Question 1

Accepted Answer

Calculate the duration of Tiger State Bank's assets and liabilities.
DA = (20/39)(0) + (8/39)(.6) + (20/39)(2.2) + (8/39)(7.5) = 2.79
DL = (20/36)(0) + (4/36)(.4) + (12/36)(3.2) = 1111

Question 2

Duration is defined as the weighted average time to maturity of a financial instrument. Explain how this knowledge can help protect against interest rate risk.

Accepted Answer

Duration measures effective time to recoup your investment.
Bond prices rise and fall with interest rate changes.
Two elements of risk
i) reinvestment risk--may earn less $ when reinvesting
ii) price--current value of bond moves inversely to interest rates.
By setting duration equal to holding horizon reinvestment and price risk offset each other.
By setting duration of assets equal to duration of liabilities, both move up and down together.

Question 3

There are always _________ counterparties in a credit default swap.

Accepted Answer

A)  zero 
B)  one 
C)  two 
D)  three 
A)  zero 
B)  one 
C)  two 
D)  three C

Question 4

Comparing long-term bonds with short-term bonds, long-term bonds are _____ volatile and therefore experience _____ price change compared with short-term bonds for the same interest rate shift.

Accepted Answer

A)  less; less 
B)  less; more 
C)  more; more 
D)  more; less 
E)  more; the same 
A)  less; less 
B)  less; more 
C)  more; more 
D)  more; less 
E)  more; the same

Question 5

The futures markets are labeled as pure speculation and even gambling. Why is this an inaccurate portrayal of the markets function.

Accepted Answer

Market to set (discover) prices for asse

Question 6

LIBOR stands for:

Accepted Answer

A)  Luasanne Interest Basis Offered Rate 
B)  Libido Over Redline. 
C)  London Interbank Offered Rate. 
D)  London Interagency Overt Rate. 
A)  Luasanne Interest Basis Offered Rate 
B)  Libido Over Redline. 
C)  London Interbank Offered Rate. 
D)  London Interagency Overt Rate.

Question 7

Calculate the duration of a 4-year $1,000 face value bond, which pays 8% coupons annually throughout maturity and has a yield to maturity of 9%.

Accepted Answer

A)  3.29 years 
B)  3.58 years 
C)  3.69 years 
D)  3.89 years 
E)  4.00 years 
A)  3.29 years 
B)  3.58 years 
C)  3.69 years 
D)  3.89 years 
E)  4.00 years

Question 8

If you bought a futures contract for $2.60 per bushel and the contract ended at $2.70 after several days of trading of $2.52, $2.57, $2.62, $2.68, and $2.70. What would the mark to market sequence be?

Accepted Answer

A)  -.08, .05, .05, .06, .02 
B)  .08, -.05, -.05, -.06, -.02 
C)  .08, .03, -.02, -.06, -.10 
D)  -.08, -.03, .02, .06, .10 
E)  .10 
A)  -.08, .05, .05, .06, .02 
B)  .08, -.05, -.05, -.06, -.02 
C)  .08, .03, -.02, -.06, -.10 
D)  -.08, -.03, .02, .06, .10 
E)  .10

Question 9

Hedging in the futures markets can reduce all risk if:

Accepted Answer

A)  price movements in both the cash and futures markets are perfectly correlated. 
B)  price movements in both the cash and futures markets have zero correlation. 
C)  price movements in both the cash and futures markets are less than perfectly correlated. 
D)  the hedge is a short hedge, but not a long hedge. 
E)  the hedge is a long hedge, but not a short hedge. 
A)  price movements in both the cash and futures markets are perfectly correlated. 
B)  price movements in both the cash and futures markets have zero correlation. 
C)  price movements in both the cash and futures markets are less than perfectly correlated. 
D)  the hedge is a short hedge, but not a long hedge. 
E)  the hedge is a long hedge, but not a short hedge.

Question 10

You hold a forward contract to take delivery of Government of Canada bonds in 9 months. If the entire term structure of interest rates shifts down over the 9-month period, the value of the forward contract will have _____ on the date of delivery.

