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Chapter 25
Derivatives and Hedging Risk
25-1
Chapter 25 - Derivatives and Hedging Risk
5. The main difference between a forward contract and a cash transaction is:
A. only the cash transaction creates an obligation to perform.
B. a forward is performed at a later date while the cash transaction is performed immediately.
C. only one involves a deliverable instrument.
D. neither allows for hedging.
E. None of the above.
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Chapter 25 - Derivatives and Hedging Risk
12. A futures contract on gold states that buyers and sellers agree to make or take delivery of
an ounce of gold for $400 per ounce. The contract expires in 3 months. The current price of
gold is $400 per ounce. If the price of gold rises and continues to rise every day over the 3
month period, then when the contract is settled, the buyer will _____ and the seller will
_____.
A. lose; gain
B. gain; lose
C. gain; break even
D. gain; gain
E. lose; lose
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Chapter 25 - Derivatives and Hedging Risk
14. A farmer with wheat in the fields and who uses the futures market to protect a profit is an
example of:
A. a long hedge.
B. a short hedge.
C. selling futures to guard against a potential loss.
D. Both A and C.
E. Both B and C.
15. A miller who needs wheat to mill to flour uses the futures market to protect a profit by:
A. a long hedge to take delivery.
B. a short hedge to deliver.
C. buying futures to guard against a potential loss.
D. Both A and C.
E. Both B and C.
16. A chocolate company which uses the futures market to lock in the price of cocoa to
protect a profit is an example of:
A. a long hedge.
B. a short hedge.
C. purchasing futures to guard against a potential loss.
D. Both A and C.
E. Both B and C.
17. If the producer of a product has entered into a fixed price sale agreement for that output,
the producer faces:
A. a nice steady profit because the output price is fixed.
B. an uncertain profit if the input prices are volatile. This risk can be reduced by a short
hedge.
C. an uncertain profit if the input prices are volatile. This risk can be reduced by a long hedge.
D. a modest profit if the input prices are stable. This risk can be reduced by a long hedge.
E. a modest profit if the input prices are stable. This risk can be reduced by a short hedge.
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Chapter 25 - Derivatives and Hedging Risk
18. You hold a forward contract to take delivery of U.S. Treasury bonds in 9 months. If the
entire term structure of interest rates shifts down over the 9-month period, the value of the
forward contract will have _____ on the date of delivery.
A. risen
B. fallen
C. not changed
D. either risen or fallen, depending on the maturity of the T-bond
E. collapsed
19. Two key features of futures contracts that make them more in demand than forward
contracts are:
A. futures are traded on exchanges and must be marked to the market.
B. futures contracts allow flexibility in delivery dates and provide a liquid market for netting
positions.
C. futures are marked to the market and allow delivery flexibility.
D. futures are traded in liquid markets and are marked to the market.
E. All of the above.
20. If rates in the market fall between now and one month from now, the mortgage banker:
A. loses as the mortgages are sold at a discount.
B. gains as the mortgages are sold at a discount.
C. loses as the mortgages are sold at a premium.
D. gains as the mortgages are sold at a premium.
E. neither gains nor loses.
21. To protect against interest rate risk, the mortgage banker should:
A. buy futures, as this position will hedge losses if rates rise.
B. sell futures, as this position will hedge losses if rates rise.
C. sell futures, as this position will add to his gains if rates rise.
D. buy futures, as this position will add to his gains if rates rise.
E. None of the above.
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Chapter 25 - Derivatives and Hedging Risk
22. Futures market transactions are used to reduce risk. Risk may not be totally offset if:
A. the two instruments have different maturities.
B. payoff schedules of the two instruments are different.
C. the volatility of the two instruments are different.
D. the price movements are not perfectly correlated.
E. All of the above.
23. Hedging in the futures markets can reduce all risk if:
A. price movements in both the cash and futures markets are perfectly correlated.
B. price movements in both the cash and futures markets have zero correlation.
C. price movements in both the cash and futures markets are less than perfectly correlated.
D. the hedge is a short hedge, but not a long hedge.
E. the hedge is a long hedge, but not a short hedge.
24. Comparing long-term bonds with short-term bonds, long-term bonds are _____ volatile
and therefore experience _____ price change than short-term bonds for the same interest rate
shift.
