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

A bank wishes to hedge its $25 million face value bond portfolio (currently priced at 106 percent of par). The bond portfolio has a duration of five years. It will hedge with put options that have a delta of 0.67. The bond underlying the option contract has a market value of $112,000 and a duration of eight years. How many put options are needed? Assume that there is no basis risk on the hedge.

For a bond put option,the ________ the exercise price,the greater the cost of the put,and for a bond call option,the ________ the exercise price,the higher the cost of the call option.

A spot contract is for immediate delivery whereas a forward contract is for future delivery.

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. Other than credit risk,what are the risks to the bank?

A forward contract

A microhedge is a

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. Design a swap that the bank could use to reduce its risks.

A bank wishes to hedge its $30 million face value bond portfolio (currently priced at 99 percent of par). The bond portfolio has a duration of 9.75 years. It will hedge with T-bond futures ($100,000 face)priced at 98 percent of par. The duration of the T-bonds to be delivered is nine years. How many contracts are needed to hedge? Should the contracts be bought or sold? Ignore basis risk.

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

An FI has DA = 2.45 years and kDL = 0.97 years. The FI has total assets equal to $375 million. The FI wishes to effectively reduce the duration gap to one year by hedging with T-bond futures that have a market value of $115,000 and a DFut = 8 years. How many contracts are needed and should the FI buy or sell them? (D = Duration)

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

An FI with DA > kDL 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?

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

The writer of an American-style bond call option has the right,but not the obligation,to buy the bond at a preset price until the option expires.

Plain vanilla interest rate swaps are exchanges of

The largest two categories of swaps are

The price of a bond rises from 98 to par. Even if you do nothing,this would still result in an immediately recognized loss on a ________ on a bond,and a paper gain on a bond ________.

A U.S. corporation has a yen-denominated loan it must repay in six months. A long position in yen futures could help offset the corporation's foreign exchange risk.

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.