Q&A Hero

Q: By selling short a futures contract of $100,000 at a price of 115, you are agreeing to deliver ________ face value securities for ________. A) $100,000; $115,000 B) $115,000; $110,000 C) $100,000; $100,000 D) $115,000; $115,000

Q: Which is not a problem of forward contracts? A) a lack of liquidity B) a lack of flexibility C) the difficulty of finding a counterparty D) default risk

Q: A short contract requires that the investor A) sell securities in the future. B) buy securities in the future. C) hedge in the future. D) close out his position in the future.

Q: A long contract requires that the investor A) sell securities in the future. B) buy securities in the future. C) hedge in the future. D) close out his position in the future.

Q: A contract that requires the investor to sell securities on a future date is called a ________. A) short contract B) long contract C) hedge D) micro hedge

Q: A contract that requires the investor to buy securities on a future date is called a ________. A) short contract B) long contract C) hedge D) cross

Q: Which of the following is not a financial derivative? A) stocks B) futures C) options D) forward contracts

Q: Financial derivatives include ________. A) stocks B) bonds C) forward contracts D) both A and B

Q: Financial derivatives include ________. A) stocks B) bonds C) futures D) none of the above

Q: Discuss the challenges regulators face in controlling the use of derivatives by financial institutions.

Q: Discuss the advantages of using swaps to protect against interest-rate risk rather than restructuring the balance sheet.

Q: Explain the advantages of protecting against interest-rate risk using options rather than futures contracts.

Q: Explain how option contracts could be used to protect against losses in portfolio value that may occur as interest rates increase.

Q: Define and distinguish between call options and put options.

Q: Explain how a swap could be used to reduce interest-rate risk for a bank with more rate-sensitive assets than rate-sensitive liabilities.

Q: How would a firm use exchange rate futures to lock in current exchange rates?

Q: Explain how a long hedge could be used to protect a bank from the risk that interest rates could rise before a loan is funded.

Q: Explain how a short hedge could be used to hedge a Treasury portfolio against interest-rate risk.

Q: Why have the futures markets grown so rapidly in recent years?

Q: Distinguish between forward and futures contracts.

Q: The 2007-2009 financial crisis illustrates that derivatives cannot be used to hedge -- financial institutions should be barred from using them in any form.

Q: Intermediaries add value to the swap markets by reducing default risk.

Q: Interest-rate swaps are more liquid than futures contracts.

Q: If Friendly Finance Company has more rate-sensitive assets than rate-sensitive liabilities, it may reduce risk with a swap.

Q: Currency swaps involve the exchange of a set of payments on one currency for a set of payments in another.

Q: Interest-rate swaps involve the exchange of a set of payments in one currency for a set of payments in another.

Q: One advantage of using options to hedge is that the accounting transaction will never require the firm to show large unrecognized losses.

Q: Using options to control interest-rate risk reduces the chance of a loss but increases the chance of a gain.

Q: Option premiums fall as the volatility of the underlying asset falls.

Q: Option premiums increase as the term to maturity increases.

Q: An option that gives the holder the right to buy an asset in the future is a put.

Q: To reduce foreign exchange risk from selling goods to a foreign country, futures contracts should be sold.

Q: To reduce the interest-rate risk of holding a portfolio of bonds, Treasury bond futures contracts should be bought.

Q: Open interest allows investors to change the interest rate on futures contracts.

Q: Futures trading is regulated by the Commodity Futures Trading Commission.

Q: Futures contracts are subject to default risk.

Q: One problem with a futures contract is finding a counterparty.

Q: A short contract obligates the holder to sell securities in the future.

Q: A long contract obligates the holder to sell securities in the future.

Q: Futures contracts are standardized.

Q: A forward contract is more flexible than a futures contract.

Q: What special assumptions do income and duration gap analyses make about interest rate changes and the yield curve?

Q: Explain how banks benefit from specialization in lending.

Q: Explain how banks benefit from long-term customer relationships.

Q: What is duration gap analysis and why is it important to a bank?

Q: What is gap analysis and why is it important to a bank?

Q: How do the concepts of adverse selection and moral hazard explain the credit risk management principles that banks adopt?

Q: What steps do banks take to reduce their exposure to credit risk?

Q: How is credit risk related to the concepts of adverse selection and moral hazard?

Q: What is the difference between credit risk and interest-rate risk?

Q: If interest rates rise by 5 percentage points, then bank profits (measured using gap analysis) will increase regardless of the income gap.

Q: Measuring the sensitivity of bank profits to changes in interest rates by multiplying the gap for several maturity subintervals by the change in the interest rate is called duration analysis.

Q: Developing and maintaining long-term customer relationships help to reduce banks' costs of screening and monitoring borrowers.

Q: Credit rationing occurs when lenders charge higher interest rates on the loans they make to riskier borrowers.

Q: Credit rationing reduces adverse selection problems.

Q: Banks face the problem of adverse selection in loan markets because bad credit risks are the ones most likely to seek bank loans.

Q: If a bank has a negative gap, then a decrease in interest rates will increase income.

Q: The difference between rate-sensitive liabilities and rate-sensitive assets is known as the duration gap.

Q: If a bank has more rate-sensitive liabilities than assets, then an increase in interest rates will reduce bank profits.

