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Champion manages portfolios of securities, for investors with differing views on hedging exchange rate risk. Levesque holds large diversified portfolios of U.S. equities; has often locked in gains on his portfolio with derivatives before a market correction and hedges his portfolio's currency risk. Levesque tells Champion to take large short position in S&P 500 index, with futures or forward contracts. Champion notices that futures price is less than current spot price and consults with Silvers. Champion thinks so because the dividend yield of S&P 500 is greater than Treasury Bill rate. Silvers thinks backwardation and notes that use of forward contract might be good because the contract will not attract attention of other market participants who might react to Levesque's move. Champion believes that Levesque wants to hedge his equity position because he thinks all U.S. interest rates will increase soon. This is bearish for equities, and negative relationship between equity prices and interest rates makes short forwards more attractive than short futures. Ragnar has large investments in oil-related assets that he often hedges with futures contracts. Champion notices that price of an oil futures contract is usually higher than spot price. Ragnar uses short term borrowings in dollars, from European and U.S. banks, to meet the liquidity needs of his oil investments, and has Champion hedge these loan positions with Eurodollar futures. Silvers thinks Champion should consider using T-bill futures to hedge loans from U.S. banks, and Eurodollar futures only for Eurodollar loans. Champion looks into that and forward rate agreements. alternatively. Champion evaluates pricing of T-bond futures 1.2 year contract. The CTD is a 6.5% 30 year bond issued 10 years ago currently yielding 5%. The conversion factor for the bond is 1.08. Assume that risk-free rate over contract period is 3%. A. Champion's statement is invalid while Silver's statement is valid? B. If Champion thinks that S&P 500 index is negatively correlated with interest rates, then choosing short forward over short futures is: appropriate because forward contract would benefit more from a higher reinvestment rate. counterproductive because a short futures contract would benefit more from a higher reinvestment rate. counterproductive because a short futures contract would benefit more from a higher borrowing rate. C. Oil futures prices might be higher than spot price because: there are more costs than benefits to holding the asset. there are more benefits than costs for holding the asset. D. With respect to using Eurodollar futures, instead of Tbill futures, to hedge short term loans from U.S. banks, Champion is: Justified, Eurodollar futures market is very liquid, LIBOR is less correlated with short term loan rates than T-bill rate. Justified, Eurodollar futures market is very liquid, LIBOR is more correlated with short term loan rates than T-bill rate. not justified, the Eurodollar futures market is not very liquid, LIBOR is more correlated with short term loan rates than T-bills.
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