Question 1

A buyer of a call option on fixed-income securities is most likely to:

Accepted Answer

A call option on fixed-income securities gives the holder the right to buy the underlying securities at a specified price. If interest rates fall, the value of fixed-income securities typically rises (since their fixed payments become more attractive compared to new securities issued at the lower rates), making it more likely for the call option to be exercised.

Question 2

The September T-bond futures contract is currently selling at 111-05 and September call option on T-bond futures for a strike price of 115-00 is currently quoting at 2-24.If an investor purchases one contract of the call option at the current market price and if the T-bond futures contract settles at 118-05 on the expiration day,what will be the net gain/loss for the investor?

Accepted Answer

The investor's net gain can be calculated by first determining the intrinsic value of the option at expiration and then subtracting the initial cost of the option. The T-bond futures contract settles at 118-05, which is 3-05 above the strike price of 115-00. Each point in T-bond futures is worth $1,000, and each 1/32 of a point is worth $31.25. Therefore, 3-05 translates to 3 points plus 5/32 of a point, or $3,000 + $156.25 = $3,156.25. The cost of the option was 2-24, or 2 points plus 24/32 of a point, which equals $2,000 + $750 = $2,750. The net gain is $3,156.25 - $2,750 = $406.25. However, due to a calculation oversight, the correct answer intended was $781.25, which suggests a misunderstanding in the calculation process. The correct calculation process should involve understanding the option's intrinsic value and cost, but the provided numbers and explanation led to an incorrect conclusion.

Question 3

Zenith Company has borrowed $1 million from Strong Capital Bank at an interest rate of LIBOR plus 2 percent.However,the CFO of Zenith fears that the short-term interest rates may rise in the near future and purchases an interest-rate cap of 5 percent from Strong Capital Bank.What will be the annual interest outflow for Zenith,if the LIBOR rate rises to 3.5 percent?

Accepted Answer

The interest rate cap of 5 percent means that Zenith will not have to pay more than 5 percent interest, even if LIBOR rises above 5 percent. In this case, LIBOR has risen to 3.5 percent, which is below the cap of 5 percent. Therefore, Zenith will pay interest at the rate of LIBOR plus 2 percent, which is 3.5 percent + 2 percent = 5.5 percent. The annual interest outflow for Zenith will be $1 million x 5.5 percent = $55,000.

Question 4

Large depository institutions tend to act:

Accepted Answer

Large depository institutions tend to act both as dealers (buying and selling securities for their clients or for themselves) and as end users (holding securities as part of their own investment portfolios).

Question 5

The American Commerce Bank (ACB)lends $1.5 million to Unity International Company for six months.The bank usually changes a rate of LIBOR plus 3 percent to companies with similar credit ratings.However,since the bank's economists are of the view that short-term interest rates may fall in the near future,ACB decided to lend money to Unity at a discounted rate of LIBOR plus 2 percent in return for an interest-rate floor of 4.5 percent.What amount of interest rebate will the bank receive,if LIBOR drops to 1.5 percent from 2.5 percent immediately after lending the amount?

Accepted Answer

The correct answer is A.The interest rate floor of 4.5 percent means that Unity International Company will pay interest at a rate of 4.5 percent even if LIBOR falls below 4.5 percent. If LIBOR drops to 1.5 percent, the bank will receive an interest rebate of $7,500, which is calculated as follows:Interest rebate = (LIBOR + 2% - Interest rate floor) x Principal x Time= (1.5% + 2% - 4.5%) x $1.5 million x 6 months= $7,500

Question 6

________ in a swap refers to the risk arising from the difference in the interest rate defined in the terms of a swap and the interest rates of the assets and liabilities held by the parties to swap.

Accepted Answer

Basis risk in a swap arises from the mismatch between the interest rate defined in the swap agreement and the actual interest rates of the assets and liabilities held by the parties involved in the swap. This can lead to a situation where the swap does not perfectly hedge the interest rate exposure of those assets and liabilities.

Question 7

A buyer of a put option on fixed-income securities is most likely to:

Accepted Answer

When interest rates rise, the value of fixed-income securities typically falls. A put option gives the buyer the right to sell the underlying asset at a predetermined price. If interest rates rise and the value of the fixed-income securities decreases, the buyer of a put option is more likely to exercise the option to sell the securities at the higher predetermined price, thus benefiting from the situation.

Question 8

If a financial institution agrees to guarantee a swap agreement negotiated between two of its customers,usually:

Accepted Answer

When a financial institution agrees to guarantee a swap agreement between two of its customers, it assumes a potential obligation to make payments in the event the swap agreement is not honored. As such, this guarantee would be recorded as a contingent liability in the institution's books until it is either fulfilled or expires.

Quiz 14: Investment Banking,Insurance,and Other Sources of Fee Income

A buyer of a call option on fixed-income securities is most likely to:

Large depository institutions tend to act:

________ in a swap refers to the risk arising from the difference in the interest rate defined in the terms of a swap and the interest rates of the assets and liabilities held by the parties to swap.

A buyer of a put option on fixed-income securities is most likely to:

If a financial institution agrees to guarantee a swap agreement negotiated between two of its customers,usually: