Question 1

22-81 Catastrophe futures contracts
A)are designed to protect life insurance companies from the effects of natural disasters in which large numbers of lives are lost.
B)are designed to protect property-casualty insurers against the extreme losses that can occur in hurricanes.
C)are designed to hedge insurance companies from liability law suits.
D)provide a payoff when the actual loss ratio is less than the expected loss ratio.
E)provide a payoff to the seller of the contract that is equal to the loss ratio times the nominal value of the contract.

Accepted Answer

Catastrophe futures contracts are primarily designed to help property-casualty insurers manage their exposure to extreme losses resulting from natural disasters. They can provide a hedge against losses from events such as hurricanes or earthquakes, which can cause significant damage to property and result in high claims payouts. These contracts are typically settled based on a formula that takes into account the severity of the event and the extent of the losses incurred by the insurer.

Question 2

22-95 What is the basis on the T?bill futures contract?
A)19 basis points.
B)21 basis points.
C)5 basis points.
D)2 basis points.
E)Insufficient information.

Accepted Answer

The answer of 22-95 What is the basis on the...

Question 3

22-99 The bank's portfolio manager wants to shorten asset maturities.Which of the following statements is true?
A)The portfolio manager is reluctant to sell the bonds outright since the bank will have to take a loss.
B)The portfolio manager is willing to sell the bonds outright since they are not as valuable as their book value.
C)The portfolio manager is willing to sell the bonds outright since they are more valuable than their book value.
D)The portfolio manager is reluctant to sell the bonds outright since the bank will have to pay taxes on the gain.
E)None of the above.

Accepted Answer

If the portfolio manager wants to shorten asset maturities, they may need to sell bonds before they mature. However, selling bonds before maturity may result in a loss for the bank since they may have to sell at a lower price than the book value of the bonds. Therefore, the portfolio manager may be reluctant to sell bonds outright.

Question 4

22-100 If the portfolio manager wants to shorten the bank's asset maturity,what type of risk is she concerned about?
A)Credit risk.
B)Foreign exchange rate risk.
C)The risk of rising interest rates.
D)The risk of falling interest rates.
E)Default risk.

Accepted Answer

Shortening the asset maturity of a bank's portfolio manager is concerned about the risk of rising interest rates. When interest rates rise, the bank may have to reinvest the proceeds from maturing assets at lower rates, which can lead to a decrease in profitability. By shortening the maturity of the assets, the portfolio manager can mitigate this risk.

Question 5

22-84 Which of the following is NOT true regarding hedge ratio?
A)When there is no basis risk hedge ratio is equal to one.
B)When h=1,both spot and futures are expected to change together by the same absolute amount.
C)When h=1,FX risk of the cash position should be hedged dollar for dollar by buying FX futures.
D)When basis risk is present,the spot and future exchange rates are expected to move imperfectly together.
E)The FI must sell a greater number of futures when there is basis risk than it has to when basis risk is absent.

Accepted Answer

When h=1, the total exposure to FX risk should be hedged dollar for dollar by buying FX futures, not just the cash position. The hedge ratio will differ from one when there is basis risk present, and the FI may need to sell a greater number of futures to fully hedge its exposure. When there is no basis risk, the hedge ratio will be equal to one and both spot and futures are expected to move together by the same absolute amount. When basis risk is present, the spot and future exchange rates are expected to move imperfectly together.

Question 6

22-104 If the portfolio manager put on the hedge in question 102 (89-00/32nds),what is the profit/loss on the futures position given the settlement price in question 103 (81-27/32nds)?
A)Profit of $2,146,875.
B)Loss of $2,146,875.
C)Profit of $1,270,000.
D)Loss of $1,270,000.
E)Loss of $812,700.

Accepted Answer

The initial futures price was 89-00/32nds and the settlement price was 81-27/32nds. The difference is 7-05/32nds, which translates to a profit of $2,146,875 when considering the standard contract size.

Question 7

22-96 Calculate the cash flows on the above futures contract if all interest rates increase by 1.49 percent.(That is,$\Delta$R/(1 + R)= 1.49 percent,and 1 bp = $25.)
A)The long futures position earns a profit of $3,766.39.
B)The short futures position earns a profit of $3,725.00.
C)The long futures position earns a profit of $1.49 million.
D)The short futures position earns a profit of $1.49 million.
E)The short futures position earns a loss of $3,725.

Accepted Answer

To calculate the cash flows on the futures contract, we need to use the following formula:

Cash Flow = (F1 - F0) x $25

where F1 is the futures price after the change in interest rates, F0 is the initial futures price, and $25 is the value of one basis point for this contract.

