Deck 22: Futures and Forwards

Question 1

A forward contract specifies immediate delivery for immediate payment.

Answer 1

False

Question 2

Federal regulations in the U.S.allow derivatives to be used only by the 25 largest banks.

Answer 2

False

Question 3

A spot contract specifies deferred delivery and payment.

Answer 3

False

Question 4

Commercial banks,investment banks,and broker-dealers are the major forward market participants.

Question 5

As of 2015,U.S.commercial banks held over $42 trillion of forward contracts that were listed for trading on the Chicago Mercantile exchange.

Question 6

An FI with a positive duration gap is exposed to interest rate declines and could hedge its interest rate risk by buying forward contracts.

Question 7

A forward contract has only one payment cash flow that occurs at the time of delivery.

Question 8

In a forward contract agreement,the quantity of product to be traded,the time of the actual trade and the price are determined at the time of the agreement.

Question 9

Delivery of the underlying asset almost always occurs in the futures market.

Question 10

An FI with a negative duration gap is exposed to interest rate declines and could hedge its interest rate risk by buying forward contracts.

Question 11

As of 2015,commercial banks held more forward contracts than futures contracts for trading.

Question 12

The notational value of derivative contracts for the top 25 derivative users was less than the total current credit risk exposure of those contracts as of 2015.

Question 13

Forward contracts are marked-to-market on a daily basis.

Question 14

A futures contract has only one payment cash flow that occurs at the time of delivery.

Question 15

Derivative contracts allow an FI to manage interest rate and foreign exchange risk.

Question 16

The Financial Accounting Standards Board requires that all derivatives be marked-to-market with any losses and gains transparent on FI's financial statements.

Question 17

Forward contracts are individually negotiated and,therefore,can be unique.

Question 18

Futures contracts are the primary security that insurance companies and banks use to hedge interest rate risk prior to originating mortgages.

Question 19

A perfect hedge,or perfect immunization,seldom occurs.

Question 20

Immunizing the balance sheet against interest rate risk means that gains (losses)from an off-balance-sheet hedge will exactly offset losses (gains)from the balance sheet position.

Question 21

Macrohedging uses a derivative contract,such as a futures or forward contract,to hedge a particular asset or liability risk.

Question 22

Selective hedging that results in an over-hedged position may be regarded as speculative by regulators.

Question 23

It is not possible to separate credit risk exposure from the lending process itself.

Question 24

Basis risk occurs when the underlying security in the futures contract is not the same asset as the cash asset on the balance sheet.

Question 25

Hedging a specific on-balance-sheet cash position usually will only require more T-bill futures contracts than hedging the same cash position with T-bond futures contracts because the T-bond contract size is only 10 percent as large as large as the T-bill contract.

Question 26

A conversion factor often is used to determine the invoice price on a futures contract when a bond other than the benchmark bond is delivered to the buyer.

Question 27

All bonds that are deliverable under a Treasury bond futures contract have a maturity of 20 years and an interest rate of 8 percent.

Question 28

In a credit forward agreement hedge,the loss on the balance sheet cash position is offset completely by the gain on the off-balance-sheet credit forward agreement if the characteristics of the benchmark bond and the bank's loan to the borrower are the same.

Question 29

An adjustment for basis risk with a value of "br" less than one means that the percent change in the spot rates is greater than the change in rate in the deliverable bond in the futures market.

Question 30

Hedging foreign exchange risk in the futures market may involve uncertainty about all of the transactions necessary to achieve the hedge to fulfillment.

Question 31

The hedge ratio measures the impact that tailing-the-hedge will have on the number of contracts necessary to hedge the cash position.

Question 32

Tailing-the-hedge normally requires an FI manager to utilize more futures contracts to hedge a cash position than are warranted by the initial analysis.

Question 33

Hedging effectiveness often is measured by the squared correlation between past changes in the spot asset prices and futures prices.

Question 34

Microhedging uses futures or forward contracts to hedge the entire balance sheet duration gap.

Question 35

Routine hedging will allow the FI to achieve greater return from the assets and liabilities on the balance sheet.

Question 36

The sensitivity of the price of a futures contract depends on the duration of the deliverable asset underlying the contract.

Question 37

More FIs fail due to credit risk exposure than exposure to either interest rate risk or foreign exchange risk.

Question 38

An off-balance-sheet forward position is used to hedge the FI's on-balance-sheet risk exposure.

Question 39

Hedging selectively only a portion of the balance sheet is an attempt to increase the return of the FI by accepting some level of interest rate risk.

Question 40

Selective hedging occurs by reducing the interest rate risk by selling sufficient futures contracts to offset the interest rate risk exposure of a portion of the cash positions on the balance sheet.

