Question 1

What is the purpose of a credit forward agreement?

Accepted Answer

A) To allow property-casualty insurers to hedge the extreme losses that occur after major catastrophes. 
B) To adjust prices on outstanding futures each day to reflect current futures market conditions. 
C) To facilitate the future exchange of an asset for cash at a price that is determined daily. 
D) To hedge a cash asset on a direct dollar-for-dollar basis with a forward or futures contract. 
E) To hedge against an increase in the default risk of a loan. 
A) To allow property-casualty insurers to hedge the extreme losses that occur after major catastrophes. 
B) To adjust prices on outstanding futures each day to reflect current futures market conditions. 
C) To facilitate the future exchange of an asset for cash at a price that is determined daily. 
D) To hedge a cash asset on a direct dollar-for-dollar basis with a forward or futures contract. 
E) To hedge against an increase in the default risk of a loan.

Question 2

Conyers Bank holds Treasury bonds with a book value of $30 million. However, the Treasury bonds currently are worth $28,387,500. If the portfolio manager wants to shorten the bank's asset maturity, what type of risk is she concerned about?

Accepted Answer

A) Credit risk. 
B) Foreign exchange rate risk. 
C) The risk of rising interest rates. 
D) The risk of falling interest rates. 
E) Default risk. 
A) Credit risk. 
B) Foreign exchange rate risk. 
C) The risk of rising interest rates. 
D) The risk of falling interest rates. 
E) Default risk.

Question 3

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/£. What should be the trading price of the BP futures contract at the end of the year in order for the FI to be perfectly hedged? That is, the FI earns its original anticipated spread without any effects of exchange rate changes?

Accepted Answer

A) $1.60/£. 
B) $1.61/£. 
C) $1.62/£. 
D) $1.63/£. 
E) $1.64/£. 
A) $1.60/£. 
B) $1.61/£. 
C) $1.62/£. 
D) $1.63/£. 
E) $1.64/£.

Question 4

Which of the following is an example of microhedging asset-side portfolio risk?

Accepted Answer

A) When an FI, attempting to lock in cost of funds to protect itself against a rise in short-term interest rates, takes a short position in futures contracts on CDs. 
B) FI manager trying to pick a futures contract whose underlying deliverable asset is not matched to the asset position being hedged. 
C) When an FI hedges a cash asset on a direct dollar-for-dollar basis with a forward or futures contract. 
D) When an FI manager wants to insulate the value of the institution's bond portfolio fully against a rise in interest rates. 
E) When an FI manager wishes to use futures or other derivative securities to hedge the entire balance sheet duration gap. 
A) When an FI, attempting to lock in cost of funds to protect itself against a rise in short-term interest rates, takes a short position in futures contracts on CDs. 
B) FI manager trying to pick a futures contract whose underlying deliverable asset is not matched to the asset position being hedged. 
C) When an FI hedges a cash asset on a direct dollar-for-dollar basis with a forward or futures contract. 
D) When an FI manager wants to insulate the value of the institution's bond portfolio fully against a rise in interest rates. 
E) When an FI manager wishes to use futures or other derivative securities to hedge the entire balance sheet duration gap.

Question 5

Routine hedging

Accepted Answer

A) is a hedging strategy that occurs on a set, predetermined basis by the FI. 
B) always results in excess returns. 
C) is a strategy to follow when interest rates are abnormally low. 
D) is a strategy used when interest rates are extremely unpredictable. 
E) is a strategy to follow when interest rates are abnormally high. 
A) is a hedging strategy that occurs on a set, predetermined basis by the FI. 
B) always results in excess returns. 
C) is a strategy to follow when interest rates are abnormally low. 
D) is a strategy used when interest rates are extremely unpredictable. 
E) is a strategy to follow when interest rates are abnormally high.

Question 6

Hedging a specific on-balance-sheet cash position usually will only require more T-bill futures contracts than hedging the same cash position with T-bond futures contracts because the T-bond contract size is only 10 percent as large as large as the T-bill contract.

