1. A(n) _________________________ is an agreement between a buyer and a seller today which
calls for the delivery of a particular security in exchange for cash at some future date for a set
price.
2. A financial institution goes _________________________ in the futures market by selling a
futures contract.
3. A financial institution goes _________________________ in the futures market by buying a
futures contract.
4. _________________________ is the difference in interest rates (or prices) between the cash
market and the futures market on an underlying security.
5. The_________________________ is the fee the buyer must pay to be able to put securities to or
to call securities away from the option writer.
6. A(n)_________________________ allows the holder the right to either sell securities to another
investor (put) or buy securities from another investor (call) for a set price before the expiration
date.
7. Futures contracts are_________________________ daily which means that the futures contracts
settled each day as the market value of the futures contracts change.
8. Most options today are traded on a(n)_________________________. These options are
standardized to make offsetting an existing position easier.
9. A(n)_________________________ means that the buyer of the option contract is betting that the
market price of the underlying security will decline in the future.
10. A(n)_________________________ means that the buyer of the option contract is betting that the
market price of the underlying security will increase in the future.
11. A(n)_________________________ is where a borrower with a lower credit rating enters into an
agreement with a borrower with a higher credit rating to exchange interest payments.
12. In an interest rate swap, the________________________ or principal amount is not exchanged.
13. A(n)_________________________ is an interest rate swap which offsets the original interest rate
swap agreement.
14. In an interest rate swap agreement , __________________ reduces the default risk. This is where
the swap parties exchange only the net difference between interest payments owed.
15. A(n)_________________________ is a contract where two parties exchange interest payments in
order to save money and hedge against interest rate risk.
16. A(n)_________________________ is an agreement between two parties where they agree to
exchange different currencies. It is designed to reduce exchange rate risk.
17. A(n)_________________________ protects the holder from rising market interest rates. It sets
the maximum interest rate that a lender can charge on the loan.
18. A(n)__________________________________________________protects the lender from
falling interest rates. It is the minimum rate that the borrower must pay on a variable-rate loan.
19. A(n)_________________________ is where there is both a minimum and a maximum interest
rate set on a loan.
20. In an interest-rate swap, the principal amount of the loan, usually called the
_________________________, is not exchanged.
21. The category of derivative contract with the largest use by banks is __________.
22. The _______ is the spread between the cash price and futures price of an underlying asset.
23. An interest-rate ________ would protect the swap party receiving a floating-rate payment in the
swap.
24. An interest-rate _______ would protect the swap party receiving a fixed-rate payment and paying
a floating-rate in a swap.
25. The combination of both a cap and floor is known as an interest-rate _________.
26. One reason that banks use derivatives is to generate important , money that
does not come from interest earned on loans and securities.
27. are financial assets that derive their value from some underlying
instrument.
28. The largest banks account for more than 99 percent of derivatives
activity in the U.S.
29. When an investor buys or sells a futures contract, they must deposit a(n) when
they first enter into the contract.
30. On the exchange floor, execute orders received from the public to buy
and sell the futures contract at the best possible price.
31. The financial futures markets are designed to shift the risk of interest rate fluctuations from risk-
avers investors to .
32. Futures contracts can be traded , without the help of an organized
exchange.
33. The is determined by the clearing house and is used to the
marked-to-market amount.
34. The most actively traded futures contract in the world is the . It is traded
on exchanges in Chicago, London, Tokyo, Singapore and elsewhere and allows investors the
opportunity to hedge against market interest rate changes.
35. The buyer of a call option has the right to buy from the writer of the option contract securities at
the .
36. One of the most popular methods of neutralizing duration gap risks is to buy and sell financial
futures contracts.
37. The financial futures markets are designed to shift the risk of interest rate fluctuations from risk-
averse investors to speculators who are willing to accept and possibly profit from such risks.
38.
When a financial institution offers to sell financial futures contract, it is “going short” in futures
and is agreeing to take delivery of certain kinds of securities on a stipulated date at a
predetermined price.