A. less; less
B. less; more
C. more; more
D. more; less
E. more; the same
25. When interest rates shift, the price of zero coupon bonds:
A. are more volatile as compared with short-term bonds of the same maturity.
B. are less volatile as compared with short-term bonds of the same maturity.
C. are more volatile as compared with long-term bonds of the same maturity.
D. are less volatile as compared with long-term bonds of the same maturity.
E. Both A and C.
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Chapter 25 - Derivatives and Hedging Risk
27. In percentage terms, higher coupon bonds experience a _______ price change compared
with lower coupon bonds of the same maturity given a change in yield to maturity.
A. greater
B. smaller
C. similar
D. smaller or greater
E. None of the above.
28. A bond manager who wishes to hold the bond with the greatest potential volatility would
be wise to hold:
A. short-term, high-coupon bonds.
B. long-term, low-coupon bonds.
C. long-term, zero-coupon bonds.
D. short-term, zero-coupon bonds.
E. short-term, low-coupon bonds.
29. The duration of a 15 year zero coupon bond priced at $182.70 is:
A. 2.74 years.
B. 15 years.
C. 17.74 years.
D. cannot determine without the interest rate.
E. None of the above.
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Chapter 25 - Derivatives and Hedging Risk
30. A set of bonds all have the same maturity. Which one has the least percentage price
change for given shifts in interest rates:
A. zero coupon bonds.
B. high coupon bonds.
C. low coupon bonds.
D. pure discount bonds.
E. not enough information to determine.
31. A financial institution can hedge its interest rate risk by:
A. matching the duration of its assets to the duration of its liabilities.
B. setting the duration of its assets equal to half that of the duration of its liabilities.
C. matching the duration of its assets, weighted by the market value of its assets with the
duration of its liabilities, weighted by the market value of its liabilities.
D. setting the duration of its assets, weighted by the market value of its assets to one half that
of the duration of the liabilities, weighted by the market value of the liabilities.
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Chapter 25 - Derivatives and Hedging Risk
34. A financial institution has equity equal to one-tenth of its assets. If its asset duration is
currently equal to its liability duration, then to immunize, the firm needs to:
A. decrease the duration of its assets.
B. increase the duration of its assets.
C. decrease the duration of its liabilities.
D. do nothing, i.e., keep the duration of its liabilities equal to the duration of its assets.
35. If a financial institution has equated the dollar effects of interest rate risk on its assets with
the dollar effects on its liabilities, it has engaged in:
A. a long hedge.
B. a short hedge.
C. a protected swap.
D. immunizing interest rate risk.
E. None of the above.
36. A savings and loan has extremely long-term assets that are currently matched against
extremely short-term liabilities. For this S&L:
A. falling interest rates will decrease the value of its equity.
B. falling interest rates will increase the value of its equity.
C. rising interest rates will increase the value of its equity.
D. rising interest rates will decrease the value of its equity.
E. Both B and D.
37. Interest rate and currency swaps allow one party to exchange a:
A. floating interest rate or currency value for a fixed value over the contract term.
B. fixed interest rate or currency value for a lower fixed value over the contract term.
C. floating interest rate or currency value for a lower floating value over the contract term.
D. fixed interest rate position for a currency position over the contract term.
E. None of the above.
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Chapter 25 - Derivatives and Hedging Risk
38. Exotic derivatives are complicated blends of other derivatives. Some exotics are:
A. inverse floaters.
B. cap and floors.
C. futures.
D. Both A and B.
E. Both B and C.
39. An inverse floater and a super-inverse floater are more valuable to a purchaser if:
A. interest rates stay the same.
B. interest rates fall.
C. interest rates rise.
D. held for a long time.
E. None of the above.
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Chapter 25 - Derivatives and Hedging Risk
45. You have taken a short position in a futures contract on corn at $2.60 per bushel. Over the
next 5 days the contract settled at 2.52, 2.57, 2.62, 2.68, 2.70. You then decide to reverse your
position in the futures market on the fifth day at close. What is the net amount you receive at
the end of 5 days?
