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Questions and Answers of Financial Markets Institutions

How supply and demand, together, determine interest rates? LO.1
What happens to the equilibrium interest rate when the supply of loanable funds increases? LO.1
What happens to the equilibrium interest rate when the demand for loanable funds increases? LO.1
Who the major demanders of loanable funds are? LO.1
Who the main suppliers of loanable funds are? LO.1
What the trends are in the growth of global financial markets since the 1990s? LO.1
The payment services that FIs perform? LO.1
Why monetary policy is transmitted through the banking system? LO.1
The two major sectors that society has identified as deserving special attention in credit allocation? LO.1
Why the need for denomination intermediation arises? LO.1
What maturity intermediation is? LO.1
What the link is between asset diversification and the liquidity of deposit contracts? LO.1
What delegated monitoring function FIs perform? LO.1
What the asset transformation function of FIs is? LO.1
The three major reasons that suppliers of funds would not want to directly purchase securities? LO.1
What derivative security markets are? LO.1
What happens to the dollar value of a U.S. investor’s holding of British pounds if the pound appreciates (rises) in value against the dollar? LO.1
What the major instruments traded in the capital markets are? LO.1
The major distinction between money markets and capital markets? LO.1
The difference between primary and secondary markets? LO.1
Bank I can issue five-year CDs at an annual rate of 11 percent fixed or at a variable rate of LIBOR + 2 percent. Bank 2 can issue five-year CDs at an annual fixed rate of 13 percent or at a variable
A British 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 British company for three years at a fixed rate of 9 percent.
A commercial bank has $200 million of floating-rate loans yielding the T-bill rate plus 2 percent. These loans are financed by $200 million of fixed-rate deposits costing 9 percent. A savings
An insurance company owns $50 million of floating-rate bonds yielding LIBOR plus 1 percent. These loans are financed by $50 million of fixed-rate guaranteed investment contracts (GICs) costing 10
A mutual fund plans to purchase $10 million of 20-year T-bonds in two months. The bonds are yielding 7.68 percent. These bonds have a duration of 11 years. The mutual fund is concerned about interest
An FI has a $200 million asset portfolio that has an average duration of 6.5 years. The average duration of its $160 million in liabilities is 4.5 years. Assets and liabilities are yielding 10
Corporate Bank has $840 million of assets with a duration of 12 years and liabilities worth $720 million with a duration of seven years. Assets and liabilities are yielding 7.56 percent. The bank is
An FI has a $100 million portfolio of six-year Eurodollar bonds that have an 8 percent coupon. The bonds are trading at par and have a duration of five years. The FI wishes to hedge the portfolio
Village Bank has $240 million worth of assets with a dura- tion of 14 years and liabilities worth $210 million with a duration of four years. In the interest of hedging interest rate risk, Village
How does consideration of basis risk change your answers? (LG 23-2)a. Compute the number of futures contracts required to construct a macrohedge if [AR/(1+R/AR/(1 + R)] = br = 0.90.b. Explain what is
Refer to Problem
What is the impact on the FI's futures position if the relative change in all interest rates is an increase of 1 percent? That is, AR/(1+R) = 0.01. Assume that the deliverable Treasury bond has a
Consider the following balance sheet (in millions) for an FI: (LG 23-1, LG 23-2) Assets Liabilities Duration = 10 years $950 Duration = 2 years $860 Equitya. What is the FI's duration gap?b. What is
A mutual fund plans to purchase $500,000 of 30-year Trea- sury bonds in four months. These bonds have a duration of 12 years and are priced at 96-08 (32nds). The mutual fund is concerned about
How would your answer for part (b) in Problem 5 change if the relationship of the price sensitivity of futures contracts to the price sensitivity of underlying bonds were br = 0.92? (LG 23-2)
Tree Row Bank has assets of $150 million, liabilities of $135 million, and equity of $15 million. The asset duration is six years and the duration of the liabilities is four years. Market interest
Hedge Row Bank has the following balance sheet (in millions): (LG 23-2) Assets $150 Liabilities $135 Equity 15 Total $150 Total $150 The duration of the assets is six years and the duration of the
