CHAPTER 23 B-357
7. The put option on the bond gives the owner the right to sell the bond at the option’s strike price. If bond
prices decline, the owner of the put option profits. However, since bond prices and interest rates move
8. The company would like to lock in the current low rates, or at least be protected from a rise in rates,
allowing for the possibility of benefit if rates actually fall. The former hedge could be implemented by
9. A swap contract is an agreement between parties to exchange assets over several time intervals in the
future. The swap contract is usually an exchange of cash flows, but not necessarily so. Since a forward
contract is also an agreement between parties to exchange assets in the future, but at a single point in
time, a swap can be viewed as a series of forward contracts with different settlement dates. The firm
10. The firm will borrow at a fixed rate of interest, receive fixed rate payments from the dealer as part of the
swap agreement, and make floating rate payments back to the dealer; the net position of the firm is that
it has effectively borrowed at floating rates.
11. Transactions exposure is the short-term exposure due to uncertain prices in the near future. Economic
exposure is the long-term exposure due to changes in overall economic conditions. There are a variety
12. The risk is that the dollar will strengthen relative to the yen, since the fixed yen payments in the future
will be worth fewer dollars. Since this implies a decline in the $/¥ exchange rate, the firm should sell
13. a. Buy oil and natural gas futures contracts, since these are probably your primary resource costs. If it
is a coal-fired plant, a cross-hedge might be implemented by selling natural gas futures, since coal
b. Buy sugar and cocoa futures, since these are probably your primary commodity inputs.
c. Sell corn futures, since a record harvest implies low corn prices.
d. Buy silver and platinum futures, since these are primary commodity inputs required in the
manufacture of photographic film.
e. Sell natural gas futures, since excess supply in the market implies low prices.
f. Assuming the bank doesn’t resell its mortgage portfolio in the secondary market, buy bond futures.
g. Sell stock index futures, using an index most closely associated with the stocks in your fund, such
as the S&P 100 or the Major Market Index for large blue-chip stocks.
h. Buy Swiss franc futures, since the risk is that the dollar will weaken relative to the franc over the
next six month, which implies a rise in the $/SFr exchange rate.
i. Sell euro futures, since the risk is that the dollar will strengthen relative to the euro over the next
three months, which implies a decline in the $/€ exchange rate.