Finance-CHAPTER 11: FORWARD AND FUTURES HEDGING, SPREAD

| January 30, 2017

Question
CHAPTER 11: FORWARD AND FUTURES HEDGING, SPREAD, AND TARGET STRATEGIES
MULTIPLE CHOICE TEST QUESTIONS

1. A short hedge is one in which

a. the margin requirement is waived

b. the hedger is short futures

c. the hedger is short in the spot market

d. the futures price is lower than the spot price

e. none of the above

2. An anticipatory hedge is one in which

a. the basis is expected to fall

b. the hedger expects to make a profit on the futures

c. the spot position will be taken in the future

d. all of the above

e. none of the above

3. A strengthening of the basis means

a. the spot price rises more than the futures price

b. the futures price falls more than the spot price

c. a short hedger benefits

d. all of the above

e. none of the above

4. A hedge in which the asset underlying the futures is not the asset being hedged is

a. a cross hedge

b. an optimal hedge

c. a basis hedge

d. a minimum variance hedge

e. none of the above

5. When the futures expires before the hedge is terminated and the hedger moves into the next futures expiration, it is called

a. spreading the hedge

b. rolling the hedge forward

c. optimally weighting the hedge

d. all of the above

e. none of the above

6. The duration of the futures contract used in the price sensitivity hedge ratio is

a. the duration of the spot bond being hedged using the futures price instead of the spot price

b. the duration of the deliverable bond using the spot price

c. the duration of the deliverable bond using the futures price

d. the duration of the overall bond portfolio

e. none of the above

7. Which technique can be used to compute the minimum variance hedge ratio?

a. duration analysis

b. present value

c. regression

d. all of the above

e. none of the above

8. Which of the following measures is used in the price sensitivity hedge ratio for bond futures?

a. beta

b. duration

c. correlation

d. variance

e. none of the above

9. Suppose you buy an asset at $50 and sell a futures contract at $53. What is your profit at expiration if the asset price goes to $49? (Ignore carrying costs)

a. -$1

b. -$4

c. $3

d. $4

e. none of the above

10. Suppose you buy an asset at $70 and sell a futures contract at $72. What is your profit if, prior to expiration, you sell the asset at $75 and the futures price is $78?

a. -$1

b. $2

c. $1

d. -$6

e. none of the above

11. Which of the following is not a reason for firms to hedge?

a. Firms can hedge less expensively than can their shareholders

b. Shareholders cannot tolerate mark-to-market losses

c. Hedging by corporations can have tax advantages

d. Shareholders are not always aware of their firms’ risks

e. none of the above

12. Find the profit if the investor buys a July futures at 75, sells an October futures at 78 and then reverses the July futures at 72 and the October futures at 77.

a. -3

b. -2

c. 2

d. 1

e. none of the above

13. Determine the optimal hedge ratio for Treasury bonds worth $1,000,000 with a modified duration of 12.45 if the futures contract has a price of $90,000 and a modified duration of 8.5 years.

a. 16.27

b. 15.93

c. 7.42

d. 11.11

e. none of the above

14. What is the profit on a hedge if bonds are purchased at $150,000, two futures contracts are sold at $72,500 each, then the bonds are sold at $147,500 and the futures are repurchased at $74,000 each?

a. -$2,500

b. -$5,500

c. -$500

d. -$3,000

e. none of the above

15. Find the optimal stock index futures hedge ratio if the portfolio is worth $1,200,000, the beta is 1.15 and the S&P 500 futures price is 450.70 with a multiplier of 250.

a. 10.65

b. 12.25

c. 6123.80

d. 5325.05

e. none of the above

16. In which of the following situations would you use a short hedge?

a. the planned purchase of a stock

b. the planned purchase of commercial paper

c. the planned issuance of bonds

d. the planned repurchase of stock to cover a short position

e. none of the above

17. You hold a stock portfolio worth $15 million with a beta of 1.05. You would like to lower the beta to 0.90 using S&P 500 futures, which have a price of 460.20 and a multiplier of 250. What transaction should you do? Round off to the nearest whole contract.

