Thursday, February 28, 2019


DERIVATIVE CASES An Investment Linked to Commodity Futures prof Richard Spurgin FIN 5310 1 Group 1 Zhongyi Qian Hao Cheng Yue Zhao Liuyang Gao Motivation for issuing the warranter Prior to the Swedish exportation Credit Co. issued the certification, the arrangeance of the GSCI showed that this index was all the way sweet. First, the increasing-trend cumulative number diminishs were higher than the concedes on S&P viosterol and the Treasury bonds, and then it became much diversified with more proximos contracts introduced after 1980.Besides, opposite attractive feature of the GSCI was its ability to act as a hem in against inflation because it had a strong positive correlation with the two close widely used measures of inflation CPI and PPI. In addition, the investment on the GSCI had the potential to decrease the happen of a portfolio because its sires were negatively correlated with returns on stocks and bonds. We could examine the index performance more specifica lly. The perfect returns on the GSCI consisted of one-third components, the conduct from the collateral Treasury bill, the spot return and the cast off furnish from the futures.According to the total return of the GSCI prior to 1990, we could find that the contribution of the T-bill go bad was considerable and relatively stable while that of the spot return was small on average and extremely volatile and that of the roll yield was positive though somewhat volatile. The primary source of return changed based on variant period with different financial environment and weighting strategy. Spot return contributed a lot in the inflationary period while the roll yield contributed more in the isinflationary period. As for the returns after 1991, we consider it logical to assume that the GSCI would continue to generate hefty returns. Since the prices of crude oil futures include in the GSCI had been in backwardation 80% to 85%, GSCI generated high roll yield that significantly contr ibute to the total return during 1981-1990. Therefore, we can say that in 1991-1993, with substantial contribution of T-bill yield and relatively high roll yield, the total return of the GSCI would continue to be hefty in short term.As a consequence, the GSCI would get more attractive and hence popularizing securities exclusively tied to it such as dismantles issued by Swedish Export. In addition, it was true that GSCI was particularly attractive because it had negative correlation with the US stock market. From Exhibit 4, we can simply find returns of GSCI had negative correlation ( developedly -0. 32) with returns of S&P 500 and in the meanwhile, generated relatively higher returns than those of S&P prior to 1991. As faraway as we concerned, it make a lot of sense since its a fully collateralized portfolio of commodity futures.As we know, in theory, commodities futures perform well when financial assets perform worse , that is to say, GSCI has a negative correlation with stock markets. Structure of the security It is possible to bend the GSCI by making a portfolio, which contains the future contracts of the commodities that includes in the GSCI and the futures of each individual commodity can be weighed approximately the identical percentage as they are in the current GSCI. When the future reaches to its maturity, the future contract go away be rolled over into the next adjacent contract just like the way the GSCI was calculated.In this way we can double over the GSCI index and the return should be likewise approximately equal to it. As for the tradeoff between buying the structured note and the replicating portfolio, one should equation them in different aspects. Although the nominal return maybe theoretically the same, the actual return of the structured note should be higher than the replicating portfolio because the transaction tiptoes and charges will be charged in the progress of making and keeping the portfolio. To replicate the payoffs of the GSCI, the investor also needs to put a certain amount of coin as the frequent margin and/or collateral postings.Besides, if the investor wants to sell what he has for cash, then he will find the liquidity for the structured note is much higher than the replicating portfolio. However, the investors would exactly get paid 95. 57% of the addition rate of GSCI index from the structure note while they did not go for such limitation on the replicating portfolio. On this transaction, Goldman Sachs earned commission fee as 0. 35% of the total amount of the note, which was $350,000, but they got far more than this for creating the index. In addition to the notes described in this case, Goldman Sachs offered a number of other products related to the index.Each of these products would generate a huge amount of commission. For Swedish Export Corp. , they could finance with no fix interest paid and the possibility that the terms of financing was even cheaper than that of issuing compan y bond directly by all odds existed. Investors would like to have this structure note in portfolios not only because the advantages illustrated above, but also because it had a negative correlation with the stock market, so it could hedge the portfolio risk to some extent. How the deal performed over timeTo calculate the total return, we first need to calculate the cash flows (Table 1) by using the formula, hit*0. 9557 *GSCI End / GSCI Begin, and when at maturity the value investors could redeem is $78781. 54. Thus the total return of security is as below (78781. 54/hundred thousand)(1/3)-1=-7. 64% 39390. 77/50000)(1/3)-1=7. 64% Compared with other alternatives such as Managed Futures Funds, Swap Transaction and CRB Futures Index, it seemed that GSCI was a good investment since all these three alternatives had relatively lower return than GSCI and still in the decreasing trend.However, the total return of GSCI was declining from 1991 to 1994. Besides, the T- bill yield was higher than the GSCI return, which made this investment meaningless. Additionally, we calculated the yearly return of GSCI and downloaded the return of S&P and Treasury of these four years. Correlations between GSCI return and S&P and Treasury return is showed in Table 2. It was obviously that at that place were positive correlation between the GSCI return and S&P and also positive between GSCI and Treasury, which meant that this future contract could not decrease risk effectively.Therefore, in retrospect from 1991 to 1994, the GSCI futures contract decreased the overall return and at the same time failed to diversify the risk of the investment portfolio. It was not a good investment for investors. Table 1 Year Par=100000 Par=50000 11/1/91 95570. 00 47785. 00 11/30/94 78781. 54 39390. 77 Table 2 Year Return S&P Treasury 91 -5. 46% 30. 23% 5. 61% 92 -4. 09% 7. 49% 3. 41% 93 -8. 20% 9. 97% 2. 98% 94 -7. 64% 1. 33% 3. 99% S&P and return 0. 327556756 T and return 0. 302031481

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