Accepted Answer

A)  risen 
B)  fallen 
C)  not changed 
D)  either risen or fallen, depending on the maturity of the T-bond 
E)  collapsed 
A)  risen 
B)  fallen 
C)  not changed 
D)  either risen or fallen, depending on the maturity of the T-bond 
E)  collapsed

Question 11

Derivatives can be used to either hedge or speculate. These actions:

Accepted Answer

A)  increase risk in both cases. 
B)  decrease risk in both cases. 
C)  spread or minimize risk in both cases. 
D)  offsets risk by hedging and increase risk by speculating. 
E)  offset risks by speculating and increase risk by hedging. 
A)  increase risk in both cases. 
B)  decrease risk in both cases. 
C)  spread or minimize risk in both cases. 
D)  offsets risk by hedging and increase risk by speculating. 
E)  offset risks by speculating and increase risk by hedging.

Question 12

Duration is a measure of:

Accepted Answer

A)  the yield to maturity of a bond. 
B)  the coupon yield of a bond. 
C)  the price of a bond. 
D)  the effective maturity of a bond. 
A)  the yield to maturity of a bond. 
B)  the coupon yield of a bond. 
C)  the price of a bond. 
D)  the effective maturity of a bond.

Question 13

In percentage terms, higher coupon bonds experience a _______ price change compared with lower coupon bonds of the same maturity given a change in yield to maturity.

Accepted Answer

A)  greater 
B)  smaller 
C)  similar 
D)  smaller or greater 
A)  greater 
B)  smaller 
C)  similar 
D)  smaller or greater

Question 14

A financial institution can hedge its interest rate risk by:

Accepted Answer

A)  matching the duration of its assets to the duration of its liabilities. 
B)  setting the duration of its assets equal to half that of the duration of its liabilities. 
C)  match the duration of its assets weighted by the market value of its assets with the duration of its liabilities weighted by the market value of its liabilities. 
D)  setting the duration of its assets weighted by the market value of its assets to one half that of the duration of the liabilities weighted by the market value of the liabilities. 
A)  matching the duration of its assets to the duration of its liabilities. 
B)  setting the duration of its assets equal to half that of the duration of its liabilities. 
C)  match the duration of its assets weighted by the market value of its assets with the duration of its liabilities weighted by the market value of its liabilities. 
D)  setting the duration of its assets weighted by the market value of its assets to one half that of the duration of the liabilities weighted by the market value of the liabilities.

Question 15

If a firm sells a floor at 6% this will:

Accepted Answer

A)  will pay the holder the LIBOR interest below the 6%. 
B)  pay the firm 6% on their purchase. 
C)  will pay the holder the LIBOR interest above 6%. 
D)  limit the amount of borrowing to 6% of assets. 
A)  will pay the holder the LIBOR interest below the 6%. 
B)  pay the firm 6% on their purchase. 
C)  will pay the holder the LIBOR interest above 6%. 
D)  limit the amount of borrowing to 6% of assets.

Question 16

The duration of a 2 year annual 10% bond that is selling for par is:

Accepted Answer

A)  2.00 years 
B)  1.00 years 
C)  1.91 years 
D)  2.09 years 
A)  2.00 years 
B)  1.00 years 
C)  1.91 years 
D)  2.09 years

Question 17

On March 1, you contract to take delivery of 1 ounce of gold for $415. The agreement is good for any day up to April 1. Throughout March, the price of gold hit a low of $385 and hit a high of $435. The price settled on March 31 at $420, and on April 1st you settle your futures agreement at that price. Your net cash flow is:

Accepted Answer

A)  -$30.00. 
B)  $20.00. 
C)  $5.00. 
D)  -$15.00. 
E)  -$20.00. 
A)  -$30.00. 
B)  $20.00. 
C)  $5.00. 
D)  -$15.00. 
E)  -$20.00.

Question 18

A set of bonds all have the same maturity. Which one has the least percentage price changes for given shifts in interest rates:

Accepted Answer

A)  zero coupon bonds. 
B)  high coupon bonds. 
C)  low coupon bonds. 
D)  pure discount bonds. 
A)  zero coupon bonds. 
B)  high coupon bonds. 
C)  low coupon bonds. 
D)  pure discount bonds.