a. sell 130 contracts

b. sell 9,778 contracts

c. sell 20 contracts

d. buy 50,000 contracts

e. sell 50,000 contracts

18. You hold a bond portfolio worth $10 million and a modified duration of 8.5. What futures transaction would you do to raise the duration to 10 if the futures price is $93,000 and its implied modified duration is 9.25? Round up to the nearest whole contract.

a. buy 109 contracts

b. buy 17 contracts

c. buy 669 contracts

d. sell 100 contracts

e. sell 669 contracts

19. Which of the following statements about the use of futures in tactical asset allocation is correct?

a. Implementing tactical asset allocation using futures is a form of market timing.

b. Futures can be used to synthetically buy or sell stocks but you cannot simultaneously adjust the beta or duration

c. A difference between the portfolio held and the index on which the futures is based will generate a gain for the investor.

d. The use of futures in tactical asset allocation will generate cash from the synthetic sale, which is then used in the synthetic purchase.

e. None of the above

20. Though a cross hedge has somewhat higher risk than an ordinary hedge, it will reduce risk if which of the following occurs?

a. futures prices are more volatile than spot prices

b. the spot and futures contracts are correctly priced at the onset

c. spot and futures prices are positively correlated

d. futures prices are less volatile than spot prices

e. none of the above

21. Which of the following correctly expresses the profit on a hedge?

a. the basis when the hedge is closed

b. the change in the basis

c. the spot profit minus the futures profit

d. the futures profit minus the spot profit

e. none of the above

22. What happens to the basis through the contract’s life?

a. it initially decreases, then increases

b. it initially increases, then decreases

c. it remains relatively steady

d. it moves toward zero

e. none of the above

23. Find the profit if the investor enters an intramarket spread transaction by selling a September futures at $4.5, buys an December futures at $7.5 and then reverses the September futures at $5.5 and the December futures at $9.5.

a. -3

b. -2

c. 2

d. 1

e. none of the above

24. Quantity risk is

a. the difficulty in measuring the volatility

b. the uncertainty about the size of the spot position

c. the risk of mismatching the futures maturity to the spot maturity

d. the possibility of regression error

e. none of the above

25. The relationship between the spot yield and the yield implied by the futures price is called

a. the yield beta

b. the price sensitivity

c. the tail

d. the hedge ratio

e. none of the above

26. All of the following are futures contract choice decisions related to hedging, except

a. which future underlying asset

b. which strike price

c. which futures contract expiration

d. whether to go long or short

e. all of the above are futures contract choice decisions

27. Hedging with futures contracts entails all of the following risks, except

a. marking to market may require large cash outflows

b. changes in margin requirements

c. basis risk

d. quantity risk

e. all of the above are potential risks

28. Based on the minimum variance hedge ratio approach, what is the optimal number of futures contracts to deploy, given the following information. The correlation coefficient between changes in the underlying instrument’s price and changes in the futures contract price is 0.95, the standard deviation of the changes in the underlying position’s value is 300%, and the standard deviation of the changes in the futures contract’s price is 11.4%.

a. long 35 futures contracts

b. long 25 futures contracts

c. long 15 futures contracts

d. short 25 futures contracts

e. short 15 futures contracts

29. Based on the minimum variance hedge ratio approach what is the hedging effectiveness, given the following information. The correlation coefficient between changes in the underlying instrument’s price and changes in the futures contract price is 0.70, the standard deviation of the changes in the underlying position’s value is 40%, and the standard deviation of the changes in the futures contract’s price is 50%. (Select the closest answer.)

a. 50%

b. 45%

c. 40%

d. 35%

e. 30%

30. Based on the price sensitivity hedge ratio approach, what is the optimal number of futures contracts to deploy, given the following information. The yield beta is 0.65, the present value of a basis point change for the underlying bond portfolio is $33,000, and the present value of a basis point change for the bond futures contract is $325. (Select the closest answer.)