39. There are some significant limitations to financial futures as interest-rate hedging devices, among
them is a special form of risk known as credit risk.
40. An effective hedge is one where the positive or negative returns earned in the cash market are
approximately offset by the profit or loss from futures trading.
41. A hedging tool that provides “one-sided” insurance against interest rate risk is the interest rate
option, which, like financial futures contracts, obligates the parties to the contract to either deliver
or take delivery of securities.
42. U.S. Treasury bond futures contracts call for the future delivery of U.S. T-bonds with minimum
denominations of $100,000 and minimum maturities of 15 years.
43. A futures hedge against interest-rate changes generally requires a bank to take an opposite
position in the futures market from its current position in the cash market.
44. The short hedge in financial futures contracts is most likely to be used in situations where a bank
would suffer losses due to falling interest rates.
45. The long hedge in financial futures contracts is most likely to be used in situations where a bank
would suffer losses due to rising interest rates.
46. The short hedge would usually be the correct choice if a bank is concerned about avoiding lower
than expected yields from loans and security investments.
47. A financial institution with a positive interest-sensitive gap and anticipating falling interest rates
could protect against loss by covering the gap with a long hedge.
48. A financial institution confronted with a negative interest-sensitive gap could avoid unacceptable
losses from rising interest rates by covering the gap with a short hedge.
49. The sensitivity of the market price of a financial futures contract depends upon the duration of the
security to be delivered under the futures contract.
50. In U.S. banking any gain or loss from futures trading must be “coincidental” to the main purpose
of the trading—interest-rate hedging.
51. If a U.S. bank’s financial futures trading can be linked to a particular asset or liability position
where it faces interest-rate risk exposure, that bank must take immediate recognition of any losses
or gains it experiences from futures trading.
52. According to the textbook the two principal uses of option contracts by banks are to protect the
value of a bond portfolio or to hedge against interest-sensitive or duration gaps.
53. Banks are generally writers (sellers) of put and call option contracts.
54. The market value of a futures contract changes daily as the market price of the underlying
security price changes.
55. A futures contract is “marked to market” weekly to reflect the current market price of the
contract. This means that one or the other party has to make a cash payment to the exchange at
the end of each week.
56. If a financial institution makes an offsetting sale and purchase of the same futures contract, it has
no obligation either to deliver or take delivery of the contract.
57. A bank will use a short hedge in the futures market to avoid higher borrowing costs or to protect
against declining asset values.
58. One of the significant disadvantages of using futures contracts to hedge against interest rate risk
is the high commissions that must be paid to brokers.
59. Basis risk is the difference in the interest rates (or prices) of the same security between the cash
market and the futures market.
60. In the typical quality swap a borrower with a positive duration gap is more likely to pay all or part
of the other swap party’s long-term interest rate.
61. A currency swap is where two parties agree to exchange interest payments in order to hedge
against interest rate risk.
62. In most interest rate swaps netting reduces the default risk because the parties actually exchange
only the difference in the interest payments.
63. One advantage of an interest rate swap agreement is that the brokerage fees are very small.
64. Unlike futures contracts, interest rate swap agreements have no basis risk.
65. Interest rate caps protect the lender from falling interest rates.
66. Interest rate floors protect the lender from falling interest rates.
67. An interest rate collar sets both a minimum and a maximum interest rate on a variable rate loan
agreement.
68.
Basis risk exists on interest rate swaps because the interest rate on the swap agreement may differ
from the interest rate on assets and liabilities that the parties hold.
69. A reverse swap is where the parties exchange the principal payments instead of the interest
payments on loans.
70. An interest-rate cap on a loan would protect the lender.
71. Many banks are not only users of derivative products but also dealers.
72. Most derivatives (measured by notional value) are traded on organized exchanges.
73. An interest-rate cap will become more valuable as interest rates rise.
74. Virtually all banks in the U.S. use derivative contracts to hedge their risks.
75. The number of futures contracts needed to hedge a position increases as the bank’s duration gap
increases.
