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In what way is a credit swap different from an interest-rate swap?
Credit swaps reduce default risk, or credit risk, rather than interest-rate risk.
An article in the Wall Street Journal in 2016 states: "After decades of spending billions of dollars to hedge against rising fuel costs, more airlines, including some of the world's largest, are backing off after getting burned by low oil prices." Source: Susan Carey, "Airlines Pull Back on Hedging Fuel Costs," Wall Street Journal, March 20, 2016. How would airlines hedge against rising fuel costs? A. Take short positions in the futures market. B. Purchase more fuel efficient planes. C. Increase ticket prices. D. Take long positions in the futures market.
D. Take long positions in the futures market.
What is meant by the "OpenInt" on a futures contract?
The volume of contracts outstanding.
If you were a speculator who expected interest rates to fall, would you have bought or sold these futures contracts?
You would buy these futures contracts, anticipating a rise in the price.
Forward contracts have counterparty risk since _______.
there is a chance that either the buyer or the seller may default on their obligations under the contract one of the parties may go bankrupt after signing the contract and be unable to fulfill their obligation
Consider the following listing for 10-year Treasury note futures on the Chicago Board of Trade. One futures contract for Treasury note=$100,000 face value of 10-year 6% notes. Month Last Chg Open High Low Volume OpenInt Dec '12 108'18.5 0'03.5 108'13.0 108'21.0 108'06.5 564,322 2,380,328 Mar '13 108'07.0 0'05.5 108'00.0 108'05.0 107'26.0 4,325 118,728 Jun '13 107'27.0 0'05.5 107'27.0 107'27.0 107'21.5 2 19 Sep '13 107'21.5 0'05.5 107'21.5 107'21.5 107'21.5 0 0 Dec '13 107'21.5 0'05.5 107'21.5 107'21.5 107'21.5 0 0 If on this day you bought two contracts expiring in December 2012, you would have paid $ ______. (Round your response to the nearest whole number.) The OpenInt on the contract expiring in March 2013 was______.
217156 The last price for the contract in the first row is $108. Thus: 18.5/32 =0.578125 , or $108.578125 per $100 of face value. The futures contracts for U.S. Treasury notes are standardized at a face value of $100,000 of notes, or the equivalent of 1,000 notes of $100 face value each. Therefore, the price of this contract is: $ 108.578125 * 1,000 = $ 108,578.125. So, the price of two contracts is: $ 108,578.125 * 2 = $ 217,156.250. 118728
What difficulties did credit default swaps cause during the financial crisis of 2007dash2009? A. Those selling credit default swaps undercharged buyers relative to the actual risk involved. Thus, when buyers attempted to collect on payments from the price declines, firms lacked sufficient collateral to meet their obligations and faced possible bankruptcy. B. Because credit default swaps were NOT issued against collateralized debt obligations, but should have, (CDOs), owners of those securities experienced severe losses when the price of the underlying security declined in value. C. Credit default swaps were issued against mortgage-backed securities without having sufficient reserves to offset the losses incurred when the housing bubble burst. Thus, when the value of the underlying asset plummeted, firms were liable to the buyers of CDSs. D. A and B are correct. E. All of the above.
D. A and B are correct.
An article in the Wall Street Journal quoted a young investor who works for the social network site LinkedIn who explained that after losing money trading securities linked to crude oil futures prices he was going to "stick to investing in what he knows, like tech." Source: Ben Eisen, Nicole Friedman, and Saumya Vaishampayan, "The New Oil Traders: Moms and Millennials," Wall Street Journal, May 26, 2016. All of the following are reasons why might someone like this investor who has a full-time job would have trouble earning a profit buying and selling oil futures (or other securities linked to the prices of oil futures), except: A. He would need a superior knowledge of how the oil market works. B. He would need to have a better understanding than Wall Street professionals of how news is likely to affect oil prices. C. He would need to follow news about the oil industry carefully. D. His trading costs are higher than those of Wall Street professionals. Is it likely that the investor would have more success buying and selling derivatives or other securities related to tech firms? A. No; few individual investors are able consistently to earn a profit by buying and selling derivatives. B. Yes; everyone is making money in tech derivatives and securities. C. No; he's not a Wall Street professional so he wouldn't have success in the derivatives market. D. Yes; his has a more intimate working knowledge of the tech industry.
D. His trading costs are higher than those of Wall Street professionals. A. No; few individual investors are able consistently to earn a profit by buying and selling derivatives.