A. $0.00
B. $2.60
C. $2.70
D. $2.80
E. Must know the number of contracts
46. You have taken a short position in a futures contract on corn at $2.60 per bushel. Over the
next 5 days the contract settled at 2.52, 2.57, 2.62, 2.68, 2.70. Before you can reverse your
position in the futures market on the fifth day you are notified to complete delivery. What will
you receive on delivery and what is the net amount you receive in total?
A. $2.60; $-0.10
B. $2.60; $0.10
C. $2.60; $2.70
D. $2.70; $-0.10
E. $2.70; $2.60
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Chapter 25 - Derivatives and Hedging Risk
47. You bought a futures contract for $2.60 per bushel and the contract ended at $2.70 after
several days of trading with the following close prices each day: $2.52, $2.57, $2.62, $2.68,
and $2.70. What would the mark to market sequence be?
A. -.08, .05, .05, .06, .02
B. .08, -.05, -.05, -.06, -.02
C. .08, .03, -.02, -.06, -.10
D. -.08, -.03, .02, .06, .10
E. .10, .06, .02, -.03, -.08
48. Suppose you agree to purchase one ounce of gold for $382 any time over the next month.
The current price of gold is $380. The spot price of gold then falls to $377 the next day. If the
agreement is represented by a futures contract marking to market on a daily basis as the price
changes, what is your cash flow at the end of the next business day?
A. $0
B. $3
C. $5
D. $-3
E. $-5
49. On March 1, you contract to take delivery of 1 ounce of gold for $415. The agreement is
good for any day up to April 1. Throughout March, the price of gold hit a low of $385 and hit
a high of $435. The price settled on March 31 at $420, and on April 1st you settle your futures
agreement at that price. Your net cash flow is:
A. $-30.
B. $-20.
C. $-15.
D. $5.
E. $20.
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Chapter 25 - Derivatives and Hedging Risk
50. A bank has a $50 million mortgage bond risk position which it hedges in the Treasury
bond futures markets at the Chicago Board of Trade. Approximately how many contracts are
needed to be held in the hedge?
A. 5
B. 50
C. 500
D. 5,000
E. 50,000
51. A mortgage banker had made loan commitments for $10 million in 3 months. How many
contracts on Treasury bonds futures must the banker write or buy?
A. Go short 10.
B. Go short 100.
C. Go long 10.
D. Go long 100.
E. None of the above.
52. The duration of a 2 year annual 10% bond that is selling for par is:
A. 1.00 years.
B. 1.91 years.
C. 2.00 years.
D. 2.09 years.
E. None of the above.
53. Firm A is paying $750,000 in interest payments a year while Firm B is paying LIBOR plus
75 basis points on $10,000,000 loans. The current LIBOR rate is 6.5%. Firm A and B have
agreed to swap interest payments. What is the net payment this year?
A. Firm A pays $750,000 to Firm B
B. Firm B pays $725,000 to Firm A
C. Firm B pays $25,000 to Firm A
D. Firm A pays $25,000 to Firm B
E. None of the above.
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Chapter 25 - Derivatives and Hedging Risk
54. A Treasury note with a maturity of 2 years pays interest semi-annually on a 9 percent
annual coupon rate. The $1,000 face value is returned at maturity. If the effective annual yield
for all maturities is 7 percent annually, what is the current price of the Treasury note?
A. $960.68
B. $986.69
C. $1,010.35
D. $1,034.40
E. $1,038.99
55. Calculate the duration of a 7-year $1,000 zero-coupon bond with a current price of
$399.63 and a yield to maturity of 14%.
A. 5 years
B. 6 years
C. 7 years
D. 8 years
E. 9 years
56. Calculate the duration of a 4-year $1,000 face value bond, which pays 8% coupons
annually throughout maturity and has a yield to maturity of 9%.