76. A financial institution with a negative gap would like to receive the floating rate in an interest–
rate swap.
77. A financial institution with a negative gap could reduce the risk of loss due to changing interest
rates by:
A) Extending asset maturities
B) Increasing short-term interest-sensitive liabilities
C) Using financial futures or options contracts.
D) All of the above.
E) None of the above.
78. If a bank has a positive gap, that is, if it is asset sensitive, the bank can hedge its interest-rate risk
by which of the following activities:
A) Reduce its asset maturities.
B) Reduce maturities of its liabilities.
C) Use a long hedge.
D) All of the above.
E) A and C only.
79. A significant limitation to financial futures as an interest-rate hedging device is a special form of
risk known as ___________ risk. Which of the following terms correctly completes the
statement?
A) Default
B) Basis
C) Credit
D) Market
E) None of the above.
80. The realized return to a bank from a combined cash and futures market trading operation is
composed of which of the following elements:
A) Return earned in the cash market.
B) Profit or loss from futures trading.
C) Difference between the opening and closing basis between cash and futures markets.
D) All of the above.
E) B and C only.
81. Advantages of trading financial futures to hedge interest-rate risk include which of the following:
A) Only a fraction of the value of the contract must be pledged as collateral.
B) Brokers’ commissions are relatively low.
C) There is no risk in trading futures contracts.
D) All of the above.
E) A and B only.
82. An option buyer can:
A) Exercise the option.
B) Sell the option to another buyer.
C) Allow the option to expire.
D) All of the above.
E) A and B only.
83. A bank wishing to avoid higher borrowing costs would be most likely to use:
A) A short or selling hedge in futures.
B) A long or buying hedge in futures.
C) A call option on futures contracts.
D) B and C above.
E) None of the above.
84. A bank seeking to avoid lower than expected yields from loans and security investments would
be most likely to use:
A) A short or selling hedge in futures.
B) A long or buying hedge in futures.
C) A put option on futures contracts.
D) B and C above.
E) None of the above.
85. The gain or loss to a bank from the use of a financial futures contract depends upon:
A) The duration of the underlying security named in the futures contract
B) The initial futures price
C) The change expected in interest rates divided by 1 + the original interest rate.
D) All of the above.
E) None of the above.
86. The number of futures contracts that a bank will need in order to fully hedge the bank’s overall
interest rate risk exposure and protect the bank’s net worth depends upon (among other factors):
A) The relative duration of bank assets and liabilities.
B) The duration of the underlying security named in the futures contract.
C) The price of the futures contract.
D) All of the above.
E) None of the above.
87. A put option would most likely be used to:
A) Protect fixed-rate loans and securities.
B) Protect variable-rate loans and securities.
C) Offset a positive interest-sensitive gap.
D) Offset a negative interest-sensitive gap.
E) None of the above.
88. A call option would most likely be used to:
A) Protect the value of fixed-rate loans and securities.
B) Offset a negative interest-sensitive gap.
C) Offset a positive duration gap.
D) Offset a negative duration gap.
E) None of the above.
89. According to the textbook, the most popular option contracts used by banks today include:
A) Federal Funds futures contracts.
B) Eurodollar time deposit futures contracts.
C) U.S. Treasury bond futures contract.
D) All of the above.
E) None of the above.
90. A futures contract which calls for the delivery of a $100,000 T-bond with a minimum of 15 years
to maturity is called a:
A) U.S. Treasury bond futures contract
B) One-month LIBOR futures contract
C) Eurodollar time deposit futures contract
D) Federal Funds futures contract
E) None of the above
91. A financial institution that sells a particular futures contract and later purchases the same contract
back is executing:
A) A long hedge
B) A short hedge
C) A sideways hedge
D) An up-side-down hedge
E) None of the above
92. A financial institution that uses a long hedge is most likely:
A) Trying to avoid higher borrowing costs
B) Trying to avoid declining asset values
C) Trying to avoid lower than expected yields on from loans and securities
D) A and B above
93. A bank that uses a short hedge is most likely: