Chicago Bank and Trust has $100 million in assets and $83 million in liabilities. The duration of the assets is 5.9 years, and the duration of the liabilities is 1.8 years. How many futures contracts does this bank need to fully hedge itself against interest-rate risk? The available Treasury bond futures contracts have a duration of 10 years, a face value of $1,000,000, and are selling for $979,000.
> Consider the decision to purchase either a five-year corporate bond or a five-year municipal bond. The corporate bond is a 12% annual coupon bond with a par value of $1,000. It is currently yielding 11.5%. The municipal bond has an 8.5% annual coupon and
> Assuming that the expectations theory is the correct theory of the term structure, calculate the interest rates in the term structure for maturities of one to five years, and plot the resulting yield curves for the following series of one-year interest r
> You observe the following market interest rates, for both borrowing and lending: one-year rate…………………………………………. 5% two-year rate………………………………………… 6% one-year rate one year from now………… 7.25% How can you take advantage of these rates to earn a riskles
> At your favorite bond store, Bonds-R-Us, you see the following prices: a. 1-year $100 zero selling for $90.19 b. 3-year 10% coupon $1000 par bond selling for $1000 c. 2-year 10% coupon $1000 par bond selling for $1000 Assume that the pure expectations th
> Little Monsters, Inc., borrowed $1,000,000 for two years from NorthernBank, Inc., at an 11.5% interest rate. The current risk-free rate is 2%, and Little Monsters’ financial condition warrants a default risk premium of 3% and a liquidity risk premium of
> Using the information from the previous question, assume that investors prefer holding short-term bonds. A liquidity premium of 10 basis points is required for each year of a bond’s maturity. What will be the interest rates on a three-year bond, a six-ye
> Explain why you would be more or less willing to buy a house under the following circumstances: a. You just inherited $100,000. b. Real estate commissions fall from 6% of the sales price to 4% of the sales price. c. You expect Polaroid stock to double in
> How does a decline in the value of the pound sterling affect British consumers?
> Predict what will happen to interest rates if prices in the bond market become more volatile.
> Predict what will happen to interest rates if the public suddenly expects a large increase in stock prices.
> Will there be an effect on interest rates if brokerage commissions on stocks fall? Explain your answer.
> Using a supply-and-demand analysis for bonds, show what the effect is on interest rates when the riskiness of bonds rises.
> What effect will a sudden increase in the volatility of gold prices have on interest rates?
> “No one who is risk-averse will ever buy a security that has a lower expected return, more risk, and less liquidity than another security.” Is this statement true, false, or uncertain? Explain your answer.
> “The more risk-averse people are, the more likely they are to diversify.” Is this statement true, false, or uncertain? Explain your answer.
> How might a sudden increase in people’s expectations of future real estate prices affect interest rates?
> Using the supply-and-demand for bonds framework, show why interest rates are procyclical (rising when the economy is expanding and falling during recessions).
> What effect might a rise in stock prices have on consumers’ decisions to spend?
> An important way in which the Federal Reserve decreases the money supply is by selling bonds to the public. Using a supply-and-demand analysis for bonds, show what effect this action has on interest rates.
> Why does a lower strike price imply that a call option will have a higher premium and a put option a lower premium?
> If the finance company you manage has a gap of +$5 million (rate-sensitive assets greater than rate-sensitive liabilities by $5 million), describe an interest-rate swap that would eliminate the company’s income gap.
> If your company has a payment of 200 million euros due one year from now, how would you hedge the foreign exchange risk in this payment with 125,000 euros futures contracts?
> If the savings and loan you manage has a gap of -$42 million, describe an interest-rate swap that would eliminate the S&L’s income risk from changes in interest rates.
> I own a professional football team, and I plan to diversify by purchasing shares in either a company that owns a pro basketball team or a pharmaceutical company. Which of these two investments is more likely to reduce the overall risk I face? Why?
> Suppose that you buy a call option on a $100,000 Treasury bond futures contract with an exercise price of 110 for a premium of $1,500. If on expiration the futures contract has a price of 111, what is your profit or loss on the contract?
