Exam 9: Exploring Financial Markets and Hedging Strategies

One of the instruments listed below is not currently traded on a futures and options exchange. This instrument is:

The Eurodollar futures option contract is unusual because settlement is in Eurodollar deposits.

Which of the following statements is/are true?

Futures trading is designed to protect an investor against price fluctuations.

Short-term interest rates tend to be ____ sensitive to business cycle changes than are long-term interest rates.

Consensus forecasts rely upon the simultaneous use of several different forecasting methods.

What type of option contract is appropriate in an environment of rising interest rates? Falling interest rates? Please illustrate this using payoff diagrams.

As the delivery date specified in the futures contract draws nearer, the gap or basis between the futures and spot prices for the same asset narrows and is termed:

What variables are used most frequently in econometric models to predict changes in interest rates?

The process of economic expansion and contraction is called the Wall Street Effect.

All swaps experience a change in notional principal from the first day the swap is in force.

Commercial bank participation in the futures markets has been limited. One reason for this is the accounting procedures used to recognize gains and losses from futures trading. These accounting procedures tend to show volatile fluctuations in income for those banks active in the futures markets.

When an investor goes "long" in the futures market, he or she expects to profit from a decline in interest rates.

Using each of the following definitions, identify which term or concept presented in this chapter matches them. a. Using financial tools to protect against fluctuations in financial asset prices or interest rates. b. The spread between the spot and forward prices of a financial asset. c. Contracts applying to the forward sale of assets at a price set when the contract is made. d. Simultaneous purchase and sale of stocks and futures contracts in order to profit from temporary price differences. e. Purchase of futures contracts.

According to your text, futures trading "works" because basis risk is less than price risk on a commodity or security.

Cross hedging rests on the assumption that the prices of most financial instruments tend to move in the same direction by roughly the same proportion.

The purpose of a short hedge is to guarantee a desired yield in case interest rates decline before securities are actually purchased in the cash market.

In general, the idea of an interest rate swap is to allow investors with differing credit worthiness and funding needs to exploit their particular comparative advantage in borrowing.

An insurance company committed itself during the month of March to buying a block of home mortgages at a fixed price from a mortgage banker in September. The mortgages have a face value of $10 million. The insurer has recently prepared a forecast that indicates that mortgage interest rates will rise between now and September by a full percentage point. What kind of futures transaction would you recommend to protect the insurance company against a sizable loss on its mortgage commitment, particularly if it has to sell the mortgages shortly after they are taken into its portfolio. Indicate specifically what buy and sell transactions you would undertake in the futures market. What futures contract would you most likely use? Why? What options contract seems best and why?

An insurance company expects to receive a large payment in three months. When the payment is received, it will be invested in short-term securities. It can hedge against a change in interest rates if it: