Q1. In each of the following cases, indicate whether it would be appropriate for an FI to (i) buy a put or a call option to hedge the appropriate risk. a. A commercial bank plans to issue CDs in three months. b. A U.S. bank lends to a French company; the loan is payable in euros. c. A finance company has assets with a duration of 6 yrs, liabilities with a duration of 13 yrs.

Q2. How can caps, floors be used to hedge interest rate risk?

Q3. A bank buys a $100 million notional call option of 9% interest rate at a premium of 0.65% of face value.

(i) If interest rate rises to 11%, what is the net profit for the bank?

(ii) If interest rate falls to 8%, what is the net profit for the bank?

(iii) Give an example when the bank uses this call option as a hedge on the balance sheet.