Accepted Answer

A) True 
 B)False

Question 7

A credit forward is a forward agreement that

Accepted Answer

A) hedges against a decrease in default risk on a loan after the loan rate is determined and the loan issued. 
B) hedges against an increase in default risk on a loan before the loan rate is determined and the loan issued. 
C) hedges against an increase in default risk on a loan after the loan rate is determined and the loan issued. 
D) hedges against a decrease in default risk on a loan before the loan rate is determined and the loan issued. 
E) hedges against an increase in default risk on a loan after the loan rate is determined and before the loan is issued. 
A) hedges against a decrease in default risk on a loan after the loan rate is determined and the loan issued. 
B) hedges against an increase in default risk on a loan before the loan rate is determined and the loan issued. 
C) hedges against an increase in default risk on a loan after the loan rate is determined and the loan issued. 
D) hedges against a decrease in default risk on a loan before the loan rate is determined and the loan issued. 
E) hedges against an increase in default risk on a loan after the loan rate is determined and before the loan is issued.

Question 8

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

Accepted Answer

A) True 
 B)False

Question 9

What does a low value of R2 indicate?

Accepted Answer

A) It means the degree of confidence increases in the use of futures contracts, with a given hedge ratio estimate, to hedge cash asset-risk position. 
B) It means that we have little confidence that the slope coefficient from the regression is actually the true hedge ratio. 
C) It indicates that there is no statistical association at all between spot rates and future prices. 
D) It indicates that the regression line does not fit the scatter of observations. 
E) It indicates a low value of hedging ineffectiveness. 
A) It means the degree of confidence increases in the use of futures contracts, with a given hedge ratio estimate, to hedge cash asset-risk position. 
B) It means that we have little confidence that the slope coefficient from the regression is actually the true hedge ratio. 
C) It indicates that there is no statistical association at all between spot rates and future prices. 
D) It indicates that the regression line does not fit the scatter of observations. 
E) It indicates a low value of hedging ineffectiveness.

Question 10

The covariance of the change in spot exchange rates and the change in futures exchange rates is 0.6606, and the variance of the change in futures exchange rates is 0.6060. The variance of the change in spot exchange rates is 0.9090. What is the degree of hedging effectiveness?

Accepted Answer

A) 0.61. 
B) 0.90. 
C) 0.87. 
D) 0.82. 
E) 0.79. 
A) 0.61. 
B) 0.90. 
C) 0.87. 
D) 0.82. 
E) 0.79.

Question 11

Commercial banks, investment banks, and broker-dealers are the major forward market participants.

Accepted Answer

A) True 
 B)False

Question 12

Catastrophe futures contracts

Accepted Answer

A) are designed to protect life insurance companies from the effects of natural disasters in which large numbers of lives are lost. 
B) are designed to protect property-casualty insurers against the extreme losses that can occur in hurricanes. 
C) are designed to hedge insurance companies from liability law suits. 
D) provide a payoff when the actual loss ratio is less than the expected loss ratio. 
E) provide a payoff to the seller of the contract that is equal to the loss ratio times the nominal value of the contract. 
A) are designed to protect life insurance companies from the effects of natural disasters in which large numbers of lives are lost. 
B) are designed to protect property-casualty insurers against the extreme losses that can occur in hurricanes. 
C) are designed to hedge insurance companies from liability law suits. 
D) provide a payoff when the actual loss ratio is less than the expected loss ratio. 
E) provide a payoff to the seller of the contract that is equal to the loss ratio times the nominal value of the contract.

Question 13

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?

Accepted Answer

A) 1.158; $132,591. 
B) 1.156; $115,600. 
C) 1.150; $131,284. 
D) 1.102; $124,200. 
E) 1.000; $114,160. 
A) 1.158; $132,591. 
B) 1.156; $115,600. 
C) 1.150; $131,284. 
D) 1.102; $124,200. 
E) 1.000; $114,160.

Question 14

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/£. What is the net gain or loss on the loan given that the exchange rates at the time of repayment were $1.63/£ in the cash market and 1.62/£ in the futures market? Assume that the futures position is opened and unwound as stated in previous questions.

Accepted Answer

A) $2,120,000 loss. 
B) $1,330,000 loss. 
C) $2,670,000 loss. 
D) $1,330,000 gain. 
E) $2,670,000 gain. 
A) $2,120,000 loss. 
B) $1,330,000 loss. 
C) $2,670,000 loss. 
D) $1,330,000 gain. 
E) $2,670,000 gain.

Question 15

How is a hedge ratio commonly determined?

