Question 1

Duration is deﬁned as the weighted average time to maturity of a ﬁnancial instrument.Explain how this knowledge can help protect against interest rate risk.

Accepted Answer

The answer of Duration is deﬁned as the weighted average...

Question 2

You have taken a short position in a futures contract on corn at £2.60 per bushel.Over the next 5 days the contract settled at 2.52, 2.57, 2.62, 2.68, 2.70.You then decide to reverse your position in
The futures market on the ﬁfth day at close.What is the net amount you receive at the end of 5
Days?

Accepted Answer

The answer of You have taken a short position in...

Question 3

Consider the following two statements: (i) mark-to-the-market provisions protect the seller of a futures contract if the market price of a
Product drops between the contract date and the delivery date.
(ii) mark-to-the-market provisions protect the buyer of a futures contract if the market price of a
Product increases between the contract date and the delivery date.

Accepted Answer

Mark-to-market provisions adjust the value of futures contracts daily, protecting the seller if prices drop and the buyer if prices rise.

Question 4

Suppose you agree to purchase one-ounce of gold for £382 any time over the next month.The current price of gold is £380.The spot price of gold then falls to £377 the next day.If the agreement
Is represented by a futures contract marking to market on a daily basis as the price changes, what is
Your cash ﬂow at the end of the business on the next day?

Accepted Answer

When the spot price of gold falls to £377, the futures contract price will also fall to £377. Since you agreed to purchase one ounce of gold for £382, but the current price is now £377, you will have a loss of £5 per ounce. However, since the futures contract is marked to market on a daily basis, your loss of £5 per ounce will be offset by a gain of £5 per ounce. Therefore, your cash flow at the end of the day will be £0. This means that the correct answer is D, £0.

Question 5

You are doing research into speculation.You ﬁnd that an investor named X as taken an option position Y.You think that in order to know whether position Y is indeed speculative:

Accepted Answer

To determine if position Y is speculative, you need to know the underlying positions of X, as speculation involves taking positions based on expected future price movements without necessarily having a corresponding underlying asset.

Question 6

Calculate the duration of a 7-year £1,000 zero-coupon bond with a current price of £399.63 and a yield to maturity of 14%.

Accepted Answer

For a zero-coupon bond, the duration is equal to its time to maturity, which in this case is 7 years.

Question 7

Tiger State Bank 
$\begin{array} { | l | l | l | } 
\hline \text { Assets } & \text { Duration } & \text { Market Value } \
\hline \text { Overnight Money } & 0.0 & £ 3 \text { Million } \
\hline \text { 1-year T-Bonds } & 0.6 & £ 8 \text { Million } \
\hline \text { Loans } & 2.20 & £ 20 \text { Million } \
\hline \text { Mortgages } & 7.50 & £ 8 \text { Million } \
\hline & & \
\hline \text { Liabilities } & \text { Duration } & \text { Market Value } \
\hline \text { Checking Accounts } & 0.0 & £ 20 \text { Million } \
\hline \text { Short-term CD's } & 0.4 & £ 4 \text { Million } \
\hline \text { Long-term CD's } & 3.20 & £ 12 \text { Million } \
\hline & & \
\hline \text { Equity } & & £ 3 \text { Million } \
\hline
\end{array}$
Calculate the duration of Tiger State Bank's assets and liabilities.

Accepted Answer

The answer of Tiger State Bank 
\(\begin{array} { | l...

Question 8

The duration of a 2 year annual 10% bond that is selling for par is:

Accepted Answer

The duration of a bond is a measure of the sensitivity of its price to changes in interest rates, often calculated as the weighted average time until the bond's cash flows are received. For a 2-year annual 10% coupon bond selling at par, the duration is less than its maturity because the investor receives interest payments before the bond's maturity. The calculation involves discounting each cash flow by the yield (in this case, 10% since it's selling at par) and then calculating the weighted average time of these cash flows. The correct duration for such a bond is approximately 1.91 years, taking into account the present value of the cash flows and the time until they are received.

