Question 1

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

Accepted Answer

A) True 
 B)False  True

Question 2

A fixed-floating interest rate swap is called a plain vanilla swap.

Accepted Answer

A) True 
 B)False  True

Question 3

The profits on a derivatives position are fixed when a bond's price falls below a certain point,but above that point the profits fall when the bond price rises. This profit profile fits which of the following positions?

Accepted Answer

A) Purchased call option 
B) Written call option 
C) Purchased put option 
D) Written put option 
E) None of the options are correct. 
A) Purchased call option 
B) Written call option 
C) Purchased put option 
D) Written put option 
E) None of the options are correct. B

Question 4

Buying a cap is similar to buying a call option on bond prices.

Accepted Answer

A) True 
 B)False

Question 5

Forward contracts are not subject to default risk because the exchanges honor the contract in case the counterparty defaults; but future contracts are subject to default risk because they are non standardized contracts.

Accepted Answer

A) True 
 B)False

Question 6

Basis risk occurs because it is generally impossible to

Accepted Answer

A) hedge unanticipated rate changes. 
B) exactly predict interest rate changes. 
C) exactly match the terms of the hedging instrument with the terms of the asset or liability at risk. 
D) find negatively correlated asset prices. 
E) All of these choices are correct. 
A) hedge unanticipated rate changes. 
B) exactly predict interest rate changes. 
C) exactly match the terms of the hedging instrument with the terms of the asset or liability at risk. 
D) find negatively correlated asset prices. 
E) All of these choices are correct.

Question 7

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

Accepted Answer

A) True 
 B)False

Question 8

A naïve hedge is one

Accepted Answer

A) in which the hedger is not fully informed. 
B) in which the hedger attempts to eliminate all of the risk of the underlying spot position. 
C) in which the hedger uses microhedges rather than macrohedges to limit risk. 
D) in which the hedger unwittingly increases the risk of the FI's position. 
E) that does not have to be reported on the FI's financial statements. 
A) in which the hedger is not fully informed. 
B) in which the hedger attempts to eliminate all of the risk of the underlying spot position. 
C) in which the hedger uses microhedges rather than macrohedges to limit risk. 
D) in which the hedger unwittingly increases the risk of the FI's position. 
E) that does not have to be reported on the FI's financial statements.

Question 9

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

Accepted Answer

A) True 
 B)False

Question 10

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

Accepted Answer

A) $105,600. 
B) $18,400. 
C) $17,600. 
D) $14,200. 
E) $11,500. 
A) $105,600. 
B) $18,400. 
C) $17,600. 
D) $14,200. 
E) $11,500.

Question 11

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

Accepted Answer

A) Forward contract 
B) Futures contract 
C) Purchased options contract 
D) Swap contract 
E) Collars 
A) Forward contract 
B) Futures contract 
C) Purchased options contract 
D) Swap contract 
E) Collars

Question 12

An FI has long-term fixed-rate assets funded by short-term variable-rate liabilities. To protect the equity value,the FI may engage in a swap to pay a ________ rate and receive a ________ interest.

Accepted Answer

A) fixed; variable 
B) variable; variable 
C) variable; fixed 
D) fixed; fixed 
E) None of the options are correct. 
A) fixed; variable 
B) variable; variable 
C) variable; fixed 
D) fixed; fixed 
E) None of the options are correct.

Question 13

A bond portfolio manager has a $25 million market value bond portfolio with a six-year duration. The manager believes interest rates may increase 50 basis points. Which of the following could be used to help limit his risk?
I. Sell the bonds forward.
II. Buy bond futures contracts.
III. Buy call options on the bonds.
IV. Buy put options on the bonds.

Accepted Answer

A) I only 
B) II only 
C) I and III only 
D) I and IV only 
E) II and III only 
A) I only 
B) II only 
C) I and III only 
D) I and IV only 
E) II and III only

Question 14

A macrohedge is a hedge of a particular asset or liability exposure to a change in a macroeconomic variable.

Accepted Answer

A) True 
 B)False

Question 15

A macrohedge is a

Accepted Answer

A) hedge of a particular asset or liability. 
B) hedge of an entire balance sheet. 
C) hedge using options. 
D) hedge without basis risk. 
E) hedge using futures on macroeconomic variables. 
A) hedge of a particular asset or liability. 
B) hedge of an entire balance sheet. 
C) hedge using options. 
D) hedge without basis risk. 
E) hedge using futures on macroeconomic variables.

