Deck 10: Fixed Rate Derivatives

Question 1

A comparative advantage swap arises when:

A) two borrowers have the same strengths and weaknesses across various markets.
B) one borrower is stronger than the other in all markets.
C) one party is a borrower and the other is a lender.
D) two borrowers have different strengths and weaknesses in differing markets.

Answer 1

D

Question 2

If A is the position in the derivative, B is the position in the underlying security, and C is a fixed- interest loan, a short synthetic position in the underlying security is represented as:

A) C - A.
B) A - B.
C) - B.
D) C + B.

Answer 2

A

Question 3

Forward rate agreements (FRAs) are:

A) ET interest rate derivatives.
B) OTC interest rate derivatives.
C) OTC share derivatives.
D) ET share derivatives.

Answer 3

B

Question 4

Which of the following is NOT one of the effects of derivatives?

A) Providing a means of dealing with market volatility.
B) Reducing the risk of financial transactions.
C) Increasing the integration of national and global financial markets.
D) Assisting the Reserve Bank to implement monetary policy.

Question 5

A position consisting of futures contracts settling on different dates is known as:

A) a strip.
B) comex trade.
C) cash- and- carry arbitrage.
D) a hedge ratio.

Question 6

The 'hedge ratio' refers to:

A) the price in the spot market divided by the price in the derivatives market.
B) the number of futures contracts needed to equate the gain on a futures position and the loss on the exposure.
C) the difference between a derivative position and the underlying fixed- rate loan.
D) the contract rate in a FRA less the benchmark rate.

Question 7

Which of the following is NOT included in the specification of a FRA?

A) The settlement date.
B) A benchmark interest rate.
C) The broker's fee.
D) A guaranteed interest rate.

Question 8

If A is the position in the derivative, B is the position in the underlying security, and C is a fixed- interest loan, if a player holds B and wishes to hedge her position then she can:

A) buy A.
B) buy C.
C) sell C.
D) sell A.

Question 9

A 'floating rate' means:

A) an interest rate that is indexed to the exchange rate.
B) a variable interest rate such as the bank bill rate.
C) an interest rate swap.
D) an interest rate that is outside the control of the Reserve Bank.

Question 10

The phrase 'yield pick- up' refers to:

A) a capital gain that the holder of a swap enjoys when the RBA decreases interest rates.
B) a gain that comes by switching from interest bearing to dividend bearing derivatives.
C) an arbitrage profit that a trader picks up by buying and selling two swap contracts simultaneously.
D) an increased floating rate yield obtained by investing in a high- yield bond and swapping into a floating- rate investment.

Question 11

Cash- and- carry arbitrage involves:

A) buying in the options market and selling in the futures.
B) buying in the cash market and selling in the forwards.
C) buying in the forward market and selling in the futures.
D) buying in the swaps market and selling in the cash market.

Question 12

An instrument that involves the exchange with a notional principal of $100 million of floating rate for fixed- rate obligations with eight settlement dates is an example of:

A) a share option.
B) a forward rate agreement.
C) an interest futures contract.
D) an interest rate swap.

Question 13

In the infamous Barings Bank disaster, the losses came about due to:

A) contagion.
B) mismanagement.
C) margin calls.
D) speculation.

Question 14

Program trading:

A) is a computerised method of arbitrage between physical, futures and options markets.
B) has been criticised for contributing to the October 1987 stock market crash.
C) ensures SPI futures are priced correctly.
D) all of the above.

Question 15

The growth of derivatives:

A) in recent years has gone into reverse.
B) did not live up to early expectations.
C) took the Reserve Bank by surprise.
D) was a response to increased volatility of financial markets following deregulation.

Question 16

To hedge a share portfolio we can:

A) buy SPI futures.
B) sell SPI futures adjusted for the portfolio beta.
C) buy and sell offsetting amounts of SPI futures.
D) borrow an amount equal to the face value of the portfolio.

Question 17

Options on company shares are available via:

A) banks.
B) the Sydney Futures Exchange.
C) the Australian Stock Exchange.
D) all of the above.

Question 18

A fixed- rate derivative:

A) creates an obligation to transact at an agreed price in the future.
B) is also known as an option.
C) cannot be used by speculators because its price is fixed.
D) none of the above.

Question 19

A forward contract involves:

A) a buyer who is willing to bear all the risk of the agreement.
B) a seller who agrees to deliver a certain amount of a commodity on a specified future date.
C) a trader who will act as broker for the client on the floor of the exchange.
D) a clearing house institution that agrees to guarantee all contracts.

Question 20

The Share Price Index (SPI) contract traded on the SFE has a face value equal to:

A) $1000 × (All Ordinaries index).
B) $25 × (S&P/ASX 200 index).
C) $1000 × (SFE index).
D) $100 × (S&P/ASX 100 index).

Question 21

Futures have the attraction that their credit exposure is carried by the clearing house, not by the holder.

Question 22

When there is a 'contango' in futures markets, it means that the spot price is below the futures price.

Question 23

Assume that in June we buy one December SPI contract at 2000 and in December the SPI200 Index is 2150. Then the settlement amount is:

A) $7500.
B) $10,000.
C) $150.
D) $3750.

Question 24

Forward contracts are settled by:

A) both physical delivery and cash payment.
B) physical delivery.
C) cash payment.
D) physical delivery or cash payment.

Question 25

A university student uses a 'commodity futures' contract. Which of the following is the underlying product most likely to be?

A) Shares.
B) Bonds.
C) Oil.
D) Cash.

Question 26

SIMEX is the abbreviation for Seoul Futures Exchange.

Question 27

Instruments whose price involves bilateral negotiation rather than a bidding process are known as instruments.