A. 3.29 years
B. 3.57 years
C. 3.69 years
D. 3.89 years
E. 4.00 years
57. On March 1, you contract to take delivery of 1 ounce of gold for $495. The agreement is
good for any day up to April 1. Throughout March, the price of gold hit a low of $425 and hit
a high of $535. The price settled on March 31 at $505, and on April 1st you settle your futures
agreement at that price. Your net cash flow is:
A. $-30.
B. $-20.
C. $-15.
D. $10.
E. $20.
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Chapter 25 - Derivatives and Hedging Risk
58. A bank has a $80 million mortgage bond risk position which it hedges in the Treasury
bond futures markets at the Chicago Board of Trade. Approximately how many contracts are
needed to be held in the hedge?
A. 5
B. 80
C. 800
D. 8,000
E. 80,000
Essay Questions
59. Calculate the duration of Tiger State Bank's assets and liabilities.
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Chapter 25 - Derivatives and Hedging Risk
60. What new asset duration will immunize the balance sheet?
61. Duration is defined as the weighted average time to maturity of a financial instrument.
Explain how this knowledge can help protect against interest rate risk.
62. The futures markets are labeled as pure speculation and even gambling. Why is this an
inaccurate portrayal of the market's function?
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Chapter 25 - Derivatives and Hedging Risk
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Chapter 25 - Derivatives and Hedging Risk
5. The main difference between a forward contract and a cash transaction is:
A. only the cash transaction creates an obligation to perform.
B. a forward is performed at a later date while the cash transaction is performed immediately.
C. only one involves a deliverable instrument.
D. neither allows for hedging.
E. None of the above.
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Chapter 25 - Derivatives and Hedging Risk
25-19
Chapter 25 - Derivatives and Hedging Risk
25-20
Chapter 25 - Derivatives and Hedging Risk
12. A futures contract on gold states that buyers and sellers agree to make or take delivery of
an ounce of gold for $400 per ounce. The contract expires in 3 months. The current price of
gold is $400 per ounce. If the price of gold rises and continues to rise every day over the 3
month period, then when the contract is settled, the buyer will _____ and the seller will
_____.
A. lose; gain
B. gain; lose
C. gain; break even
D. gain; gain
E. lose; lose
14. A farmer with wheat in the fields and who uses the futures market to protect a profit is an
example of:
A. a long hedge.
B. a short hedge.
C. selling futures to guard against a potential loss.
D. Both A and C.
E. Both B and C.
25-21
Chapter 25 - Derivatives and Hedging Risk
15. A miller who needs wheat to mill to flour uses the futures market to protect a profit by:
A. a long hedge to take delivery.
B. a short hedge to deliver.
C. buying futures to guard against a potential loss.
D. Both A and C.
E. Both B and C.
16. A chocolate company which uses the futures market to lock in the price of cocoa to
protect a profit is an example of:
A. a long hedge.
B. a short hedge.
C. purchasing futures to guard against a potential loss.
D. Both A and C.
E. Both B and C.
17. If the producer of a product has entered into a fixed price sale agreement for that output,
the producer faces:
A. a nice steady profit because the output price is fixed.
B. an uncertain profit if the input prices are volatile. This risk can be reduced by a short
hedge.
C. an uncertain profit if the input prices are volatile. This risk can be reduced by a long hedge.
D. a modest profit if the input prices are stable. This risk can be reduced by a long hedge.
E. a modest profit if the input prices are stable. This risk can be reduced by a short hedge.
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Chapter 25 - Derivatives and Hedging Risk
18. You hold a forward contract to take delivery of U.S. Treasury bonds in 9 months. If the
entire term structure of interest rates shifts down over the 9-month period, the value of the
forward contract will have _____ on the date of delivery.
A. risen
B. fallen
C. not changed
D. either risen or fallen, depending on the maturity of the T-bond
E. collapsed
19. Two key features of futures contracts that make them more in demand than forward
contracts are:
A. futures are traded on exchanges and must be marked to the market.
B. futures contracts allow flexibility in delivery dates and provide a liquid market for netting
positions.
