Exam 22: Futures and Forwards

Conyers Bank holds Treasury bonds with a book value of $30 million. However, the Treasury bonds currently are worth $28,387,500. Assume that the portfolio manager sells the bonds at a price of87-05/32, and that she closes out the futures hedge position at a price of81-17/32. What will be the net gain or loss on the entire bond transaction from the time that the hedge was placed?

A conversion factor often is used to determine the invoice price on a futures contract when a bond other than the benchmark bond is delivered to the buyer.

Futures contracts are the primary security that insurance companies and banks use to hedge interest rate risk prior to originating mortgages.

Microhedging uses futures or forward contracts to hedge the entire balance sheet duration gap.

When will the estimated hedge ratio be greater than one?

A U.S. bank issues a 1-year, $1 million U.S. CD at 5 percent annual interest to finance a C$1.274 million investment in 2-year fixed-rate Canadian bonds selling at par and paying 7 percent annually. The U.S. bank expects to liquidate its position in 1 year upon maturity of the CD. Spot exchange rates are US$0.78493 per Canadian dollar. If in one year there is no change in either interest rates or exchange rates, what is the end-of-year profit or loss of the U.S. bank's cash position? Assume that annual interest is paid on both the CD and the Canadian bonds on the date of liquidation in exactly one year.

A naive hedge occurs when

The notational value of the world-wide credit derivative securities markets stood at _________ trillion as of June 2012, which compares to _________ trillion as of July 2008.

What is the reason for decrease in the number of futures contract needed to hedge a cash position in case of tailing the hedge?

The number of futures contracts that an FI should buy or sell in a macrohedge depends on the

A forward contract specifies immediate delivery for immediate payment.

Immunizing the balance sheet against interest rate risk means that gains (losses) from an off-balance-sheet hedge will exactly offset losses (gains) from the balance sheet position.

If a 16-year 12 percent semi-annual $100,000 T-bond, currently yielding 10 percent, is used to deliver against a 20-year, 8 percent T-bond at 114-16/32, what is the conversion factor? What would the buyer have to pay the seller?

XYZ Bank lends $20,000,000 to ABC Corporation which has a credit rating of BB. The spread of a BB rated benchmark bond is 2.5 percent over the U.S. Treasury bond of similar maturity. XYZ Bank sells a $20,000,000 one-year credit forward contract to IWILL Insurance Company. At maturity, the spread of the benchmark bond against the Treasury bond is 2.1 percent, and the benchmark bond has a modified duration of 4 years. What is the amount of payment paid by whom to whom at the maturity of the credit forward contract?

A spot contract specifies deferred delivery and payment.

Forward contracts are marked-to-market on a daily basis.

XYZ Bank lends $20,000,000 to ABC Corporation which has a credit rating of BB. The spread of a BB rated benchmark bond is 2.5 percent over the U.S. Treasury bond of similar maturity. XYZ Bank sells a $20,000,000 one-year credit forward contract to IWILL Insurance Company. At maturity, the spread of the benchmark bond against the Treasury bond is 2.1 percent, and the benchmark bond has a modified duration of 4 years. What is the amount of payment paid by whom to whom at the maturity of the credit forward contract?

An FI has a 1-year 8-percent US$160 million loan financed with a 1-year 7-percent UK£100 million CD. The current exchange rate is $1.60/£. If the exchange rate remains the same, what is the dollar spread earned by the bank at the end of the year?

A perfect hedge, or perfect immunization, seldom occurs.

A forward contract has only one payment cash flow that occurs at the time of delivery.