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Hi John,
In this question, we are given specifically the basis points between spot price and future price. However we have no idea whether the Spot price is higher or lower than the Future price in regards of this basis risk. Lets say on 1 Feb, the LIBOR increased to 4.3%, thus spot price will be 95.7. From this, we can calculate future price will be either 95.7 + 0.22 basis or 95.7 – 0.22 basis depending whether the future price is assumed to be lower or higher than LIBOR price.
In this regards, do we need to state such assumption in exam on whether future price is higher or lower than LIBOR price? The answer of the question seems to assume future price is lower without stating any assumption. Can you please help advise on the correct approach in such case where basis point is given?
One more thing for this question is that the question itself did not mention anything about Keshi will borrow 18m at floating rate. Instead it only says Keshi has option to borrow at floating rate + 0.4% or borrow at fixed rate 5.5%. But the answer seems to assume that Keshi will borrow at floating rate and hedge based on this basis without considering Keshi borrowing at fixed rate. Do we have to consider its option to borrow at fixed rate as well?
Thank you
This question was poor in that it is not clear whether the basis should be added or subtracted (it is the only question in which this has happened). You therefore have no choice but to state your assumption, and you would then get the marks whichever you assumed.
With regard to the swap, again it is poor, but swapping the way the answer does is the only way that swapping in this case results in a saving.
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