Deck 9: Exploring Financial Markets and Hedging Strategies

Question 1

Interest rates tend to rise during a period of economic expansion.

Answer 1

True

Question 2

Long-term security prices tend to be more volatile than the prices of short-term securities.

Answer 2

True

Question 3

Short-term interest rates tend to be more volatile than long-term interest rates.

Answer 3

True

Question 4

Long-term securities as a rule carry more principal risk than short-term securities.

Question 5

Long-term securities carry greater income risk to the investor than short-term securities.

Question 6

Long-term interest rates typically rise in the late spring through mid-summer (June or July) and fall during the winter months.

Question 7

While modest, seasonal patterns in interest rates tend to be stable over time.

Question 8

If projected money-supply growth is less than projected GNP growth interest rates are likely to fall, other factors held constant.

Question 9

According to the Fisher effect, if the rate of expected inflation decreases, the real rate must fall and the nominal rate also declines.

Question 10

Accurate prediction of interest rates would lead to substantial gains to the predictor.

Question 11

According to the expectations hypothesis, an upward-sloping yield curve implies that investors in the financial markets expect interest rates to rise above their current levels in the future.

Question 12

Consensus forecasts rely upon the simultaneous use of several different forecasting methods.

Question 13

The result of an interest-rate swap is usually a lower interest rate for both swap partners and a better balance between cash inflows and outflows for both parties to the swap.

Question 14

The notional amount of a swap never changes hands.

Question 15

Interest rate swaps represent iron clad agreements between two borrowers, so there is never any real risk related to the performance of your partner.

Question 16

In general, the idea of an interest rate swap is to allow investors with differing credit worthiness and funding needs to exploit their particular comparative advantage in borrowing.

Question 17

Airbag swaps often induce both rate ceilings and floors, protecting the participants against losses from rising market interest rates.

Question 18

A call option grants the buyer the right to purchase a specific number of securities on or before an expiration date at a specified price.

Question 19

Swaps are used to reduce default risk.

Question 20

A swap eliminates all interest-rate risk.

Question 21

All swaps experience a change in notional principal from the first day the swap is in force.

Question 22

The process of economic expansion and contraction is called the Wall Street Effect.

Question 23

The concept of futures trading is a relatively new idea.

Question 24

Futures trading is designed to protect an investor against price fluctuations.

Question 25

The advantage of hedging is that it significantly reduces risk.

Question 26

Trading in financial futures by financial institutions (such as commercial banks) is relatively free of restrictions.

Question 27

There is a relatively stable relationship between spot and futures prices.

Question 28

Hedging can potentially reduce risk, according to the textbook.

Question 29

An option contract gives the buyer the right to sell a commodity or security at a set price on or before expiration of the contract.

Question 30

Most terms of trade for futures contracts are completely controlled by the various exchanges.

Question 31

One of the major options involving money market instruments is the Eurodollar deposit futures option.

Question 32

The Eurodollar futures option contract is unusual because settlement is in Eurodollar deposits.

Question 33

The Treasury bond futures option contract is traded in units of $100,000.

Question 34

In order to hedge against rising interest rates a bank would buy a call option on Eurodollar futures.

Question 35

Most American style options are held to expiration.

Question 36

The purpose of a short hedge is to guarantee a desired yield in case interest rates decline before securities are actually purchased in the cash market.

Question 37

Cross-hedging is characterized by using different types of securities in the spot and futures markets.

Question 38

Savings and loan associations use futures to hedge the market value of their mortgage-related securities.

Question 39

One disadvantage of the financial futures market is that it may prohibit financial institutions from extending increased amounts of credit.

Question 40

The futures and options markets tend to promote greater efficiency in the use of scarce financial resources.

Question 41

A perfect hedge is rare.

Question 42

Hedging may be compared to insurance in that it helps to protect against certain kinds of risk exposure.

Question 43

Trading in Treasury note futures began at the Chicago Board of Trade in 1967.

Question 44

One-year T-bill futures contracts carry denominations of $250,000.

Question 45

Most options on financial instruments are traded on the New York Futures Exchange.