Question 19

A financial institution has equity equal to one-tenth of its assets. If its asset duration is currently equal to its liability duration, then to immunize, the firm needs to:

Accepted Answer

A)  decrease the duration of its assets. 
B)  increase the duration of its assets. 
C)  decrease the duration of its liabilities. 
D)  do nothing, i.e., keep the duration of its liabilities equal to the duration of its assets. 
A)  decrease the duration of its assets. 
B)  increase the duration of its assets. 
C)  decrease the duration of its liabilities. 
D)  do nothing, i.e., keep the duration of its liabilities equal to the duration of its assets.

Question 20

A forward contract is described by:

Accepted Answer

A)  agreeing today to buy a product at a later date at a price to be set in the future. 
B)  agreeing today to buy a product today at its current price. 
C)  agreeing today to buy a product at a later date at a price set today. 
D)  agreeing today to buy a product if and only if its price rises above the exercise price today at its current price. 
A)  agreeing today to buy a product at a later date at a price to be set in the future. 
B)  agreeing today to buy a product today at its current price. 
C)  agreeing today to buy a product at a later date at a price set today. 
D)  agreeing today to buy a product if and only if its price rises above the exercise price today at its current price.

Exam 26: Derivatives and Hedging Risk

Duration is defined as the weighted average time to maturity of a financial instrument. Explain how this knowledge can help protect against interest rate risk.

There are always _________ counterparties in a credit default swap.

Comparing long-term bonds with short-term bonds, long-term bonds are _____ volatile and therefore experience _____ price change compared with short-term bonds for the same interest rate shift.

The futures markets are labeled as pure speculation and even gambling. Why is this an inaccurate portrayal of the markets function.

LIBOR stands for:

Calculate the duration of a 4-year $1,000 face value bond, which pays 8% coupons annually throughout maturity and has a yield to maturity of 9%.

If you bought a futures contract for $2.60 per bushel and the contract ended at $2.70 after several days of trading of $2.52, $2.57, $2.62, $2.68, and $2.70. What would the mark to market sequence be?

Hedging in the futures markets can reduce all risk if:

You hold a forward contract to take delivery of Government of Canada bonds in 9 months. If the entire term structure of interest rates shifts down over the 9-month period, the value of the forward contract will have _____ on the date of delivery.

Derivatives can be used to either hedge or speculate. These actions:

Duration is a measure of:

In percentage terms, higher coupon bonds experience a _______ price change compared with lower coupon bonds of the same maturity given a change in yield to maturity.

A financial institution can hedge its interest rate risk by:

If a firm sells a floor at 6% this will:

The duration of a 2 year annual 10% bond that is selling for par is:

A set of bonds all have the same maturity. Which one has the least percentage price changes for given shifts in interest rates:

A financial institution has equity equal to one-tenth of its assets. If its asset duration is currently equal to its liability duration, then to immunize, the firm needs to:

A forward contract is described by:

Introduction to Corporate Finance

Accounting Statements and Cash Flow

Financial Planning and Growth

Financial Markets and Net Present Value: First Principles of Finance

The Time Value of Money

How to Value Bonds and Stocks

Net Present Value and Other Investment Rules

Net Present Value and Capital Budgeting

Risk Analysis, Real Options, and Capital Budgeting

Risk and Return: Lessons From Market History

Risk and Return: the Capital Asset Pricing Model

An Alternative View of Risk and Return: the Arbitrage Pricing Theory

Risk, Return, and Capital Budgeting

Corporate Financing Decisions and Efficient Capital Markets

Long-Term Financing: an Introduction

Capital Structure: Basic Concepts

Capital Structure: Limits to the Use of Debt

Valuation and Capital Budgeting for the Levered Firm

Dividends and Other Payouts

Issuing Equity Securities to the Public

Long-Term Debt

Leasing

Options and Corporate Finance: Basic Concepts

Options and Corporate Finance: Extensions and Applications

Warrants and Convertibles

Short-Term Finance and Planning

Cash Management

Credit Management

Mergers and Acquisitions

Financial Distress

International Corporate Finance

Filters

Comparing long-term bonds with short-term bonds, long-term bonds are _ volatile and therefore experience _ price change compared with short-term bonds for the same interest rate shift.