Deck 9: Using Derivatives to Manage Interest Rate Risk

Question 1

When you buy a futures contract, your futures position is:

A)flat.
B)long.
C)short.
D)the same as the cash position.
E)a.and d.

Answer 1

B

Question 2

____________ of financial futures contracts require physical delivery.

A)Nearly 100%
B)Approximately 75%
C)Approximately 50%
D)Approximately 25%
E)Less than 1%

Answer 2

E

Question 3

Which of the following would generally not be considered a speculator?

A)Local
B)Day trader
C)Scalper
D)Position trader
E)Commission broker

Answer 3

E

Question 4

Which of the following executes trades for other parties?

A)Local
B)Day trader
C)Scalper
D)Position trader
E)Commission broker

Question 5

When an interest-bearing security is the underlying asset for a futures contract, it is called:

A)a forward contract.
B)an interest rate futures.
C)a commission futures.
D)a speculative futures.
E)an interest rate swap.

Question 6

Financial futures are:

A)a commitment between two parties to trade a financial instrument at a certain rate at a specified time in the future.
B)A call option on a standardized asset at a certain price at a specified time in the future.
C)A put option on a standardized asset at a certain price at a specified time in the future.
D)a commitment between two parties on the price of a standardized financial asset with the final settlement specified time in the future.
E)b.and c.

Question 7

Which of the following primarily takes futures positions that are outstanding for just minutes?

A)Scalper
B)Local
C)Day trader
D)Position trader
E)Commission broker

Question 8

The "initial margin" on a futures contract:

A)is a cash deposit the buyer places with the seller as good faith money.
B)can be cash or U.S.government securities placed with an exchange member.
C)are U.S.government securities the buyer places with the seller for safekeeping.
D)are the first installment on the payment for a futures contract.
E)is the amount by which the futures contract is initially "in the money."

Question 9

When you sell a futures contract, your futures position is:

A)flat.
B)long.
C)short.
D)the same as the cash position.
E)b.and d.

Question 10

An instrument that derives its value from another underlying asset is known as a(n):

A)hedge.
B)derivative.
C)basis.
D)backdate agreement.
E)original document.

Question 11

The daily change in the value due to the marking-to-market process is know as the:

A)maintenance margin.
B)variation margin.
C)market margin.
D)initial margin.
E)marked margin.

Question 12

Banks use financial derivatives for all of the following except:

A)hedge asset yields.
B)adjust maturities by creating synthetic liabilities.
C)adjust the sensitivity of earnings to changes in interest rates.
D)lock-in the cost of liabilities.
E)Banks use financial derivatives for all of the above.

Question 13

Which of the following is correct about futures contracts?

A)Buyers of futures contracts make a profit when prices fall.
B)Buyers of futures contracts make a profit when interest rates rise.
C)Sellers of futures contracts make a profit when prices fall.
D)Sellers of futures contracts make a profit when prices rise.
E)a.and d.

Question 14

Which of the following is correct about futures contracts?

A)Buyers of futures contracts make a profit when prices rise.
B)Buyers of futures contracts make a profit when interest rates rise.
C)Sellers of futures contracts make a profit when prices rise.
D)Sellers of futures contracts make a profit when prices interest rates fall.
E)b.and d.

Question 15

The daily settlement process that credits gains or deducts losses from a futures customer's account is called:

A)the variation margin.
B)marking-to-market.
C)the initial margin.
D)the maintenance margin.
E)the gain/loss ratio.

Question 16

When you own the underlying security, your spot position is _______.

A)flat.
B)long.
C)short.
D)is also known as your cash position.
E)b.and d.

Question 17

To buy a futures contract, one must post a(n):

A)maintenance margin.
B)variation margin.
C)market margin.
D)initial margin.
E)marked margin.

Question 18

Which of the following is not a difference between futures and forward contracts?

A)Futures contracts are marked-to-market daily, while futures contracts are not.
B)Buyers and sellers deal directly with each other on forward contracts but go through and exchange with futures contracts.
C)Futures contracts are standardized, forward contracts generally are not.
D)Delivery rarely occurs on futures contracts but generally occurs with forward contracts.
E)All of the above are differences between futures and forward contracts.

Question 19

Which of the following wishes to reduce risk?

A)Scalper
B)Local
C)Arbitrageur
D)Hedger
E)Day trader

Question 20

When you wish to own the underlying security, your spot position is _______.

A)fat.
B)long.
C)short.
D)skinny.
E)a.and c.

