1 What is a difference between a forward contract and a future contract?

a. The settlement price of a forward contract is fixed over the life of the contract
but in a futures contract is marked to market daily
2. Why does basis risk occur?
e. Changes in the spot asset's price are not perfectly correlated with changes in
the price of the asset delivered under a forward or futures contract, and spot and
futures contracts are traded in different markets with different demand and
supply functions.
3. A bank plans to issue GICs in three months. What is the FI's interest rate risk
exposure and how can it use financial forwards to hedge that risk exposure?
a. Long hedge (buy forwards) because the FI is exposed to interest rate
increases.
4. An FI issued $1 million of 1-year maturity floating rate commercial paper. The
commercial paper is repriced every three months at the 91-day Treasury bill rate
plus 2%. Therefore the duration of the FI assets is lower than the duration of its
liabilities. What is the FI's interest rate risk exposure and how can it use financial
futures to hedge that risk exposure?
e. The FI cannot hedge its exposure to interest rate increases or decreases using
financial futures
5. A bank plans to sell bonds in one year. What is the FI's interest rate risk
exposure and how can it use financial forwards to hedge that risk exposure?
c. Short hedge (sell forwards) because the FI is exposed to interest rate
increases.
6 Given the duration gap, the FI should enter which position in futures contracts
to hedge their interest rate exposure?
b. Short hedge (sell futures) because the FI is exposed to interest rate increases.
7. What is the number of T-bond futures contracts necessary to hedge the
balance sheet if the duration of the deliverable bonds is 9 years and the current
price of the futures contract is $95 per $100 face value. Each futures contract is
for a $100,000 face value of deliverable bonds. The basis risk shows that for
every 1% shock to interest rates, i.e., R/(1 + R) = 0.01, the implied rate on the
deliverable bonds in the futures market increases by 1.1 percent,i.e., Rf/(1 +
Rf) = 0.011? Do not round the number of contracts.
a. 1,520.47 contracts
8. What is the gain or loss on the futures position using T-Bonds (Duration = 9
years, $95 per $100 face value) if interest rates increase from the current rates
of 10% to 11% (i.e., R = +0.01, and 1 + R = 1.10 and basis risk is 1.1)? Do not
round the number of contracts when calculating the change in futures value.

Expected V= -DGAP[R/(1 + R)]A *Number of contract =$ 1181818 as sold

a. $11,818,181.82 gain

Problem 9 What is the change in the value of the FI's equity for a 1 percent
increase in interest rates from the current rates of 10 percent (i.e., R = +0.01,
and 1 + R = 1.10)?
Expected E = -DGAP[R/(1 + R)]A = -6.5*200*(0.01/1.1)
e. -$11,818,181.82
10 The FI should enter which position in US futures contracts to hedge their
foreign exchange exposure?
d. Short hedge because the FI is exposed to US dollar depreciation
11. Calculate the number of futures contracts needed to fully hedge the foreign
exchange. US future contracts are sold in standardized units of US$10,000. Do
not round the number of contracts.
c. 15,000.00 contracts
12. If the US futures price falls from $1.3548/US$ to $1.3147/US$, what will be
the impact on the FIs futures position? Do not round the number of contracts
when calculating the change in the value of the futures.
Gain = - ( 1.3147-1.3548)x 1500x 10,000
c.$6,015,000.00 gain
13. If the US spot exchange rate falls from $1.2953/US$ to $1.2352/US$, how will
this impact the FIs
currency exposure?
D(s) = -0.0601
a. -$1,503,750.00
14. The FI has made a loan commitment of 10 million Euro that is likely to be
taken down in six months. The FI should enter which position in Euro futures
contracts to hedge their foreign exchange exposure?
d. Short hedge because the FI is exposed to Euro depreciation
15. A FI lends $30,000,000 to a BB rated corporation. The spread of a BB rated
benchmark bond is 2.8% over the U.S. Treasury bond of similar maturity. The FI

sells a $30,000,000 one-year credit forward contract to an insurance company. At

maturity, the spread of the benchmark bond against the Treasury bond is 2.4%,
and the benchmark bond has a modified duration of 5 years. What is the amount
paid when the contract matures?
d. The buyer pays the seller $120,000
16. What kind of interest rate swap (of liabilities) should the FI utilize to hedge
interest rate risk exposure?
b. Swap floating-rate receipts for fixed-rate payments
17. What is the optimal (not rounded) number of swap contracts into which the
bank should enter?
a. 3,250.00 contracts
18. Consider the duration of the fixed and the floating portion of a swap, which of
the following statements is most correct?
e. The market value of the swap will increase with an increase in interest rates.
19. The credit union has funded 10% fixed-rate assets with variable-rate
liabilities at LIBOR + 2%. A bank has funded variable-rate assets with fixed-rate
liabilities at 6%. The bank's variable-rate assets earn LIBOR + 1%. The credit
union and the bank have reached agreement on an interest-rate swap with the
fixed-rate swap payment at 6% and the variable-rate swap payment at LIBOR.
What will be the net after-swap cost of funds forthe credit union if the cash
market liabilities are included in the analysis?
b. Fixed-rate at 8%
20. The credit union has funded 10% fixed-rate assets with variable-rate
liabilities at LIBOR + 2%. A bank has funded variable-rate assets with fixed-rate
liabilities at 6%. The bank's variable-rate assets earn LIBOR + 1%. The credit
union and the bank have reached agreement on an interest-rate swap with the
fixed-rate swap payment at 6% and the variable-rate swap payment at LIBOR.
What will be the net after-swap cost of funds for the bank if the cash market
liabilities are included in the analysis?
a. Variable-rate at LIBOR
21. Assume that LIBOR is 5.25% in year one and 6.25% in year two. What will be
the net swap cash flow for the credit union in the first and the second year of the
swap, if the notional value of a swap is $281,250,000?
b. The credit union receives $703,125 from the bank in year one and pays
$2,109,375 to the bank in year two
22. What is the Swiss FIs foreign exchange exposure?

