Question 1

The Eurodollar futures contract is a popular hedging vehicle because it is based on the three-month LIBOR.

Accepted Answer

A) True 
 B)False

Question 2

Exhibit 21.6
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Assume that you observe the following prices in the T-Bill and Eurodollar futures markets $$\begin{array}{l}
\begin{array} { c c } 
&\text { T-Bill } & \text { Eurodollar } \
\hline \text { September }& 93.25 & 92.35
\end{array}
\end{array}$$
-Refer to Exhibit 21.6. If you expected the TED spread to widen over the next month then an appropriate strategy would be to

Accepted Answer

A) Go long T-Bill futures and long Eurodollar futures. 
B) Go short T-Bill futures and short Eurodollar futures. 
C) Go long T-Bill futures and short Eurodollar futures. 
D) Go short T-Bill futures and long Eurodollar futures. 
E) None of the above. 
A) Go long T-Bill futures and long Eurodollar futures. 
B) Go short T-Bill futures and short Eurodollar futures. 
C) Go long T-Bill futures and short Eurodollar futures. 
D) Go short T-Bill futures and long Eurodollar futures. 
E) None of the above.

Question 3

Exhibit 21.2
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Assume you are the Treasurer for the Johnson Pharmaceutical Company and in late July 2004, the company is considering the sale of $500 million in 20-year debentures that will most likely be rated the same as the firm's other debt issues. The firm would like to proceed at the current rate of 8.5%, but you know that it will probably take until November to bring the issue to market. Therefore, you suggest that the firm hedge the pending issue using Treasury bond futures contracts which each represent $100,000. $$\begin{array} { l c c } 
& \text { Case 1 } & \text { Case 2 } \
\hline  \text { Current Value - July 2004 } & & \
\quad \text { Bond Rate } & 8.5 \% & 8.5 \% \
\quad \text { Dec. } 2004 \text { Treasury Bonds } & 87.75 & 87.75 \
\text { Estimated Values - Nov. 2004 } & & \
\quad \text { Bond Rate } & 9.5 \% & 7.5 \% \
\quad \text { Dec. } 2004 \text { Treasury Bonds } & 85.60 & 91.65
\end{array}$$
-Refer to Exhibit 21.2. What is the dollar gain or loss assuming that future conditions described in Case 1 actually occur? (Ignore commissions and margin costs, and assume a naive hedge ratio.)

Accepted Answer

A) $47,316,683.00 gain 
B) $36,566,683.00 loss 
C) $10,750,000.00 gain 
D) $10,750,000.00 loss 
E) None of the above 
A) $47,316,683.00 gain 
B) $36,566,683.00 loss 
C) $10,750,000.00 gain 
D) $10,750,000.00 loss 
E) None of the above

Question 4

The optimal hedge ratio is a function of all of the following except

Accepted Answer

A) The standard deviation of changes in spot prices. 
B) The variance deviation of changes in forward prices. 
C) The covariance between changes in spot and forward prices. 
D) Choices a and b only 
E) All of the above 
A) The standard deviation of changes in spot prices. 
B) The variance deviation of changes in forward prices. 
C) The covariance between changes in spot and forward prices. 
D) Choices a and b only 
E) All of the above

Question 5

The goal of a hedge transaction is to increase expected returns of a fundamental holding.

Accepted Answer

A) True 
 B)False

Question 6

Exhibit 21.12
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Suppose you are a loan officer for a commercial bank and one of your clients has just approached you about a one-year loan for $4,000,000. Interest on the new loan will be paid at the end of each quarter based on the prevailing level of LIBOR at the beginning of each quarter. The LIBOR yield curve in the cash market is as follows: $$\begin{array} { l l } 
90 \text {-day LIBOR } & 2.70 \% \
180 \text {-day LIBOR } & 2.85 \% \
270 \text {-day LIBOR } & 3.10 \% \
360 \text {-day LIBOR } & 3.40 \%
\end{array}$$
-Refer to Exhibit 21.12. What will the dollar level of the bank's interest receipt be at the end of the first quarter?