Question 21

The value of a basis point for 90-day Eurodollar Time Deposit futures contract is:

A)$10.
B)$100.
C)$25.
D)$250.
E)$500.

Question 22

A cross hedge often has greater risk then a perfect hedge because:

A)futures and cash interest rates are perfectly positively correlated.
B)futures and cash interest rates are perfectly negatively correlated.
C)cross hedging uses a contract based on the identical underlying asset.
D)futures and cash interest rates may not move together.
E)b.and d.

Question 23

An investor anticipates she will have funds to invest in the T-Bill market.If she hedges by buying futures contracts and rates decline, which of the following is true?

A)The investor will profit on the futures contract.
B)The investor will profit in the spot market.
C)The investor will have locked in a minimum 10% return.
D)The investor will lose in the spot market.
E)a.and d.

Question 24

What is a microhedge?

A)It is a hedge of the bank's aggregate portfolio.
B)It is a hedge using just one type of futures contract.
C)It is the hedge of a specific asset or liability for which the bank is exposed to interest rate risk.
D)It is a hedge using two or more types of futures contracts.
E)It is a has that has a duration of less than one month.

Question 25

Which of the following would require a short hedge?

A)The bank has a positive gap in three months.
B)The bank anticipates receiving the repayment of a $30 million loan in 2 months.The funds will be rolled over immediately.
C)The bank is going to invest a large amount of money in Treasury bills.
D)The bank has a negative duration gap.
E)The bank plans to roll variable-rate CDs over into fixed-rate CDs.

Question 26

Most interest rate swaps are set up for:

A)less than 6 months.
B)6 months to 1 year.
C)1 year to 10 years.
D)11 to 20 years.
E)over 20 years.

Question 27

Which of the following is not an advantage of the swap market over the futures market for managing interest rate risk?

A)Getting out of a contract is easier in the swap market.
B)With a swap contract, you can hedge away longer-term risks than with futures contracts.
C)The notional amount of the swap can be set to any value acceptable to both trading parties.
D)All of the above are advantages of the swap market over the futures market.
E)a.and c.are not advantages of the swap market over the futures market.

Question 28

In an interest rate swap, the notional principle:

A)is the difference in the fixed and floating interest rates.
B)is the difference in the fixed and floating interest payments.
C)is used to calculate the FRA basis.
D)is used to calculate the value of the interest payments.
E)is used to calculate the hedge ratio.

Question 29

Swap participants are subject to:

A)margin requirements.
B)Federal Reserve regulation E.
C)exchange performance.
D)counterparty risk.
E)All of the above.

Question 30

What is a macrohedge?

A)It is a hedge of the bank's aggregate portfolio.
B)It is a hedge using just one type of futures contract.
C)It is the hedge of a specific asset or liability for which the bank is exposed to interest rate risk.
D)It is a hedge using two or more types of futures contracts.
E)It is a has that has a duration of less than one month.

Question 31

Which of the following is not true regarding the basis?

A)The basis systematically declines as expiration approaches.
B)The basis must equal zero at expiration.
C)The basis may not equal zero before expiration.
D)The basis may be positive or negative.
E)both b.and c.are not true regarding the basis.

Question 32

A trader buys a 90-day Eurodollar futures contract at 95.25.The next day, interest rates fall 4.5%.Which of the following is true? Assume that the initial and maintenance margins are $5,000.

A)The trader would have to deposit an additional $62,500 into her account.
B)The trader would have to deposit an additional $2,500 into her account.
C)The trader would have to deposit an additional $625 into her account.
D)The trader could withdraw $2,500 from her margin account.
E)The trader could withdraw $625 from her margin account.

Question 33

Assume that two firms, one considered a high credit risk (HCR) and the other a low credit risk (LCR), are considering an interest rate swap.Each can borrow at the following rates: An interest rate swap would be beneficial to both parties if:

A)the LCR firm wants to borrow at the fixed rate and the HCR firm wants to borrow at the variable rate.
B)the HCR firm wants to borrow at the fixed rate and the LCR firm wants to borrow at the variable rate.
C)both firms want to borrow at the variable rate.
D)both firms want to borrow at the fixed rate.
E)an interest rate swap would be never be beneficial in this situation.

Question 34

How many 90-day Eurodollar futures contracts should a bank purchase to hedge the roll-over of a 1-year, $5 million loan if loan rates and Eurodollar rates have the same volatility?