Question 41

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

A)Federal Reserve.
B)Commodity Futures Trading Commission.
C)CME Group (formerly Chicago Mercantile Exchange).
D)Chicago Board of Trade.

Question 42

An agreement between a buyer and a seller at time 0 to exchange a pre-specified asset for cash at a specified later date is the characteristic of a

A)spot contract.
B)forward contract.
C)futures contract.
D)put options contract.

Question 43

The payoff on a catastrophe futures contract is adjusted for the actual loss ratio of the insurer.

Question 44

As a result of the Volcker Rule (2014)there was an increase in the use of derivative securities by U.S.depository institutions.

Question 45

An agreement between a buyer and a seller at time 0 to exchange a standardized,pre-specified asset for cash at a specified later date is characteristic of a

A)spot contract.
B)forward contract.
C)futures contract.
D)put options contract.

Question 46

The use of futures contracts by banks is subject to risk-based capital guidelines through the off-balance-sheet risk calculations for risk-based capital.

Question 47

A naive hedge occurs when

A)an FI manager wishes to use futures or other derivative securities to hedge the entire balance sheet duration gap.
B)a cash asset is hedged on a direct dollar-for-dollar basis with a forward or futures contract.
C)an FI reduces its interest rate or other risk exposure to the lowest possible level by selling sufficient futures to offset the interest rate risk exposure of its whole balance sheet.
D)an FI purchases an insurance cover to the extent of 80% of losses arising from adverse movement in asset prices.

Question 48

Catastrophe futures are designed to hedge extreme losses of natural disasters for property-casualty insurance companies.

Question 49

The primary benefit of a futures exchange is

A)always knowing its exact location.
B)indemnifying counterparties against credit or default risk.
C)guarantee of trading volume.
D)intervention on the trader's behalf with government regulators.

Question 50

What is a difference between a forward contract and a future contract?

A)The settlement price of a forward contract is fixed over the life of the contract but in a futures contract is marked to market daily.
B)Forward contracts are normally arranged through an organized exchange,while most futures contracts are OTC contracts.
C)Both are essentially the same,except for trading volumes which are higher for futures contracts.
D)Both are essentially the same,except for the fact that the terms of a forward contract is set by the exchange,subject to the approval of the Commodity Futures Trading Commission (CFTC).

Question 51

The Volcker Rule,implemented in April 2014,resulted in only the investment banking arm of a depository institutions to engage in proprietary trading.

Question 52

Routine hedging

A)is a hedging strategy that occurs on a set,predetermined basis by the FI.
B)always results in excess returns.
C)is a strategy to follow when interest rates are abnormally low.
D)is a strategy used when interest rates are extremely unpredictable.

Question 53

Which of the following identifies the largest group of derivative contracts as of 2015?

A)Futures.
B)Forwards.
C)Options.
D)Swaps.

Question 54

A futures contract

A)is tailor-made to fit the needs of the buyer and the seller.
B)has more credit risk than a forward contract.
C)is marked to market more frequently than a forward contract.
D)has a shorter time to delivery than a forward contract.

Question 55

Which of the following group of derivative securities had the smallest notational value among the top 25 FIs as of 2015?

A)Futures and forwards.
B)Caps,floors,and collars.
C)Options.
D)Swaps.
E)Credit derivatives.

Question 56

An agreement between a buyer and a seller at time 0 where the seller of an asset agrees to deliver an asset immediately and the buyer agrees to pay for the asset immediately is the characteristic of a

A)spot contract.
B)forward contract.
C)futures contract.
D)put options contract.

Question 57

A forward contract

A)has more credit risk than a futures contract.
B)is more standardized than a futures contract.
C)is marked to market more frequently than a futures contract.
D)has a shorter time to delivery than a futures contract.

Question 58

Financial futures can be used by FIs to manage

A)credit risk.
B)interest rate risk.
C)liquidity risk.
D)foreign exchange risk.
E)credit risk,interest rate risk,and foreign exchange risk.

Question 59

A credit forward agreement specifies a credit spread on a benchmark U.S.Treasury bond.

Question 60

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

A)contract size.
B)delivery month.
C)specific asset to be delivered.
D)trading hours.

Question 61

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?

A)$107,240.
B)$109,240.
C)$109,750.
D)$110,250.

Question 62

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?

A)0.306.
B)0.694.
C)1.440.
D)1.200.

Question 63

The notational value of the world-wide credit derivative securities markets stood at _________ trillion as of 2015,which compares to _________ trillion as of July 2008.

A)$22.6;$54.6
B)$13.2;$31.2
C)$31.2;$16.8
D)$7.8;$14.7

Question 64

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

A)The price movement in the underlying cash asset cannot be forecasted perfectly.
B)The prices of the assets or liabilities are imperfectly correlated over time with the prices on the futures.
C)Basis risk prevents the minimum risk of the portfolio from reaching zero.
D)Treasury has been issuing more shorter-dated bonds to finance U.S.budget deficits.

Question 65

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

A)microhedging.
B)selective hedging.
C)routine hedging.
D)overhedging.

Question 66

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

A)When an FI,attempting to lock in cost of funds to protect itself against a rise in short-term interest rates,takes a short position in futures contracts on CDs.
B)FI manager trying to pick a futures contract whose underlying deliverable asset is not matched to the asset position being hedged.
C)When an FI hedges a cash asset on a direct dollar-for-dollar basis with a forward or futures contract.
D)When an FI manager wants to insulate the value of the institution's bond portfolio fully against a rise in interest rates.

Question 67

How is a hedge ratio commonly determined?

A)By discounting the optimal number of futures to sell per $1 of cash position using the yield involved.
B)By using the ratio of the most recent spot and futures price changes.
C)By running an ordinary least squares regression of changes in spot prices on changes in futures prices.
D)By using the conversion factor.

Question 68

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

A)Hedge ratio.
B)Open position.
C)Implied volatility.
D)Payoff.

Question 69

Why does basis risk occur?

A)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.
B)The daily marking-to-market process enables an FI manager to close out a futures position by taking an exactly offsetting position.
C)Spot and futures contracts are traded in the same market,and they have the same demand and supply functions.
D)Due to illiquid markets,the equilibrium spot and futures contracts are often mispriced.

Question 70

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?

A)1.158;$132,591.
B)1.156;$115,600.
C)1.150;$131,284.
D)1.102;$124,200.

Question 71

What is overhedging?

A)Selectively hedging a proportion of an FI's balance sheet position.
B)Choosing to bear some interest rate risk as well as credit and FX risks.
C)Reducing the risk to the lowest level possible.
D)Using more hedge vehicles than is necessary to offset the risk in the cash asset.

Question 72

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

A)0.70.
B)0.77.
C)1.30.
D)1.43.

Question 73

In a credit forward contract transaction

A)the credit forward buyer is the lender who is trying to hedge the loan.
B)the credit forward seller is the lender who is trying to hedge the loan.
C)the credit forward buyer will pay the credit forward seller if the credit spread at the maturity of the forward contract is less than at the initiation of the contract.
D)the credit forward seller will pay the credit forward buyer if the credit spread at the maturity of the forward contract is greater than at the initiation of the contract.

Question 74

The covariance of the change in spot exchange rates and the change in futures exchange rates is 0.6606,and the variance of the change in futures exchange rates is 0.6060.The variance of the change in spot exchange rates is 0.9090.What is the degree of hedging effectiveness?

A)0.61.
B)0.90.
C)0.87.
D)0.82.
E)0.79.

Question 75

A credit forward is a forward agreement that

A)hedges against a decrease in default risk on a loan after the loan rate is determined and the loan issued.
B)hedges against an increase in default risk on a loan before the loan rate is determined and the loan issued.
C)hedges against an increase in default risk on a loan after the loan rate is determined and the loan issued.
D)hedges against a decrease in default risk on a loan before the loan rate is determined and the loan issued.

Question 76

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?

A)1.1027;$110,531.
B)1.2257;$135,478.
C)1.8370;$253,830.
D)1.3622;$163,339.

Question 77

When will the estimated hedge ratio be greater than one?

A)When spot rate changes are greater than futures rate changes.
B)When spot rate changes are less sensitive than futures price changes over time.
C)When spot rate changes are equally sensitive as futures price changes over time.
D)When basis risk is absent.

Question 78

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?

A)The FI can hedge its exposure to interest rate increases by selling financial futures.
B)The FI can hedge its exposure to interest rate decreases by selling financial futures.
C)The FI can hedge its exposure to interest rate increases by buying financial futures.
D)The FI can hedge its exposure to interest rate increases by buying call options.

Question 79

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

A)size of its interest rate risk exposure.
B)direction of its interest rate risk exposure.
C)return risk trade-off from fully hedging that risk.
D)return risk trade-off from selectively hedging that risk.
E)All of the options.

Question 80

What is the purpose of a credit forward agreement?

A)To allow property-casualty insurers to hedge the extreme losses that occur after major catastrophes.
B)To adjust prices on outstanding futures each day to reflect current futures market conditions.
C)To facilitate the future exchange of an asset for cash at a price that is determined daily.
D)To hedge a cash asset on a direct dollar-for-dollar basis with a forward or futures contract.
E)To hedge against an increase in the default risk of a loan.