TEST BANK
Use the following to answer questions 1-15.
Bank of Charub ($ million)
Assets: Liabilities and Net Worth:
270 day US Treasury bills $500m 1 year Certificates of Deposit $550m
2 year consumer loans Demand Deposits $750m
Fixed rate, 12% p.a. annually $275m 2 year Bonds $175m
7 year commercial loans $350m Fixed rate, 7.5% p.a. annually
Fixed rate, 9% p.a. annually Overnight Fed Funds $350m
10 year fixed rate mortgages $675m
Fixed rate, 6.5% p.a. monthly
10 year floating rate mortgages $125m Equity $100m
LIBOR+50bp, monthly roll date
Notes: The 1 year Certificates of Deposit pay 1.95% p.a. annually. The demand deposits are non-interest bearing and have a duration of zero. The 7 year commercial loans have a duration of 4.75 years. The fixed rate mortgages have a duration of 8.3 years. All values are market values.
1. What is the duration of the floating rate mortgages?
a. 0.25 years
b. 10 years
c. 2 years
d. 0.08 years
e. There is not enough information to answer the question.
2. What is the duration of the 2 year bonds they are selling at par at 7.5% p.a. interest, compounded annually?
a. 1.93 years
b. 1 year
c. 2 years
d. 1.5 years
e. 3.86 years
3. What is the face value of the 2 year consumer loans if they yield 6% p.a. with a coupon rate of 12% p.a. paid annually?
a. $175 million
b. $165 million
c. $247.7 million
d. $155 million
e. $172 million
4. What is the duration of the 2 year consumer loans if they yield 6% p.a. with a coupon rate of 12% p.a. paid annually?
a. 1.87 years
b. 3.84 years
c. 2 years
d. 0.5 years
e. 1.9 years
5. What is the convexity of the 2 year consumer loans if they yield 6% p.a. with a coupon rate of 12% p.a. paid annually?
a. 4.98
b. 2.83
c. 3.85
d. 1.95
e. 2.01
6. What is the duration of the bank’s assets?
a. 1.05 years
b. 4.24 years
c. 0.94 years
d. 0.49 years
e. 3.85 years
7. What is the duration of the bank’s liabilities?
a. 1.05 years
b. 4.24 years
c. 0.94 years
d. 0.49 years
e. 3.85 years
8. What is the bank’s duration gap?
a. -0.49 years
b. +4.24 years
c. –0.94 years
d. -2.81 years
e. +3.78 years
9. What is the impact on the bank’s equity values if interest rates increase 25 basis points? (That is, DR/(1+R) is equal to an increase of 25 basis points.)
- -$12.69 million
- +$12.69 million
- -$18.19 million
- +$18.19 million
- -$25,000
10. What is the Bank of Charub’s interest rate risk exposure?
a. Exposed to interest rate declines because a negative duration gap implies that equity values decline when interest rates fall.
b. Exposed to interest rate increases because a negative duration gap implies that equity values decline when interest rates rise.
c. Exposed to interest rate declines because a positive duration gap implies that equity values decline when interest rates fall.
d. Exposed to interest rate increases because a positive duration gap implies that equity values decline when interest rates rise.
e. The Bank of Charub has no interest rate risk exposure.
11. Which of the following can be used to hedge Bank of Charub’s interest rate risk exposure?
a. Sell futures and/or sell puts to construct a short hedge.
b. Buy futures and/or sell puts to construct a short hedge.
c. Buy futures and/or buy puts to construct a long hedge.
d. Sell futures and/or sell puts to construct a long hedge.
e. Sell futures and/or buy puts to construct a short hedge.
12. Use the following US Treasury bill futures contract to construct a perfect (naïve) hedge. The June contract is currently price at 97.5. (Assume that all interest rates increase by 25 basis points.)
a. Sell one US Treasury bill futures contract at 97.5
b. Buy one US Treasury bill futures contract at 97.5.
c. Sell 28,780 US Treasury bill futures contracts at 97.5
d. Buy 28,780 US Treasury bill futures contracts at 97.5
e. Sell 100 US Treasury bill futures contracts at 97.5.
13. What is the dollar price of the US Treasury bill futures contract in question 12?
a. $975,000
b. $97,500
c. $993,681
d. $996,208
e. $97.50
14. Use an at the money US Treasury bill futures option to construct a perfect (naïve) hedge of Bank of Charub’s interest rate risk. (Assume that all interest rates increase by 25 basis points.)
a. Sell one put option at 97.5.
b. Buy one call option at 97.5.
c. Buy 58,577 put options at 97.5.
d. Buy 58,577 call options at 97.5
e. Buy one put option at 97.5.
15. What might prevent the hedges in questions 12 and 14 from completely eliminating Bank of Charub’s interest rate risk exposure?
a. Incorrect calculation of the number of contracts.
b. Basis risk.
c. Pricing errors.
d. Failure to execute the order.
e. Unanticipated shifts in interest rates.
Use the following information to answer questions 16-24.
Consider the following currency portfolio held by a US financial intermediary.
Assets Denominated in Foreign currency / Liabilities Denominated in Foreign currency / Currency Bought Forward / Currency Sold ForwardJapanese yen / 755m yen / 525m yen / 135m yen / 440m yen
Euro / 25m euro / 100m euro / 15m euro / 325m euro
Pound sterling / 10m pound / 5m pound / 50m pound / 0
Notes: The current spot rates are: $1.13/euro; $1.61/pound sterling; $0.0084/yen. The current forward rates are: $1.15/euro; $1.57/pound sterling; $0.0089/yen. All $ are US dollars.
16. What is the portfolio’s exposure to the Japanese yen?
a. -$75 million
b. $+75 million
c. –75 million yen
d. +75 million yen
e. +230 million yen
17. What is the portfolio’s exposure to the euro?
a. -$385 million
b. +$385 million
c. –385 million euro
d. +385 million euro
e. –75 million euro
18. What is the portfolio’s exposure to the pound sterling?
a. -$55 million
b. +$55 million
c. –55 million pounds
d. +55 million pounds
e. +5 million pounds
19. Using the difference between the spot and the forward rate as the measure of the exchange rate shock, what is the US dollar impact on the portfolio of the change in Japanese yen? (Measure the exchange rate change using the forward rate minus the spot rate.)
a. - $37,500
b. -$6.5 million
c. -$2.2 million
d. -$10.5 million
e. -$22.2 million
20. Using the difference between the spot and the forward rate as the measure of the exchange rate shock, what is the US dollar impact on the portfolio of the change in euro? (Measure the exchange rate change using the forward rate minus the spot rate.)
a. - $37,500
b. -$6.5 million
c. -$2.2 million
d. -$10.5 million
e. -$22.2 million
21. Using the difference between the spot and the forward rate as the measure of the exchange rate shock, what is the US dollar impact on the portfolio of the change in pound sterling? (Measure the exchange rate change using the forward rate minus the spot rate.)
a. - $37,500
b. -$6.5 million
c. -$2.2 million
d. -$10.5 million
e. -$22.2 million
22. Use currency forwards to construct a perfect (naïve) hedge for the portfolio’s exposure to the Japanese yen.
a. Buy 75 million yen forward.
b. Sell 75 million yen forward.
c. Buy 755 million yen forward.
d. Sell 755 million yen forward.
e. Buy 525 million yen forward.
23. Use currency forwards to construct a perfect (naïve) hedge for the portfolio’s exposure to the euro.
a. Buy 325 million euro forward.
b. Sell 325 million euro forward.
c. Buy 25 million euro forward.
d. Sell 25 million euro forward.
e. Buy 100 million euro forward.
24. Use currency forwards to construct a perfect (naïve) hedge for the portfolio’s exposure to the pound sterling.
a. Buy 55 million pounds forward.
b. Sell 55 million pounds forward.
c. Buy 10 million pounds forward.
d. Sell 10 million pounds forward.
e. Sell 5 million pounds forward.
25. Comparing options hedges to futures/forward hedges:
a. Options hedges mark to market more frequently than futures/ forward hedges.
b. Options hedges have higher transactions costs than futures/forward hedges.
c. Options hedges have asymmetric cash flows, whereas futures/forward hedges have symmetric cash flows.
d. Only Choice B is correct.
e. Choices A, B and C are correct.
Use the following information to answer questions 26-43.
Book Value Balance Sheet for Bucks Bank ($ millions)
ASSETS: LIABILITIES & NET WORTH:
Mortgages $55m 2 year CD $101
Money Market Securities 5 1 year CD 45
2 year commercial loans 125 15 year bonds 38
10 year commercial loans 12.5 Equity 13.5
Notes: All assets and liabilities are priced at par with the exception of the 2 year commercial loans, which have an annual coupon rate of 5% p.a. and yield 8.5% p.a. The CDs are pure discount instruments. Both the mortgages and the 15 year bonds have durations of 9 years. The money market securities have a 1 year duration and the 10 year commercial loans have a 6 year duration.
