Exam 9: Exploring Financial Markets and Hedging Strategies

Selling futures contracts can help protect a firm against an expected decline in commodity prices.

Hedging essentially involves adopting equal and opposite positions in the spot and futures markets for the same assets.

Futures contracts on 90-day U.S. Treasury bills for delivery in 3 months carried a yield today of 10.25 percent while futures contracts on comparable T-bills for delivery in 6 months carried a yield of 10.625 percent. Today's yields on 90-day bills for immediate (cash) delivery are 10.12 percent. The implied market forecast is that interest rates will:

According to your text, during a period of economic expansion:

While modest, seasonal patterns in interest rates tend to be stable over time.

Stock index futures contracts are settled by the transfer of ownership of a diversified basket of stocks.

Investors interested in hedging may buy a futures contract in order to lock in a price on a specific asset at a future date.

Hedging in the futures market reduces the overall risk in the market.

In order to hedge against rising interest rates a bank would buy a call option on Eurodollar futures.

The Federal funds futures contract traded on the Chicago Board of Trade's exchange covers 90 days.

Financial futures and options contracts are less beneficial to investors heavily leveraged with debt because their net earnings are particularly sensitive to changes in interest rates.

Some financial analysts feel that futures and options markets, rather than helping reduce risk and promoting the more efficient use of scarce resources, may in fact be aimed at wealthy investors, giving them a speculative outlet for their funds and, thus, the futures and options markets really increase risk.

Savings and loan associations use futures to hedge the market value of their mortgage-related securities.

A thrift with a large fixed-rate mortgage portfolio wants to protect itself against an increase in interest rates. It should:

The principal active traders in financial futures and options in the U.S. are:

The mark-to-market daily feature of financial futures requires:

In an interest-rate swap transaction, a large corporation can borrow in the bond market at a current fixed rate of 9 percent and can also obtain a floating-rate loan in the short-term market at the prime bank rate. However, this firm wishes to borrow short-term because it has a large block of assets that roll over into cash each month. The other party to the swap is a company with a lower credit rating that can borrow in the bond market at an interest rate of 11.5 percent and in the short-term market at prime plus 1.50 percent. This lower-rated company has long-term predictable cash inflows, however. The higher-credit-rated company wishes to pay for its part in the swap an interest rate of prime less 50 basis points. The lower-rated company is willing to pay the underwriting cost associated with the higher-rated company's security issue, which is estimated to be 25 basis points. The swap transaction is valued at $100 million. What kind of interest rate swap can be arranged here? Which company will borrow short term and which long term? If the prime bank rate is currently 10 percent, who will pay what interest cost to whom? Explain what the benefit is to each party in this swap.

Which type of hedge works best in an environment of rising interest rates? Of falling interest rates? Can you illustrate this using a payoff diagram?

If projected money-supply growth is less than projected GNP growth interest rates are likely to fall, other factors held constant.

The spread between the cash or spot price of a commodity or security and its futures price is known as basis.