a. long 100 futures contracts

b. long 55 futures contracts

c. short 66 futures contracts

d. short 22 futures contracts

e. short 11 futures contracts

CHAPTER 12: SWAPS
MULTIPLE CHOICE TEST QUESTIONS

1. The difference between the swap rate and the rate on a Treasury security of the same maturity is called the

a. swap spread

b. risk premium

c. swap basis

d. settlement spread

e. LIBOR

2. Interest rate swap payments are made

a. on the last day of the quarter

b. on the first day of each month

c. at whatever dates are agreed upon by the counterparties

d. on the 15th of the agreed-upon months

e. on the last day of the month

3. To determine the fixed rate on a swap, you would

a. use put-call parity

b. price it as the issuance of a fixed rate bond and purchase of a floating rate bond or vice versa

c. use the same fixed rate as that of a zero coupon bond of equivalent maturity

d. use the continuously compounded rate for the shortest maturity bond

e. none of the above

4. Which of the following is not a type of swap?

a. settlement swaps

b. commodity swaps

c. interest rate swaps

d. equity swaps

e. currency swaps

5. The underlying amount of money on which the swap payments are made is called

a. settlement value

b. market value

c. notional amount

d. base value

e. equity value

6. The most basic and common type of swap is called

a. basis swap

b. plain vanilla swap

c. plain paper swap

d. commercial swap

e. bond swap

7. An interest rate swap with both sides paying a floating rate is called a

a. plain vanilla swap

b. two-way swap

c. floating swap

d. spread swap

e. basis swap

8. Consider a swap to pay currency A floating and receive currency B floating. What type of swap would be combined with this swap to produce a swap to produce a plain vanilla swap in currency B.

a. pay currency B floating, receive currency A fixed

b. pay currency B fixed, receive currency A floating

c. pay currency B fixed, receive currency A fixed

d. pay currency B floating, receive currency A floating

e. none of the above

9. For a currency swap with $10 million notional amount, the notional amount in British pounds if the exchange rate is $1.55 is (approximately)

a. ₤11.55 million

b. ₤15.5 million

c. ₤10 million

d. ₤6.45 million

e. none of the above

10. A currency swap without the exchange of notional amount is most likely to be used in what situation?

a. a company issuing a bond

b. a company generating cash flows in a foreign currency

c. a company arranging a loan

d. a dealer trying to hedge a currency option

e. none of the above

11. Which of the following distinguishes equity swaps from currency swaps?

a. equity swap payments are always hedged

b. equity swap payments are made on the first day of the month

c. equity swap payments can be negative

d. equity swap payments have more credit risk

e. none of the above

12. Find the upcoming net payment in a plain vanilla interest rate swap in which the fixed party pays 10 percent and the floating rate for the upcoming payment is 9.5 percent. The notional amount is $20 million and payments are based on the assumption of 180 days in the payment period and 360 days in a year.

a. fixed payer pays $1,950,000

b. fixed payer pays $950,000

c. floating payer pays $1 million

d. floating payer pays $50,000

e. fixed payer pays $50,000

13. Find the upcoming payment interest payments in a currency swap in which party A pays U. S. dollars at a fixed rate of 5 percent on notional amount of $50 million and party B pays Swiss francs at a fixed rate of 4 percent on notional amount of SF35 million. Payments are annual under the assumption of 360 days in a year, and there is no netting.

a. party A pays $2,500,000, and party B pays SF1,400,000

b. party A pays SF1,400,000, and party B pays $2,500,000

c. party A pays SF1,750,000, and party B pays SF1,400,000

d. party A pays $2,500,000, and party B pays $2,000,000

e. party A pays $50 million, and party B pays SF35 million

14. Find the net payment on an equity swap in which party A pays the return on a stock index and party B pays a fixed rate of 6 percent. The notional amount is $10 million. The stock index starts off at 1,000 and is at 1,055.15 at the end of the period. The interest payment is calculated based on 180 days in the period and 360 days in the year.

a. party B pays $851,500

b. parry B pays $48,500

c. party B pays $251,500

d. party A pays $251,500

e. party A pays $851,500

15. Find the approximate upcoming net payment on an equity swap in which party A pays the return on stock index 1 and party B pays the return on stock index 2. The notional amount is $25 million. Stock index 1 starts the period at 1500 and goes up to 1600 at the end of the period. Stock index 2 starts the period at 3500 and goes up to 3300 at the end of the period.

