Chapter 7 Managing interest rate risk using off balance sheet instruments PDF

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Chapter 07 Testbank_Student: ____________________________________________________________________________1.A ... is an agreement between a buyer and seller at time 0, when there is a contractual agreement that an asset will be exchanged for cash at some later date.A. call option B. put option C. for...

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Chapter 07 Testbank Student: ___________________________________________________________________________

1.! A ... is an agreement between a buyer and seller at time 0, when there is a contractual agreement that an asset will be exchanged for cash at some later date.

! A.!call option B.!put option C.!forward contract D.!swap !

2.! A ... is a (non-standard) contract between two parties to deliver and pay for an asset in the future.

! A.!call option B.!put option C.!forward contract D.!swap !

3.! A ... is a standardised contract guaranteed by organised exchanges to deliver and pay for an asset in the future.

! A.!call option B.!put option C.!forward contract D.!futures contract !

4.! Which of the following statements is true?

! A.! Marking to market refers to the process by which the prices on outstanding futures contracts are adjusted each hour to reflect current futures market conditions. B.! Marking to market refers to the process by which the prices on outstanding futures contracts are adjusted each day to reflect current futures market conditions. C.! Marking to market refers to the process by which the prices on outstanding futures contracts are adjusted each week to reflect current futures market conditions. D.! Marking to market refers to the process by which the prices on outstanding futures contracts are adjusted each month to reflect current futures market conditions. !

5.! ... is the process by which the prices on outstanding futures contracts are adjusted each day to reflect current futures market conditions.

! A.!Hedging B.!Marking to market C.!Arbitrage D.!Securitisation !

6.! Which of the following statements is true?

! A.! If a cash asset is hedged on a dollar for dollar basis with a forward or futures contract, we refer to this hedge as a dollar hedge. B.! If a cash asset is hedged on a dollar for dollar basis with a forward or futures contract, we refer to this hedge as a plain hedge. C.! If a cash asset is hedged on a dollar for dollar basis with a forward or futures contract, we refer to this hedge as a naïve hedge. D.! All of the listed options are correct. !

7.! In a 'plain Vanilla swap' the swap buyer agrees to make:

! A.! fixed-interest payments to the swap seller on a loan that is originally floating, but which is then modified through the use of derivatives to turn it into a fixed-rate loan B.! fixed-interest payments to the swap seller on a loan that is originally fixed, but which is then modified through the use of derivatives to turn it into a floating-rate loan C.! floating-interest payments to the swap seller on a loan that is originally floating, but which is then modified through the use of derivatives to turn it into a fixed loan D.! None of the listed options are correct. !

8.! Which of the following statements is true?

! A.! Using a futures or forward contract to hedge a specific asset or liability risk is called macrohedging. B.! Using a futures or forward contract to hedge a specific asset or liability risk is called microhedging. C.! Using a futures or forward contract to hedge a specific asset or liability risk is called asset- or liability-specific hedging. D.! Using a futures or forward contract to hedge a specific asset or liability risk is called naïve hedging. !

9.! Which of the following statements is true?

! A.! Microhedging refers to hedging the entire duration gap of an FI using futures or forward contracts. B.! Macrohedging refers to hedging the entire duration gap of an FI using futures or forward contracts. C.! Microhedging refers to hedging the entire balance sheet of an FI using futures or forward contracts. D.! Macrohedging refers to hedging the entire balance sheet of an FI using futures or forward contracts. !

10.!

Which of the following statements is true?

! A.! Routine hedging seeks to hedge all interest rate risk exposure. B.! Routine hedging seeks to hedge all foreign exchange rate risk exposure. C.! Routine hedging seeks to hedge all liquidity risk exposure. D.! Routine hedging seeks to hedge all capital risk exposure. !

11.! ... is a residual risk that arises because the movement in a spot (cash) asset's price is not perfectly correlated with the movement in the price of the asset delivered under a futures or forward contract.

! A.!Macro risk B.!Micro risk C.!Basis risk D.!Duration risk !

12.! Partially hedging the gap or individual assets and liabilities is referred to as?

! A.! hedging arbitrarily B.! hedging selectively C.! hedging partially D.! hedging naively !

13.! The final settlement in which all bought and sold futures contracts in existence at the close of trading in the contract month are settled at the cash settlement price is called a:

! A.! periodical cash settlement B.! mandatory cash settlement C.! monthly cash settlement D.! final cash settlement !

14.! An undeliverable futures contract refers to a futures contract in which:

! A.! there is no physical settlement B.! there is no mandatory cash settlement C.! one of the parties is unable to deliver D.! money has been lost due to a party having chosen an unfavourable hedging strategy !

15.! Which of the following is an adequate definition of conversion factor?

!

A.! A factor used to calculate the invoice price on a futures contract when a bond other than the benchmark bond is delivered to the buyer. B.! A factor used to calculate the invoice price on a futures contract when the benchmark bond is delivered to the buyer. C.! A factor used to calculate the invoice price on a futures contract when a bond other than the benchmark bond is delivered to the seller. D.! A factor used to calculate the invoice price on a futures contract when the benchmark bond is delivered to the seller. !

16.! Within the futures market, to be fully hedged means:

! A.! Buying a sufficient number of futures contracts so that the loss of net worth on the FI's balance sheet when interest rates rise is just offset by the gain from the off-balance-sheet selling of futures when interest rates rise. B.! Selling a sufficient number of futures contracts so that the loss of net worth on the FI's balance sheet when interest rates rise is just offset by the gain from the off-balance-sheet selling of futures when interest rates rise. C.! Selling a sufficient number of futures contracts so that the gain of net worth on the FI's balance sheet when interest rates rise is just offset by the gain from the off-balance-sheet selling of futures when interest rates rise. D.! None of the listed options are correct. !

17.! The dollar value of the outstanding futures position depends on the:

! A.! number of contracts bought and sold and the price of each contract B.! cash exposure ratio C.! number of contracts bought and sold and the change in interest rates D.! contracts that should be sold per dollar of cash exposure !

18.! Which of the following are contracts that give the holder the right, but not the obligation, to buy or sell an underlying asset at a prespecified price for a specified time period?

! A.! options B.! futures C.! forwards D.! swaps !

19.! Which of the following statements is true?

! A.! In equity markets, delivery and cash settlement normally occur two business days after the spot agreement. B.! In equity markets, delivery and cash settlement normally occur three business days after the spot agreement. C.! In equity markets, delivery and cash settlement normally occur four business days after the spot agreement. D.! In equity markets, delivery and cash settlement normally occur five business days after the spot agreement. !

20.! Which of the following is a major difference between forwards and futures?

! A.! Forwards are marked to market, while futures are not. B.! Futures are tailor made, while forwards are standardised. C.! The default risk of futures is significantly reduced by the futures exchange guaranteeing to indemnify counterparties against credit risk, while this is not the case for forwards. D.! Forwards are marked to market, while futures are not, futures are tailor made, while forwards are standardised and the default risk of futures is significantly reduced by the futures exchange guaranteeing to indemnify counterparties against credit risk, while this is not the case for forwards. !

21.! An Australian bank must pay US$10 million in 90 days. It wishes to hedge the risk in the futures market. To do so, the bank should:

! A.! buy A$10 million in US dollar futures B.! sell A$10 million in US dollar futures, with three-month maturity C.! buy US$10 million in US dollar futures D.! sell US$10 million in US dollar futures !

22.! Which of the following is true of the market price of a futures contract over time?

! A.! It is set at time 0. B.! It is fixed over the life of the contract. C.! It changes based on the market value of the underlying asset. D.! It decreases with time to expiration. !

23.! Which of the following statements is true?

! A.! In a spot contract the buyer and seller enter into a contract at time 0, the contract is marked to market, the seller agrees on a price at time 0 and the bonds is delivered by the seller to the buyer 'at that time'. B.! In a spot contract the buyer and seller agree on a price at time 0 and the bonds is delivered by the seller at a future point in time, for example, after three months. C.! In a spot contract the buyer and on a daily basis, and the buyer pays the spot price quoted at expiry. D.! None of the listed options are correct. !

24.! Which of the following statements is true?

! A.! In a forward contract the buyer and seller agree on a price at time 0 and the bonds are delivered by the seller to the buyer 'at that time'. B.! In a forward contract the buyer and seller agree on a price at time 0 and the bonds are delivered by the seller at a future point in time, for example, after three months. C.! In a forward contract the buyer and seller enter into a contract at time 0, the contract is marked to market on a daily basis, and the buyer pays the forward price quoted at expiry. D.! None of the listed options are correct. !

25.! Which of the following statements is true?

! A.! In a futures contract the buyer and seller agree on a price at time 0 and the bonds are delivered by the seller to the buyer 'at that time'. B.! In a futures contract the buyer and seller agree on a price at time 0 and the bonds are delivered by the seller at a future point in time, for example, after three months. C.! In a futures contract the buyer and seller enter into a contract at time 0, the contract is marked to market on a daily basis, and the buyer pays the futures price quoted at expiry. D.! None of the listed options are correct. !

26.! Which of the following statements is true?

! A.!A very actively traded spot contract is the spot rate agreement (SRA). B.!A very actively traded spot contract is the futures rate agreement (FRA). C.!A very actively traded forward contract is the forward rate agreement (FRA), commonly used to lock in the interest rate on shorter term borrowings. D.! A very actively traded spot contract is the option rate agreement (ORA), commonly used to grant the right to buy or sell an asset at a specified price.

!

27.! Which of the following is a common use of FRAs?

! A.! To lock in an interest rate on relatively shorter term borrowings. B.! To lock in an interest rate on medium-term borrowings. C.! To lock in an interest rate on relatively longer term borrowings. D.! To lock in an interest rate on any term of borrowings. !

28.! Which of the following statements is true?

! A.! In a futures contract, daily cash flows pass, via the clearing house, between the buyer and seller in response to the mark-to-market process. B.! In a forward contract, daily cash flows pass, via the clearing house, between the buyer and seller in response to the mark-to-market process. C.! In a futures contract, daily cash flows pass, via the clearing house, between the buyer and seller in response to the mark-to-book value process. D.! In a forward contract, daily cash flows pass, via the clearing house, between the buyer and seller in response to the mark-to-book value process. !

29.!

A company is considering using futures contracts to hedge an identified interest rate exposure on its debt facilities. However, it is concerned about the impact of basis risk. All of the following statements regarding basis risk are correct, except:

! A.! basis risk is the difference between prices in the physical market and the price of the relevant futures market contract. B.! the existence of basis risk removes the opportunity for a perfect borrowing hedge. C.! initial basis will be evident while the market is of the view that physical market prices will remain stable. D.! final basis will exist where a futures contract is used to hedge a risk associated with a different physical market product. !

30.! An FI portfolio manager holds 10-year $1 million face value bonds. At time 0, these bonds are valued at $95 per $100 of face value and the manager expects interest rates to rise over the next three months. What should the manager do?

! A.! The FI portfolio manager should leave the position untouched as changes in the interest rate have no impact on bond prices. B.! The FI portfolio manager should leave the position untouched as an increase in interest rates will lead to higher bond prices. C.! The FI portfolio manager should hedge the position by selling a three months forward contract with a face value of $1 million. D.! The FI portfolio manager should hedge the position by buying a three months forward contract with a face value of $1 million. !

31.! Assume that the price paid by the buyer of a forward is $82 000 and further assume that the spot price of purchasing the hedged underlying asset at delivery date is $85 000. What is the result for the forward seller?

! A.! The result is a $3000 profit. B.! The result is a $3000 loss. C.! The answer depends on how the forward price develops over time. D.! There is too little information to answer the question. !

32.! Financial futures are used by FIs to manage:

! A.! credit risk B.! interest rate risk C.! liquidity risk D.! sovereign country risk !

33.! A forward contract:

! A.! has more credit risk than a futures contract B.! is more standardised than a futures contract C.! is marked to market more frequently than a futures contract D.! has a shorter time to delivery than a futures contract

E.! is less risky than a futures contract. !

