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business
financial institutions management

Questions and Answers of Financial Institutions Management

How would your answer for part (b) in problem 16 change if the relationship of the price sensitivity of futures contracts to the price sensitivity of underlying bonds were br = 0.92?
A mutual fund plans to purchase $500,000 of 30-year Treasury bonds in four months. These bonds have a duration of 12 years and are priced at 96.25 (percent of face value). The mutual fund is
Consider the following balance sheet (in millions) for an FI:a. What is the FI’s duration gap?b. What is the FI’s interest rate risk exposure?c. How can the FI use futures and forward contracts
Refer again to problem 21.How does consideration of basis risk change your answers to problem 21?a. Compute the number of futures contracts required to construct a macrohedge if[Δ R f / (1 + R f ) /
An FI has an asset investment in euros. The FI expects the exchange rate of dollars/euro to increase by the maturity of the asset.a. Is the dollar appreciating or depreciating against the euro?b. To
What is meant by tail the hedge? What factors allow an FI manager to tail the hedge effectively?
What does the hedge ratio measure? Under what conditions is this ratio valuable in determining the number of futures contracts necessary to fully hedge an investment in another currency?
An FI has assets denominated in British pounds of $125 million and pound liabilities of $100 million. The exchange rate of pounds for dollars is currently$1.20/£.a. What is the FI’s net FX
An FI is planning to hedge its one-year, 100 million Swiss francs (SFr)–denominated loan against exchange rate risk. The current spot rate is $1.10/SFr.A one-year SFr futures contract is currently
A U.S. FI has a long position in £75,500,000 assets funded with U.S. dollardenominated liabilities. The FI manager is concerned about the £ appreciating relative to the dollar and is considering a
An FI has made a loan commitment in Swiss francs (SFr) of SFr10 million that is likely to be taken down in six months. The current spot rate is $1.10/SFr.a. Is the FI exposed to the dollar’s
A U.S. FI has assets denominated in Swiss francs (SFr) of 75 million and liabilities of 125 million. The spot rate is $1.0600/SFr and one-year futures are available for $1.0512/SFr.a. What is the
A property–casualty (PC) insurance company purchased catastrophe futures contracts to hedge against losses during the hurricane season. At the time of purchase, the market expected a loss ratio of
Go to the Office of the Comptroller of the Currency website at www.occ.treas.gov. Find the most recent levels of futures, forwards, options, swaps, and credit derivatives using the following steps.
How do interest rate increases affect the payoff from buying a call option on a bond?How do they affect the profit from writing a call option on a bond?
How do interest rate increases affect the payoff from buying a put option on a bond?How do they affect the profit from writing a put option on a bond?
What are some of the economic reasons for an FI not to write options?
What are some regulatory reasons why an FI might choose to buy options rather than write options?
What are two common models used to calculate the fair value of a bond option?Which is preferable, and why?
In the example above, calculate the value of the option if the exercise price(X) = $88. (P = $0.064)
Why are bond or interest rate futures options generally preferred to options on the underlying bond?
If an FI hedges by buying put options on futures and interest rates rise (i.e., bond prices fall), what is the outcome?
If interest rates fall, are you better off purchasing call or put options on T-bonds and why?
In the example above, what number of put options should you purchase if δ = 0.25 and D = 6? (Np = 1,718.213)
What is the difference between options on foreign currency and options on foreign currency futures?
If an FI has to hedge a $5 million liability exposure in Swiss francs (SFr), what options should it purchase to hedge this position? Using Figure 24–13, how many contracts of Swiss franc futures
What is the difference between a credit spread call option and a digital default option?
What is the difference between the payoff on the catastrophe call spread option in Figure 24–19 and the payoff of a standard call option on a stock?
In Example 24–4, suppose that in year 3 the highest and lowest rates were 12 percent and 6 percent instead of 11 percent and 7 percent, respectively. Calculate the fair premium on the cap.
Assume two exercise dates at the end of year 2 and the end of year
Suppose that the FI buys a floor of 4 percent at time
The binomial tree suggests that rates at the end of year 2 could be 3 percent (p = 0.5) or 5 percent (p = 0.5) and at the end of year 3 rates could be 2 percent (p = 0.25), 4 percent (p = 0.5), or 6
What is a put option?
In each of the following cases, identify what risk the manager of an FI faces and whether that risk should be hedged by buying a put or a call option.a. A commercial bank holds three-month CDs in its
What are the regulatory reasons why FIs seldom write options?
A pension fund manager anticipates the purchase of a 20-year, 8 percent coupon Treasury bond at the end of two years. Interest rates are assumed to change only once every year at year-end with an
Consider Figure 24–13. What are the prices paid for the following futures options?a. May T-bond calls at $156.00.b. April 10-year T-note puts at $127.50.c. June Eurodollar calls at 98.94 percent.
Consider Figure 24–13 again. What happens to the option price of the following?a. A call when the exercise price increases.b. A call when the time until expiration increases.c. A put when the
An FI must make a single payment of 500,000 Swiss francs in six months at the maturity of a CD. The FI’s in-house analyst expects the spot price of the franc to remain stable at the current
An American insurance company issued \($10\) million of one-year, zero-coupon GICs (guaranteed investment contracts) denominated in Swiss francs at a rate of 5 percent. The insurance company holds no
An FI has made a loan commitment of SFr10 million that is likely to be taken down in six months. The current spot exchange rate is $1.0210/SFr.a. Is the FI exposed to the dollar depreciating or the