a. The party paying index 1 pays about $238,000

b. The party paying index 2 pays about $238,000

c. The party paying index 2 pays about $3.095 million

d. The party paying index 1 pays about $25 million

e. The party paying index 1 pays about $3.095 million

16. Find the fixed rate on a plain vanilla interest rate swap with payments every 180 days (assume a 360-day year) for one year. The prices of Eurodollar zero coupon bonds are 0.9756 (180 days) and 0.9434 (360 days).

a. 5.9 percent

b. 5 percent

c. 6 percent

d. 5.5 percent

e. 2.95 percent

17. Use the information in problem 16 to find the fixed rate on an equity swap in which the stock index is at 2,000.

a. 5.9 percent

b. 5 percent

c. 6 percent

d. 2.95 percent

e. 3.5 percent

18. Find the market value of a plain vanilla swap from the perspective of the fixed rate payer in which the upcoming payment is in 30 days, and there is one more payment 180 days after that. The fixed rate is 7 percent and the upcoming floating payment is at 6.5 percent. The notional amount is $15 million. Assume 360 days in a year. The prices of Eurodollar zero coupon bonds are 0.9934 (30 days) and 0.9528 (210 days).

a. the fixed payer pays $31,763.75

b. the fixed payer pays $71,527.50

c. the floating payer pays $49,500

d. the floating payer pays $194,228

e. none of the above

19. Which of the following statements about constant maturity swaps is not true?

a. the CMT rate is linked to a U. S. treasury security of equivalent maturity

b. the typical maturity is 2 to 5 years

c. the maturity is constant

d. one rate is based on a security of a longer rate than the settlement period

e. the swap is a type of interest rate swap

20. Which of the following is not a way to terminate a swap:

a. the two counterparties cash settle the market value

b. enter into an opposite swap with another counterparty

c. hold the swap to its maturity date

d. use a forward contract or option on the swap to enter into an offsetting swap

e. borrow the notional amount and pay off the counterparty

21. An equity swap with fixed interest payments has two payments remaining. The first occurs in 30 days and the second occurs in 210 days. The discount factors are 0.9934 (30 days) and 0.9528 (210 days). The upcoming fixed payment is at 4 percent and is based 180 days in a 360-day year. The equity index was at 1150 at the beginning of the period and is now at 1152.75. The notional amount is $60 million. Find the approximate value of the equity swap from the perspective of the party making the equity payment and receiving the fixed payment.

a. $143,478

b. $642,000

c. -$143,478

d. -$642,000

e. -$496,560

22. The present value of the series of dollar payments in a currency swap per $1 notional amount is $0.03. The present value of the series of euro payments in the same currency swap per €1 is €0.0225. The current exchange rate is $1.05 per euro. If the swap has a notional amount of $100 million and €105 million, find the market value of the swap from the perspective of the party paying euros and receiving dollars.

a. $519,375

b. -$2,480,625

c. $3,000,000

d. -$3,000,000

e. -$519,375

23. Equity swaps can be used for all of the following except:

a. to synthetically buy stock

b. to synthetically sell stock

c. to convert dividends into capital gains

d. to synthetically re-align an equity portfolio

e. none of the above

24. Which of the following statements about diff swaps is true?

a. they involve interest payments in separate currencies

b. they are based on the difference between interest rates in two countries

c. they are based on the difference between interest rates of different maturities

d. the notional amount reduces throughout the life of the swap

e. the notional amount increases throughout the life of the swap

25. Interest rate swaps can be used for all of the following purposes except:

a. to borrow at the prime rate

b. to convert a fixed-rate loan into a floating-rate loan

c. to convert a floating-rate loan into a fixed-rate loan

d. to speculate on interest rates

e. to hedge interest rate risk

26. The value of a pay-fixed, receive floating interest rate swap is found as the value of a

a. floating-rate bond times the value of a fixed-rate bond.

b. floating-rate bond plus the value of a fixed-rate bond.

c. floating-rate bond minus the value of another floating-rate bond.

d. fixed-rate bond minus the value of another fixed-rate bond.

e. floating-rate bond minus the value of a fixed-rate bond.