Q: A bank manager concerned about interest income who expects interest rates to fall and who knows the bank currently has a positive gap should ________ rate-sensitive assets and ________ rate-sensitive liabilities. A) increase; increase B) decrease; increase C) decrease; decrease D) increase; decrease

Q: A bank manager concerned about interest income who expects interest rates to rise and who knows the bank currently has a positive gap should ________ rate-sensitive assets and ________ rate-sensitive liabilities. A) increase; increase B) decrease; increase C) decrease; decrease D) increase; decrease

Q: One problem with basic gap analysis is that it A) is calculated assuming interest rates on all maturities are equal. B) is calculated assuming interest rates on all maturities change by equal amounts. C) measures the sensitivity of net worth to interest rate changes. D) does not measure the sensitivity of income to interest rate changes. E) applies only to financial institutions.

Q: One problem with duration gap analysis is that it A) is calculated assuming that the yield curve is flat. B) is calculated assuming that the yield curve does not change. C) does not measure the sensitivity of net worth to interest rate changes. D) does not measure the sensitivity of income to interest rate changes. E) applies only to financial institutions.

Q: If a rise in interest rates causes the market value of a bank's net worth to rise, then the bank must have a ________. A) negative duration gap B) positive duration gap C) negative gap D) positive gap

Q: If a decline in interest rates causes the market value of a bank's net worth to rise, then the bank must have a ________. A) negative duration gap B) positive duration gap C) negative gap D) positive gap

Q: If a bank has a duration gap of 2 years, then a fall in interest rates from 6 percent to 3 percent will lead to A) a rise in the market value of its net worth of 5.66 percent. B) a fall in the market value of its net worth of 5.66 percent. C) a rise in net interest income of 5.66 percent. D) a fall in net interest income of 5.66 percent. E) an unknown change.

Q: If a bank has a duration gap of 2 years, then a rise in interest rates from 6 percent to 9 percent will lead to A) a rise in the market value of its net worth of 5.66 percent. B) a rise in net interest income of 5.66 percent. C) a fall in the market value of its net worth of 5.66 percent. D) a fall in net interest income of 5.66 percent. E) an unknown change.

Q: To use the concept of duration to analyze the effect of changes in interest rates on the market value of an asset, a bank manager would multiply A) the negative of the duration of the asset by the change in the interest rate, Δi. B) the negative of the duration of the asset by Δi /(1 + i). C) the duration of the asset by the change in the interest rate, Δi. D) the duration of the asset by Δi /(1 + i).

Q: Duration analysis involves comparing the average duration of the bank's ________ to the average duration of its ________. A) securities portfolio; nondeposit liabilities B) loan portfolio; nondeposit liabilities C) loan portfolio; rate-sensitive liabilities D) rate-sensitive assets; rate-sensitive liabilities E) assets; liabilities

Q: Duration gap analysis A) is a refinement of basic gap analysis that accounts for interest-rate changes over a multiyear period. B) is a refinement of basic gap analysis that accounts for how long a gap will last. C) is a complement to basic gap analysis that accounts for the effect of interest rate changes on market value. D) is a complement to basic gap analysis that accounts for the influence of partially rate-sensitive assets.

Q: Measuring the sensitivity of bank profits to changes in interest rates by multiplying the gap for several maturity subintervals by the change in the interest rate is called A) basic gap analysis. B) the segmented maturity approach to gap analysis. C) the maturity bucket approach to gap analysis. D) the segmented maturity approach to interest-exposure analysis. E) none of the above.

Q: Measuring the sensitivity of bank profits to changes in interest rates by multiplying the gap times the change in the interest rate is called ________. A) basic duration analysis B) basic gap analysis C) interest-exposure analysis D) gap-exposure analysis

Q: If First National Bank has a gap equal to a negative $30 million, then a 5 percentage point increase in interest rates will cause profits to A) increase by $15 million. B) increase by $1.5 million. C) decline by $15 million. D) decline by $1.5 million.

Q: If First State Bank has a gap equal to a positive $20 million, then a 5 percentage point drop in interest rates will cause profits to A) increase by $10 million. B) increase by $1.0 million. C) decline by $10 million. D) decline by $1.0 million.

Q: First National BankTable 23.2Refer to Table 23.2. Assuming that the average duration of the bank's assets is four years, while the average duration of its liabilities is three years, a rise in interest rates from 5 percent to 10 percent will cause the net worth of First National to ________ by ________ of the total original asset value.A) decline; 5%B) decline; 1.3%C) decline; 6.2%D) increase; 5%

Q: First National BankTable 23.2Referring to Table 23.2, if interest rates rise by 5 percentage points, then bank profits (measured using gap analysis) willA) decline by $0.5 million.B) decline by $1.5 million.C) decline by $2.5 million.D) increase by $2.0 million.

Q: First National BankTable 23.2Referring to Table 23.2, First National Bank has a gap of ________.A) -10B) 10C) 20D) 0

Q: The difference between rate-sensitive liabilities and rate-sensitive assets is known as the ________. A) duration B) interest-sensitivity index C) interest-rate risk index D) gap

Q: If a bank has ________ rate-sensitive assets than rate-sensitive liabilities, then a(n) ________ in interest rates will increase bank profits. A) more; decline B) more; increase C) less; increase D) both A and C

Q: If a bank has more rate-sensitive assets than rate-sensitive liabilities, then a(n) ________ in interest rates will ________ bank profits. A) increase; increase B) increase; reduce C) decline; increase D) decline; not affect