26. What is the market value of the 2 year commercial loans?
a. $117.25 million
b. $125 million
c. $ 93.8 million
d. $120.1 million
e. $114.67 million
27. What is the market value of equity?
a. $13.5 million
b. $ 5.75 million
c. $17.7 million
d. $ 8.33 million
e. $ 2.9 million
28. What is the duration of the 2 year commercial loans?
a. 2 years
b. 1.75 years
c. 1.95 years
d. 1.89 years
e. 1.92 years
29. What is the convexity of the 2 year commercial loans?
a. 4.9
b. 3.7
c. 2.6
d. 25.4
e. 12.3
30. Use the duration approximation to calculate the impact on the market value of the 2 year loans if interest rates increase 25 basis points. (That is, DR = 25 basis points.)
a. A decrease of $527,000
b. An increase of $527,000
c. An increase of $494,000
d. A decrease of $494,000
e. There is insufficient information to answer the question.
31. Use the convexity approximation to calculate the impact on the market value of the 2 year loans if interest rates increase 25 basis points. (That is, DR = 25 basis points.)
a. A decrease of $1,694
b. An increase of $1,694
c. A decrease of $526,000
d. An increase of $526,000
e. There is insufficient information to answer the question.
32. What is the duration of the assets of Bucks Bank?
a. 4.15 years
b. 3.2 years
c. 1.13 years
d. 1.17 years
e. 4.24 years
33. What is the duration of the liabilities of Bucks Bank?
a. 4.15 years
b. 3.2 years
c. 1.13 years
d. 1.17 years
e. 4.24 years
34. What is Bucks Bank’s duration gap?
a. +4.15 years
b. -3.2 years
c. +1.13 years
d. -1.17 years
e. +4.24 years
35. What can you say about the interest rate risk exposure of Bucks Bank?
a. Bucks Bank is exposed to interest rate decreases because the duration of assets exceeds the duration of liabilities.
b. Bucks Bank is exposed to interest rate increases because the duration of assets exceeds the duration of liabilities.
c. Bucks Bank is exposed to interest rate decreases because the duration of assets is less than the duration of liabilities.
d. Bucks Bank is exposed to interest rate increases because the duration of assets is less than the duration of liabilities.
e. Nothing.
36. What is the impact on Bucks Bank’s equity market value if interest rates increase 50 basis points? (That is, DR/(1+R) = 50 basis points.)
a. A loss of $1.16 million
b. A gain of $1.16 million
c. A loss of $3.26 million
d. A gain of $1.07 million
e. A loss of $1.07 million
37.How would Bucks Bank use futures to hedge its interest rate risk exposure?
a. Put on a long hedge by buying futures and buying call options.
b. Put on a long hedge by selling futures and buying put options.
c. Put on a short hedge by buying futures and buying call options.
d. Put on a short hedge by selling futures and buying put options.
e. Put on a short hedge by selling futures and buying call options.
38.If the IMM Index price on US Treasury bill futures is 96.95, what is the price of the underlying security?
- $96.95
- $969,500
- $9.695 million
- $992,290
- $995,678
39.Use US Treasury bill futures in question 38 to construct a perfect hedge against a 50 basis point increase in interest rates for Bucks Bank. (That is, DR/(1+R) = 50 basis points.)
a. Sell 865 futures
b. Buy 865 futures
c. Sell 967 futures
d. Buy 967 futures
e. Sell 1 futures contract
40.In practice, which of the following hedges would be likely recommendations if Bucks Bank’s CEO is very risk averse, but the Chairman of the Board is risk tolerant?
a. The CEO wants to sell 865 futures and the Chairman of the Board wants to sell 967 futures.
b. The CEO wants to sell 500 futures and the Chairman of the Board wants to sell 100 futures.
c. The CEO wants to sell 100 futures and the Chairman of the Board wants to sell 500 futures.
d. The CEO wants to sell 865 futures and the Chairman of the Board wants to sell 865 futures.
e. The CEO wants to sell 967 futures and the Chairman of the Board wants to sell 967 futures.
41.How would Bucks Bank use options to hedge its interest rate risk exposure?
a. Buy call options to hedge the bank’s positive duration gap.
b. Buy put options to hedge the bank’s negative duration gap.
c. Buy call options to hedge the bank’s negative duration gap.
d. Buy put options to hedge the bank’s positive duration gap.
e. Sell put options to hedge the bank’s positive duration gap.
42. Using at-the-money options on the Treasury bill futures contract in question 38, construct the perfect options hedge against a 50 basis point increase in interest rates. (That is, DR/(1+R) = 50 basis points.)