Money and Banking Exam
By selling short a futures contract of $100,000 at a price of 115 you are agreeing to deliver
$100,000 face value securities for $115,000
By buying a long $100,000 futures contract for 115 you agree to pay
$115,000 for $100,000 face value bonds
If you sell twenty-five $100,000 futures contracts to hedge holdings of a Treasury security, the value of theTreasury securities you are holding is
$2,500,000
If a bank has more rate-sensitive assets than rate-sensitive liabilities
it reduces interest rate risk by swapping rate-sensitive income for fixed rate income
Hedging by buying an option
limits losses
A contract that requires the investor to buy securities on a future date is called a
long contract
When interest rates are expected to rise on the future a banker is likely to
make short term rather than long term loans
An increase in the volatility of the underlying asset, all other things held constant, will
increase the option premium
The main advantage of using options on futures contracts rather than the futures contracts themselves is that
interest rate risk is controlled while preserving the possibility of gains
To say that the forward market lacks liquidity means that
it may be difficult to make the transaction
Hedging risk for a long position is accomplished by
taking a short position
All other things held constant, premiums on options will increase when the
term to maturity increases
Last year you purchased a bond with an interest rate of 5 percent. nOw the interest rate on the bond market drops to 4 percent
that means you will receive the same amount of coupons payments from the issuer while you are holding the bond and you can sell your bond at todays markets for a higher price
The advantage of forward contracts over futures contracts is that they
are more flexible
When interest rates fall, a bank that perfectly hedges its portfolio of Treasury securities in the futures market
has no change in its income
Futures differ from forwards because they are
a standardized contract
Bruce the Bank Manager can reduce interest rate risk by shortening the duration of the bank's assets to increase their rate sensitivity or
alternatively lengthening the duration of the bank's liabilities.
In the long run what cause depreciation of domestic currency is
an increase in domestic price level and an increase in imports demand
The advantage of futures contracts relative to forward contracts is that futures contracts
are standardized, making it easier to match parties, thereby increasing liquidity and specify that more than one bond is eligible for delivery, making it harder for someone to corner the marketand squeeze traders
If a bank manager wants to protect the bank against losses that would be incurred on its portfolio of treasury securities should interest rates rise, he could
buy put options on financial futures
If a firm must pay for goods it has ordered with foreign currency, it can hedge its foreign exchange rate risk by
buying foreign exchange futures long
An increase in domestic price level and an increase in imports demand
cause the public to expect a depreciation of domestic currency
Hedging in the futures market
eliminates the opportunity for gains and eliminates the opportunity for losses
All other things held constant, premiums on call options will increase when the
exercise price falls
If a bank manager chooses to hedge his portfolio of treasury securities by selling futures contracts, he
gives up the opportunity for gains and removes the chance of loss
Forward contracts are of limited usefulness to financial institutions because
of default risk and of lack of liquidity
Options are contracts that give the purchasers the
option to buy or sell an underlying asset
If Second National Bank has more rate-sensitive liabilities then rate-sensitive assets, it can reduce interest rate risk with a swap that requires Second National to
pay fixed rate while receiving floating rate
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 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 a firm is due to be paid in deutsche marks in two months, to hedge against exchange rate risk the firm should
sell foreign exchange futures short
A short contract requires that the investor
sell securities in the future.
Parties who have bought a futures contract and thereby agreed to buy
the bonds are said to have taken a long position
Assume you are holding Treasury securities and have sold futures to hedge against interest rate risk. If interest rates rise
the decrease in the value of the securities equals the increase in the value of the futures contracts
Assume you are holding Treasury securities and have sold futures to hedge against interest-rate risk. If interest rates fall
the increase in the value of the securities equals the decrease in the value of the futures contracts
The seller of an option has the
the obligation to buy or sell the underlying asset
A call option gives the seller
the obligation to sell the underlying security
When the exchange rate for the British pound changes from 1.80 per pound to 1.60 per pound then holding everything else constant
the pound has depreciated , American wheat sold in Britain becomes more expensive and British cars sold in the U.S become less expensive
If you buy a put option on treasury futures at 110, and at expiration the market price is 115
the put will not be exercised
A put option gives the owner
the right to sell the underlying security
When a central bank increases the nominal interest rate but the real interest rate remains the same, it gives a signal to the public that the inflation rate is expected to increase
therefore people expect the value of the domestic currency to decrease as results based on the interest parity condition the domestic currency depreciates
A disadvantage of a forward contract is that
these contracts have default risk, the forward market suffers from lack of liquidity, it may be difficult to locate a counterparty
The main reason to buy an option on a futures contract rather than the futures contract is
to limit losses and preserve the possibility of gains
If you sold a short contract on financial futures you hope interest rates
wil rise
If you sold a short futures contract you will hope that bond prices
will fall
If you bought a long futures contract you hope that bond prices
will rise
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 loss is $3000
If you purchase a $100,000 interest-rate futures contract for 110, and the price of the Treasury securities on the expiration date is 106
your loss is $4000
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 profit is $3000
If, for a $1000 premium, you buy a $100,000 put option on bond futures with a strike price of 114, and at the expiration date the price is 110
your profit is $3000