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

In a credit forward agreement hedge, the loss on the balance sheet cash position is offset completely by the gain on the off-balance-sheet credit forward agreement if the characteristics of the benchmark bond and the bank's loan to the borrower are the same.

Accepted Answer

A) True 
 B)False

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.
-Your position is exposed to:

Accepted Answer

A) interest rate risk only. 
B) credit risk only. 
C) exchange rate risk only. 
D) interest rate and exchange rate risk only. 
E) interest rate risk, exchange rate risk, and credit risk. 
A) interest rate risk only. 
B) credit risk only. 
C) exchange rate risk only. 
D) interest rate and exchange rate risk only. 
E) interest rate risk, exchange rate risk, and credit risk.

Question 4

A credit forward agreement specifies a credit spread on a benchmark U.S. Treasury bond.

Accepted Answer

A) True 
 B)False

Question 5

An FI issued $1 million of 1-year maturity floating rate commercial paper. The commercial paper is repriced every three months at the 91-day Treasury bill rate plus 2 percent. What is the FI's interest rate risk exposure and how can it use financial futures and options to hedge that risk exposure?

Accepted Answer

A) The FI can hedge its exposure to interest rate increases by selling financial futures. 
B) The FI can hedge its exposure to interest rate decreases by selling financial futures. 
C) The FI can hedge its exposure to interest rate increases by buying financial futures. 
D) The FI can hedge its exposure to interest rate increases by buying call options. 
E) The FI cannot hedge its exposure to interest rate increases or decreases using financial futures 
A) The FI can hedge its exposure to interest rate increases by selling financial futures. 
B) The FI can hedge its exposure to interest rate decreases by selling financial futures. 
C) The FI can hedge its exposure to interest rate increases by buying financial futures. 
D) The FI can hedge its exposure to interest rate increases by buying call options. 
E) The FI cannot hedge its exposure to interest rate increases or decreases using financial futures

Question 6

A perfect hedge, or perfect immunization, seldom occurs.

Accepted Answer

A) True 
 B)False

Question 7

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

Accepted Answer

A) size of its interest rate risk exposure. 
B) direction of its interest rate risk exposure. 
C) return risk trade-off from fully hedging that risk. 
D) return risk trade-off from selectively hedging that risk. 
E) All of the above. 
A) size of its interest rate risk exposure. 
B) direction of its interest rate risk exposure. 
C) return risk trade-off from fully hedging that risk. 
D) return risk trade-off from selectively hedging that risk. 
E) All of the above.

Question 8

The covariance of the change in spot exchange rates and the change in futures exchange rates is 0.6060, and the variance of the change in futures exchange rates is 0.5050. What is the estimated hedge ratio for this currency?

Accepted Answer

A) 0.306. 
B) 0.694. 
C) 1.440. 
D) 1.200. 
E) 0.833. 
A) 0.306. 
B) 0.694. 
C) 1.440. 
D) 1.200. 
E) 0.833.

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

A spot contract specifies deferred delivery and payment.

Accepted Answer

A) True 
 B)False

Question 11

An FI with a positive duration gap is exposed to interest rate declines and could hedge its interest rate risk by buying forward contracts.

Accepted Answer

A) True 
 B)False

Question 12

What is a difference between a forward contract and a future contract?

Accepted Answer

A) The settlement price of a forward contract is fixed over the life of the contract but in a futures contract is marked to market daily. 
B) Forward contracts are normally arranged through an organized exchange, while most futures contracts are OTC contracts. 
C) Both are essentially the same, except for trading volumes which are higher for futures contracts. 
D) Both are essentially the same, except for the fact that the terms of a forward contract is set by the exchange, subject to the approval of the Commodity Futures Trading Commission (CFT
C) . 
E) Delivery of the underlying asset almost always occurs on a futures contract but almost never occurs on a forward contract. 
A) The settlement price of a forward contract is fixed over the life of the contract but in a futures contract is marked to market daily. 
B) Forward contracts are normally arranged through an organized exchange, while most futures contracts are OTC contracts. 
C) Both are essentially the same, except for trading volumes which are higher for futures contracts. 
D) Both are essentially the same, except for the fact that the terms of a forward contract is set by the exchange, subject to the approval of the Commodity Futures Trading Commission (CFT
C) . 
E) Delivery of the underlying asset almost always occurs on a futures contract but almost never occurs on a forward contract.

Question 13

The average duration of the loans is 10 years. The average duration of the deposits is 3 years. $$\begin{array} { | l | r | l | r | } 
\hline \text { Consumer loans } & \$ 50 \text { million } & \text { Deposits } & \$ 235 \text { million } \
\hline \text { Commercial Loans } & \$ 200 \text { million } & \text { Equity } & \$ 15 \text { million } \
\hline \text { Total Assets } & \$ 250 \text { million } & \text { Total Liabilities \& Equity } & \$ 250 \text { million } \
\hline
\end{array}$$
-What is the number of T-bond futures contracts necessary to hedge the balance sheet if the duration of the deliverable bonds is 9 years and the current price of the futures contract is $96 per $100 face value?