How does a credit default swap differ from the other swap contracts discussed in this chapter? Credit default swaps are: A. contracts where counterparties agree to swap interest payments over a specified period on a fixed dollar amount. B. contracts in which interest-rate payments are exchanged, with the intention of reducing default risk. C. contracts where counterparties agree to exchange principle amounts denominated in different currencies. D. derivatives requiring sellers to make payments to buyers if the price of the underlying security declines in value.
D. derivatives requiring sellers to make payments to buyers if the price of the underlying security declines in value.
Suppose you are a corn farmer. What risk do you face from price fluctuations? What would have to be true of a derivatives security if the security were to help you to hedge this risk?
Falling corn prices. The derivative need to go up in value if corn prices fell.
Which of the following does not describe derivatives?
Insurance is required when purchasing derivative securities.
Suppose the December futures contract is sold, and one day later the Chicago Board of Trade informs you that it has credited funds to your margin account. What happened to interest rates during that day?
Interest rates increased, bond prices decreased, and the value of the contract increased.
Why did futures markets originate in agricultural markets? Would a farmer buy or sell futures contracts? What would a farmer hope to gain by doing so? A farmer would _______ futures contracts to reduce the risk of agricultural prices ______. Would General Mills buy or sell futures contracts in wheat? What would General Mills hope to gain by doing so? General Mills would ______ futures contracts in wheat to reduce the risk of prices _______.
The supply of agricultural products depends on the weather and can be subject to wide price fluctuations. sell, falling buy, rising
According to an article in the Wall Street Journal, Canadian firms that import goods that are priced in U.S. dollars "buy futures contracts that guarantee that they can exchange Canadian dollars for U.S. [dollars] at fixed prices..." Source: Phred Dvorak and Andy Georgiades, "Strong Loonie Sets Off a Retail Tiff," Wall Street Journal, May 19, 2010. Do you agree that futures contracts make it possible to fix the price of the underlying asset?
Yes, futures contracts make it possible to lock into a price if futures contracts are not sold for profit or loss.
After the United Kingdom's electorate voted on June 23, 2016 to leave the European Union an article in the Wall Street Journal noted: "Credit-default swaps on the debt of Bank of America and Citigroup Inc. are up 25% from a day earlier." Source: John Carney, "Bank Credit Default Swaps Surge on Brexit Fears," Wall Street Journal, June 24, 2016. The increase in the _____ of credit-default swaps on these bonds indicates investors believe the default _____ on Bank of America and Citigroup Inc. debt has _____ from the previous day. What likely happened to the yields on those bonds? A. The yield decreased as the price of the bonds increased. B. The yield increased as the price of the bonds decreased. C. The yield decreased as the price of the bonds decreased. D. The yield increased as the price of the bonds increased.
price, risk, increased B. The yield increased as the price of the bonds decreased.
Suppose that you are a wheat farmer. Answer the following questions. It is September, and you intend to have 50,000 bushels of wheat harvested and ready to sell in November. The current spot market price of wheat is $2.67 per bushel, and the current December futures price of wheat is $2.92 per bushel. If each wheat futures contract is for 5,000 bushels, how many contracts will you buy or sell? You will (buy/sell) ___ contracts. The total value of these futures contracts is $_____. It is now November, and you sell 50,000 bushels of wheat at the spot price of $2.77 per bushel. If the futures price is $3.02 and you settle your position in the futures market, what was your gain or loss on your futures market position? The (gain/loss) on your futures market position was $_____. The (gain/loss) on your spot market position was $_____. Therefore, you (were/ were not) successful in completely hedging your risk from price fluctuations in the wheat market.
sell, 10 14600 2.92*10*5000=146000 loss, 5000 Profit (or loss)=Contract's value in September - Contract's value in November. That is: $146,000(10 * 5,000*$ 2.92)-$151,000(10 * 5,000*$ 3.02)=Loss of $5,000. gain, 5000 Profit (or loss) = Spot value in November - Spot value in September. That is: $138,500(10* 5,000 *$ 2.77)-$133,500(10*5,000*$ 2.67) = Gain of $5,000. were
Suppose that the Dow Jones Industrial Average is above the 12,500 level. If the Dow were to fall to 9,500, who would gain the most? A. Investors who had bought put options. B. Investors who had sold call options. C. Investors who had sold put options. D. Investors who had bought call options. Who would be hurt the most? A. Investors who had sold put options. B. Investors who had bought put options. C. Investors who had bought call options. D. Investors who had sold call options.
