FIL 241 Exam 3

Which of the following is NOT true regarding forward contracts?

A seller delivers the underlying asset before the settlement date

Which of the following is NOT a difference between futures and forward contracts?

Futures contracts are agreements to buy/sell a specific amount of an asset at a specific future date forward contracts are not

The sale of securities to the public via an investment banker by a new corporation raising funds is called a(n) ____.

Initial Public Offering

Which of the following is NOT specified in an interest rate swap contract?

Initial and maintenance margin

What is the main difference between hedgers and speculators?

Hedgers look to eliminate or reduce risk, whereas speculators take on risk

Which of the following is a criterion for setting the opening market price for a stock on a stock exchange? (Not in the text - see the handout)

Maximization of the order flow Minimization of the order surplus

Which of the following statements about mortgage rate caps is true?

Most ARMs have interest rate caps

Which of the following is NOT a characteristic of individual mortgages or markets for individual mortgages?

Multiple lenders per issue

Cash flows of which MBS are affected by mortgage prepayments?

Pass-throughs Principal-only strips Interest-only strips CMOs

Which of the following statements regarding options is NOT true

Potential losses to a put option writer are theoretically infinite

Which of the following statements about fixed-rate mortgages is wrong?

Principal portion of the required payment is decreasing over time Interest portion is increasing

Which of the following is true about adjustable-rate mortgages (ARMs)?

The ARM's rate can be adjusted periodically. ARMs reduce interest rate risk to the lender.

What is most likely to happen to an ARM in an increasing interest rate environment?

The borrower's required payments will increase

Who will lose if the price of an underlying asset fails?

The buyer of a future contract

You are a speculator and you expect the price of the stock JP Morgan Chase to appreciate in the near future. If your forecast is correct, what combination of options positions would help you realize the most profit?

buy a call, sell a put

3 types of equity securities

common stock preferred stock convertible securities

An option writer's position if they already own the securities that they have agreed to sell or have already sold short the securities that they have agreed to buy is known as a _____ option

covered

Frequently, basis risk is the result of _____.

cross-hedging

_____ voting gives minority shareholders more control over the firm's decisions.

cumulative

An investment bank that maintains some Treasury bond holdings sells Treasury bond futures contracts. If interest rates increase, the market value of the bond holdings will _______ and the position in futures contracts will result in a _______.

decrease; gain

An investment bank that maintains some Treasury bond holdings buys Treasury bond futures contracts. If interest rates increase, the market value of the bond holdings will _______ and the position in futures contracts will result in a _______.

decrease; loss

As interest rates rise, the value of principal-only (PO) mortgage-backed strips _______ and the value of interest-only (IO) strips _______. (Assume the underlying mortgages are fixed-rate. Assume no default risk.)

decreases; increases

convertible securities

either corporate bonds or preferred stock that converts to common stock at the investors option

If interest rates _______ and bond prices ______, short positions in T-bond futures will _____ value and long positions will _____ value.

fall; rise; lose; gain rise; fall; lose; gain

A bank that suffers from increasing interest rates would make ________ payments in an interest rate swap in order to hedge

fixed rate

A bank that suffers from declining interest rates would make ________ payments

floating rate

characteristics of options

grants the option buyer the right to buy (call) or sell (put) a specified amount of an asset for a specified period of time

If speculators believe interest rates will _____, they would consider_____ T-bond futures contracts.

increase; selling decrease; buying

Which of the following is NOT true about American Depository Receipts (ADRs)?

ADRs are claims issued by U.S. financial intermediaries (FIs) against shares in foreign companies, with the shares held in custody by financial intermediaries for investors. ADRs are issued in the U.S. and are denominated in U.S. dollars. All cash flows to the investor are in dollars. An ADR enhances a companys visibility, status and profile in the U.S. and internationally among investors. ADRs help U.S. investors to diversify internationally.

Which of the following is NOT associated with tightening (i.e., stricter) mortgage credit standards?

An increase in the required loan-to-value ratio

The New York Stock Exchange is a(n) ____ market.

Auction Exchange Secondary

Which of the following statements about put options is true

The longer the time to expiration, the higher the value of a put

Which of the following statements is NOT true of all mortgage-backed pass-through securities?

Their interest and principal repayments are easily predictable.

What is the securities distribution method in which the investment banker purchases the securities from the company for a guaranteed price (net proceeds) and then resells the securities to investors at a higher price?

