Question 1

A perfect hedge, or perfect immunization, seldom occurs.

Accepted Answer

A perfect hedge, where the risk associated with an investment is totally eliminated, is difficult to achieve because of factors such as changes in market conditions, interest rate fluctuations, and unforeseen events. Thus, a perfect hedge or perfect immunization seldom occurs.

Question 2

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.

Accepted Answer

Immunizing the balance sheet against interest rate risk means that the gains (losses) from an off-balance-sheet hedge will exactly offset losses (gains) from the balance sheet position. This is achieved through careful design and management of the hedging strategy.

Question 3

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.

Accepted Answer

The notational value of derivative contracts for the top 25 derivative users is typically much larger than the total current credit risk exposure of those contracts. The notational value represents the total value of the contracts, while the credit risk exposure is usually a much smaller amount, reflecting the potential loss if the counterparty defaults.

Question 4

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

Accepted Answer

In the futures market, delivery of the underlying asset is optional and usually does not occur. Instead, most futures contracts are settled financially, meaning that the cash difference between the contract price and the market price of the underlying asset at expiration is exchanged. This allows traders to participate in the market without physically taking delivery of large quantities of the underlying asset. However, there are some futures contracts that do require physical delivery, such as agricultural commodities or energy products.

Question 5

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

Accepted Answer

In a forward contract, there is typically only one payment cash flow that occurs at the time of delivery, where the buyer pays the agreed-upon price to the seller for the underlying asset.

Question 6

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

Accepted Answer

Derivative contracts such as interest rate swaps, options, and futures can help an FI hedge against fluctuations in interest rates and foreign exchange rates.

Question 7

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

Accepted Answer

Forward contracts are not marked-to-market daily; instead, they are settled at the end of the contract term, unlike futures contracts which are marked-to-market daily.

Question 8

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

Accepted Answer

A futures contract has two payment cash flows - the initial margin payment at the time of entering into the contract and the final settlement payment at the time of delivery.

Question 9

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.

Accepted Answer

In a forward contract agreement, the quantity of product to be traded, the time of the actual trade and the price are all determined at the time of the agreement. This is one of the defining features of a forward contract.

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.

Accepted Answer

A financial institution (FI) with a negative duration gap has liabilities that are more sensitive to interest rate changes than its assets. If interest rates decline, the value of its liabilities could increase more than the value of its assets, leading to a potential loss. By buying forward contracts, the FI can hedge against this risk by locking in future interest rates, thus protecting against the adverse effects of declining rates.

Question 11

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

Accepted Answer

A positive duration gap means the FI is more sensitive to interest rate increases, not declines. To hedge against interest rate increases, the FI would sell forward contracts, not buy them.

Question 12

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

Accepted Answer

The statement is false. As of 2015, U.S. commercial banks held over $42 trillion of derivatives contracts, not specifically forward contracts listed for trading on the Chicago Mercantile Exchange.

Question 13

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

Accepted Answer

Insurance companies and banks primarily use interest rate swaps, not futures contracts, to hedge interest rate risk prior to originating mortgages. Interest rate swaps allow these institutions to exchange variable interest rate payments for fixed-rate payments, thus managing their exposure to interest rate fluctuations.

Question 14

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

Accepted Answer

Forward contracts are customized agreements between two parties, so each contract can vary in its terms and specifications.

Question 15

A spot contract specifies deferred delivery and payment.

Accepted Answer

A spot contract specifies immediate delivery and payment, not deferred delivery and payment.

Question 16

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

Accepted Answer

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

Question 17

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

Accepted Answer

According to data from the Bank for International Settlements, as of 2015, commercial banks held $11.4 trillion in forward contracts compared to $3.7 trillion in futures contracts for trading. Therefore, commercial banks held more forward contracts than futures contracts for trading.

Question 18

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

Accepted Answer

This statement is true. The FASB requires that all derivatives be marked-to-market, which means their value is adjusted to reflect current market prices, and any gains or losses are transparent on a company's financial statements. This is done to ensure transparency and accuracy in reporting the value of financial instruments.

Question 19

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

Accepted Answer

Federal regulations in the U.S. do not restrict the use of derivatives to only the 25 largest banks. However, there may be certain regulatory requirements and capital requirements that could affect the use of derivatives by financial institutions.

Question 20

A forward contract specifies immediate delivery for immediate payment.

Accepted Answer

A forward contract specifies a future delivery date and payment at that future date, not immediate delivery and payment.

Quiz 23: Futures and Forwards

A perfect hedge, or perfect immunization, seldom occurs.

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.

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.

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

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

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

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

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

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.

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

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

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

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

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

A spot contract specifies deferred delivery and payment.

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

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

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

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

A forward contract specifies immediate delivery for immediate payment.