Question 1

22-79 Selling a credit forward agreement generates a payoff similar to
A)selling a call option.
B)buying a call option.
C)selling a put option.
D)buying a put option.
E)buying forward contracts.

Accepted Answer

The answer of 22-79 Selling a credit forward agreement generates...

Question 2

22-78 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.

Accepted Answer

A credit forward agreement is used to hedge against an increase in the default risk of a loan, providing protection against potential credit losses.

Question 3

22-63 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.
E)speculation.

Accepted Answer

The FI has reduced its interest rate risk exposure to the lowest possible level by using futures to offset the risk exposure of its entire balance sheet or cash positions, which is a routine hedging strategy. This involves utilizing derivatives to hedge against market fluctuations in order to protect the value of the portfolio. Microhedging involves hedging individual positions, while selective hedging involves selectively hedging certain positions in the portfolio. Overhedging refers to hedging beyond the required level, while speculation involves taking positions in the market solely for the purpose of profiting from market movements.

Question 4

22-64 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.
E)Partially hedging the individual assets and liabilities.

Accepted Answer

Overhedging refers to using more hedge vehicles than is necessary to offset the risk in the cash asset. This can result in additional costs and may not always provide the intended level of risk reduction.

Question 5

22-69 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.
E)$115,760.

Accepted Answer

To calculate the price to be paid for the T-Bonds, we use the following formula: 
Price = (Price Quote/100) x Face Value 
In this case, the face value is $100,000. 
So, Price = (109.24/100) x $100,000 = $109,240. 
Therefore, the correct answer is B, $109,240.

Question 6

22-71 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.
E)1.7263; $141,788.

Accepted Answer

The answer of 22-71 If a 12-year,6.5 percent semi-annual $100,000...

Question 7

22-76 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.
E)hedges against an increase in default risk on a loan after the loan rate is determined and before the loan is issued.

Accepted Answer

A credit forward is used to hedge against an increase in default risk on a loan after the loan rate is determined and the loan is issued. This allows the lender to reduce their exposure to default risk and protect their investment.

Question 8

22-62 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.
E)When an FI manager wishes to use futures or other derivative securities to hedge the entire balance sheet duration gap.

Accepted Answer

The answer of 22-62 Which of the following is an...

Question 9

22-77 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.
E)the characteristics of the benchmark bond must be the same as those of the bank's loan to the borrower.

Accepted Answer

The answer of 22-77 In a credit forward contract transaction
A)the...

Question 10

22-75 The notational value of the world-wide credit derivative securities markets stood at _________ trillion as of June 2009,which compares to _________ trillion as of July 2008.
A)$31.2; $54.6
B)$13.2; $31.2
C)$31.2; $16.8
D)$ 7.8; $14.7
E)$16.0; $27.4

Accepted Answer

The question provides two values for two different time periods. As of June 2009, the notational value of the world-wide credit derivative securities markets stood at $31.2 trillion, and as of July 2008, the value was $54.6 trillion. The only option that matches these values is (A) $31.2; $54.6. Therefore, the correct answer is (A).

Question 11

22-70 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.
E)1.000; $114,160.

Accepted Answer

The conversion factor can be calculated using:
Conversion Factor = (Full Price of Basis Bond / Full Price of Deliverable Bond)
= (114-16/32 + 8/32 * 1/32) / (100 + 6/32 * 1/32)
= 1.158

The buyer would have to pay the seller:
Total Amount = (Conversion Factor * Face Value of Deliverable Bond * Quoted Price of Deliverable Bond)
= (1.158 * $100,000 * 114-16/32)
= $132,591.

Question 12

22-66 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.
E)Risk ratio.

Accepted Answer

The hedge ratio measures the dollar value of futures contracts that should be sold per dollar of cash position exposure. This ratio helps in establishing an effective hedging strategy by balancing the exposure to price fluctuations between the cash and futures markets.

Question 13

22-73 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.
E)0.833.

Accepted Answer

The answer of 22-73 The covariance of the change in...

Question 14

22-72 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.
E)1.86.

