Question

In: Accounting

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


Related Solutions

It is March and Bank A is concerned about what an increase in interest rates will...
It is March and Bank A is concerned about what an increase in interest rates will do to the value of its bond portfolio. The portfolio currently has a market value of $101.1 million and Bank A management intends to liquidate $1.1 million in bonds in June to fund additional corporate loans. If interest rates rise to 6% the bond will sell for $1 million with a loss of $100000.Bank A's management sells 10 June Treasury bond contracts at 109-050...
You are concerned about potential volatility in market interest rates in the coming years that could...
You are concerned about potential volatility in market interest rates in the coming years that could drive YTM up or down suddenly. Since you are managing a bond portfolio, you want to be able to say how much your bond values will change in the face of a changing YTM. In particular, you are looking at a $1,000 face value bond by Pik-U-Up, Inc. The bond has 6 years until maturity, has a coupon of 4.1% paid semiannually, and an...
Which of the following statements about bonds is most likely to be true? a)The higher the...
Which of the following statements about bonds is most likely to be true? a)The higher the coupon rate, the lower the price of the bond, holding all else constant. b)The higher the coupon frequency, the higher the price of the bond, holding all else constant. c)The higher the yield to maturity, the higher the price of the bond, holding all else constant.
Indicate which bond in the following pairs of bonds is likely to bear the higher interest...
Indicate which bond in the following pairs of bonds is likely to bear the higher interest rate (yield) and state why. If there is no general reason for a difference indicate that they would be the same. A. A corporate bond rated Aaa or a municipal bond rated Aaa B. A municipal bond rated Baa or a municipal bond rated Aa C. A general obligation bond issued by a city or a revenue bond issued by a city D. A...
a. Explain which of the following bonds has higher interest rate sensitivity. Bond A is a...
a. Explain which of the following bonds has higher interest rate sensitivity. Bond A is a 15-year, noncallable bond with a coupon rate of 7%, selling at par. Bond B is a 15-year, callable bond with a coupon rate of 9%, also selling at par. b. Tony, a fixed-income portfolio manager, is managing a portfolio of $10 million. His target duration is 7 years, and he can choose from two bonds: a zero-coupon bond with maturity of 3 years, and...
Current US Treasury Markets indicate that the bonds will rise and proxies for risk-free-rates will fall....
Current US Treasury Markets indicate that the bonds will rise and proxies for risk-free-rates will fall. a. How will this impact nominal rates and risk premiums? b. What are the implications of falling risk-free-rates?
QUESTION 8 Part A: Assume that interest rates on 20-year Treasury and corporate bonds are as...
QUESTION 8 Part A: Assume that interest rates on 20-year Treasury and corporate bonds are as follows: T-bond = 7.72% AAA = 8.72% A = 9.64% BBB = 10.18% The differences in these rates were probably caused primarily by: a. Real risk-free rate differences. b. Maturity risk differences. c. Default and liquidity risk differences. d. Inflation differences. e. Tax effects. Part B: Which of the following is incorrect? a. the currency’s purchasing power is reduced by a rate known as...
Which is INCORRECT regarding corporate bonds? A. Corporate bonds typically have higher yields compared to treasury...
Which is INCORRECT regarding corporate bonds? A. Corporate bonds typically have higher yields compared to treasury bonds with the same maturity. B. The majority of corporate bonds are callable, especially the high yield ones. C. Corporate bonds are traded on the dealers market, and are generally less liquid than stocks. D. The higher the credit rating, the higher the credit spread.
Which of the following theories can explain the stylized fact that interest rates on bonds of...
Which of the following theories can explain the stylized fact that interest rates on bonds of different maturities move together over time? a) Expectations theory b) Segmented markets theory c) Liquidity premium theory d) a) and c) e) a) and b) Which one of the following statement is true? a) The expectation theory explains why the yield curve is upward slopping. b) The segmented markets theory explains why the interest rates of bonds with different maturity dates move together over...
Suppose that US Federal Reserve implements a contractionary monetary policy that leads to higher interest rates...
Suppose that US Federal Reserve implements a contractionary monetary policy that leads to higher interest rates in the US. At the same time, the US economy is experiencing an expansion. Can one use this information to predict what will happen to the USD/AUD exchange rate?
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT