Question 1

Use the following two choices to identify whether each intermediary or entity is a net buyer or net seller of credit derivative securities.
-Insurance companies

Accepted Answer

A) Net buyer 
B) Net seller 
A) Net buyer 
B) Net seller

Question 2

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 at the end of the year, the exchange rate is $1.65/≤, what is the spread earned on the loan by the FI in dollars after adjusting fully for exchange rates?

Accepted Answer

A) -$3,750,000. 
B) -$1,250,000. 
C) +$1,250,000. 
D) +$3,750,000. 
E) +$5,000,000. 
A) -$3,750,000. 
B) -$1,250,000. 
C) +$1,250,000. 
D) +$3,750,000. 
E) +$5,000,000.

Question 3

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. You expect to liquidate your position in 1 year upon maturity of the CD. Spot exchange rates are US $0.78493 per Canadian dollar.
-What is the end-of-year profit or loss on the bank's cash position if in one year Canadian bond rates increase to 7.5 percent? Assume no change in either current U.S. interest rates or current exchange rates. (Choose the closest answer)

Accepted Answer

A) Loss of US $5,000. 
B) Profit of US $15,000. 
C) Loss of C $119,000. 
D) Profit of C $50,000. 
E) Loss of C $50,000. 
A) Loss of US $5,000. 
B) Profit of US $15,000. 
C) Loss of C $119,000. 
D) Profit of C $50,000. 
E) Loss of C $50,000.

Question 4

An FI has reduced its interest rate risk exposure to the lowest possible level by selling sufficient futures to offset the risk exposure of its whole balance sheet or cash positions in each asset and liability. The FI is involved in

Accepted Answer

A) microhedging. 
B) selective hedging. 
C) routine hedging. 
D) overhedging. 
E) speculation. 
A) microhedging. 
B) selective hedging. 
C) routine hedging. 
D) overhedging. 
E) speculation.

Question 5

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 6

Why does basis risk occur?

Accepted Answer

A) Changes in the spot asset's price are not perfectly correlated with changes in the price of the asset delivered under a forward or futures contract. 
B) The daily marking-to-market process enables an FI manager to close out a futures position by taking an exactly offsetting position. 
C) Spot and futures contracts are traded in different markets with different demand and supply functions. 
D) Answers B and C only. 
E) Answers A and C only. 
A) Changes in the spot asset's price are not perfectly correlated with changes in the price of the asset delivered under a forward or futures contract. 
B) The daily marking-to-market process enables an FI manager to close out a futures position by taking an exactly offsetting position. 
C) Spot and futures contracts are traded in different markets with different demand and supply functions. 
D) Answers B and C only. 
E) Answers A and C only.

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

Hedging effectiveness often is measured by the squared correlation between past changes in the spot asset prices and futures prices.

Accepted Answer

A) True 
 B)False

Question 9

The portfolio manager for Conyers Bank wishes to sell the entire issue of Treasury bonds at a current price of 87-05/32nds. What will be the gain or loss on the cash position since the futures contract was placed? (That is, since the bonds were valued at $28,387,500.)

Accepted Answer

A) Loss of $3,834,375. 
B) Loss of $3,853,125. 
C) Gain of $2,240,625. 
D) Gain of $3,853,125. 
E) Loss of $2,240,625. 
A) Loss of $3,834,375. 
B) Loss of $3,853,125. 
C) Gain of $2,240,625. 
D) Gain of $3,853,125. 
E) Loss of $2,240,625.

Question 10

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. You expect to liquidate your position in 1 year upon maturity of the CD. Spot exchange rates are US $0.78493 per Canadian dollar.
-If you wanted to hedge your bank's risk exposure, what hedge position would you take?

