Exam 23: Managing Risk Off the Balance Sheet With Derivative Securities

The safest way to hedge a bond asset with options is to

The largest two categories of swaps are

A U.S. bank has deposit liabilities denominated in euros that must be repaid in two years. The deposits pay a fixed interest rate of 4 percent. The bank took the money raised and converted it to dollars,whereupon it lent the dollars to a corporate customer that will repay the bank over the next two years in dollars at a variable rate of interest equal to LIBOR +3 percent. The interest rate earned may change every six months.

A macrohedge is a

Why is the credit risk on a plain vanilla interest rate swap generally less than the credit risk of a loan with an equivalent (notional)principal amount?

After conducting a rate-sensitive analysis,a bank finds itself with the following amounts of rate-sensitive assets and liabilities (RSAs and RSL)and fixed-rate assets and liabilities (FRAs and FRLs); the rate of return and cost rates on the accounts are also given: If we were to design a macrohedge,which of the following positions would help reduce the bank's interest rate risk? I. Long position in bond futures contracts II. Buying put options on bonds III. Purchasing an interest rate cap

What are the advantages and disadvantages of forwards versus futures contracts?

A regional bank negotiates the purchase of a one-year interest rate cap with a cap rate of 5.45 percent with a large bank. The option has a notional principle of $2 million and costs $3,400. In one year,interest rates are 6.33 percent. The regional bank's net profit,ignoring commissions and taxes,was

Writing a call option on a bond pays off if interest rates rise.

Gains and losses on a futures contract must be recognized daily.

Basis risk is the risk that the prices or value of the underlying spot and the derivatives instrument used to hedge do not move predictably relative to one another.

Draw a graph of the gains and losses from owning a bond and simultaneously buying a put on the bond.

Which of the following requires daily cash flow settlements between the parties?

As interest rates fall,bond prices and call option potential profits increase.

Which of the following are potentially subject to risk-based capital requirements?

Is it safer to hedge a contingent liability with options,futures,forwards,or swaps? Explain.

A U.S. firm is earning British pounds from its foreign subsidiary. A UK firm is earning dollars from its U.S. subsidiary. Neither firm can borrow at a cost-effective rate outside of its home country/currency. What kind of swap could be used to limit the FX risk of both firms and explain the payment flows involved? (Be specific.)

The lack of perfect correlation between spot and futures prices implies that most hedges will have some basis risk.

An FI with D_A > kD_L could do which of the following to reduce the duration gap?

After conducting a rate-sensitive analysis,a bank finds itself with the following amounts of rate-sensitive assets and liabilities (RSAs and RSL)and fixed-rate assets and liabilities (FRAs and FRLs); the rate of return and cost rates on the accounts are also given: Suppose the institution wishes to fully hedge the interest rate risk with a swap. A swap is available with whatever notional principal is needed that pays fixed at 4.95 percent and pays variable at LIBOR. LIBOR is currently 5.11 percent. By how much would profits change right now if the bank engages in the swap?