Accepted Answer

A) $26,500 
B) $27,000 
C) $28,500 
D) $108,000 
E) None of the above 
A) $26,500 
B) $27,000 
C) $28,500 
D) $108,000 
E) None of the above

Question 7

Exhibit 21.4
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
A 3-month T-bond futures contract (maturity 20 years, coupon 6%, face $100,000) currently trades at $98,781.25 (implied yield 6.11%). A 3-month T-note futures contract (maturity 10 years, coupon 6%, face $100,000) currently trades at $101,468.80 (implied yield 5.80%). Assume semiannual compounding.
-Refer to Exhibit 21.4. If you expected the yield curve to flatten, the appropriate NOB futures spread strategy would be

Accepted Answer

A) Go long the T-bond and short the T-note 
B) Go short the T-bond and long the T-note 
C) Go long the T-bond and long the T-note 
D) Go short the T-bond and short the T-note 
E) None of the above 
A) Go long the T-bond and short the T-note 
B) Go short the T-bond and long the T-note 
C) Go long the T-bond and long the T-note 
D) Go short the T-bond and short the T-note 
E) None of the above

Question 8

Exhibit 21.3
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
As a relationship officer for a money-center commercial bank, one of your corporate accounts has just approached you about a one-year loan for $3,000,000. The customer would pay a quarterly interest expense based on the prevailing level of LIBOR at the beginning of each quarter. As is the bank's convention on all such loans, the amount of the interest payment would then be paid at the end of the quarterly cycle when the new rate for the next cycle is determined. You observe the following LIBOR yield curve in the cash market: $$\begin{array} { l l } 
90 \text {-day LIBOR } & 4.70 \% \
180 \text {-day LIBOR } & 4.85 \% \
270 \text {-day LIBOR } & 5.10 \% \
360 \text {-day LIBOR } & 5.40 \%
\end{array}$$
-Refer to Exhibit 21.3. If 90-day LIBOR rises to the levels "predicted" by the implied forward rates, what will the dollar level of the bank's interest receipt be at the end of the third quarter?

Accepted Answer

A) $35,250.00 
B) $36,375.00 
C) $38,250.00 
D) $41,005.50 
E) None of the above 
A) $35,250.00 
B) $36,375.00 
C) $38,250.00 
D) $41,005.50 
E) None of the above

Question 9

A riskless stock index arbitrage profit is possible if the following condition holds: F0,T = S0(1 + rf - d)T, where spot price now is S0, value now of a futures contract expiring at time T is (F0,T), rf is the risk free rate and d is the dividend.

Accepted Answer

A) True 
 B)False

Question 10

Exhibit 21.3
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
As a relationship officer for a money-center commercial bank, one of your corporate accounts has just approached you about a one-year loan for $3,000,000. The customer would pay a quarterly interest expense based on the prevailing level of LIBOR at the beginning of each quarter. As is the bank's convention on all such loans, the amount of the interest payment would then be paid at the end of the quarterly cycle when the new rate for the next cycle is determined. You observe the following LIBOR yield curve in the cash market: $$\begin{array} { l l } 
90 \text {-day LIBOR } & 4.70 \% \
180 \text {-day LIBOR } & 4.85 \% \
270 \text {-day LIBOR } & 5.10 \% \
360 \text {-day LIBOR } & 5.40 \%
\end{array}$$
-Refer to Exhibit 21.3. If 90-day LIBOR rises to the levels "predicted" by the implied forward rates, what will the dollar level of the bank's interest receipt be at the end of the first quarter?

Accepted Answer

A) $35,250.00 
B) $36,375.00 
C) $38,250.00 
D) $40,500.00 
E) None of the above 
A) $35,250.00 
B) $36,375.00 
C) $38,250.00 
D) $40,500.00 
E) None of the above

Question 11

Exhibit 21.7
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Assume that you observe the following prices in the T-Bill and Eurodollar futures markets $$\begin{array}{l}
\begin{array} { c c } 
&\text { T-Bill } & \text { Eurodollar } \
\hline \text { September }& 95.24 & 94.6
\end{array}
\end{array}$$
-Refer to Exhibit 21.7. If you expected the TED spread to narrow over the next month then an appropriate strategy would be to

Accepted Answer

A) Go long T-Bill futures and long Eurodollar futures. 
B) Go short T-Bill futures and short Eurodollar futures. 
C) Go long T-Bill futures and short Eurodollar futures. 
D) Go short T-Bill futures and long Eurodollar futures. 
E) None of the above. 
A) Go long T-Bill futures and long Eurodollar futures. 
B) Go short T-Bill futures and short Eurodollar futures. 
C) Go long T-Bill futures and short Eurodollar futures. 
D) Go short T-Bill futures and long Eurodollar futures. 
E) None of the above.