C. futures are marked to the market and allow delivery flexibility.
D. futures are traded in liquid markets and are marked to the market.
E. All of the above.
20. If rates in the market fall between now and one month from now, the mortgage banker:
A. loses as the mortgages are sold at a discount.
B. gains as the mortgages are sold at a discount.
C. loses as the mortgages are sold at a premium.
D. gains as the mortgages are sold at a premium.
E. neither gains nor loses.
25-23
Chapter 25 - Derivatives and Hedging Risk
21. To protect against interest rate risk, the mortgage banker should:
A. buy futures, as this position will hedge losses if rates rise.
B. sell futures, as this position will hedge losses if rates rise.
C. sell futures, as this position will add to his gains if rates rise.
D. buy futures, as this position will add to his gains if rates rise.
E. None of the above.
22. Futures market transactions are used to reduce risk. Risk may not be totally offset if:
A. the two instruments have different maturities.
B. payoff schedules of the two instruments are different.
C. the volatility of the two instruments are different.
D. the price movements are not perfectly correlated.
E. All of the above.
23. Hedging in the futures markets can reduce all risk if:
A. price movements in both the cash and futures markets are perfectly correlated.
B. price movements in both the cash and futures markets have zero correlation.
C. price movements in both the cash and futures markets are less than perfectly correlated.
D. the hedge is a short hedge, but not a long hedge.
E. the hedge is a long hedge, but not a short hedge.
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Chapter 25 - Derivatives and Hedging Risk
24. Comparing long-term bonds with short-term bonds, long-term bonds are _____ volatile
and therefore experience _____ price change than short-term bonds for the same interest rate
shift.
A. less; less
B. less; more
C. more; more
D. more; less
E. more; the same
25. When interest rates shift, the price of zero coupon bonds:
A. are more volatile as compared with short-term bonds of the same maturity.
B. are less volatile as compared with short-term bonds of the same maturity.
C. are more volatile as compared with long-term bonds of the same maturity.
D. are less volatile as compared with long-term bonds of the same maturity.
E. Both A and C.
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Chapter 25 - Derivatives and Hedging Risk
27. In percentage terms, higher coupon bonds experience a _______ price change compared
with lower coupon bonds of the same maturity given a change in yield to maturity.
A. greater
B. smaller
C. similar
D. smaller or greater
E. None of the above.
28. A bond manager who wishes to hold the bond with the greatest potential volatility would
be wise to hold:
A. short-term, high-coupon bonds.
B. long-term, low-coupon bonds.
C. long-term, zero-coupon bonds.
D. short-term, zero-coupon bonds.
E. short-term, low-coupon bonds.
29. The duration of a 15 year zero coupon bond priced at $182.70 is:
A. 2.74 years.
B. 15 years.
C. 17.74 years.
D. cannot determine without the interest rate.
E. None of the above.
25-26
Chapter 25 - Derivatives and Hedging Risk
30. A set of bonds all have the same maturity. Which one has the least percentage price
change for given shifts in interest rates:
A. zero coupon bonds.
B. high coupon bonds.
C. low coupon bonds.
D. pure discount bonds.
E. not enough information to determine.
31. A financial institution can hedge its interest rate risk by:
A. matching the duration of its assets to the duration of its liabilities.
B. setting the duration of its assets equal to half that of the duration of its liabilities.
C. matching the duration of its assets, weighted by the market value of its assets with the
duration of its liabilities, weighted by the market value of its liabilities.
D. setting the duration of its assets, weighted by the market value of its assets to one half that
of the duration of the liabilities, weighted by the market value of the liabilities.