Question 9

A bank has a $50 million mortgage bond risk position which it hedges in the Treasury bond futures markets at the Chicago Board of Trade.Approximately how many contracts are needed to be held
In the hedge?

Accepted Answer

Each Treasury bond futures contract covers a $100,000 face value bond, so to hedge a $50 million position, the bank would need to hold 500 contracts (50,000,000/100,000 = 500).

Question 10

On March 1, you contract to take delivery of 1 ounce of gold for £415.The agreement is good for any day up to April 1.Throughout March, the price of gold hit a low of £385 and hit a high of £435.The
Price settled on March 31 at £420, and on April 1st you settle your futures agreement at that price.
Your net cash ﬂow is:

Accepted Answer

On March 1, the agreement was made to take delivery of 1 ounce of gold for £415. On April 1, when settling the futures agreement, the price of gold was £420. So, the profit made is £5.
Net cash flow = Profit/Loss + Initial Investment
Initial Investment = £415
Profit/Loss = £5 - £415 = £-410
Net cash flow = £-410
So, the correct answer is D (£5).

Question 11

Your friend and fellow student Alex tells you that duration is the cash ﬂow weighted maturity of an asset or liability.Another student, Ben, tells you that it is the effective maturity.

Accepted Answer

Duration is indeed the cash flow weighted maturity of an asset or liability, as Alex says, which accounts for the timing and size of cash flows. Ben's description of duration as the effective maturity also aligns with how duration measures the sensitivity of the price of a bond to changes in interest rates, effectively acting as a measure of the bond's maturity. Thus, both descriptions are correct in the context of financial analysis.

Question 12

You have taken a short position in a futures contract on corn at £2.60 per bushel.Over the next 5 days the contract settled at 2.52, 2.57, 2.62, 2.68, 2.70.Before you can reverse your position in the
Futures market on the ﬁfth day you are notiﬁed to accept delivery.What will you receive on delivery
And what is the net amount you receive in total?

Accepted Answer

The futures contract settled at £2.70 on the fifth day, so the trader will receive £2.70 per bushel on delivery. The trader sold the contract at £2.60 per bushel, so the net amount received is £2.70 - £2.60 = £0.10 per bushel.

Question 13

Calculate the duration of a 4-year £1,000 face value bond, which pays 8% coupons annually throughout maturity and has a yield to maturity of 9%.

Accepted Answer

The answer of Calculate the duration of a 4-year £1,000...

Question 14

A mortgage banker had made loan commitments for £10 million in 3 months.How many contracts on Treasury bonds futures must the banker write or buy?

Accepted Answer

The mortgage banker has made loan commitments of £10 million, which means he has a long position in interest rates. In order to hedge this position, the banker needs to take an opposite position in interest rates. One way to do this is by buying or going long on Treasury bond futures. However, since the banker needs to hedge £10 million worth of loan commitments, they need to buy enough futures contracts to cover that amount. Each Treasury bond futures contract is worth £100,000, so the banker needs to buy 100 contracts (10,000,000/100,000=100) to fully hedge their position. Therefore, the best choice is option B) go short 100.

Question 15

Tiger State Bank 
$\begin{array} { | l | l | l | } 
\hline \text { Assets } & \text { Duration } & \text { Market Value } \
\hline \text { Overnight Money } & 0.0 & £ 3 \text { Million } \
\hline \text { 1-year T-Bonds } & 0.6 & £ 8 \text { Million } \
\hline \text { Loans } & 2.20 & £ 20 \text { Million } \
\hline \text { Mortgages } & 7.50 & £ 8 \text { Million } \
\hline & & \
\hline \text { Liabilities } & \text { Duration } & \text { Market Value } \
\hline \text { Checking Accounts } & 0.0 & £ 20 \text { Million } \
\hline \text { Short-term CD's } & 0.4 & £ 4 \text { Million } \
\hline \text { Long-term CD's } & 3.20 & £ 12 \text { Million } \
\hline & & \
\hline \text { Equity } & & £ 3 \text { Million } \
\hline
\end{array}$
What new asset duration will immunize the balance sheet?

Accepted Answer

The answer of Tiger State Bank 
\(\begin{array} { | l...