Accepted Answer

A) 1,630 contracts. 
B) 1,475 contracts. 
C) 1,900 contracts. 
D) 2,078 contracts. 
E) 3,225 contracts. 
A) 1,630 contracts. 
B) 1,475 contracts. 
C) 1,900 contracts. 
D) 2,078 contracts. 
E) 3,225 contracts.

Question 14

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

Accepted Answer

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

Question 15

An adjustment for basis risk with a value of "br" less than one means that the percent change in the spot rates is greater than the change in rate in the deliverable bond in the futures market.

Accepted Answer

A) True 
 B)False

Question 16

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 17

Calculate the cash flows on the above futures contract if all interest rates increase by 1.49 percent. (That is, ΔR/(1 + R) = 1.49 percent, and 1 bp = $25.)

Accepted Answer

A) The long futures position earns a profit of $3,766.39. 
B) The short futures position earns a profit of $3,725.00. 
C) The long futures position earns a profit of $1.49 million. 
D) The short futures position earns a profit of $1.49 million. 
E) The short futures position suffers a loss of $3,725. 
A) The long futures position earns a profit of $3,766.39. 
B) The short futures position earns a profit of $3,725.00. 
C) The long futures position earns a profit of $1.49 million. 
D) The short futures position earns a profit of $1.49 million. 
E) The short futures position suffers a loss of $3,725.

Question 18

Which of the following is NOT true regarding hedge ratio?

Accepted Answer

A) When there is no basis risk hedge ratio is equal to one. 
B) When h = 1, both spot and futures are expected to change together by the same absolute amount. 
C) When h = 1, FX risk of the cash position should be hedged dollar for dollar by buying FX futures. 
D) When basis risk is present, the spot and future exchange rates are expected to move imperfectly together. 
E) The FI must sell a greater number of futures when there is basis risk than it has to when basis risk is absent. 
A) When there is no basis risk hedge ratio is equal to one. 
B) When h = 1, both spot and futures are expected to change together by the same absolute amount. 
C) When h = 1, FX risk of the cash position should be hedged dollar for dollar by buying FX futures. 
D) When basis risk is present, the spot and future exchange rates are expected to move imperfectly together. 
E) The FI must sell a greater number of futures when there is basis risk than it has to when basis risk is absent.

Question 19

Delivery of the underlying asset almost always occurs in the futures market.

Accepted Answer

A) True 
 B)False

Question 20

The average duration of the loans is 10 years. The average duration of the deposits is 3 years. $$\begin{array} { | l | r | l | r | } 
\hline \text { Consumer loans } & \$ 50 \text { million } & \text { Deposits } & \$ 235 \text { million } \
\hline \text { Commercial Loans } & \$ 200 \text { million } & \text { Equity } & \$ 15 \text { million } \
\hline \text { Total Assets } & \$ 250 \text { million } & \text { Total Liabilities \& Equity } & \$ 250 \text { million } \
\hline
\end{array}$$
-What is the number of T-bond futures contracts necessary to hedge the balance sheet if the duration of the deliverable bonds is 9 years and the current price of the futures contract is $96 per $100 face value and if basis risk shows that for every 1 percent shock to interest rates, i.e., ?R/(1 + R) = 0.01, the implied rate on the deliverable bonds in the futures market increases by 1.1 percent, i.e., ?Rf/(1 + Rf) = 0.011?

Accepted Answer

A) 1,500 contracts. 
B) 1,888 contracts. 
C) 2,100 contracts. 
D) 2,408 contracts. 
E) 3,100 contracts. 
A) 1,500 contracts. 
B) 1,888 contracts. 
C) 2,100 contracts. 
D) 2,408 contracts. 
E) 3,100 contracts.

Exam 22: Futures and Forwards

What is the purpose of a credit forward agreement?

In a credit forward agreement hedge, the loss on the balance sheet cash position is offset completely by the gain on the off-balance-sheet credit forward agreement if the characteristics of the benchmark bond and the bank's loan to the borrower are the same.

A credit forward agreement specifies a credit spread on a benchmark U.S. Treasury bond.

An FI issued $1 million of 1-year maturity floating rate commercial paper. The commercial paper is repriced every three months at the 91-day Treasury bill rate plus 2 percent. What is the FI's interest rate risk exposure and how can it use financial futures and options to hedge that risk exposure?

A perfect hedge, or perfect immunization, seldom occurs.

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

The covariance of the change in spot exchange rates and the change in futures exchange rates is 0.6060, and the variance of the change in futures exchange rates is 0.5050. What is the estimated hedge ratio for this currency?

What does a low value of R2 indicate?

A spot contract specifies deferred delivery and payment.

An FI with a positive duration gap is exposed to interest rate declines and could hedge its interest rate risk by buying forward contracts.

What is a difference between a forward contract and a future contract?

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

An adjustment for basis risk with a value of "br" less than one means that the percent change in the spot rates is greater than the change in rate in the deliverable bond in the futures market.

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?

Calculate the cash flows on the above futures contract if all interest rates increase by 1.49 percent. (That is, ΔR/(1 + R) = 1.49 percent, and 1 bp = $25.)

Which of the following is NOT true regarding hedge ratio?

Delivery of the underlying asset almost always occurs in the futures market.

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

What does a low value of R² indicate?