BNAD 301 ch 14

Short term; long term

- If a financial instituion has bought a security and has therefore take a long position, it conducts a hedge by contracting to sell that security (take a short position) at some future date. -If it has taken short by selling a security that it needs to deliver at a future dat, then it conducts a hedge by contracting to buy that security (take a long position) at a future date

Micro hedge

- the financial institution is hedging the interest-rate risk for a specific asset it is holding.

Advantage of forward contracts

-is that they can be flexible as the parties involved want them to be. This means that an institution like the First National Bank may be able to hedge completely the interest-rate risk for the exact security it is holding in its portfolio.

Futures contracts have an advantage over forward contracts in that

-they are subject to default risk and are more liquid A financial futures contract is similar to an interest-rate forward contract, in that it specifies that a financial instrument must be delivered by one party to another on a stated future date. However, it has advantages over a forward contract in that it is no subject to default risk and is more liquid. Forward and futures contracts can be used by financial institutions to hedge (protect) against interest-rate risk.

Consider a put contract on a T-bond with an exercise price of 102 12/32. The contract represents $100,000 of bond principal and had a premium of $750. The actual T-bond price falls to 99 16/32 at the expiration. What is the gain or loss on the position?

$2125= (102 + 12/32)-(99+16/32)* 1000 - 750

Futures contracts are regularly traded on the

Chicago Board of Trade

Your company owes 10M EUR three months from now. How would you hedge the foreign exchange risk with 125,000 EUR futures contracts?

Go long 80 EUR futures contracts for three months

You have a call option on a $100,000 Treasury bond futures contract with an exercise price of 110. The premium was $1,500 and at expiration the futures contract has a price of 11. What is your profit or loss if you exercise this option?

Loss: $500

A contract that requires the investor to buy securities on a future date is called a...

long contract

If you sell a $100,000 interest-rate futures contract for 105, and the price of the Treasury securities on the expiration date is 108, your .. is ..

loss; $3000

Interest forward contracts are used to:

hedge against interest rate risk

A fund manager who specializes in corporate bonds believes that credit spreads are going to tighen and that interest rates are going to continue to decline. To protect the fund, he could:

Buy a call on a credit option

Parties who have bought a futures contract and thereby agreed to .... (take delivery of) the bonds are said to have taken a ... position

Buy; long

A swap agreement calls fro Durbin Industries to pay interest annually, based on a rate of 2.00% over one year T-bill rate, currently 6.00%. In return, Durbin receives interest at a rate of 6.00% on fixed-rate basis. The notational principal for the swap is $60,000. What is Durbin's net interest payment for the year after the agreement?

Durbin pays 8.00% * $60,000 and receives 6% * $60,000 or net, Durbin pays 2% * $60,000=1200

At the expiration date, a deliverable Treasury bond is selling for 101 but the Treasury bond futures contract is selling for 102. The futures price will:

Fall to 101 due to arbitrage

Agreeing to deliver an asset at some future date is called taking a ... position. Taking a .... position can offset the risk

Short; long -Financial derivatives can be used to reduce risk by invoking the following basic principle of hedging: Hedging risk involves engaging in a financial transaction that offsets a long position by taking an additional short position, or offsets a short position by taking an additional long position.

The portfolio you manage is holding $25M of 6s of 2023 Treasury bonds with a price of 110. You would like to hedge the interest rate risks using a forward contract on these next year. You could ...

Take a short position for T-bonds at the same interest rate and maturity.

Interest rate swaps have an advantage over options and futures in that:

They can be written for a long horizon

A swap that involves the exchange of one set of interest payments for another set of interest payments is called

an interest rate swap

By taking the long position on a futures contract of $100,000 at a price of 115 you are agreeing to ... a ...face value security for ...

buy; $100,000; $115,000

If you buy a call option on Treasury futures at 115, and at expiration the market price is 110, the ... will... exercised

call; not be

The credit derivative that, for a fee, gives the purchases the right to receive profits that are tied either to the price of an underlying security or to an interest rate is called a

credit option

An option that can only be exercised at maturity is

european option

All other things held constant, premiums on call options will increase when the

exercise price falls

If you bought a long contract on finacial futures you hope that interest rates

fall

Options on futures contracts are referred to as

futures options

a call option give the seller the

obligation to sell the underlying security

The seller of an option has the ... to buy or sell the underlying asset while the purchaser of an option has the ... to buy or sell the asset

obligation; right

Forward contracts are of limited usefulness to financial institutions because

of default risk

You have bought a put option on a $100,000 Treasury bond futures contract with an exercise price of 95. The premium for the option was $4000. The price of the Treasury bond at expiration is 120 You are:

out of money

If, for a $1000 premium, you buy a $100,000 call option on bond futures with a strike price of 110, and at the expiration date the price is 114, your... is....

profit; $3000

An option that gives the owner the right to sell a financial instrument at the exercise price within a specified period of time is a

put option

If you buy a put option on Treasury futures at 115, and at expiration the market price is 110, the

put; be

If second National Bank has more rate-sensitive assets than rate-sensitive liabilities, it can reduce interest-rate risk with a swap that requires Second National to

receive fixed rate while paying floating rate

If you bought a long futures contract you hope that bond prices

rise

A short contract requires that the investor...

sell securities in the future

The price specified on an option at which the holder can buy or sell the underlying asset is called the

strike price

A disadvantage of using contracts to hedge is

that their market is illiquid -A serious problem for the market in interest-rate forwad contracts, then, is that it may be difficult to make the financial transaction or that it will have to be made at a disadvantageous price. The second problem with forward contracts is that they are subject to default risk.

A macro hedge is a hedge in which

the hedge is for the institutions entire portfolio - a hedge is called a macro hedge because the financial institution engage in a macro hedge, in which the hedge is for the institutions entire portfolio.

The most common type of interest-rate swap is

the plain vanilla swap

A disadvantage to using interest-rates swaps is that

they can be written over long horizons