27. A basis swap is priced by adding a spread to the higher rate or subtracting a spread from the lower rate. This spread is found as

a. the difference between the floating rate on a plain vanilla swap based on one of the rates and the fixed rate on a plain vanilla swap based on the other rate.

b. the addition of the fixed rate on a plain vanilla swap based on one of the rates and the fixed rate on a plain vanilla swap based on the other rate.

c. the difference between the fixed rate on a plain vanilla swap based on one of the rates and the fixed rate on a plain vanilla swap based on the other rate.

d. the difference between the floating rate on a plain vanilla swap based on one of the rates and the floating rate on a plain vanilla swap based on the other rate.

e. none of the above correctly explain how this spread is found

28. The value of a pay-fixed, receive-floating interest rate swap is found as the value of a

a. floating-rate bond minus the value of a fixed-rate bond.

b. fixed-rate bond minus the value of a floating-rate bond.

c. floating-rate bond minus the value of another floating-rate bond.

d. fixed-rate bond minus the value of another fixed-rate bond.

e. none of the above correctly identify how this value is found.

29. Swap payments typically involve adjusting for the fraction of the year in some fashion. This adjustment is known as

a. the compounding convention

b. the accrual period

c. the fraction convention

d. the money market convention

e. the payment period

30. The combination of a pay euro fixed and receive dollar fixed swap with a pay dollar floating and receive euro fixed results in

a. a currency swap

b. a currency swap, receive euro fixed and pay euro floating

c. an interest rate swap, pay dollar fixed and receive dollar floating

d. an interest rate swap, receive euro fixed and pay euro floating

e. an interest rate swap, pay dollar floating and receive dollar fixed

CHAPTER 16: MANAGING RISK IN AN ORGANIZATION

MULTIPLE CHOICE TEST QUESTIONS

1. Derivatives activities in end users are primarily conducted by

a. the human resources group

b. the sales staff

c. the chief financial officer

d. the board of directors

e. the treasury group

2. Which of the following best describes a company that practices enterprise risk management?

a. interest rate risk and currency risk would be managed in unison

b. a single department to manage risk

c. it would manage insurance-related risks along with financial risk

d. credit risk would be managed the same way as market risk

e. operational risk would be managed

3. The front office refers to

a. the compliance office

b. the traders who engage in derivatives transactions

c. legal counsel

d. the risk management function

e. senior management

4. FAS 133 defines effective hedging as

a. a hedge with no basis risk

b. a correctly priced hedge

c. a perfect hedge

d. a hedge that reduces 80 to 125 percent of the risk

e. none of the above

5. In which of the following activities is hedge accounting prohibited?

a. hedging an overall portfolio as opposed to an individual transaction

b. using short calls to protect a long asset

c. using long puts to protect an asset

d. hedging a long position with a short futures

e. hedging a swap with a swaption

6. Which of the following organizations recommends best practices for the investment management industry?

a. PRMIA

b. Risk Standards Working Group

c. GARP

d. G-30

e. Financial Accounting Standards Board

7. Which of the following activities does senior management not do?

a. ensure that personnel are qualified

b. ensure that controls are in place

c. execute hedge transactions

d. establish policies

e. define roles and responsibilities

8. The primary distinction between FAS 133 and IAS 39 is

a. IAS 39 does not permit hedge accounting

b. IAS 39 was adopted earlier than FAS 133

c. IAS 39 applies only to publicly traded corporations

d. IAS 39 applies to all financial assets and liabilities, not just derivatives

e. none of the above

9. Metalgesellschaft lost about $1.3 billion doing what?

a. hedging short-term commitments with long-term options

b. using crude oil futures options to hedge crude oil futures

c. trading futures spreads on crude oil

d. hedging fixed rate oil price commitments with swaptions

e. none of the above

10. “Independent risk management” means which of the following?

