Ignore taxation.

Required:

(a) Discuss the advantages and disadvantages of interest rate swaps. (10 marks)

(b) Evaluate, using an illustrative swap, whether or not an interest rate swap may be

arranged that is beneficial to both companies. (10 marks)

(c) Explain how swaption may benefit either firm in minimising interest rate risk.

(5 marks)

(Total: 25 marks)

36

Question 5

(a) Briefly discuss the meaning and importance of the terms Delta, Theta, Gamma, Rho and Vega in option pricing. (15 marks)

(b) Assume that your company has invested in 200,000 shares of Hull Ltd, a

manufacturer of office furnitures based in Malaysia. You are concerned about the

recent volatility in Hulls share price due to the unpredictable government policy in Malaysia. You wish to protect your companys investment from a possible fall in Hulls share price in six months time, but do not wish to sell the shares at present. No dividends are due to be paid by Hull during the next six months.

Market data:

Hulls current share price: 300 sen Call option exercise price: 350 sen

Time to expiry: 180 days (6 months)

Interest rates (annual): 5%

Volatility of Hulls shares 60% (standard deviation per year)

Assume that option contracts are for the purchase or sale of units of 1,000 shares.

Required:

(i) Devise a delta hedge that is expected to protect the investment against changes

in the share price for six months. Delta may be estimated using N(d1).

(8 marks)

(ii) Comment upon whether or not such is likely to be totally successful.

(2 marks)

(Total: 25 marks)

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Formulae Sheet

The Put Call Parity relationship

The Black-Scholes Option Pricing Model

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