> If you buy a put option on a $100,000 Treasury bond futures contract with an exercise price of 95 and the price of the Treasury bond is 120 at expiration, is the contract in the money, out of the money, or at the money? What is your profit or loss on the
> If you buy a $100,000 February Treasury bond contract for 108 and the price of the deliverable Treasury bond at the expiration date is 102, what is your profit or loss on the contract?
> If the portfolio you manage is holding $25 million of 6s of 2032 Treasury bonds with a price of 110, what forward contract would you enter into to hedge the interest-rate risk on these bonds over the coming year?
> If the pension fund you manage expects to have an inflow of $120 million six months from now, what forward contract would you seek to enter into to lock in current interest rates?
> A swap agreement calls for Durbin Industries to pay interest annually based on a rate of 1.5% over the one-year T-bill rate, currently 6%. In return, Durbin receives interest at a rate of 6% on a fixed-rate basis. The notional principal for the swap is $
> Consider a put contract on a T-bond with an exercise price of 101 12/32. The contract represents $100,000 of bond principal and had a premium of $750. The actual T-bond price falls to 98 16/32 at the expiration. What is the gain or loss on the position?
> A bank customer will be going to London in June to purchase £100,000 in new inventory. The current spot and futures exchange rates are as follows: Exchange Rates Dollars/Pound Period…………………….Rate Spot……………………………1.5342 March………………………..1.6212 June…………………
> Assume the bank in the previous question partially hedges the mortgage by selling three 10-year T-note futures contracts at a price of 100 20/32. Each contract is for $1,000,000. After two months, the futures contract has fallen in price to 98 24/32. Wha
> Futures are available on three-month T-bills with a contract size of $1 million. If you take a long position at 96.22 and later sell the contracts at 96.87, how much would the total net gain or loss be on this transaction?
> A hedger takes a short position in five T-bill futures contracts at the price of 98 5/32. Each contract is for $100,000 principal. When the position is closed, the price is 95 12/32. What is the gain or loss on this transaction?
> Suppose that your company will be receiving 30 million euros six months from now and the euro is currently selling for 1 euro per dollar. If you want to hedge the foreign exchange risk in this payment, what kind of forward contract would you want to ente
> If your company has to make a 10 million euros payment to a German company in June, three months from now, how would you hedge the foreign exchange risk in this payment with a 125,000 euros futures contract?
> A bank issues a $100,000 variable-rate 30-year mortgage with a nominal annual rate of 4.5%. If the required rate drops to 4.0% after the first six months, what is the impact on the interest income for the first 12 months? Assume the bank hedged this risk
> Explain why greater volatility or a longer term to maturity leads to a higher premium on both call and put options.
> How would you use the options market to accomplish the same thing as in Problem 5? What are the advantages and disadvantages of using an options contract rather than a futures contract?
> Suppose that the pension you are managing is expecting an inflow of funds of $100 million next year and you want to make sure that you will earn the current interest rate of 8% when you invest the incoming funds in long-term bonds. How would you use the
> If at the expiration date, the deliverable Treasury bond is selling for 101 but the Treasury bond futures contract is selling for 102, what will happen to the futures price? Explain your answer.
> North-Northwest Bank (NNWB) has a differential advantage in issuing variable-rate mortgages but does not want the interest income risk associated with such loans. The bank currently has a portfolio of $25,000,000 in mortgages with an APR of prime +150 ba
> The president of the United States announces in a press conference that he will fight the higher inflation rate with a new anti-inflation program. Predict what will happen to interest rates if the public believes him.
> A trust manager for a $100,000,000 stock portfolio wants to minimize short-term downside risk using Dow put options. The options expire in 60 days, have a strike price of 9,700, and a premium of $50. The Dow is currently at 10,100. How many options shoul
> A banker commits to a two-year $5,000,000 commercial loan and expects to fulfill the agreement in 30 days. The interest rate will be determined at that time. Currently, rates are 7.5% for such loans. To hedge against rates falling, the banker buys a 30-d
> A bank issues a $100,000 fixed-rate 30-year mortgage with a nominal annual rate of 4.5%. If the required rate drops to 4.0% immediately after the mortgage is issued, what is the impact on the value of the mortgage? Assume the bank hedged the position wit
> Springer County Bank has assets totaling $180 million with a duration of five years, and liabilities totaling $160 million with a duration of two years. Bank management expects interest rates to fall from 9% to 8.25% shortly. A T-bond futures contract i
> A bank issues a $3 million commercial mortgage with a nominal APR of 8%. The loan is fully amortized over 10 years, requiring monthly payments. The bank plans on selling the loan after two months. If the required nominal APR increases by 45 basis points
> Laura, a bond portfolio manager, administers a $10 million portfolio. The portfolio currently has a duration of 8.5 years. Laura wants to shorten the duration to 6 years using T-bill futures. T-bill futures have a duration of 0.25 years and are trading a
> Can a financial institution keep borrowers from engaging in risky activities if there are no restrictive covenants written into the loan agreement?