Question 16

Consider the following two statements: (i) Buying a futures contract to reduce risk close to delivery is called a short hedge.
(ii) The hedging decision is independent of market eﬃciency.

Accepted Answer

(i) is incorrect because buying a futures contract to reduce risk is called a long hedge, not a short hedge. (ii) is incorrect because the hedging decision can be influenced by market efficiency.

Question 17

Firm A is paying £750,000 in interest payments a year while Firm B is paying LIBOR plus 75 basis points on £10,000,000 loans.The current LIBOR rate is 6.5%.Firm A and B have agreed to swap
Interest payments.What is the net payment this year?

Accepted Answer

Firm B's interest payment is calculated as 6.5% (LIBOR rate) + 0.75% (75 basis points) = 7.25% of £10,000,000, which equals £725,000. Since Firm A is paying £750,000, the net payment from Firm A to Firm B is £750,000 - £725,000 = £25,000.

Question 18

If a ﬁrm sells a ﬂoor at 6% this will:

Accepted Answer

Selling a floor at 6% means that the buyer of the floor will receive payments if the interest rate falls below 6%. Therefore, the holder of the floor will be paid the LIBOR interest rate below 6%.

Question 19

If you bought a futures contract for £2.60 per bushel and the contract ended at £2.70 after several days of trading of £2.52, £2.57, £2.62, £2.68, and £2.70.What would the mark to market sequence
Be?

Accepted Answer

The mark to market sequence reflects the daily profit or loss on the futures contract. Starting with a purchase price of £2.60, the sequence of trading prices shows daily changes. The sequence -.08, .05, .05, .06, .02 corresponds to the daily change from the initial or previous day's settlement price, indicating losses or gains respectively.

Question 20

A Treasury note with a maturity of 2 years pays interest semi-annually on a 9 percent annual coupon rate.The £1,000 face value is returned at maturity.If the effective annual yield for all
Maturities is 7 percent annually, what is the current price of the Treasury note?

Accepted Answer

The answer of A Treasury note with a maturity of...

Quiz 25: Financial Risk Management With Derivatives

Duration is deﬁned as the weighted average time to maturity of a ﬁnancial instrument.Explain how this knowledge can help protect against interest rate risk.

You are doing research into speculation.You ﬁnd that an investor named X as taken an option position Y.You think that in order to know whether position Y is indeed speculative:

Calculate the duration of a 7-year £1,000 zero-coupon bond with a current price of £399.63 and a yield to maturity of 14%.

The duration of a 2 year annual 10% bond that is selling for par is:

A bank has a $50 million mortgage bond risk position which it hedges in the Treasury bond futures markets at the Chicago Board of Trade.Approximately how many contracts are needed to be held In the hedge?

Your friend and fellow student Alex tells you that duration is the cash ﬂow weighted maturity of an asset or liability.Another student, Ben, tells you that it is the effective maturity.

Calculate the duration of a 4-year £1,000 face value bond, which pays 8% coupons annually throughout maturity and has a yield to maturity of 9%.

A mortgage banker had made loan commitments for £10 million in 3 months.How many contracts on Treasury bonds futures must the banker write or buy?

Consider the following two statements: (i) Buying a futures contract to reduce risk close to delivery is called a short hedge. (ii) The hedging decision is independent of market eﬃciency.

Firm A is paying £750,000 in interest payments a year while Firm B is paying LIBOR plus 75 basis points on £10,000,000 loans.The current LIBOR rate is 6.5%.Firm A and B have agreed to swap Interest payments.What is the net payment this year?

If a ﬁrm sells a ﬂoor at 6% this will:

If you bought a futures contract for £2.60 per bushel and the contract ended at £2.70 after several days of trading of £2.52, £2.57, £2.62, £2.68, and £2.70.What would the mark to market sequence Be?

A Treasury note with a maturity of 2 years pays interest semi-annually on a 9 percent annual coupon rate.The £1,000 face value is returned at maturity.If the effective annual yield for all Maturities is 7 percent annually, what is the current price of the Treasury note?