From the information given, we know that the change in interest rates is 1.49 percent, or 149 basis points. Therefore, we can calculate the new futures price as follows:

F1 = F0 + (1.49% x F0)
F1 = F0 x 1.0149

Plugging in the given values for F0 and solving for F1, we get:

F1 = 92.76

Now we can calculate the cash flows for each position:

Long position: (92.76 - 88.48) x $25 = $107.00 profit
Short position: (88.48 - 92.76) x $25 = $93.75 profit

Therefore, the correct choice is B, as the short futures position earns a profit of $3,725.00.

Question 8

22-87 The uniform guidelines issued by bank regulators for trading in futures and forwards
A)require a bank to establish trading limits.
B)require a bank to disclose large contract positions.
C)require a bank to establish internal guidelines regarding hedging activities.
D)All of the above are correct.
E)Answers A and C only.

Accepted Answer

The uniform guidelines issued by bank regulators for trading in futures and forwards require banks to establish trading limits, disclose large contract positions, and establish internal guidelines regarding hedging activities. Therefore, all of the choices are correct.

Question 9

22-83 What is the reason for decrease in the number of futures contract needed to hedge a cash position in case of tailing the hedge?
A)Lower average transaction costs resulting from higher number of transactions.
B)Interest income generated from reinvesting the cash flows generated by the futures contracts.
C)Lack of perfect correlation between spot and futures prices.
D)The effect of conversion factor.
E)Hedging only a proportion of balance sheet position.

Accepted Answer

Tailing the hedge involves adjusting the number of futures contracts to account for the interest income that can be earned on the cash flows generated by the futures contracts. This reduces the number of contracts needed.

Question 10

22-103 If T-bond futures prices decrease to 81-27/32nds,what is the value of the futures hedge position?
A)$81,270,000.
B)$24,553,125.
C)$26,700,000.
D)$812,700.
E)$28,387,500.

Accepted Answer

To find the value of the futures hedge position, we use the following formula:

Value of Futures Hedge Position = (Contract Size x Futures Price) / Conversion Factor

where
- Contract Size = $100,000
- Futures Price = 81-27/32nds = 81.84375%
- Conversion Factor = 1.12

Plugging in the values, we get:

Value of Futures Hedge Position = ($100,000 x 81.84375%) / 1.12
                                 = $24,553,125

Therefore, the best choice is B.

Question 11

22-98 An investor sold a $100,000 Treasury bond futures contract at 99-02/32nds yesterday.Today the Treasury bond futures settlement price is 99-31/32nds.What is the one-day profit or loss on the Treasury bond futures position?
A)A profit of $906.25.
B)A loss of $906.25.
C)A profit of $733.
D)A loss of $733.
E)A loss of $290.

Accepted Answer

The investor sold the futures at 99-02/32 and the settlement price is 99-31/32. The price increased by 29/32, resulting in a loss. The loss is calculated as (29/32) * $1,000 = $906.25.

Question 12

22-107 What is the leveraged-adjusted duration gap of the bank's portfolio?
A)10 years.
B)7.3 years.
C)7 years.
D)7.18 years.
E)3 years.

Accepted Answer

The formula for leveraged-adjusted duration gap is as follows:
Leveraged-Adjusted Duration Gap = (Economic Value of Equity / Total Assets) x Duration Gap
= ($10,000,000 / $100,000,000) x 0.72
= 0.1 x 7.2
= 0.72
Therefore, the leveraged-adjusted duration gap of the bank's portfolio is 7.18 years, which is closest to answer choice D.

Question 13

22-97 An investor buys a $100,000 Treasury bond futures contract at 99-13/32nds.The following day the Treasury bond futures settlement price is 99-26/32nds.What is the one-day profit or loss on the Treasury bond futures position?
A)A profit of $406.25.
B)A loss of $406.25.
C)A profit of $130.
D)A loss of $329.
E)A profit of $329.

Accepted Answer

The initial price is 99-13/32, which is 99.40625% of $100,000, equaling $99,406.25. The settlement price is 99-26/32, which is 99.8125% of $100,000, equaling $99,812.50. The profit is $99,812.50 - $99,406.25 = $406.25.

Question 14

22-86 What does a low value of R2 indicate?
A)It means the degree of confidence increases in the use of futures contracts,with a given hedge ratio estimate,to hedge cash asset-risk position.
B)It means that we have little confidence that the slope coefficient from the regression is actually the true hedge ratio.
C)It indicates that there is no statistical association at all between spot rates and future prices.
D)It indicates that the regression line does not fit the scatter of observations.
E)It indicates a low value of hedging ineffectiveness.

Accepted Answer

It means that we have little confidence that the slope coefficient from the regression is actually the true hedge ratio.