The FI would like to hedge against this interest rate forecast with an appropriate position in a forward contract. What will this position be? Show that if rates rise by 1 percent as forecast, the
An FI holds a 15-year, $10,000,000 par value bond that is priced at 104 and yields 7 percent. The FI plans to sell the bond but for tax purposes must wait two months. The bond has a duration of 9.4
Answer the following. (LG 23-2, LG 23-3)a. What is the duration of a 20-year 8 percent coupon (paid semiannually) Treasury bond (deliverable against the Treasury bond futures contract) selling at
A bank purchases a six-month $1 million Eurodollar deposit at an interest rate of 6.5 percent per year. It invests the funds in a six-month Swedish krona bond paying 7.5 percent per year. The current
Why is the credit risk on a swap lower than the credit risk on a loan? (LG 23-5)
How does a pure credit swap differ from a total return swap? (LG 23-5)
What is a total return swap? (LG 23-5)
Give two reasons why credit swaps have been the fastest- growing form of swaps in recent years. (LG 23-5)
Distinguish between a swap seller and a swap buyer. (LG 23-5)
Explain the similarity between a swap and a forward con- tract. (LG 23-6)
Suppose that a pension fund manager anticipates the pur- chase of a 20-year 8 percent coupon T-bond at the end of two years. Interest rates are assumed to change only once every year at year end. At
Suppose that an FI manager writes a call option on a T-bond futures contract with an exercise price of 114 at a quoted price of 0-55. What type of opportunities or obligations does the manager have?
In each of the following cases, identify what risk the man- ager of an FI faces and whether the risk should be hedged by buying a put or a call option. (LG 23-4)a. A commercial bank plans to issue
Contrast the use of financial futures options with the use of options on cash instruments to construct interest rate hedges. (LG 23-6)
How does hedging with options differ from hedging with forward or futures contracts? (LG 23-6)
Consider Table 23-3 again. (LG 23-4)a. What happens to the price of a call when: (1) The exercise price increases? (2) The time until expiration increases?b. What happens to the price of the put when
Consider Table 23-3. What are the prices paid for the fol- lowing futures options: (LG 23-4)a. March U.S. Treasury-Bond calls at 13600.b. December 5-year Treasury puts at 11950.c. December Eurodollar
Answer the following: (LG 23-4)a. What are the two ways to use call and put options on T-bonds to generate positive cash flows when interest rates decline?b. When and how can an FI use options on
What is basis risk? What are the sources of basis risk? (LG 23-2)
What are the reasons why an FI may choose to hedge selec- tively its portfolio? (LG 23-3)
What are the differences between a microhedge and a macro- hedge for an FI? Why is it generally more efficient for Fls to employ a macrohedge than a series of microhedges? (LG 23-3)
Mark your position to market.
What is your loss or gain?d. Assume that the Treasury bond futures price rises to
Suppose that you purchase a Treasury bond futures contract at $95 per $100 of face value. (LG 23-2)a. What is your obligation when you purchase this futures contract?b. If an FI purchases this
What is a naive hedge? How does a naive hedge protect an FI from risk? (LG 23-1)
In each of the following cases, indicate whether it would be appropriate for an FI to buy or sell a forward contract to hedge the appropriate risk. (LG 23-1)a. A commercial bank plans to issue CDs in
What are some of the major differences between futures and forward contracts? (LG 23-1, LG 23-2)
The ISDA is the trade group that oversees the market for credit default swaps. Credit default swaps are essentially insurance policies against bond defaults (see Chapter 10). LO.1
For a detailed summary of each of these, see BIS Quarterly Review, December 2008, www.bis.org. LO.1
See the discussion of the interest rate parity theorem in Chapter 9. LO.1
In reality, not all of the $500 million will generally be deposited in demand deposit accounts of commercial banks, and commercial banks will not generally hold all of the $500 million in reserve
As of June 2016, there were 23 primary securities dealers trading, on average, $0.82 trillion of securities per day. LO.1
In addition to the tools described here, the Fed (as well as the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency) can indirectly affect the money supply by
On October 1, 2008, the Board of Governors amended its rules governing the payment of interest on excess reserves so that the interest rate on excess balances was set at 25 basis points. LO.1