A) over- the- counter
B) public- exchange- traded
C) not- for- negotiation
D) mark- to- market

Question 28

'Basis' in futures trading is defined as the difference between the futures price and the spot price of the underlying commodity.

Question 29

Swaps are always exchange- traded.

Question 30

An instrument whose price depends on the price of an underlying product is known as a:

A) market index.
B) two- way price.
C) derivative.
D) contingent cash flow.

Question 31

A credit derivative is a contract agreeing an exchange where at least one leg of the cash flow depends on the performance of a specified underlying credit- sensitive asset or liability.

Question 32

The basis in futures is positive when we observe that the futures price is below the spot price.

Question 33

Which of the following is an exchange- traded instrument?

A) Collars.
B) Swaps.
C) Forward rate agreements.
D) Futures.

Question 34

In a bill futures contract, the buyer's receipts equal:

A) price of the bill minus yield on the bill.
B) face value of the bill minus the price of the bill on settlement date.
C) price of the bill at purchase yield plus the interest rate.
D) price of the bill on settlement date minus price of the bill at purchase yield.

Question 35

In reading the financial press in regards to derivatives:

A) the price in the spot market can be easily calculated from the price in the derivatives market.
B) the first trade is the price at which trading closed on the day.
C) we can judge the liquidity in the market from the volume of turnover.
D) it will always show an inverse- shaped yield curve.

Question 36

In futures trading, margin calls are made by:

A) the buyer.
B) the clearing house.
C) the seller.
D) the holder of the underlying security.

Question 37

If A is the position in the derivative, B is the position in the underlying security, and C is a fixed- interest loan, then a derivative product can be summarised as:

A) A = B - C.
B) A = B × C.
C) A = B + C.
D) A = B/C.

Question 38

If we buy a $100 90- day bank bill futures contract at $95.60, which of the following is true?

A) We pay $98.23 on settlement day.
B) We receive a bank bill on settlement day worth $95.60.
C) The bill will earn us 4.40% p.a. over 90 days starting from the settlement date.
D) There is a cash settlement involving us in paying $4.40.

Question 39

An investor with a fixed- rate investment who fears that interest rates might rise can use:

A) a paying floating/receiving fixed interest rate swap.
B) a paying floating/receiving floating interest rate swap.
C) a paying fixed/receiving floating interest rate swap.
D) a paying fixed/receiving fixed interest rate swap.

Question 40

In a forward rate agreement, the settlement amount is determined by the difference between the benchmark rate and the guaranteed rate.

Question 41

The Sydney Futures Exchange (SFE) is structured as a company limited by guarantee.

Question 42

Comex is the name given to the SFE gold contract.

Question 43

We can get gold six months from now at a known price by buying it at the current spot price, holding it for six months, and funding the holding with a fixed- rate loan.

Question 44

Reverse cash- and- carry refers to arbitrage in which the commodity is bought in the spot market and sold in the futures/forward market.

Question 45

The prices of A and (B +
C) must be the same, otherwise arbitrage will occur.

Question 46

The theoretical forward price plus the cost of carrying the commodity to settlement date equals the spot price of the commodity.

Question 47

Futures are traded over- the- counter.

Question 48

The basic equation for swaps is: pay fixed/receive floating swap = Bond - Bill.

Question 49

Assume a fund manager holds B. Then he can hedge this position by taking out position C and creating (B -
C).

Question 50

An advantage of forwards compared with futures is that they have a more liquid market.

Question 51

An example of a fixed- rate OTC instrument is share price index futures.

Question 52

In interest rate futures trading, margin calls are made on a player holding a sell contract when interest rates are falling.

Question 53

The cash- and- carry arbitrage becomes a risk arbitrage in the case of share futures because, unlike interest flows, dividend payments cannot be predicted exactly.

Question 54

The SPI contract on the SFE has face value equal to ($25 × S&P/ASX 200 Index).

Question 55

The bank bill contract traded at the SFE has a face value of $1,000,000 and settlement occurs in every month except January.

Question 56

Suppose a bank can borrow five- year fixed- rate funds at 9% p.a. and floating rate at BBR (bank bill rate). Assume a company must pay 11% fixed and (BBR + 2%) for floating. Then there is no scope for a profitable swap because the bank is better off in both markets going it alone.

Question 57

If the price value of a basis point (PVBP) is 24.13 and the market yield increases by 35 basis points then the gain is $845.

Question 58

Contracts for difference (CFDs) are contracts on shares, indices, foreign exchange and commodities bought or sold at the current market price, where settlement depends on the difference between the purchase or sale price and the price on settlement day.

Question 59

The main advantage of fixed- rate derivatives is the hedger does not miss out on the benefit of upside movements.

Question 60

Any long- term rate can be created by a strip of shorter- term futures contracts.

Question 61

What are interest rate swaps?

Question 62

The most frequently traded derivatives in Australia are forward foreign exchange contracts.

Question 63

The value of the hedge ratio is that it tells us PVBP per unit of exposure to price risk.

Question 64

If a university student buys gold six months forward at US$386.25 per ounce and the current spot rate is US$375, then the implied six- month market interest rate is 3%.

Question 65

We can create a synthetic 90- day bill from (180- day bill +90- day bill futures).

Question 66

Explain the algebraic equation for a derivative A = B + C.

Question 67

If A is the derivative position, B is the position in the underlying security, and C is a fixed- interest loan, then B generates the same cash flows as (A -
C).

Question 68

Discuss role, pricing and dangers of share price index futures.

Question 69

Compare and contrast forwards and futures.

Question 70

List the dangers of using derivatives.