Accepted Answer

The hedge ratio is the ratio of the change in the spot rate to the change in the futures price. In this case, the spot rate is 30% more sensitive than the futures price, so the hedge ratio is 1.30.

Question 15

22-80 XYZ Bank lends $20,000,000 to ABC Corporation which has a credit rating of BB.The spread of a BB rated benchmark bond is 2.5 percent over the U.S.Treasury bond of similar maturity.XYZ Bank sells a $20,000,000 one-year credit forward contract to IWILL Insurance Company.At maturity,the spread of the benchmark bond against the Treasury bond is 2.1 percent,and the benchmark bond has a modified duration of 4 years.What is the amount of payment paid by whom to whom at the maturity of the credit forward contract?
A)The seller pays the buyer $320,000.
B)The buyer pays the seller $320,000.
C)The seller pays the buyer $80,000.
D)The buyer pays the seller $80,000.
E)The borrower receives $240,000.

Accepted Answer

To calculate the payment under a credit forward contract, we need to determine the difference between the actual spread at maturity and the contracted spread, and multiply it by the notional amount of the contract ($20,000,000).

The contracted spread is given as 2.5%, and the actual spread at maturity is 2.1%. Therefore, the difference is 0.4%. Multiplying this by $20,000,000 gives us the payment amount of $80,000.

However, since the contract is sold by XYZ Bank to IWILL Insurance Company, the payment is made by the seller (XYZ Bank) to the buyer (IWILL Insurance Company). Therefore, the correct answer is A) The seller pays the buyer $320,000 (4 times $80,000).

Question 16

22-68 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.
E)When the spot and future exchange rates are expected to move perfectly together.

Accepted Answer

When spot rate changes are greater than futures rate changes, the estimated hedge ratio will be greater than one. This is because the futures contract will not perfectly offset the price movements in the spot market, so a higher ratio is needed to provide adequate hedging.

Question 17

22-74 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.

Accepted Answer

The answer of 22-74 The covariance of the change in...

Question 18

22-61 Which of the following indicates the need to place a hedge?
A)The price movement in the underlying cash asset can not 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.budge deficits.
E)Spot bonds and futures on bonds are traded in different markets.

Accepted Answer

The need to place a hedge arises when the price movement in the underlying cash asset cannot be forecasted perfectly, as hedging is used to mitigate the risk of unpredictable price changes.

Question 19

22-67 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.
E)By squaring the correlation between past changes in spot asset prices and futures prices.

Accepted Answer

The hedge ratio is commonly determined by running an ordinary least squares regression of changes in spot prices on changes in futures prices. This approach calculates the slope coefficient of the regression as the hedge ratio, which represents the number of futures contracts needed to offset the risk in a cash position of a given size.

Question 20

22-65 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 different markets with different demand and supply functions.
D)Answers B and C only.
E)Answers A and C only.

Accepted Answer

Basis risk occurs because 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. Additionally, spot and futures contracts are traded in different markets with different demand and supply functions, which can contribute to basis risk. The daily marking-to-market process (answer B) is a way to manage the risk of futures positions, but it does not eliminate basis risk. Answer D is incorrect because answer B is not a valid reason for basis risk to occur.

Quiz 22: Futures and Forwards

22-79 Selling a credit forward agreement generates a payoff similar to

22-78 What is the purpose of a credit forward agreement?

22-63 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

22-64 What is overhedging?

22-69 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?

22-71 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?

22-76 A credit forward is a forward agreement that

22-62 Which of the following is an example of microhedging asset-side portfolio risk?

22-77 In a credit forward contract transaction

22-75 The notational value of the world-wide credit derivative securities markets stood at _ trillion as of June 2009,which compares to _ trillion as of July 2008.

22-70 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?

22-66 Which of the following measures the dollar value of futures contracts that should be sold per dollar of cash position exposure?

22-73 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?

22-72 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

22-68 When will the estimated hedge ratio be greater than one?

22-74 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?

22-61 Which of the following indicates the need to place a hedge?

22-67 How is a hedge ratio commonly determined?

22-65 Why does basis risk occur?