34.! The benefit of a futures exchange is:

! A.! elimination of customer risk exposure B.! provision of clearing services C.! guarantee of trading volume D.! intervention on the trader's behalf with government regulators !

35.! In June, an investor finds out that in September she will receive $10 million to invest in three-month maturity securities. In June, the 91-day Treasury bill rate is 5.50 per cent. What is the investor's profit (loss) if the 91-day rate falls to 5.20 per cent in September?

! A.! The investor loses $30 000 because of the 30 basis point decline in interest rates. B.! The investor gains $30 000 because of the 30 basis point decline in interest rates. C.! The investor gains $7583 because of the 30 basis point decline in interest rates. D.! The investor loses $7583 because of the 30 basis point decline in interest rates. !

36.! In June, an investor finds out that in September she will receive $10 million to invest in three-month maturity securities. In June, the 91-day Treasury bill rate is 5.50 per cent. If the investor uses 10 T-bill futures contracts to hedge the interest rate risk, should she take a long or a short hedge? What are the returns on the futures hedge if there is no basis risk?

! A.! She earns $30 000 on the short futures hedge. B.! She earns $30 000 on the long futures hedge. C.! She earns $7500 on the short futures hedge. D.! She earns $7500 on the long futures hedge. !

37.! Which of the following statements is true?

! A.!The advantage of using forwards for creating a synthetic fixed rate position is that there are no cash flows until the contract matures. B.!The advantage of using futures for creating a synthetic fixed rate position is that futures contracts are standardised. C.!The advantage of using forwards for creating a synthetic fixed rate position is that futures contracts are standardised. D.! The advantage of using futures for creating a synthetic fixed rate position is that there are no cash flows until the contract matures.

!

38.! Which of the following statements is true?

! A.! The mismatches between changes in the price of the exposure and the value of the instrument used to hedge the position is called value risk. B.! The mismatches between changes in the price of the exposure and the value of the instrument used to hedge the position is called basis risk. C.! The mismatches between changes in the price of the exposure and the value of the instrument used to hedge the position is called gap risk. D.! The mismatches between changes in the price of the exposure and the value of the instrument used to hedge the position is called fundamental risk. !

39.! Which of the following statements is true?

! A.! Micro- and macrohedging always lead to the same hedging strategies and results. B.! Micro- and macrohedging can lead to the same hedging strategies but will lead to different results. C.! Micro- and macrohedging will lead to different hedging strategies but will also lead to the same results. D.! Micro- and macrohedging can lead to different hedging strategies and results. !

40.! Which of the following is a reason why the default risk of a futures contract is assumed to be less than that of a forward contract?

! A.! Forward contracts are classified as exotic derivatives. B.! Margin requirements on futures. C.! More flexibility as the buyer can decide whether or not to exercise the contract at maturity. D.! None of the listed options are correct, as the default risk of a futures contract is generally considered to be higher than that of a forward contract. !

41.! Which of the following statements is true?

! A.! Over-hedging will lead to a significant reduction in risk, but also in returns. B.! In terms of risk and return, there is a linear relationship between an unhedged, a selectively hedged, a fully hedged and an over-hedged position. C.! It is not possible to over-hedge a position. D.! Over-hedging will lead to a significant reduction in risk, but also in returns, in terms of risk and return, there is a linear relationship between an unhedged, a selectively hedged, a fully hedged and an over-hedged position and it is not possible to over-hedge a position. !

42.! What is a swap?

! A.! An agreement between two parties to exchange assets or a series of cash flows for a specific period of time at a specified interval. B.! An agreement between a buyer and a seller at time 0 to exchange a non-standardised asset for cash at some future date. C.! A contract that gives the holder the right, but not the obligation, to buy or sell the underlying asset at a specified price within a specified period of time.

D.! Trading in securities prior to their actual issue. !

43.! Which of the following best describes a derivative contract?

! A.! Contractual commitments to make a loan up to a stated amount at a given interest rate in the future. ...