Exam 9: Interest-Rate Forecasting and Hedging: Swaps, Financial Futures, and Options

Hedging is a low-cost method of transferring the risk of unanticipated changes in asset prices or interest rates from one investor or institution to another.

Even interest rate protection products like swaps are subject to interest rate risk.

Hedging reduces risk, according to the textbook.

In an IAR swap what amount is adjusted as market interest rates move?

Misuse of derivative contracts caused the failure of Barings bank and the near-collapse of Long-Term Capital Management. As a result of these (and other) examples, the following things have happened:

Swaps are used to protect against ____ risk, but they do not automatically protect the two parties from ____ risk.

The International Monetary Market (IMM) was the first futures market to open in Europe.

The Chicago Board of Trade opened active trading in futures contracts in October 1975, but the only type of contracts to be traded at that time were:

A large money center bank plans to offer money market CDs in substantial volume (at least $100 million) in six months due to a projected upsurge in credit deals from some of its most valued corporate customers. Unfortunately, the bank's economist has just predicted that money market interest rates should rise over the next year (with perhaps a full 1.5 percentage point increase within the next six months). Explain why the bank's management would be concerned about this development. Suppose management expects its corporate loan customers to resist any loan terms that would automatically result in loan rates being immediately adjusted upward to reflect any rate increases in the money market. What futures market transaction would you recommend? What is the best options contract alternative for the bank?