A bank with short-term floating-rate assets funded by long-term fixed-rate liabilities could hedge this risk by I. buying Treasury bond futures. II. buying call options on Treasury bonds. III. entering into a swap agreement to pay a fixed rate and receive a variable rate. IV. entering into a swap agreement to pay a variable rate and receive a fixed rate.
Added by Ronald L.
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The bank has short-term floating-rate assets and long-term fixed-rate liabilities, which exposes it to interest rate risk. If interest rates rise, the cost of funding (fixed-rate liabilities) remains the same while the income from floating-rate assets increases, Show more…
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Which of the following could be appropriately used to reduce the gap for a bank that specializes in mortgage lending? I. Issue more ARMs II. Securitize and sell mortgages III. Buy futures on long-term treasury bonds IV. Enter into a swap to pay fixed and receive a variable rate of interest A. I and II B. I, II, and III C. I, II, and IV D. II, III, and IV E. I, II, III, and IV
Akash M.
INTEGRATED MINI CASE: HEDGING INTEREST RATE RISK WITH FUTURES, OPTIONS, AND SWAPS On January 4, 2015, an FI has the following balance sheet (rate: 8 percent): Assets: $450m Liabilities/Equity: Liabilities: $396m Equity: $54m Asset duration: 8 years Liabilities duration: 4 years DGAP = [8 - (396/450)4] = 4.48 years > 0 The FI manager thinks rates will increase by 0.55 percent in the next three months. If this happens, the equity value will change by: E = -[8 - (396/450m)(4)]450m (0.0055/1.08) = -$10,266,667 The FI manager will hedge this interest rate risk with either futures contracts, option contracts, or swap contracts. If the FI uses futures, it will select June T-bonds to hedge. The duration on the T-bonds underlying the contract is 14.5 years, and the T-bond futures are selling at a price of $110,531.25 per $100, or $110,531.25. T-bond futures rates, currently 5 percent, are expected to increase by 0.75 percent over the next three months. If the FI uses options, it will buy puts on 15-year T-bond futures with a June maturity, an exercise price of 109, and an option premium of 36/64 percent. The spot price on the T-bond underlying the option is $115.78125 per $100 of face value. The duration on the T-bonds underlying the options is 14.5 years, and the delta of the put options is 0.85. Managers expect these T-bond rates to increase by 0.7 percent from 5.25 percent in the next three months. If the FI uses swaps, a swap agent offers a swap involving D Fixed 8 years (based on the 15-year Treasury bond rate) and D Floating 1 year (based on Treasury bills). If by April 4, 2015, balance sheet rates increase by 0.5 percent, futures rates by 0.7 percent, and T-bond rates underlying the option contracts by 0.66 percent, calculate the on- and off-balance sheet cash flows to the FI when using futures contracts, option contracts, and swap contracts as its hedge instrument. If by April 4, 2015, balance sheet rates actually fall by 0.25 percent, futures rates fall by 0.35 percent, and T-bond rates underlying the option contract fall by 0.34 percent, calculate the on- and off-balance-sheet cash flows to the FI when using futures contracts, option contracts, and swap contracts as its hedge instrument.
Which of the following statements about options are TRUE? I. You write one MBI July 120 call contract (equivalent to 100 shares) for a premium of $4, and when MBI stock sells for $121 per share, you will realize a $300 profit on the investment. II. A call option on crude oil has a strike price of $85 per barrel, and a premium of $5 per barrel. If the current market price of oil is $83 per barrel, the net loss associated with this option is $5. III. You purchase a call option on a stock. The profit at contract maturity of the option position is max (-C0, ST - X - C0), where X equals the option's strike price, ST is the stock price at contract expiration, and C0 is the original purchase price of the option. IV. The writer of a call option has the right to sell shares at a set price.
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