Question 46

Selling futures contracts can help protect a firm against an expected decline in commodity prices.

Question 47

Financial futures and options contracts are less beneficial to investors heavily leveraged with debt because their net earnings are particularly sensitive to changes in interest rates.

Question 48

Some financial analysts feel that futures and options markets, rather than helping reduce risk and promoting the more efficient use of scarce resources, may in fact be aimed at wealthy investors, giving them a speculative outlet for their funds and, thus, the futures and options markets really increase risk.

Question 49

Commercial bank participation in the futures markets has been limited. One reason for this is the accounting procedures used to recognize gains and losses from futures trading. These accounting procedures tend to show volatile fluctuations in income for those banks active in the futures markets.

Question 50

Hedging may be compared to insurance in that it actually reduces risk.

Question 51

Trading in the financial futures market allows an investor to sell futures contracts on selected securities to protect against the risk of a decline in the yield of the investment.

Question 52

Cross hedging rests on the assumption that the prices of most financial instruments tend to move in the same direction by roughly the same proportion.

Question 53

The spread between the cash or spot price of a commodity or security and its futures price is known as basis.

Question 54

The risk of futures trading is the risk of changes in the basis.

Question 55

According to your text, futures trading "works" because basis risk is less than price risk on a commodity or security.

Question 56

The notion of convergence states that the difference between spot and future prices will approach zero as the length of time between the current and the time in which the option will be traded approaches infinity.

Question 57

Financial futures provide the trader with a near perfect insulation to market risk.

Question 58

The writer of a put option benefits if the market value of the futures contract or security stays below the option's strike price.

Question 59

For the purchaser of a put option, the option will normally be exercised for profit if the difference between the strike price and the value of the underlying futures contract or security exceeds the sum of the option premium, taxes and transactions costs.

Question 60

For the purchaser of a call option the option will normally be exercised for profit if the market price of the underlying futures contract or security climbs above the sum of the strike price, option premium, taxes and transactions costs.

Question 61

The volatility ratio is a measure of basis risk associated with a futures contract.

Question 62

The principle of convergence suggests that option prices tend to approach the value of the underlying futures contract as the expiration date of the options approaches.

Question 63

Stock index futures contracts are settled by the transfer of ownership of a diversified basket of stocks.

Question 64

Arbitrageurs hope to profit from price differences in markets around the world.

Question 65

When an investor goes "long" in the futures market, he or she expects to profit from a decline in interest rates.

Question 66

All futures contracts trade in the same quantities and have the same delivery dates.

Question 67

In the international money market interest-rate risk associated with large commercial loans can be dealt with using the one-month LIBOR futures contract, according to the textbook.

Question 68

Jefferson County Alabama experienced fiscal troubles due to the amount of bad swaps they engaged in.

Question 69

Normally arbitrage trading based upon price difference between two different securities markets is highly risky due to the simultaneous holding of both long and short positions.

Question 70

The Federal funds futures contract traded on the Chicago Board of Trade's exchange covers 90 days.

Question 71

Most financial futures trading centers on U.S.T-bill contracts.

Question 72

When interest rates rise, asset prices normally fall and this is particularly true of fixed income securities.

Question 73

Interest rates are notoriously difficult to predict, however they do tend to follow the business cycle.

Question 74

Implied market forecasts are predictions that are based on the interest rate expectations of the market.

Question 75

Research has increasingly pointed towards time patterns in market interest rates that come close to a random walk, that is, it can be predicted on a consistent basis.

Question 76

Derivatives have recently come under greater scrutiny due to their possible role in the great credit crisis of 2007-2009.

Question 77

Investors interested in hedging may buy a futures contract in order to lock in a price on a specific asset at a future date.

Question 78

Hedging in the futures market reduces the overall risk in the market.

Question 79

A key feature of the futures market that allows the hedging process to transfer risk effectively is the fact that prices in the spot market are generally correlated with prices in the futures market.

Question 80

Hedging essentially involves adopting equal and opposite positions in the spot and futures markets for the same assets.