> “If more customers want to borrow funds at the prevailing interest rate, a financial institution can increase its profits by raising interest rates on its loans.” Is this statement true, false, or uncertain? Explain your answer.
> In the aftermath of the global financial crisis, U.S. government budget deficits increased dramatically, yet interest rates on U.S. Treasury debt fell sharply and stayed low for many years. Does this make sense? Why or why not?
> Why is being nosy a desirable trait for a banker?
> Why are secured loans an important method of lending for financial institutions?
> “Because diversification is a desirable strategy for avoiding risk, it never makes sense for a financial institution to specialize in making specific types of loans.” Is this statement true, false, or uncertain? Explain your answer.
> A bank almost always insists that the firms it lends to keep compensating balances at the bank. Why?
> If the First National Bank sells $10 million of its securities with maturities greater than two years and replaces them with securities maturing in less than one year, what is the income gap for the bank? What will happen to profits next year if interest
> The following financial statement is for the current year. After you review the data, calculate the duration gap for the bank. Second National Bank Duration Duration Assets (in years) Liabilities (in years) Reserves $5,000,000 0.00 Checkable deposit
> Calculate the change in the market value of assets and liabilities when the average duration of assets is 3.60, the average duration of liabilities 0.88, and interest rates increase from 5% to 5.5%.
> A bank added a bond to its portfolio. The bond has a duration of 12.3 years and cost $1,109. Just after buying the bond, the bank discovered that market interest rates are expected to rise from 8% to 8.75%. What is the expected change in the bond’s value
> Chicago Avenue Bank has the following assets: What is Chicago Avenue Bank’s asset portfolio duration? Duration Asset Value (in years) $100,000,000 $40,000,000 T-bills 0.55 Consumer loans 2.35 Commercial loans $15,000,000 5.90
> Calculate the income gap for a financial institution with rate-sensitive assets of $20 million and rate-sensitive liabilities of $48 million. If interest rates rise from 4% to 4.8%, what is the expected change in income?
> Explain what effect a large federal deficit might have on interest rates.
> A bank’s balance sheet contains interest-sensitive assets of $280 million and interest-sensitive liabilities of $465 million. Calculate the income gap.
> Given the estimates of duration in Problem 27, how should the Friendly Finance Company alter the duration of its liabilities to immunize its net worth from interest-rate risk? Data from Problem 27: If the manager of the Friendly Finance Company revises
> Given the estimates of duration found in Problem 27, how should the Friendly Finance Company alter the duration of its assets to immunize its net worth from interest-rate risk?
> If the manager of the Friendly Finance Company revises the estimates of the duration of the company’s assets to two years and liabilities to four years, what is the effect on net worth if interest rates rise by 3 percentage points?
> Given the estimates of duration in Problem 21, how should the bank alter the duration of its liabilities to immunize its net worth from interest-rate risk? Data from Problem 21: If the manager of the First National Bank revises the estimates of the dura
> Given the estimates of duration in Problem 21, how should the bank alter the duration of its assets to immunize its net worth from interest-rate risk?
> If the manager of the First National Bank revises the estimate of the percentage of fixed-rate mortgages that are repaid within a year from 20% to 10%, what will be the revised estimate of the interest-rate risk the bank faces? What will happen to profit
> Calculate the duration of a $100,000 fixed-rate 30-year mortgage with a nominal annual rate of 7.0%. What is the expected percentage change in value if the required rate drops to 6.5% immediately after the mortgage is issued?
> A bank issues a $100,000 fixed-rate 30-year mortgage with a nominal annual rate of 4.5%. If the required rate drops to 4.0% immediately after the mortgage is issued, what is the impact on the value of the mortgage?
> A bank issues a $100,000 variable-rate 30-year mortgage with a nominal annual rate of 4.5%. If the required rate drops to 4.0% after the first six months, what is the impact on the interest income for the first 12 months?
> Last month, corporations supplied $250 billion in bonds to investors at an average market rate of 11.8%. This month, an additional $25 billion in bonds became available, and market rates increased to 12.2%. Assuming a Loanable Funds Framework for interes
> Given the estimates of duration in Table 23.2, what will happen to the Friendly Finance Company’s net worth if interest rates rise by 3 percentage points? Will the company stay in business? Why or why not? Table 23.2 TABLE 23.2 Dura
> If the Friendly Finance Company raises an additional $20 million with commercial paper and uses the funds to make $20 million of consumer loans that mature in less than one year, what happens to its interest-rate risk? In this situation, what additional
> If the manager of the Friendly Finance Company decides to sell off $10 million of the company’s consumer loans, half maturing within one year and half maturing in greater than two years, and uses the resulting funds to buy $10 million of Treasury bills,
> If the manager of the First National Bank revises the estimates of the duration of the bank’s assets to four years and liabilities to two years, what is the effect on net worth if interest rates rise by 2 percentage points?
> Given the estimates of duration in Table 23.1, what will happen to the bank’s net worth if interest rates rise by 10 percentage points? Will the bank stay in business? Why or why not? Table 23.1: Weighted Duration (years) Amount
> If the manager of the First National Bank revises the estimate of the percentage of checkable deposits that are rate-sensitive from 10% to 25%, what will be the revised estimate of the interest-rate risk the bank faces? What will happen to profits next y
> If the First National Bank decides to convert $5 million of its fixed-rate mortgages into variable-rate mortgages, what happens to its interest-rate risk? Explain with income gap and duration gap analyses
> The manager for Tyler Bank and Trust has the following assets and liabilities to manage: If the manager wants a duration gap of 3.00, what level of saving accounts should the bank raise? Assume that any difference between assets and liabilities is held
> Springer County Bank has assets totaling $180 million with a duration of five years, and liabilities totaling $160 million with a duration of two years. If interest rates drop from 9% by 75 basis points, what is the change in the bank’s capitalization ra
> The following financial statement is for the current year. From the past, you know that 10% of fixedrate mortgages prepay each year. You also estimate that 10% of checkable deposits and 20% of savings accounts are rate-sensitive. What is the current inco
> Consider a $1,000-par junk bond paying a 12% annual coupon. The issuing company has 20% chance of defaulting this year; in which case, the bond would not pay anything. If the company survives the first year, paying the annual coupon payment, it then has
> Calculate the income gap given the following items: • $8 million in reserves • $25 million in variable-rate mortgages • $4 million in checkable deposits • $2 million in savings deposits • $6 million of 2-year CD’s
> Calculate the duration of a commercial loan. The face value of the loan is $2,000,000. It requires simple interest yearly, with an APR of 8%. The loan is due in four years. The current market rate for such loans is 8%.
> The value of a $100,000 fixed-rate 30-year mortgage falls to $89,537 when interest rates move from 5% to 6%. What is the approximate duration of the mortgage?
> What are the principal advantages often cited as motivation for a private equity buyout?
> Why would an investment banker advise a firm to issue a security using best efforts rather than underwriting?
> Is it better for a security issue to be fully subscribed or oversubscribed?
> Why do investment banking firms often form syndicates for selling securities to the public?
> Does the fact that a security has passed an SEC review mean that investors can buy the security without having to worry about taking a loss on the investment?
> What are the primary services that an investment banker will provide a firm issuing securities?
> What does it mean to say that investment bankers underwrite a security offering? How is this different from a best-efforts offering?
> You own a $1,000-par zero-coupon bond that has 5 years of remaining maturity. You plan on selling the bond in one year and believe that the required yield next year will have the following probability distribution: Probability……………….Required Yield 0.1……
> What law separated investment banking and commercial banking?
> What was the motivation behind legislation separating commercial banking and investment banking?
> Why do commercial banks object to brokerage houses being allowed to offer many of the services traditionally reserved for banks?