Underwritten offering

A mortgage-backed instrument consisting of different classes of related debt obligations, called tranches, and passing through principal and interest payments to investors according to a predetermined schedule is known as _______.

a collateralized mortgage obligation (CMO)

explain how government and private market innovations have led to a vastly expanded popularity for mortgages and mortgage backed securities in the nations capital markets

a national secondary market in mortgages developed after the development of fed mortgage insurance and gov sponsored agencies that guarantee mortgage loans insurance and other financial guarantees reduce credit risk in the market

characteristics of forwards and futures

agreements between 2 parties to exchange a specified amount of an asset for a predetermined prices at a predetermined point in time in the future

derivative markets

allow people to guarantee the price of future transactions with greater certainty

discuss the risks involved in using futures contracts to hedge an underlying risk exposure

basis risk, related-contract risk, and manipulation risk may all affect the returns to hedging with standardized exchange-listed contracts

explain how swap work

involve 2 parties agreeing to exchange payment obligations swap terms may vary with future foreign or domestic interest rates because of their great flexibility in transferring interest rate or currently risk, swaps markets have grown

characteristics of swaps

involved 2 parties exchanging periodic payments for a predetermined length of time

A farmer growing wheat is _____ in wheat and may hedge by _____ wheat futures.

long; selling

If interest rates unexpectedly decrease, cash flows to interest-only mortgage-backed strips would likely be _____ and cash flows to principal-only strips would likely be _____ anticipated before the interest rate change. (Assume underlying mortgages are fixed-rate. Assume no default risk.)

lower than; higher than

The risk of having a futures position liquidated if a margin call is not satisfied is _____ risk.

margin

An order to the New York Stock Exchange to buy at the best available current price is a _____ order.

market

A put option is out of the money when the

market price of the underlying security exceeds the exercise price

describe the role of mortgage bankers and how they earn profits

mortgage bankers originate and service mortgage loans. they bear little interest rate risk because they hold on to mortgages only long enough to sell them in the secondary market

Explain the basic structure of mortgages as debt instruments

mortgages are collateralized loans that are amortized over time monthly mortgage payments include interest and principal

explain how equity securities are sold in the primary market and the role of underwriters

new issues may be sold directly to investors by the issuing corporation, but get are usually distributed by an investment bankers in an underwritten offering a private placement or a shelf registration

discuss why some people prefer options to forward or future contracts

options markets provide opportunity for one sided returns in exchange for the payment of a premium to the seller of the option

If the spot price of the underlying asset is less than the strike price, a call option is _______ and a put option is __________

out of the money; in the money

Amortization of a mortgage is the ______.

process of gradually retiring a loan by periodic principal payments

discuss how the nature of mortgage markets has evolved over time

regional mortgage markets dominated by local lending institutions such as savings banks or savings and loans have given way to national mortgage markets dominated by key government agencies, mortgage bankers and commercial and investment bankers.

describe the advantages and disadvantages of each derivative security

regulated futures and options markets differ from forward markets in that they involve the trading of standardized contracts on organized exchanges by people who typically don't know who has taken the opposite side of their transactions and look only to the exchange to guarantee their contracts

An institution that suffers from increasing interest rates may hedge by

selling interest rate futures making fixed rate payments in exchange for floating-rate payments in an interest rate swap

preferred stock

stockholders typically do not vote but they are given preference in receiving dividend payments over common shareholders

explain how equity securities are traded in the secondary market

take 4 possible forms: direct search, brokers, dealer, and auction markets most major US stocks trade on the NASDAQ or the NYSE

common stock

the basic form of corporate ownership stock holders typically vote on the corporations board of directors, may receive periodic cash payments called dividends

describe the key roles that fannie mae, freddie mac, ginnie mae, mortgage bankers and mortgage insurers have played in developing secondary mortgage markets

the majority of mortgages are now sold in the secondary mortgage markets. mortgage bankers and government agencies facilitate secondary mortgage market operations

discuss the wide variety of mortgage backed securities and mortgage backed debt issues

they were developed that increased the appeal of MBSs relative to the original mortgages by reducing all risk, extension risk, or payment uncertainties for some types or tranches of MBSs.

explain how a short sale works

when an investor borrows shares from a broker and sells those shares today the investor hopes to buy the shares back in the market at some point for a lower price