Fixed Income Securities Future Value Equivalent

Question: Describe about the Fixed Income Securities for Future Value Equivalent. Answer: 1. Based on the question, it is apparent that interest is not paid for the first two years but is paid only for one period of six months at the rate of 8% per annum Hence, future value of the FRA after 2.5 years = P (!+r)N = 1,000 *(1+ 0.08/2) = $1,040 The current value of the FRA should be equivalent of the net present value of the above payment computed using a discount rate of 6% pa which would be semi annualised(Hull 2014). Hence, value of FRA = 1040/(1+0.06/2)5 = $ 897.1 The FRA is priced lower than the principal because on two years no interest needs to be paid, however returns can be derived on the value of FRA at the rate of 6% pa semi-annual compounding(Tuckman and Serrat 2011). 2. In order to hedge the market risk, the trader should short in the future or forward markets. This is because the investor has already taken a long position in the cash segment and hence needs protection against any adverse movement of the index from the current level of 1,250. Hence, if the price falls below the current levels of 1,250, then the short trade may be closed and any decrease in the value in the cash segment could be made by the profits earning in the forward market(Hull 2014). It is apparent from the given data that the margin call would be triggered when the margin account loss has crossed $ 1,000 as a result of which the account level dives below the specified maintenance margin level(Hull 2014). It is apparent that the company has assumed a short position and hence the increase in price by a mere 1 cent or $ 0.01 would result in loss of 50000*0.01 = $ 500. Thus, in order to cause a loss of $ 1,000 in the margin account, the price would have to increase by 2cents or become equal to 72 cents per unit. This loss of $ 1,000 would trigger a margin call. 3. One of the key requirements with regards to asset sale is that it should be sold constructively which implies that offsetting positions must be taken to the positions that have already been taken so as to ensure that the investment gains are not locked. In the given case, out of the given choices, Option B has not been sold in a constructive manner. In case of A.C and D, the profit recognition cannot be deferred but the same cannot be said about B. If a put option is bought which is deep in money, then profit arising from the asset can be successfully locked and in the process the tax liability is deferred(Tuckman and Serrat 2011). References Hull, John. Options, Futures, and Other Derivatives . New York: Pearson, 2014. Tuckman, Bruce, and Angel Serrat. Fixed Income Securities: Tools for Today's Markets . London: Wiley Sons, 2011.