Question 12

Exhibit 21.2
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Assume you are the Treasurer for the Johnson Pharmaceutical Company and in late July 2004, the company is considering the sale of $500 million in 20-year debentures that will most likely be rated the same as the firm's other debt issues. The firm would like to proceed at the current rate of 8.5%, but you know that it will probably take until November to bring the issue to market. Therefore, you suggest that the firm hedge the pending issue using Treasury bond futures contracts which each represent $100,000. $$\begin{array} { l c c } 
& \text { Case 1 } & \text { Case 2 } \
\hline  \text { Current Value - July 2004 } & & \
\quad \text { Bond Rate } & 8.5 \% & 8.5 \% \
\quad \text { Dec. } 2004 \text { Treasury Bonds } & 87.75 & 87.75 \
\text { Estimated Values - Nov. 2004 } & & \
\quad \text { Bond Rate } & 9.5 \% & 7.5 \% \
\quad \text { Dec. } 2004 \text { Treasury Bonds } & 85.60 & 91.65
\end{array}$$
-Refer to Exhibit 21.2. What is the dollar gain or loss assuming that future conditions described in Case 2 actually occur? (Ignore commissions and margin costs, and assume a naive hedge ratio.)

Accepted Answer

A) $19,500,000.00 gain 
B) $27,816,683.04 gain 
C) $27,816,683.04 loss 
D) $19,500,000.00 loss 
E) None of the above 
A) $19,500,000.00 gain 
B) $27,816,683.04 gain 
C) $27,816,683.04 loss 
D) $19,500,000.00 loss 
E) None of the above

Question 13

The pure expectations hypothesis suggests futures prices serve as unbiased forecasts of future spot prices.

Accepted Answer

A) True 
 B)False

Question 14

In the absence of arbitrage opportunities, the forward contract price should be equal to the current price plus

Accepted Answer

A) Contract price. 
B) The cost of carry. 
C) Margin requirement. 
D) The price discovery rate. 
E) The convenience return. 
A) Contract price. 
B) The cost of carry. 
C) Margin requirement. 
D) The price discovery rate. 
E) The convenience return.

Question 15

Exhibit 21.8
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Consider a portfolio manager with a $20,500,000 equity portfolio under management. The manager wishes to hedge against a decline in share values using stock index futures. Currently a stock index future is priced at 1250 and has a multiplier of 250. The portfolio beta is 1.25.
-Refer to Exhibit 21.8. Assume that a month later the equity portfolio has a market value of $20,000,000 and the stock index future is priced at 1150 with a multiplier of 250. Calculate the profit on the equity position.

Accepted Answer

A) $100,000 
B) -$200,000 
C) $600,000 
D) -$500,000 
E) $400,000 
A) $100,000 
B) -$200,000 
C) $600,000 
D) -$500,000 
E) $400,000

Question 16

Interest rate parity is a key concept in managing risk in the commodities market.

Accepted Answer

A) True 
 B)False

Question 17

Exhibit 21.4
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
A 3-month T-bond futures contract (maturity 20 years, coupon 6%, face $100,000) currently trades at $98,781.25 (implied yield 6.11%). A 3-month T-note futures contract (maturity 10 years, coupon 6%, face $100,000) currently trades at $101,468.80 (implied yield 5.80%). Assume semiannual compounding.
-Refer to Exhibit 21.4. If you expected the yield curve to steepen, the appropriate NOB futures spread strategy would be

Accepted Answer

A) Go long the T-bond and short the T-note 
B) Go short the T-bond and long the T-note 
C) Go long the T-bond and long the T-note 
D) Go short the T-bond and short the T-note 
E) None of the above 
A) Go long the T-bond and short the T-note 
B) Go short the T-bond and long the T-note 
C) Go long the T-bond and long the T-note 
D) Go short the T-bond and short the T-note 
E) None of the above

Question 18

In the absence of arbitrage opportunities, the forward price should be equal to the spot price plus the cost of carry.

Accepted Answer

A) True 
 B)False

Question 19

Exhibit 21.3
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
As a relationship officer for a money-center commercial bank, one of your corporate accounts has just approached you about a one-year loan for $3,000,000. The customer would pay a quarterly interest expense based on the prevailing level of LIBOR at the beginning of each quarter. As is the bank's convention on all such loans, the amount of the interest payment would then be paid at the end of the quarterly cycle when the new rate for the next cycle is determined. You observe the following LIBOR yield curve in the cash market: $$\begin{array} { l l } 
90 \text {-day LIBOR } & 4.70 \% \
180 \text {-day LIBOR } & 4.85 \% \
270 \text {-day LIBOR } & 5.10 \% \
360 \text {-day LIBOR } & 5.40 \%
\end{array}$$
-Refer to Exhibit 21.3. What is the implied 90-day forward rate at the beginning of the fourth quarter?