A)1 contract
B)5 contracts
C)10 contracts
D)20 contracts
E)50 contracts

Question 35

How many 90-day Eurodollar futures contracts should a bank purchase to hedge the roll-over of a 6-month, $20 million loan if loan rates and Eurodollar rates have the same volatility?

A)2 contracts
B)4 contracts
C)10 contracts
D)20 contracts
E)40 contracts

Question 36

A bank anticipates it will need to borrow funds in the Eurodollar market in the future.It hedges by selling futures contracts.If rates decline, which of the following is true?

A)The bank will profit on the futures contract.
B)The bank will profit in the cash market.
C)The bank will have locked in a low cost of borrowing.
D)The bank will lose in the cash market.
E)a.and d.

Question 37

When the net profit on both the futures and cash position equals zero, this is known as a(n):

A)cross hedge.
B)perfect hedge.
C)imperfect hedge.
D)basis hedge.
E)return hedge.

Question 38

Which of the following is not true of forward rate agreements (FRA)?

A)The two counterparties to an FRA agree to a notional principal.
B)FRAs are traded on an organized exchange.
C)The buyer of a FRA agrees to pay a fixed-rate coupon payment.
D)FRAs are not as liquid as most futures contracts.
E)FRAs can be used to manage interest rate risk.

Question 39

The basis on a futures contract is defined as:

A)the cash price minus the forward price.
B)the forward price minus the cash price.
C)the futures price minus the cash price.
D)the cash price minus the futures price.
E)None of the above.

Question 40

A trader buys a 90-day Eurodollar futures contract at 95.25.The next day, interest rates rise 5.25%.Which of the following is true? Assume that the initial and maintenance margins are $5,000.

A)The trader would have to deposit an additional $62,500 into her account.
B)The trader would have to deposit an additional $1,500 into her account.
C)The trader would have to deposit an additional $625 into her account.
D)The trader could withdraw $1,250 from her margin account.
E)The trader could withdraw $625 from her margin account.

Question 41

If a hedger is owns the underling security, he will be long the futures position.

Question 42

Speculators focus on avoiding or reducing risk.

Question 43

An interest rate collar consists of:

A)buying an interest rate cap and selling an interest rate floor.
B)buying an interest rate floor and selling an interest rate cap.
C)selling an interest rate floor and buying an interest rate cap.
D)buying a call option and selling a futures contract.
E)selling a put option and buying a futures contract.

Question 44

A long hedge would be appropriate for a bank that wants to reduce its cash market risk associated with .a decline in interest rates.

Question 45

Give an example where an interest rate swap would benefit both counterparties.

Question 46

How can a bank hedge when it makes 1-year fixed-rate loans and finances them with 3-month floating-rate deposits?

A)Buy Eurodollar futures contracts.
B)Sell put options on Eurodollar futures contracts.
C)Sell Eurodollar futures contracts.
D)Buy call options on Eurodollar futures contacts.
E)b.and c.

Question 47

A bank can establish a floor on interest rate costs by:

A)buying a call option on Eurodollar futures.
B)selling Eurodollar futures contracts.
C)selling a call option on Eurodollar futures.
D)a.and b.
E)b.and c.

Question 48

Your bank has a positive GAP and wants to hedge against changes in interest rates.Would a collar or reverse collar serve as a better hedge? Why?

Question 49

Forward contracts rarely require a performance guarantee or collateral.

Question 50

Explain the concepts of cross hedging and basis risk.

Question 51

Speculators take a position to reduce their risk profile.

Question 52

"Locals" trade futures for their own account.

Question 53

A zero cost collar:

A)is risk-free.
B)is designed to offset margin requirements.
C)has a larger premium than a reverse collar.
D)designed so the buyer has no net premium payment.
E)None of the above.

Question 54

Discuss the relative advantages and disadvantages of using futures versus forward contracts.

Question 55

Every futures contract has a formal expiration date.

Question 56

When futures prices falls, buyers gain at the expense of sellers.

Question 57

Banks can often replicate on-balance sheet transactions with off-balance sheet contracts.

Question 58

A reverse collar consists of:

A)buying an interest rate floor and an interest rate cap.
B)buying an interest rate floor and selling an interest rate cap.
C)selling an interest rate floor and buying an interest rate cap.
D)buying a call option and selling a futures contract.
E)selling a put option and buying a futures contract.

Question 59

Discuss the difference between speculating and hedging.

Question 60

Derivatives can be a cost-effective way to manage interest rate risk.