25-27
Chapter 25 - Derivatives and Hedging Risk
34. A financial institution has equity equal to one-tenth of its assets. If its asset duration is
currently equal to its liability duration, then to immunize, the firm needs to:
A. decrease the duration of its assets.
B. increase the duration of its assets.
C. decrease the duration of its liabilities.
D. do nothing, i.e., keep the duration of its liabilities equal to the duration of its assets.
35. If a financial institution has equated the dollar effects of interest rate risk on its assets with
the dollar effects on its liabilities, it has engaged in:
A. a long hedge.
B. a short hedge.
C. a protected swap.
D. immunizing interest rate risk.
E. None of the above.
25-28
Chapter 25 - Derivatives and Hedging Risk
36. A savings and loan has extremely long-term assets that are currently matched against
extremely short-term liabilities. For this S&L:
A. falling interest rates will decrease the value of its equity.
B. falling interest rates will increase the value of its equity.
C. rising interest rates will increase the value of its equity.
D. rising interest rates will decrease the value of its equity.
E. Both B and D.
37. Interest rate and currency swaps allow one party to exchange a:
A. floating interest rate or currency value for a fixed value over the contract term.
B. fixed interest rate or currency value for a lower fixed value over the contract term.
C. floating interest rate or currency value for a lower floating value over the contract term.
D. fixed interest rate position for a currency position over the contract term.
E. None of the above.
38. Exotic derivatives are complicated blends of other derivatives. Some exotics are:
A. inverse floaters.
B. cap and floors.
C. futures.
D. Both A and B.
E. Both B and C.
25-29
Chapter 25 - Derivatives and Hedging Risk
39. An inverse floater and a super-inverse floater are more valuable to a purchaser if:
A. interest rates stay the same.
B. interest rates fall.
C. interest rates rise.
D. held for a long time.
E. None of the above.
25-30
Chapter 25 - Derivatives and Hedging Risk
25-31
Chapter 25 - Derivatives and Hedging Risk
45. You have taken a short position in a futures contract on corn at $2.60 per bushel. Over the
next 5 days the contract settled at 2.52, 2.57, 2.62, 2.68, 2.70. You then decide to reverse your
position in the futures market on the fifth day at close. What is the net amount you receive at
the end of 5 days?
A. $0.00
B. $2.60
C. $2.70
D. $2.80
E. Must know the number of contracts
Contract nets to you the original price. The net position is based on daily marking to the
market. The net change is $- .10, Close - Change = $2.70 -$10 = $2.60
46. You have taken a short position in a futures contract on corn at $2.60 per bushel. Over the
next 5 days the contract settled at 2.52, 2.57, 2.62, 2.68, 2.70. Before you can reverse your
position in the futures market on the fifth day you are notified to complete delivery. What will
you receive on delivery and what is the net amount you receive in total?
A. $2.60; $-0.10
B. $2.60; $0.10
C. $2.60; $2.70
D. $2.70; $-0.10
E. $2.70; $2.60
Delivery is made at the settle price of $2.70. The net position is based on daily marking to the
market. The difference of -.10 = (.08 + -.05 + -.05 + -.06 + - .02), which is a loss versus the
last settle price.
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Chapter 25 - Derivatives and Hedging Risk
47. You bought a futures contract for $2.60 per bushel and the contract ended at $2.70 after
several days of trading with the following close prices each day: $2.52, $2.57, $2.62, $2.68,
and $2.70. What would the mark to market sequence be?
A. -.08, .05, .05, .06, .02
B. .08, -.05, -.05, -.06, -.02
C. .08, .03, -.02, -.06, -.10
D. -.08, -.03, .02, .06, .10
E. .10, .06, .02, -.03, -.08
48. Suppose you agree to purchase one ounce of gold for $382 any time over the next month.
The current price of gold is $380. The spot price of gold then falls to $377 the next day. If the
agreement is represented by a futures contract marking to market on a daily basis as the price
changes, what is your cash flow at the end of the next business day?
A. $0
B. $3
C. $5
D. $-3
E. $-5
25-33
Chapter 25 - Derivatives and Hedging Risk
49. On March 1, you contract to take delivery of 1 ounce of gold for $415. The agreement is
good for any day up to April 1. Throughout March, the price of gold hit a low of $385 and hit
a high of $435. The price settled on March 31 at $420, and on April 1st you settle your futures
agreement at that price. Your net cash flow is:
A. $-30.
B. $-20.
C. $-15.
D. $5.
E. $20.
50. A bank has a $50 million mortgage bond risk position which it hedges in the Treasury
bond futures markets at the Chicago Board of Trade. Approximately how many contracts are
needed to be held in the hedge?
