Question

Determine the optimal hedge ratio for Treasury bonds worth $1,000,000 with a duration of 12.45, yielding 11.9 percent if the futures has a price of $90,000, a duration of 8.5 years and an implied yield of 9.5 percent.

a. 16.27

b. 16.63

c. 7.42

d. 11.11

e. none of the above

which of the following is the interpretation of a VAR of $5 million for one year at .05.

a. the probability is .05 that the firm will lose at least $5 million in one year

b. the probability is at least .05 that the firm will lose $5 million in one year

c. the probability is .05 that the firm will lose $5 million in one year

d. the probability is less than .05 that the firm will lose $5 million in one year none of the above

25. Which of the following are not methods of determining the VAR?

a. simulation method

b. historical method

c. estimation method

d. analytical method

e. none of the above

Consider a swap to pay currency A floating and receive currency B floating. What type of swap would be combined with this swap to produce a swap to produce a plain vanilla Interest rate swap (pay fixed and receive floating) in currency B.

a. pay currency B floating, receive currency A fixed

b. pay currency B fixed, receive currency A floating

c. pay currency B fixed, receive currency A fixed

d. pay currency B floating, receive currency A floating

e. none of the above

Each of the following is a benefit of practicing risk management by companies except

investment opportunities

1. companies can manage risk better than their shareholders

2. risk management can avoid bankruptcy costs

3. risk management can lower taxes

4. risk management can increase employment opportunities

5. risk management can help prevent companies from passing up valuable

33. Find the approximate upcoming net payment on an equity swap in which party A pays the return on stock index 1 and party B pays the return on stock index 2. The notional principal is $25 million. Stock index 1 starts the period at 1500 and goes up to 1600 at the end of the period. Stock index 2 starts the period at 3500 and goes up to 3300 at the end of the period.

    1. The party paying index 1 pays about $238,000

    2. The party paying index 2 pays about $238,000

    3. The party paying index 2 pays about $3.095 million

    4. The party paying index 1 pays about $25 million

    5. The party paying index 1 pays about $3.095 million

33. The advantage of a collar over a cap is

    1. it offers the possibility of greater returns

    2. it lowers the out-of-pocket cost

    3. it eliminates the risk

    4. it has lower transaction costs

Answer 1

Question 2 - answer =(a)

Question 3 - answer =(d) none of the above because VAR has 3 types of methods - historical method, covariance-variance method (uses expected or estimated values) and monte carlo simulation (analytical method)

Question 4 - answer =(b)

• Paying A - floating Receiving B floating = current
• Pay B -fixed Receive B floating = want
• Pay B - fixed Receive A floating = net

Question 5 - answer =(e)

• Shareholders necessarily might not be avioling benefits of a diversified portfolio. Hence, unsystematic risk of the stocks might exist in their portfolio. If the company itself is undertaking risk management, unsystematic risk is considerably reduced.
• Risk management surely reduces bankruptcy costs since financial risks are continuously tracked and measures can be taken in case of deviation.
• Risk management entails hedging of exposures, which in turn lead to mark-to-market losses in profit and loss account. The same are tax deductible.
• Risk management can lead to demand of financial risk managers (FRMs) and chartered financial analysts (CFAs)
• Due to adversity of risk, some opportunities even though value adding might have to be ignored.

Question 7 - answer (d)

Since in a collar there is ceiling on both high and low amount, we are selling call up to a higher level and selling put upto to a level below. Hence, transaction costs are minimized since we are obtaining premiums and in cap we pay premium

Question 1-

			Bond	Futures	PORTFOLIO
	Market value		1,000,000	90,000	1,090,000.0			Hedge ratio
	WEIGHT		0.917	0.083		bond duration/forward duration	bond forward value	P*Dp/Fc.Df
How long does it take to earn back bond price through cash flows	DUR		12.45	8.5	12.1	1.46	1,464,705.9	(forward value*duration of portfolio)/(futures price*duration of bond)
	YTM		11.90%	9.50%				15.8