a. The FI has positive net interest in US$ and is exposed to US dollar appreciation
23. What are the cash flows if exchange rates are unchanged over the next three
years?
a. Sf4.95 million each year
24. Consider the FI short hedges the assets proceeds at the current exchange
rate Sf1.1/US$. If the US dollar is expected to appreciate against the Sf to
Sf1.25/$, Sf1.45$ and Sf1.65/US$ over the next three years, what will be the net
cash flows in Swiss franc for the FI each year?
c. Sf3.15 mil in year 1, Sf0.75 mil in year 2 and Sf84.15 mil in year 3
25. Consider the FI swaps dollar payments for Swiss franc payments at the
current spot exchange rate (the FI pays 8% on the Sf165 million = 150 million x
Sf1.1/US$ and receives 8% on the US$150 million notional). What are the cash
flows to the swap? Continue to consider that the dollar is expected to appreciate
against the Sf to Sf1.25/ US $, Sf1.45/US $ and Sf1.65/US$ over the next three
years.
a. Sf1.8 mil in year 1, Sf4.2 mil in year 2 and Sf89.1 mil in year 3
26. What are the cash flows on the entire hedged position (the short hedge in
problem 24 and the currency swap in problem 25).
d. Sf4.95 mil in year 1, Sf4.95 mil in year 2 and Sf4.95 mil in year 3
27. Market interest rates are expected to increase from 11% to 12% in the next
year. If this occurs, what will be the effect on the market value of equity?
Duration = - (1/V) x (dV/dY)
1.95 = - (1/150) x(dV/0.01)
dV1 = -1.365
dV2 = -5.120
dV3 = -4.100
change in Value of equity = ($4.100million - $1.365 million - $5.120 million)
b. -$2,385,000.00
Q.28 The FI wants to hedge the balance sheet with T- bond option contracts. The
underlying bonds currently have a duration of 8.12 years and a market value of
$95,000 per $100,000 face value. Further, the delta of the put options is 0.45.
What hedge would be appropriate for the FI and how many contracts should the
FI use to hedge this balance sheet?
d. Short calls; 309.18 contracts ( by conducting duration matching)

Q29 If rates increase with 1%, what will be the change in value of the option
position?
Change in price of spot = - 2385014.52 $
Change in price of option = 1073256.534 $
e. None of the above
Q30 At the time of placement, the premium on the put options is quoted at $1.75
per $1,000. What is the cost to in placing the hedge?
b. $541,062
Q 31. How much must interest rates change before the payoff of the hedge will
exactly cover the cost of placing the hedge?
a. 0.454%
Q 32. A bank purchases a 3-year, 6% $5 million cap. The payments are paid or
received at the end of year 2 and 3. Assume interest rates are 2% in year 2 and
7% in year 3. Which of the following is true?
d. The bank will receive $0 at the end of year 2 and receive $50,000 at the
end of year 3

Q33. A bank purchases a 3-year, 4% $5 million floor. The payments are paid or
received at the end of year 2 and 3. Assume interest rates are 2% in year 2 and
7% in year 3. Which of the following is true?
e. The bank will receive $100,000 at the end of year 2 and pay $0 at the end
of year 3
Q34. A bank purchases a 3-year, 6% $5 million cap and a 3-year, 4% $5 million
floor. The payments are paid or received at the end of year 2 and 3. Assume
interest rates are 2% in year 2 and 7% in year 3. Which of the following is true?
a. The bank will receive $100,000 at the end of year 2 and receive $50,000
at the end of year 3
35. What is the monthly payment on the mortgage pass-through?
b. $110,065
36. For the first monthly payment, what portion is principal and what portion is
interest?
d. $100,000 interest and $10,065 principal

37. If the entire mortgage pool is repaid after the second month, what is the
second month's (liquidating) principal and interest payments?
a. $99,933 interest and $14,989,935 principal
38. What is the weighted average life of the above mortgage pool?
b. 2 months
39. What is the present value of the mortgage pass-through if the entire pool is
repaid after two months and there is no change in interest rates?
c. $15,000,000
40. What are the annual coupon payments promised to each tranche? (Assume
no prepayments and non amortization of principal.)
a. $5.5 million on Tranche A and $6.3 million on Tranche B
Explanation: 110*5/100 = 5.5$ million, and 90*7/100 = 6.3 $million
41. If at the end of the first year, the CMO trustee receives total cash flows of
$15 million, how are they distributed?
Interest = $5.5 million on Tranche A and $6.3 million on Tranche B = 11.8
$million
Total cash flows = $15 million , resources left for capital repayment = $15 million
- 11.8 $million = 3.2 $million
Capital payment for tranche A = 1.6 $million , tranche B = 1.6 $million
e. $7.1 million to Tranche A and $7.9 million to Tranche B
42. What is the principal outstanding on Tranche A and Tranche B after the end of
year payment in the previous question?
e. $108.4 million on Tranche A and $88.4 million on Tranche B