A. 5
B. 50
C. 500
D. 5,000
E. 50,000
25-34
Chapter 25 - Derivatives and Hedging Risk
51. A mortgage banker had made loan commitments for $10 million in 3 months. How many
contracts on Treasury bonds futures must the banker write or buy?
A. Go short 10.
B. Go short 100.
C. Go long 10.
D. Go long 100.
E. None of the above.
52. The duration of a 2 year annual 10% bond that is selling for par is:
A. 1.00 years.
B. 1.91 years.
C. 2.00 years.
D. 2.09 years.
E. None of the above.
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Chapter 25 - Derivatives and Hedging Risk
53. Firm A is paying $750,000 in interest payments a year while Firm B is paying LIBOR plus
75 basis points on $10,000,000 loans. The current LIBOR rate is 6.5%. Firm A and B have
agreed to swap interest payments. What is the net payment this year?
A. Firm A pays $750,000 to Firm B
B. Firm B pays $725,000 to Firm A
C. Firm B pays $25,000 to Firm A
D. Firm A pays $25,000 to Firm B
E. None of the above.
Firm A pays a fixed payment of $750,000 to B in exchange for the floating payment of (.065
+ .0075) 10,000,000 = 725,000. The net position is that Firm A pays $25,000 to Firm B.
54. A Treasury note with a maturity of 2 years pays interest semi-annually on a 9 percent
annual coupon rate. The $1,000 face value is returned at maturity. If the effective annual yield
for all maturities is 7 percent annually, what is the current price of the Treasury note?
A. $960.68
B. $986.69
C. $1,010.35
D. $1,034.40
E. $1,038.99
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Chapter 25 - Derivatives and Hedging Risk
55. Calculate the duration of a 7-year $1,000 zero-coupon bond with a current price of
$399.63 and a yield to maturity of 14%.
A. 5 years
B. 6 years
C. 7 years
D. 8 years
E. 9 years
56. Calculate the duration of a 4-year $1,000 face value bond, which pays 8% coupons
annually throughout maturity and has a yield to maturity of 9%.
A. 3.29 years
B. 3.57 years
C. 3.69 years
D. 3.89 years
E. 4.00 years
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Chapter 25 - Derivatives and Hedging Risk
57. On March 1, you contract to take delivery of 1 ounce of gold for $495. The agreement is
good for any day up to April 1. Throughout March, the price of gold hit a low of $425 and hit
a high of $535. The price settled on March 31 at $505, and on April 1st you settle your futures
agreement at that price. Your net cash flow is:
A. $-30.
B. $-20.
C. $-15.
D. $10.
E. $20.
58. A bank has a $80 million mortgage bond risk position which it hedges in the Treasury
bond futures markets at the Chicago Board of Trade. Approximately how many contracts are
needed to be held in the hedge?
A. 5
B. 80
C. 800
D. 8,000
E. 80,000
Essay Questions
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Chapter 25 - Derivatives and Hedging Risk
59. Calculate the duration of Tiger State Bank's assets and liabilities.
Topic: DURATION
Type: ESSAYS
60. What new asset duration will immunize the balance sheet?
Topic: DURATION
Type: ESSAYS
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Chapter 25 - Derivatives and Hedging Risk
61. Duration is defined as the weighted average time to maturity of a financial instrument.
Explain how this knowledge can help protect against interest rate risk.
Duration measures effective time to recoup your investment. Bond prices rise and fall with
interest rate changes. There are two elements of risk. The first being reinvestment risk--may
earn less $ when reinvesting, and the second being price. The value of the bond moves
inversely with interest rates. By setting duration equal to holding horizon, reinvestment and
price risk offset each other. By setting duration of assets equal to duration of liabilities, both
move up and down together.
Topic: DURATION
Type: ESSAYS
62. The futures markets are labeled as pure speculation and even gambling. Why is this an
inaccurate portrayal of the market's function?
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