Accepted Answer

A) By discounting the optimal number of futures to sell per $1 of cash position using the yield involved. 
B) By using the ratio of the most recent spot and futures price changes. 
C) By running an ordinary least squares regression of changes in spot prices on changes in futures prices. 
D) By using the conversion factor. 
E) By squaring the correlation between past changes in spot asset prices and futures prices. 
A) By discounting the optimal number of futures to sell per $1 of cash position using the yield involved. 
B) By using the ratio of the most recent spot and futures price changes. 
C) By running an ordinary least squares regression of changes in spot prices on changes in futures prices. 
D) By using the conversion factor. 
E) By squaring the correlation between past changes in spot asset prices and futures prices.

Question 16

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

Accepted Answer

A) True 
 B)False

Question 17

If a 12-year, 6.5 percent semi-annual $100,000 T-bond, currently yielding 4.10 percent, is used to deliver against a 6-year, 5 percent T-bond at 110-17/32, what is the conversion factor? What would the buyer have to pay the seller?

Accepted Answer

A) 1.1027; $110,531. 
B) 1.2257; $135,478. 
C) 1.8370; $253,830. 
D) 1.3622; $163,339. 
E) 1.7263; $141,788. 
A) 1.1027; $110,531. 
B) 1.2257; $135,478. 
C) 1.8370; $253,830. 
D) 1.3622; $163,339. 
E) 1.7263; $141,788.

Question 18

Selling a credit forward agreement generates a payoff similar to

Accepted Answer

A) selling a call option. 
B) buying a call option. 
C) selling a put option. 
D) buying a put option. 
E) buying forward contracts. 
A) selling a call option. 
B) buying a call option. 
C) selling a put option. 
D) buying a put option. 
E) buying forward contracts.

Question 19

Hedging selectively only a portion of the balance sheet is an attempt to increase the return of the FI by accepting some level of interest rate risk.

Accepted Answer

A) True 
 B)False

Question 20

Selling a credit forward agreement generates a payoff similar to

Accepted Answer

A) selling a call option. 
B) buying a call option. 
C) selling a put option. 
D) buying a put option. 
E) buying forward contracts. 
A) selling a call option. 
B) buying a call option. 
C) selling a put option. 
D) buying a put option. 
E) buying forward contracts.

Exam 22: Futures and Forwards

What is the purpose of a credit forward agreement?

Conyers Bank holds Treasury bonds with a book value of $30 million. However, the Treasury bonds currently are worth $28,387,500. If the portfolio manager wants to shorten the bank's asset maturity, what type of risk is she concerned about?

Which of the following is an example of microhedging asset-side portfolio risk?

Routine hedging

Hedging a specific on-balance-sheet cash position usually will only require more T-bill futures contracts than hedging the same cash position with T-bond futures contracts because the T-bond contract size is only 10 percent as large as large as the T-bill contract.

A credit forward is a forward agreement that

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

What does a low value of R2 indicate?

The covariance of the change in spot exchange rates and the change in futures exchange rates is 0.6606, and the variance of the change in futures exchange rates is 0.6060. The variance of the change in spot exchange rates is 0.9090. What is the degree of hedging effectiveness?

Commercial banks, investment banks, and broker-dealers are the major forward market participants.

Catastrophe futures contracts

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?

How is a hedge ratio commonly determined?

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

If a 12-year, 6.5 percent semi-annual $100,000 T-bond, currently yielding 4.10 percent, is used to deliver against a 6-year, 5 percent T-bond at 110-17/32, what is the conversion factor? What would the buyer have to pay the seller?

Selling a credit forward agreement generates a payoff similar to

Hedging selectively only a portion of the balance sheet is an attempt to increase the return of the FI by accepting some level of interest rate risk.

Selling a credit forward agreement generates a payoff similar to

Why Are Financial Institutions Special

Deposit-Taking Institutions

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Mutual Funds, Hedge Funds, and Pension Funds

Insurance Companies

Risks of Financial Institutions

Interest Rate Risk I

Interest Rate Risk II

Credit Risk: Individual Loans

Credit Risk: Loan Portfolio and Concentration Risk

Liquidity Risk

Foreign Exchange Risk

Sovereign Risk

Market Risk

Off-Balance-Sheet Risk

Technology and Other Operational Risks

Liability and Liquidity Management

Deposit Insurance and Other Liability Guarantees

Capital Adequacy

Product and Geographic Expansion

Options, Caps, Floors, and Collars

Swaps

Loan Sales

Securitization Index

Filters

What does a low value of R² indicate?