Question

What kind of futures or options hedges would be called for in the following situations?

Choose one best combination:
Buy futures and buy call options Buy futures and sell call options Buy futures and buy put options Buy futures and sell put options		Sell futures and buy call options Sell futures and sell call options Sell futures and buy put options Sell futures and sell put options

1-1.   Bank A has interest-sensitive assets less than interest-sensitive liabilities by $43 million. If interest rates increase (as suggested by data from the Federal Reserve Board) the bank’s net interest margin may be squeezed.

        

Choice: _______

1-2.   Bank A finds that its assets have an average duration of 1.2 years and its liabilities have an average duration of 1.8 years. The ratio of liabilities to assets is 0.88. Interest rates are expected to decrease by 50 basis points during the next six months.

Choice: _______

1-3.   A survey of Bank A’s corporate loan customers this month (January) indicates that on balance, this group of firms will need to draw $183 million from their credit lines in February and March, which is $72 million more than the bank’s management has forecasted and prepared for. The bank’s economist has predicted a significant increase in money market interest rates over the next 60 days.

Choice: _______

1-4.   Bank A has interest-sensitive assets of $76 million and interest-sensitive liabilities of $57 million over the next 30 days and market interest rates are expected to fall.

Choice: _______

1-5.   Market interest rates are expected to increase and Bank A’s asset-liability managers expect to liquidate a portion of their bond portfolio to meet customers’ demands for funds in the upcoming quarter.

Choice: _______

Answer 1

Hedging = change in current position + change in hedge instrument = 0

1) buying futures and buying call as liability is more interest sensitive then asset.Therefore outflow will increase more and to hedge against it we need to buy futures so that inflow from futures nulifies outflows. And we will also buying call option as call value increases due to increase in interest rate (from option greeks).

2) selling future and buying a put. As liability duration is more than asset then change in liablity will be more. Therefore as interest rate decrease liablity falls more so selling a future is good. And from option greeks we know that put value increases as interest rate fall , thus we are buying a put.

3) buying futures and buying call. Bank's outflow tends to increase in near future to hedge against it bank needs to buy future. And buy call as well due to increase in interest rate.

4) selling future and buying a put. Bank has more interest sensitive asset than liability, therefore fall will be more in asset due to fall in interest rate. To hedge against it we need to sell future and buy put as its value increases due to fall in interest rate.   

5) selling future and buying a put option. Bank will liquidate its thus it selling future and buy put to hedge against downdside risk.