A. Investors who had bought put options. A. Investors who had sold put options.
What services do forward contracts provide in the financial system? (Check all that apply) A. They allow an agreement in the present to exchange a given amount of a commodity or a financial asset at a particular date in the future for a set price. B. They allow firms to delay signing contracts until a commodity or financial asset is actually delivered. C. They allow transactions to be agreed to in the present but to be settled in the future. D. They add additional risk to the market which increases the returns that farmers earn since demand for agricultural products is usually price elastic. E. They give firms and investors an opportunity to hedge the risk on transactions that depend on future prices.
A. They allow an agreement in the present to exchange a given amount of a commodity or a financial asset at a particular date in the future for a set price. C. They allow transactions to be agreed to in the present but to be settled in the future. E. They give firms and investors an opportunity to hedge the risk on transactions that depend on future prices.
Why would low oil prices cause airlines to be "burned"? A. Airlines would be on the hook to sell oil at an above market cost. B. Airlines would be on the hook to buy oil at an above market cost. C. Airlines would be on the hook to buy oil at a below market cost. D. Airlines would be on the hook to sell oil at a below market cost.
B. Airlines would be on the hook to buy oil at an above market cost.
The article also noted that: "Speculative investors in oil cut their bullish bets on the price of crude ..." What does the article mean by a "cut their bullish bet"? A. Investors were betting oil futures would not continue to fall. B. Investors were betting oil prices would rise. C. Investors were betting oil prices would not continue to rise. D. Investors were betting oil prices would fall.
C. Investors were betting oil prices would not continue to rise.
An article in the Wall Street Journal on the futures market for oil in the United Kingdom noted that on the day the article was published, "the number of long positions ... fell by 6%." Source: Georgi Kantchev, "Speculative Investors Cut Bullish Crude Oil Price Bets," Wall Street Journal, May 9, 2016. What is a long position in the futures market? A. The right of the buyer to sell the underlying asset on the specified future date. B. The right and obligation of the buyer to sell the underlying asset on the specified future date. C. The right and obligation of the buyer to receive or buy the underlying asset on the specified future date. D. The right of the buyer to receive or buy the underlying asset on the specified future date.
C. The right and obligation of the buyer to receive or buy the underlying asset on the specified future date.
How would these investors have cut their bets? A. Buy futures in coal. B. Buy futures in natural gas. C. Take short positions in crude. D. Liquidate their futures contracts.
D. Liquidate their futures contracts.
What is the difference between hedging and speculating? ______ serves to reduce risk in financial markets, while ______ may increase risk by placing financial bets on assets in an attempt to earn higher profits in the market. Which of the following is an example of speculating using commodity futures? Which of the following is an example of speculating using financial futures?
Hedging, speculating Buying a wheat futures contract expecting the future spot price to exceed the current futures price. Buying Treasury futures expecting future interest rates to be lower than indicated by the current price of Treasury futures.
Would derivative markets be better off if the only people buying and selling derivative contracts were hedgers?
No, as in all markets, at least two parties are required for each transaction, and speculators help provide liquidity and efficiency in financial markets.
Is a firm likely to have a long position in both the spot market and the futures market? Hedging involves taking a long position in the futures market to offset a _____ position in the spot market.
No, this would imply the firm intends to both buy and sell the same asset in the future. short
Suppose you are a manufacturer of cornbread. What risk do you face from price fluctuations? What would have to be true of a derivatives security if the security were to help you to hedge this risk?
Rising corn prices. The derivative need to go up in value if corn prices rose.
Credit swaps are:
contracts in which interest-rate payments are exchanged, with the intention of reducing default risk.
The fact that airlines were burned by their fuel hedges in 2016 means that hedging their fuel costs was a _____ idea because _____.
good, market conditions at the time indicated prices would continue to rise
Someone with no connection to an industry that places financial bets on futures contracts within the industry in an attempt to profit from changes in asset prices is called a _______ Suppose that you are a wealthy investor. Although you have no connection with the oil industry, you are convinced from studying the determinants of demand and supply in the oil market that the price of oil will decline sharply in the future. How might you use forward contracts to profit from your forecast?
speculator You could sell oil futures with the intention of buying them back at the lower price on or before the settlement date.
