Question 1

In percentage terms,higher coupon bonds experience a _______ price change compared with lower coupon bonds of the same maturity given a change in yield to maturity.

Accepted Answer

The answer of In percentage terms,higher coupon bonds experience a...

Question 2

A pure discount bond pays:

Accepted Answer

A pure discount bond pays no coupons, which means that its cash flows are solely determined by the principal amount and the maturity date. Therefore, its duration will equal its maturity.

Question 3

A financial institution can hedge its interest rate risk by:

Accepted Answer

Matching the duration of assets to liabilities is a common method of interest rate risk hedging, but it is only effective if the market conditions do not change. Setting the duration of assets equal to half that of liabilities or weighted by market value does not necessarily minimize interest rate risk. The best method is to match the duration of assets weighted by the market value of assets with the duration of liabilities weighted by the market value of liabilities, which ensures that the institution is hedged against interest rate risk regardless of market conditions.

Question 4

A financial institution has equity equal to one-tenth of its assets.If its asset duration is currently equal to its liability duration,then to immunize,the firm needs to:

Accepted Answer

Since the equity is only one-tenth of assets, the firm is highly leveraged and hence should try to reduce its risk. As both assets and liabilities have the same duration, the firm can reduce its risk by decreasing the duration of its assets. By doing so, it will reduce the sensitivity of the value of its assets to changes in interest rates, thereby achieving immunization. Hence, choice A is the best course of action.

Question 5

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

Question 6

Interest rate and currency swaps allow one party to exchange a:

Accepted Answer

Interest rate and currency swaps involve exchanging a floating interest rate or currency value for a fixed value over the contract term. This allows one party to hedge against potential fluctuations in interest rates or currency values.

Question 7

A set of bonds all have the same maturity.Which one has the least percentage price changes for given shifts in interest rates:

Accepted Answer

High coupon bonds have the least percentage price change for given shifts in interest rates because the higher coupon payments provide more income earlier, reducing the bond's duration and making it less sensitive to interest rate changes.

Question 8

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

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

Question 9

The duration of a 15 year zero coupon bond priced at €182.70 is:

Accepted Answer

The answer of The duration of a 15 year zero...

Question 10

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

To calculate the mark to market sequence, we need to subtract the contract price from each day's settlement price. 
Day 1: £2.52 - £2.60 = -£0.08
Day 2: £2.57 - £2.60 = -£0.03
Day 3: £2.62 - £2.60 = £0.02
Day 4: £2.68 - £2.60 = £0.08
Day 5: £2.70 - £2.60 = £0.10

Therefore, the mark to market sequence is -£0.08, £0.05, £0.05, £0.06, £0.02, which corresponds to choice A.

Question 11

If a firm purchases a cap at 10% this will:

Accepted Answer

Purchasing a cap at 10% means that the holder of the cap will receive compensation in the form of the LIBOR interest rate that exceeds 10%. This compensation is designed to limit the firm's exposure to rising interest rates while still allowing for borrowing at a variable rate. Choice A is incorrect because purchasing a cap does not limit the amount of borrowing, it simply limits the interest rate risk associated with borrowing. Choice B is incorrect because the cap does not pay the firm, it pays the holder of the cap. Choice D is incorrect because the holder of the cap would prefer to receive a higher LIBOR interest rate, not a lower one. Choice E is incorrect because one of the options is correct.

Question 12

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

To hedge against the interest rate risk associated with the £10 million in loan commitments, the banker should buy Treasury bond futures contracts. The number of contracts needed is determined by the notional value of the loan commitments divided by the notional value of the futures contracts. Assuming the notional value of the loan commitments and the futures contracts is both £100,000, the banker would need to buy 100 contracts (10,000,000 ÷ 100,000 = 100). Since the question does not specify whether the banker should go long or short on the futures contracts, either choice could be correct depending on the banker's view of interest rates. However, since shorting the futures contracts would provide a direct hedge against rising interest rate risk, choice B ("Go short 100") would be the best answer.

Question 13

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 14

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

Accepted Answer

The answer of If a firm sells a floor at...

Question 15

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

The initial agreed-upon price was £382, which is higher than the current spot price of £380. Therefore, the futures contract currently has a value of +£2 for the seller (you) relative to the market. 
However, the spot price falls to £377 the next day, which means the value of the futures contract has also decreased. The seller (you) now have a loss of £5 relative to the market.
Since the contract marks to market on a daily basis, this means you need to pay the counterparty (buyer) the loss of £5 at the end of the business day. Therefore, your cash flow is -£5. Answer D is the closest to this value.

Question 16

If a financial institution has equated the dollar effects of interest rate risk on the assets with the dollar effects on the liabilities,it has engaged in:

Accepted Answer

When a financial institution has equated the dollar effects of interest rate risk on the assets with the dollar effects on the liabilities, it has immunized interest rate risk. By immunizing, the financial institution has eliminated the potential impact of interest rate changes in the economy, making it easier to predict future cash flows. This is a technique used by many financial institutions to minimize their risk exposure.

Question 17

Duration of a coupon paying bond is:

Accepted Answer

The answer of Duration of a coupon paying bond is:
...

Question 18

An inverse floater and a super-inverse floater are more valuable to a purchaser if:

Accepted Answer

Inverse floaters and super-inverse floaters increase in value when interest rates fall, as their coupon payments are inversely related to interest rate movements.

Question 19

A bond manager who wishes to hold the bond with the greatest potential volatility would be wise to hold:

Accepted Answer

The answer of A bond manager who wishes to hold...

Question 20

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

The contract was for 1 ounce of gold at £415. The settlement price was £420. Therefore, you made a profit of £5 per ounce. Your net cash flow would be the profit minus the initial cost, which is £5 - £415 = £-410. However, keep in mind that you made a profit, so the answer would be a positive value. Therefore, the correct answer is £5.

Quiz 25: Financial Risk Management With Derivatives