You own US Treasury bonds. You are concerned about higher interest rates. Which of the following...

You own US Treasury bonds. You are concerned about higher interest rates. Which of the following is true?

Question options:

	A. You should buy a futures contract to hedge against higher bond prices
	B. You should buy a forward contract on Treasuries
	C. You should sell a futures contract thus being in a long position in Treasuries and in a shot position in the futures market.
	D. You should sell a futures contract that will pay you when bond prices increase

Suppose that Tesla shares are selling for $875 per share and you own a call option to buy Tesla at $795 per share by the end of the year. The intrinsic value of your option is

Question options:

	A. Impossible to determine until the end of the year
	B. $80
	C. $875
	D. $795

Users of hedges are primarily interested in:

Question options:

	A. reducing their exposure to the risk of price fluctuations
	B. increasing market liquidity.
	C. reducing the spread between bid and ask prices on bonds.
	D. betting on anticipated changes in prices.

Solutions

Expert Solution

Answer to Question 1:

On the increase of market interest rate, the price of a bond decreases

As we are concerned about higher interest prices, it also means that we are concerned about a fall in the price of the bond. So in order to hedge the risk, we need to do something so that we make a profit on an increase in the interest rates or on fall in the price of the bond.

If the interest rate rises, the price of the futures will fall. So we need to sell futures now (short position).

Hence the correction option is

C. You should sell a futures contract thus being in a long position in Treasuries and in a short position in the futures market.

Answer to Question 2:

The intrinsic value of an option is the benefit that will be derived from the option by excercising it now. Hence if the Tesla share price is $ 875, and the Call option has an exercise price of $795, we have an option to buy the shares at an amount lower than the market price. Hence the intrinsic value is:

Intrinsic Value = Market Price - Excercise price

= 875 - 795

= $ 80 per option

Correct option is:

B. $ 80

Answer to Question No. 3:

The main purpose of hedging is to reduce the risk of price fluctuation. Since the market has varied types of risks like price risk, interest rate risks, and so on. Using the hedging instruments, such risks can be eliminated.

So the correct option is:

A. reducing their exposure to the risk of price fluctuations

ekkarill92 answered 1 year ago

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