How do the cash flows to the lender for a credit spread call option hedge differ from the cash flows for a digital default option?
Use the following information to price a three-year collar by purchasing an in-the-money cap and writing an out-of-the-money floor. Assume a binomial options pricing model with an equal probability
Use the following information to price a three-year collar by purchasing an outof-the-money cap and writing an in-the-money floor. Assume a binomial options pricing model with an equal probability of
Contrast the total cash flows associated with the collar position in question 34 against the collar in question
Do the goals of FIs that utilize the collar in question 34 differ from those that put on the collar in question 35? If so, how?
What credit risk exposure is involved in buying caps, floors, and collars for hedging purposes?
Referring to the fixed-fixed currency swap in Table 25–6, if the net cash flows on the swap are zero, why does either FI enter into the swap agreement?
Referring to Table 25–8, suppose that the U.S. FI had agreed to make floating payments of LIBOR + 1 percent instead of LIBOR + 2 percent. What would its net payment have been to the U.K. FI over
What is the link between preserving “customer relationships” and credit derivatives such as total return swaps?
Is there any difference between a digital default option (see Chapter 24) and a pure credit swap?
Are swaps as risky as equivalent-sized loans?
An insurance company owns $50 million of floating-rate bonds yielding LIBOR plus 1 percent. These loans are financed with $50 million of fixed-rate guaranteed investment contracts (GICs) costing 10
A commercial bank has $200 million of four-year maturity floating-rate loans yielding the T-bill rate plus 2 percent. These loans are financed with $200 million of four-year maturity fixed-rate
Bank 1 can issue five-year CDs at an annual rate of 11 percent fixed or at a variable rate of LIBOR plus 2 percent. Bank 2 can issue five-year CDs at an annual rate of 13 percent fixed or at a
First Bank can issue one-year, floating-rate CDs at prime plus 1 percent or fixedrate CDs at 12.5 percent. Second Bank can issue one-year floating-rate CDs at prime plus 0.5 percent or fixed-rate CDs
Describe how an inverse floater swap works to the advantage of an investor who receives coupon payments of 10 percent minus LIBOR if LIBOR is currently at 4 percent.When is it a disadvantage to the
A Swiss bank issues a $100 million, three-year eurodollar CD at a fixed annual rate of 7 percent. The proceeds of the CD are lent to a Swiss company for three years at a fixed rate of 9 percent. The
Use the following information to construct a swap of asset cash flows for the bank in problem
The bank is a price taker in both the fixed-rate market at 9 percent and the rate-sensitive market at the T-bill rate plus 1.5 percent. A securities dealer has a large portfolio of rate-sensitive
Consider the following currency swap of coupon interest on the following assets:5 percent (annual coupon) fixed-rate US$1 million bond 5 percent (annual coupon) fixed-rate bond denominated in Swiss
Consider the following fixed-floating-rate currency swap of assets: 5 percent(annual coupon) fixed-rate US$1 million bond and floating-rate SFr1.5 million bond set at LIBOR annually. Currently LIBOR
What role did the swap market play in the financial crisis of 2008–2009?The following problem refers to material in Appendix 25A.
Which loans should have the highest yields: (a) loans sold with recourse or (b) loans sold without recourse?
Which have higher yields, junk bonds or leveraged loans? Explain your answer.
Describe the two basic types of loan sale contracts by which loans can be transferred between seller and buyer.
Explain the main reason behind the growth in loan sales in the 1980s and the early 2000s.
What institutions are the major buyers in the traditional U.S. domestic loan sales market? What institutions are the major sellers in this market?
What are some of the economic and regulatory reasons why FIs choose to sell loans?
How can an FI use its loans to mitigate a liquidity problem?
What are some of the factors that are likely to deter the growth of the loan sales market in the future?
What are some specific legal concerns that have hampered the growth of the loan sales market?
What are some of the factors that are likely to encourage loan sales growth in the future?
Why have the FASB and the SEC advocated that financial services firms replace book value accounting with market value accounting?
What is the difference between a life insurance contract and an annuity contract?
Describe the different forms of ordinary life insurance.
Why do life insurance companies invest in long-term assets?
What is the major source of life insurance underwriting risk?
Who are the main regulators of the life insurance industry?
Why is traditional life insurance in decline?
Why do PC insurers hold more capital and reserves than do life insurers?
Why are life insurers’ assets, on average, longer in maturity than those of PC insurers?
Describe the main lines of insurance offered by PC insurers.
What are the components of the combined ratio?
How does the operating ratio differ from the combined ratio?
Why does the combined ratio tend to behave cyclically?
What is refinancing risk?
Why does a rise in the level of interest rates adversely affect the market value of both assets and liabilities?
Explain the concept of maturity matching.
Why does credit risk exist for FIs?
How does diversification affect an FI’s credit risk exposure?
Why might an FI face a sudden liquidity crisis?
What circumstances might lead an FI to liquidate assets at fire-sale prices?
Explain why the returns on domestic and foreign portfolio investments are not, in general, perfectly correlated.
A U.S. bank is net long in European assets. If the euro appreciates against the dollar, will the bank gain or lose?
Can an FI be subject to sovereign risk if it lends only to the highest-quality foreign corporations?
What is one major way an FI can discipline a country that threatens not to repay its loans?
What is market, or trading, risk?
What modern conditions have led to an increase in this particular type of risk for FIs?
Why are letter of credit guarantees an off-balance-sheet item?

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