Accepted Answer

A) A short interest rate hedge to protect against interest rate declines and a short currency hedge to protect against increases in the value of the Canadian dollar with respect to the U.S.dollar. 
B) A short interest rate hedge to protect against interest rate increases and a short currency hedge to protect against declines in the value of the Canadian dollar with respect to the U.S.dollar. 
C) A long interest rate hedge to protect against interest rate increases and a long currency hedge to protect against declines in the value of the Canadian dollar with respect to the U.S.dollar. 
D) A long interest rate hedge to protect against interest rate declines and a long currency hedge to protect against increases in the value of the Canadian dollar with respect to the U.S.dollar. 
E) A long interest rate hedge to protect against interest rate declines and a short currency hedge to protect against increases in the value of the Canadian dollar with respect to the U.S.dollar. 
A) A short interest rate hedge to protect against interest rate declines and a short currency hedge to protect against increases in the value of the Canadian dollar with respect to the U.S.dollar. 
B) A short interest rate hedge to protect against interest rate increases and a short currency hedge to protect against declines in the value of the Canadian dollar with respect to the U.S.dollar. 
C) A long interest rate hedge to protect against interest rate increases and a long currency hedge to protect against declines in the value of the Canadian dollar with respect to the U.S.dollar. 
D) A long interest rate hedge to protect against interest rate declines and a long currency hedge to protect against increases in the value of the Canadian dollar with respect to the U.S.dollar. 
E) A long interest rate hedge to protect against interest rate declines and a short currency hedge to protect against increases in the value of the Canadian dollar with respect to the U.S.dollar.

Question 11

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 12

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. You expect to liquidate your position in 1 year upon maturity of the CD. Spot exchange rates are US $0.78493 per Canadian dollar.
-What is the end-of-year profit or loss on the bank's cash position if in one year the exchange rate falls to US $0.765/C $1? Assume there is no change in interest rates. (Choose the closest answer)

Accepted Answer

A) Loss of US $75,000. 
B) Profit of C $274,000. 
C) Loss of US $7,000. 
D) Profit of C $9,000. 
E) Loss of US $5,000. 
A) Loss of US $75,000. 
B) Profit of C $274,000. 
C) Loss of US $7,000. 
D) Profit of C $9,000. 
E) Loss of US $5,000.

Question 13

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 14

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 15

Derivative contracts allow an FI to manage interest rate and foreign exchange risk.

Accepted Answer

A) True 
 B)False

Question 16

An off-balance-sheet forward position is used to hedge the FI's on-balance-sheet risk exposure.

Accepted Answer

A) True 
 B)False

Question 17

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.

Accepted Answer

A) $24.9; $54.6 
B) $13.2; $31.2 
C) $31.2; $16.8 
D) $7.8; $14.7 
E) $16.0; $27.4 
A) $24.9; $54.6 
B) $13.2; $31.2 
C) $31.2; $16.8 
D) $7.8; $14.7 
E) $16.0; $27.4

Question 18

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 19

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 20

Selective hedging occurs by reducing the interest rate risk by selling sufficient futures contracts to offset the interest rate risk exposure of a portion of the cash positions on the balance sheet.

Accepted Answer

A) True 
 B)False

Exam 22: Futures and Forwards

Use the following two choices to identify whether each intermediary or entity is a net buyer or net seller of credit derivative securities. -Insurance companies

An FI has reduced its interest rate risk exposure to the lowest possible level by selling sufficient futures to offset the risk exposure of its whole balance sheet or cash positions in each asset and liability. The FI is involved in

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.

Why does basis risk occur?

A credit forward is a forward agreement that

Hedging effectiveness often is measured by the squared correlation between past changes in the spot asset prices and futures prices.

The portfolio manager for Conyers Bank wishes to sell the entire issue of Treasury bonds at a current price of 87-05/32nds. What will be the gain or loss on the cash position since the futures contract was placed? (That is, since the bonds were valued at $28,387,500.)

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?

If the portfolio manager wants to shorten the bank's asset maturity, what type of risk is she concerned about?

Derivative contracts allow an FI to manage interest rate and foreign exchange risk.

An off-balance-sheet forward position is used to hedge the FI's on-balance-sheet risk exposure.

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.

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

Catastrophe futures contracts

Selective hedging occurs by reducing the interest rate risk by selling sufficient futures contracts to offset the interest rate risk exposure of a portion of the cash positions on the balance sheet.

Why Are Financial Institutions Special

Financial Services: Depository Institutions

Financial Services: Finance Companies

Financial Services: Securities Brokerage and Investment Banking

Financial Services: Mutual Funds and Hedge Funds

Financial Services: Insurance

Risks of Financial Institutions

Interest Rate Risk I

Interest Rate Risk II

Credit Risk: Individual Loan Risk

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

Filters

The portfolio manager for Conyers Bank wishes to sell the entire issue of Treasury bonds at a current price of 87-05/32^nds. What will be the gain or loss on the cash position since the futures contract was placed? (That is, since the bonds were valued at $28,387,500.)

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.