Accepted Answer

A) 6.19% 
B) 5.10% 
C) 6.07% 
D) 5.68% 
E) None of the above 
A) 6.19% 
B) 5.10% 
C) 6.07% 
D) 5.68% 
E) None of the above

Question 20

Like hedging, arbitrage results in increased returns with a disproportional increase in risk.

Accepted Answer

A) True 
 B)False

The Eurodollar futures contract is a popular hedging vehicle because it is based on the three-month LIBOR.

The optimal hedge ratio is a function of all of the following except

The goal of a hedge transaction is to increase expected returns of a fundamental holding.

A riskless stock index arbitrage profit is possible if the following condition holds: F_0,T = S₀(1 + r_f - d)^T, where spot price now is S₀, value now of a futures contract expiring at time T is (F_0,T), r_f is the risk free rate and d is the dividend.

The pure expectations hypothesis suggests futures prices serve as unbiased forecasts of future spot prices.

In the absence of arbitrage opportunities, the forward contract price should be equal to the current price plus

Interest rate parity is a key concept in managing risk in the commodities market.

In the absence of arbitrage opportunities, the forward price should be equal to the spot price plus the cost of carry.

Like hedging, arbitrage results in increased returns with a disproportional increase in risk.

The Investment Setting

The Asset Allocation Decision

Selecting Investments in a Global Market

Organization and Functioning of Securities Markets

Security-Market Indexes

Efficient Capital Markets

An Introduction to Portfolio Management

An Introduction to Asset Pricing Models

Multifactor Models of Risk and Return

Analysis of Financial Statements

Introduction to Security Valuation

Macroanalysis and Microvaluation of the Stock Market

Industry Analysis

Company Analysis and Stock Valuation

Technical Analysis

Equity Portfolio Management Strategies

Bond Fundamentals

The Analysis and Valuation of Bonds

Bond Portfolio Management Strategies

An Introduction to Derivative Markets and Securities

Option Contracts

Swap Contracts, Convertible Securities, and Other Embedded Derivatives

Professional Money Management, Alternative Assets, and Industry Ethics

Evaluation of Portfolio Performance

Filters

Exam 21: Forward and Futures Contracts

The Eurodollar futures contract is a popular hedging vehicle because it is based on the three-month LIBOR.

The optimal hedge ratio is a function of all of the following except

The goal of a hedge transaction is to increase expected returns of a fundamental holding.

A riskless stock index arbitrage profit is possible if the following condition holds: F0,T = S0(1 + rf - d)T, where spot price now is S0, value now of a futures contract expiring at time T is (F0,T), rf is the risk free rate and d is the dividend.

The pure expectations hypothesis suggests futures prices serve as unbiased forecasts of future spot prices.

In the absence of arbitrage opportunities, the forward contract price should be equal to the current price plus

Interest rate parity is a key concept in managing risk in the commodities market.

In the absence of arbitrage opportunities, the forward price should be equal to the spot price plus the cost of carry.

Like hedging, arbitrage results in increased returns with a disproportional increase in risk.

The Investment Setting

The Asset Allocation Decision

Selecting Investments in a Global Market

Organization and Functioning of Securities Markets

Security-Market Indexes

Efficient Capital Markets

An Introduction to Portfolio Management

An Introduction to Asset Pricing Models

Multifactor Models of Risk and Return

Analysis of Financial Statements

Introduction to Security Valuation

Macroanalysis and Microvaluation of the Stock Market

Industry Analysis

Company Analysis and Stock Valuation

Technical Analysis

Equity Portfolio Management Strategies

Bond Fundamentals

The Analysis and Valuation of Bonds

Bond Portfolio Management Strategies

An Introduction to Derivative Markets and Securities

Option Contracts

Swap Contracts, Convertible Securities, and Other Embedded Derivatives

Professional Money Management, Alternative Assets, and Industry Ethics

Evaluation of Portfolio Performance

Filters

A riskless stock index arbitrage profit is possible if the following condition holds: F_0,T = S₀(1 + r_f - d)^T, where spot price now is S₀, value now of a futures contract expiring at time T is (F_0,T), r_f is the risk free rate and d is the dividend.