Question 15

22-85 What does R2 =0 indicate?
A)Changes in the spot rate and changes in the futures price are perfectly correlated.
B)All observations between changes in spot rate and changes in futures price lie on a straight line.
C)The spot and future exchange rates are expected to move imperfectly together.
D)The FI must sell a greater number of futures to hedge the cash position.
E)There is no statistical association between changes in spot rates and changes in futures price.

Accepted Answer

The answer of 22-85 What does R2 =0 indicate?
A)Changes in...

Question 16

22-101 How can the portfolio manager use futures markets to protect against the risk exposure of rising interest rates?
A)Buy interest rate futures.
B)Sell currency futures.
C)Buy currency futures.
D)Sell interest rate futures.
E)Sell stock market index futures.

Accepted Answer

The answer of 22-101 How can the portfolio manager use...

Question 17

22-82 Who are the common buyers of credit forwards?
A)Insurance companies.
B)Banks.
C)Federal Reserve.
D)Stock brokers.
E)Credit unions.

Accepted Answer

The answer of 22-82 Who are the common buyers of...

Question 18

22-102 If Treasury bond futures prices are currently 89-00/32nds,what is the value of the Treasury bond futures hedge position?
A)$30,000,000.
B)$28,387,500.
C)$26,700,000.
D)$89,000,000.
E)$890,000.

Accepted Answer

The answer of 22-102 If Treasury bond futures prices are...

Question 19

22-106 Assume that the portfolio manager sells the bonds at the price in question 105 (87-05/32),and that she closes out the futures hedge position at the price in question 103 (81-17/32).What will be the net gain or loss on the entire bond transaction from the time that the hedge was placed?
A)Gain of $2,583,125.
B)Loss of $93,750.
C)Loss of $2,583,125.
D)Gain of $93,750.
E)Gain of $812,700.

Accepted Answer

The answer of 22-106 Assume that the portfolio manager sells...

Question 20

22-105 The portfolio manager for Conyers Bank wishes to sell the entire issue of Treasury bonds at a current price of 87-05/32nds.What will be the gain or loss on the cash position since the futures contract was placed? (That is,since the bonds were valued at $28,387,500.)
A)Loss of $3,834,375.
B)Loss of $3,853,125.
C)Gain of $2,240,625.
D)Gain of $3,853,125.
E)Loss of $2,240,625.

Accepted Answer

The answer of 22-105 The portfolio manager for Conyers Bank...

Quiz 22: Futures and Forwards

22-81 Catastrophe futures contracts

22-95 What is the basis on the T?bill futures contract?

22-99 The bank's portfolio manager wants to shorten asset maturities.Which of the following statements is true?

22-100 If the portfolio manager wants to shorten the bank's asset maturity,what type of risk is she concerned about?

22-84 Which of the following is NOT true regarding hedge ratio?

22-104 If the portfolio manager put on the hedge in question 102 (89-00/32nds) ,what is the profit/loss on the futures position given the settlement price in question 103 (81-27/32nds) ?

22-96 Calculate the cash flows on the above futures contract if all interest rates increase by 1.49 percent.(That is, $\Delta$ R/(1 + R) = 1.49 percent,and 1 bp = $25.)

22-87 The uniform guidelines issued by bank regulators for trading in futures and forwards

22-83 What is the reason for decrease in the number of futures contract needed to hedge a cash position in case of tailing the hedge?

22-103 If T-bond futures prices decrease to 81-27/32nds,what is the value of the futures hedge position?

22-98 An investor sold a $100,000 Treasury bond futures contract at 99-02/32nds yesterday.Today the Treasury bond futures settlement price is 99-31/32nds.What is the one-day profit or loss on the Treasury bond futures position?

22-107 What is the leveraged-adjusted duration gap of the bank's portfolio?

22-97 An investor buys a $100,000 Treasury bond futures contract at 99-13/32nds.The following day the Treasury bond futures settlement price is 99-26/32nds.What is the one-day profit or loss on the Treasury bond futures position?

22-86 What does a low value of R2 indicate?

22-85 What does R2 =0 indicate?

22-101 How can the portfolio manager use futures markets to protect against the risk exposure of rising interest rates?

22-82 Who are the common buyers of credit forwards?

22-102 If Treasury bond futures prices are currently 89-00/32nds,what is the value of the Treasury bond futures hedge position?

22-106 Assume that the portfolio manager sells the bonds at the price in question 105 (87-05/32) ,and that she closes out the futures hedge position at the price in question 103 (81-17/32) .What will be the net gain or loss on the entire bond transaction from the time that the hedge was placed?

22-105 The portfolio manager for Conyers Bank wishes to sell the entire issue of Treasury bonds at a current price of 87-05/32nds.What will be the gain or loss on the cash position since the futures contract was placed? (That is,since the bonds were valued at $28,387,500.)