Negative Basis Trade Finance Assignment Help With Solution

Negative Basis Trade Finance Assignment Help With Solution

A) Describe a “negative basis trade” in 1 paragraph
Given the following information
i) Marriott hotel bond 5 year maturity; priced at par; yield (and coupon) 7%; $100mio available to be purchased by a hedge fund
ii) Marriott hotel bond could be repo financed at LIBOR plus 0.15% (15bps) at a haircut of 10%
iii) Protection could be purchase on the Marriott hotel bond for 5 years in the credit default swap market for an annual cost of 1%
iv) the 5 year swap interest rate swap fixed rate is 5% vs LIBOR (flat … not incremental spread)
v) for simplicity ignore day count fractions or to put it another way assume all calculations subsequently are done on a an annual 30/360 basis (ie the day count fraction equals 1)
B) Draw a “boxes and arrows” diagram of a negative basis trade on the Marriott hotel bond
C) Solve the following
(i) Solve the return to the hedge fund (the equity the hedge fund has to put into this negative basis trade position) on a LIBOR plus basis
(ii) Solve the return to the hedge fund (the equity the hedge fund has to put into this negative basis trade position) on a LIBOR plus basis IF THE HAIRCUT ON THE REPO IS INCREASED TO 20%
(iv) Solve the return to the hedge fund (the equity the hedge fund has to put into this negative basis trade position) on a LIBOR plus basis IF THE SPREAD OVER LIBOR ON THE REPO IS INCREASED TO 2%

D) In addition to the changes in the repo terms, describe other risks to the hedge fund from the negative basis trade.

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