A second major wire transfer service is the Clearing House Interbank Payments System(CHIPS). CHIPS operates as a private network, independent of the Federal Reserve. At the core of the CHIPS system
An Edge Act corporation is a subsidiary of a federally chartered domestic bank holding company that generally specializes in financing international transactions. An agreement corporation operates
The length of the term is intended to limit the president’s control over the Fed and thus to reduce political pressure on board members; the nonrenewable nature of an appointment prevents any
These state-chartered banks are called state-chartered member banks. State-chartered banks that are not members of the FRS are called state-chartered nonmember banks (see Chapter 11). LO.1
The Office of the Comptroller of the Currency (OCC) charters, regulates, and supervises national banks in the United States to ensure a safe, sound, and competitive banking system (see Chapters 11
The Panic of 1907 was a financial crisis that hit the United States at the turn of the 20th century while the country was in the midst of an economic recession. The New York Stock Exchange index fell
Calculate the percentage change in each of these rates since June 2016. LO.1
What are the current levels for each of these interest rates? LO.1
Brown Bank currently has $350 million in transaction deposits on its balance sheet. The current reserve requirement is 10 percent, but the Federal Reserve is increasing this requirement to 11
Marly Bank currently has $650 million in transaction deposits on its balance sheet. The current reserve requirement is 10 percent, but the Federal Reserve is decreasing this requirement to 9 percent.
The FOMC has instructed the FRBNY Trading Desk to purchase $750 million in U.S. Treasury securities. The Federal Reserve has currently set the reserve requirement at 10 percent of transaction
The FOMC has instructed the FRBNY Trading Desk to purchase $500 million in U.S. Treasury securities. The Federal Reserve has currently set the reserve requirement at 5 percent of transaction
MHM Bank currently has $250 million in transaction deposits on its balance sheet. The current reserve requirement is 10 percent, but the Federal Reserve is increasing this requirement to 12 percent.
National Bank currently has $500 million in transaction deposits on its balance sheet. The current reserve requirement is 10 percent, but the Federal Reserve is decreasing this requirement to 8
BSW Bank currently has $150 million in transaction deposits on its balance sheet. The Federal Reserve has currently set the reserve requirement at 10 percent of transaction deposits. (LG 4-3)page
Bank Three currently has $600 million in transaction deposits on its balance sheet. The Federal Reserve has currently set the reserve requirement at 10 percent of transaction deposits. (LG 4-3)a. If
Suppose the Federal Reserve instructs the Trading Desk to sell $850 million of securities. Show the result of this transaction on the balance sheets of the Federal Reserve System and commercial
Suppose the Federal Reserve instructs the Trading Desk to purchase$1 billion of securities. Show the result of this transaction on the balance sheets of the Federal Reserve System and commercial
Summarize the monetary policy measures taken by central banks to address the worldwide financial crisis. (LG 4-5) LO.1
Describe how expansionary activities conducted by the Federal Reserve impact the money supply, credit availability, interest rates, and security prices. Do the same for contractionary activities. (LG
Which of the monetary tools available to the Federal Reserve is most often used? Why? (LG 4-3) LO.1
What changes did the Fed implement to its discount window lending policy in the early 2000s? in the late 2000s? (LG 4-3) LO.1
Why does the Federal Reserve rarely use the discount rate to implement its monetary policy? (LG 4-3) LO.1
Explain how a decrease in the discount rate affects credit availability and the money supply. (LG 4-3) LO.1
What are the tools used by the Federal Reserve to implement monetary policy? (LG 4-3) LO.1
Why did U.S. government agency securities go from nothing to being the largest asset account on the Federal Reserve’s balance sheet in the late 2000s? (LG 4-2) LO.1
What are the major assets of the Federal Reserve System? Describe each. (LG 4-2) LO.1
Why did reserve deposits increase to the point that this account represented the largest liability account on the Federal Reserve’s balance sheet in the late 2000s? (LG 4-2) LO.1
What are the major liabilities of the Federal Reserve System?Describe each. (LG 4-2) LO.1

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