Question 1

Which of the following indicates the need to place a hedge?

Accepted Answer

The price movement in the underlying cash asset cannot be forecasted perfectly, so a hedge is needed to reduce the risk of loss.

Question 2

Why does basis risk occur?

Accepted Answer

Basis risk occurs because 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. This can result in a difference between the actual price paid or received and the price that was anticipated.

Question 3

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

The FI is exposed to interest rate increases because the cost of its floating rate commercial paper will rise with increasing rates. Selling financial futures allows the FI to lock in current interest rates, thus hedging against future rate increases.

Question 4

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

Accepted Answer

The answer of Which of the following is an example...

Question 5

Historical analysis of recent changes in exchange rates in both the spot and futures markets for a given currency reveals that spot rates are thirty percent more sensitive than futures prices.Given this information, the hedge ratio for this currency is

Accepted Answer

The hedge ratio is the ratio of the change in the futures price to the change in the spot price. In this case, the spot rates are thirty percent more sensitive than futures prices, so the hedge ratio is 1 / (1 + 0.3) = 0.77.

Question 6

When will the estimated hedge ratio be greater than one?

Accepted Answer

A hedge ratio greater than one means that the investor needs to take a larger futures position relative to his spot position to fully hedge against risk. This occurs when the spot rate changes are greater than futures rate changes, indicating that the investor needs to take on more risk in order to fully hedge their exposure.

Question 7

How is a hedge ratio commonly determined?

Accepted Answer

The hedge ratio is commonly determined by running an ordinary least squares regression of changes in spot prices on changes in futures prices. This calculates the slope of the regression line, which represents the hedge ratio.

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

The answer of The covariance of the change in spot...

Question 9

The primary benefit of a futures exchange is

Accepted Answer

The primary benefit of a futures exchange is to indemnify counterparties against credit or default risk through the use of clearinghouses, which act as intermediaries between buyers and sellers, guaranteeing the performance of the trade. This reduces counterparty risk and promotes market liquidity. The other choices are not accurate descriptions of the benefits of a futures exchange.

Question 10

Futures contracts are standard in terms of all of the following EXCEPT

Accepted Answer

The answer of Futures contracts are standard in terms of...

Question 11

What is overhedging?

Accepted Answer

Overhedging refers to using more hedge vehicles than necessary to offset the risk in the cash asset. This can lead to additional costs and potentially lower returns.

Question 12

Routine hedging

Accepted Answer

The answer of Routine hedging
...

Question 13

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

Accepted Answer

The number of futures contracts that an FI should buy or sell in a macrohedge depends on the size and direction of its interest rate risk exposure, as well as the return risk trade-off from fully hedging or selectively hedging that risk. Therefore, all of the options listed are important considerations when deciding how many futures contracts to trade.

Question 14

The terms of futures contracts traded in the U.S.are set by the exchange on which they propose to be traded, but are subject to approval by the

Accepted Answer

Futures contracts traded in the U.S. are subject to approval by the Commodity Futures Trading Commission (CFTC). The CFTC is the regulatory body that oversees the futures and options markets in the U.S. and approves the terms of each contract before it is traded. While exchanges like the CME Group and Chicago Board of Trade set the terms of their contracts, they must receive approval from the CFTC before they can be traded.

Question 15

If a 12-year, 6.5 percent semi-annual $100,000 T-bond, currently yielding 4.10 percent, is used to deliver against a 6-year, 5 percent T-bond at 110-17/32, what is the conversion factor? What would the buyer have to pay the seller?

Accepted Answer

The conversion factor for a bond is calculated to adjust for differences in coupon rates and time to maturity when delivering a bond different from the standard bond in futures contracts. The buyer pays the seller the product of the quoted futures price and the conversion factor, plus accrued interest. Without the specific formula and calculations provided in the question, the correct answer cannot be determined through explanation alone. However, choice B is identified as the correct answer based on the information given.

Question 16

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

The conversion factor is calculated as follows:
Conversion factor = (Present value of bond's cash flows at 8% / Present value of bond's cash flows at 10%) = ($91.49 / $79.05) = 1.158
The buyer would have to pay the seller:
Bond price = Conversion factor x Bond's price quote
Bond price = 1.158 x $114,812.50 = $132,591.

Question 17

The current price of June $100,000 T-Bonds trading on the Chicago Board of Trade is 109-24.What is the price to be paid if the contract is delivered in June?

Accepted Answer

The price of a T-Bond contract is calculated by multiplying the quoted price by $1,000. The quoted price is in 32nds of a dollar, so 109-24 means 109 and 24/32. The calculation is (109 + 24/32) * $1,000 = $109,750.

Question 18

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

The FI has hedged its entire balance sheet or cash positions, indicating that this is a routine hedging practice. Microhedging involves hedging specific individual assets or liabilities. Selective hedging involves hedging some positions but not others based on certain criteria. Overhedging would involve hedging to an excessive degree, which is not indicated in the scenario. Speculation would involve taking a position in the market in anticipation of potential gains, rather than hedging to manage risk exposure.

Question 19

A naive hedge occurs when

Accepted Answer

A naive hedge is a simple, direct hedge that matches the risk exposure of a cash asset with a forward or futures contract. It does not consider other factors such as basis risk or basis point value. Option B describes a direct dollar-for-dollar hedge, which is an example of a naive hedge. Options A, C, and D describe more complex hedging strategies. Option E includes all options, but only option B matches the definition of a naive hedge.

Question 20

Which of the following measures the dollar value of futures contracts that should be sold per dollar of cash position exposure?

Accepted Answer

The hedge ratio measures the dollar value of futures contracts that should be sold per dollar of cash position exposure. It helps investors determine the appropriate number of futures contracts to buy or sell to fully hedge their exposure to the underlying asset.

Quiz 23: Futures and Forwards