a. that risk management of a firm is independent of its overall corporate policy decisions

b. that the risk management function is provided by an outside consulting firm

c. that the risk manager cannot be influenced by the traders

d. that the risk manager is independent of the firm’s senior managers

e. none of the above

11. End users are all of the following types of organizations except?

a. investment funds

b. non-financial corporations

c. governments

d. financial institutions

e. none of the above

12. What is the primary activity of a firm’s front office?

a. risk management

b. trading

c. pricing derivative products

d. auditing

e. none of the above

13. Orange County lost $1.6 billion doing what?

a. betting that interest rates would remain stable

b. buying Treasury bond futures

c. selling Eurodollar futures

d. buying short- and intermediate-term bonds on margin

e. trading money market options

14. Risk managers should report to

a. the chief trader

b. legal counsel

c. the executive in charge of the front office

d. the executive in charge of the back office

e. none of the above

15. Prior to FAS 133, where on the financial statements were derivatives reported?

a. as contingent liabilities

b. as goodwill

c. as intangible assets

d nowhere because they were off-balance sheet items

e. in Other Comprehensive Income

16. Which of the following methods is not acceptable for disclosure under the SEC’s rules?

a. the CEO’s letter to the shareholders

b. tabular information

c. sensitivity analysis

d VAR

e. none of the above

17. Ultimate authority for risk management lies with

a. legal counsel

b. the head trader

c. senior management

d. the internal auditors

e. the external auditors

18. Derivatives dealers primarily conduct derivatives transactions for which of the following reasons?

a. to enhance the returns on their other investment transactions

b. to profit off of their ability to execute trades at the right time

c. to profit off of their market making services

d. to provide services to enhance the overall attractiveness of their product line

a. none of the above

19. Which of the following methods is not permitted to satisfy the SEC’s requirements for disclosure of derivatives activity?

a. an explanation in the chairman’s letter

b. a Value-at-Risk figure

c. a sensitivity analysis

d. a table of market values and related terms

e. none of the above

20. Hedge accounting is which of the following?

a. describing all hedges in footnotes to accounting statements

b. deferring all recording of hedge profits and losses until the hedge is over

c. associating the derivative profit or loss with the instrument being hedged

d. all of the above

e. none of the above

21. Which of the following statements is not true about fair value hedges?

a. it requires a method of determining the fair value of the derivative

b. it defers recognition of all profits and losses until the hedge is terminated

c. it will cause earnings to fluctuate if hedges are not effective

d. it requires proper documentation

e. none of the above

22. Which of the following statements is not true about fair value hedges?

a. it requires identification of the effective and ineffective parts

b. derivatives profits and losses are temporarily carried in an equity account

c. it requires proper documentation

d. only dealer firms are eligible to use it

e. none of the above

23. Barings lost $1.2 billion because of what?

a. a failure of risk controls in one of its foreign offices

b. model risk in their VAR models

c. fraudulent transactions

d. regulators shut it down because of poor risk management

e. speculating on German interest rates

24. Which of the following would not be included among typical derivatives end users in the U. S.?

a. pension funds

b. corporations

c. state and local governments

d. the federal government

e. hedge funds

25. Procter and Gamble lost $157 million doing what?

a. speculating on a worldwide recession

b. failure to hedge their borrowing cost on a bond issue

c. speculating on foreign interest and exchange rates

d. speculating on a decrease in the federal budget deficit

e. mismanagement of a hedge fund in their pension fund

26. All of the following make up the financial derivatives risk management industry, except

a. end users

b. dealers

c. consultants

d. specialized software companies

e. GRAP professionals

27. Enterprise risk management includes all of the following except

a. a process in which a firm seeks to controls all of its risks in a centralized, integrated manner

b. seeks to manage traditional financial risks, such as interest rate and foreign currency risks

c. seeks to manage risk of product obsolescence risk

d. seeks also to manage nontraditional financial risks, such as insurable risks

e. all of the above

28. Hedge accounting, based on FAS 133, addresses all of the following except

a. fair value hedges

b. unfair value hedges

c. cash flow hedges

d. foreign investment hedges

e. speculation

29. Responsibilities of senior management include all of the following except

a. establish written policies

b. define roles and responsibilities

c. identify acceptable strategies

d. ensure that control systems are in place

e. all of the above

30. Hedge accounting is a method of accounting for which the

a. gains and losses from a hedge are deferred until the hedge is completed.

b. debits and credits are managed to keep the cash account stable

c. derivatives revenues and expenses are recorded so as to exactly balance

d. gains and losses on derivatives are shown before the hedge is terminated

e. none of the above

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