Question 16

A FI buys a $500 million cap of 7 percent at a premium of 0.75 percent of face value. In addition,it sells $500 million floor of 3 percent at a premium of 0.70 percent of face value.
If interest rates rise to 7.25% what is the net profit of the FI?

Accepted Answer

A) −$1,250,000 
B) −$250,000 
C) $0 
D) $1,000,000 
E) $1,250,000 
A) −$1,250,000 
B) −$250,000 
C) $0 
D) $1,000,000 
E) $1,250,000

Question 17

In terms of direct costs,are futures or options likely to be a more expensive form of hedging? Why? In terms of opportunity costs,which is more expensive? Why?

Accepted Answer

In terms of direct costs,options are gen

Question 18

A thrift purchases a one-year interest rate floor with a floor rate of 4.23 percent from a large bank. The option has a notional principal of $1 million and costs $2,000. If in one year,interest rates are 3.15 percent,the thrift's net profit,ignoring commissions and taxes,was ________; and if in one year,interest rates were 5.2 percent,the thrift's net profit was ________.

Accepted Answer

A) $0; $7,500 
B) $8,800; −$2,000 
C) $8,800; $0 
D) $29,500; −$2,000 
E) $29,500; $0 
A) $0; $7,500 
B) $8,800; −$2,000 
C) $8,800; $0 
D) $29,500; −$2,000 
E) $29,500; $0

Question 19

A purchaser of a bond call option gains if interest rates fall.

Accepted Answer

A) True 
 B)False

Question 20

The buyer of an American-style bond call option has the right,but not the obligation,to sell the bond at a set price until the option expires.

Accepted Answer

A) True 
 B)False

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

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

A fixed-floating interest rate swap is called a plain vanilla swap.

The profits on a derivatives position are fixed when a bond's price falls below a certain point,but above that point the profits fall when the bond price rises. This profit profile fits which of the following positions?

Buying a cap is similar to buying a call option on bond prices.

Forward contracts are not subject to default risk because the exchanges honor the contract in case the counterparty defaults; but future contracts are subject to default risk because they are non standardized contracts.

Basis risk occurs because it is generally impossible to

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

A naïve hedge is one

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

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

An FI has long-term fixed-rate assets funded by short-term variable-rate liabilities. To protect the equity value,the FI may engage in a swap to pay a ________ rate and receive a ________ interest.

A macrohedge is a hedge of a particular asset or liability exposure to a change in a macroeconomic variable.

A macrohedge is a

A FI buys a $500 million cap of 7 percent at a premium of 0.75 percent of face value. In addition,it sells $500 million floor of 3 percent at a premium of 0.70 percent of face value. If interest rates rise to 7.25% what is the net profit of the FI?

In terms of direct costs,are futures or options likely to be a more expensive form of hedging? Why? In terms of opportunity costs,which is more expensive? Why?

A purchaser of a bond call option gains if interest rates fall.

The buyer of an American-style bond call option has the right,but not the obligation,to sell the bond at a set price until the option expires.

Introduction

Determinants of Interest Rates

Interest Rates and Security Valuation

The Federal Reserve System, monetary Policy, and Interest Rates

Money Markets

Bond Markets

Mortgage Markets

Stock Markets

Foreign Exchange Markets

Derivative Securities Markets

Commercial Banks: Industry Overview

Commercial Banks Financial Statements and Analysis

Regulation of Commercial Banks

Other Lending Institutions: Savings Institutions, credit Unions, and Finance Companies

Insurance Companies

Securities Firms and Investment Banks

Investment Companies

Pension Funds

Types of Risks Incurred by Financial Institutions

Managing Credit Risk on the Balance Sheet

Managing Liquidity Risk on the Balance Sheet

Managing Interest Rate Risk and Insolvency Risk on the Balance Sheet

Managing Risk Off the Balance Sheet With Loan Sales and Securitization

Filters

An FI has long-term fixed-rate assets funded by short-term variable-rate liabilities. To protect the equity value,the FI may engage in a swap to pay a rate and receive a interest.