Derivatives and Risk Management

1038 Words Mar 1st, 2015 5 Pages

Please see the preface for information on the AACSB letter indicators (F, M, etc.) on the subject lines.



(24.1) Risk management FP Answer: a EASY
1. One objective of risk management can be to reduce the volatility of a firm’s cash flows.

a. True
b. False

(24.4) Swaps FP Answer: b EASY
2. Interest rate swaps allow a firm to exchange fixed for floating-rate payments, but a swap cannot reduce actual net interest expenses.

a. True
b. False

(24.5) Speculative versus pure risk FP Answer: a EASY
3. Speculative risks are symmetrical in the sense that they offer the chance of a gain as well as a loss, while pure risks are those that
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a. Entering into an interest rate swap where the bank receives a fixed payment stream, and in return agrees to make payments that float with market interest rates.
b. Purchase principal only (PO) strips that decline in value whenever interest rates rise.
c. Enter into a short hedge where the bank agrees to sell interest rate futures.
d. Sell some of the bank’s floating-rate loans and use the proceeds to make fixed-rate loans.
e. Buying inverse floaters.

Multiple Choice: Problems


(24.4) Swaps—nonalgorithmic CP Answer: b MEDIUM
11. Company A can issue floating-rate debt at LIBOR + 1% and can issue fixed rate debt at 9%. Company B can issue floating-rate debt at LIBOR + 1.5% and can issue fixed-rate debt at 9.4%. Suppose A issues floating-rate debt and B issues fixed-rate debt, after which they engage in the following swap: A will make a fixed 7.95% payment to B, and B will make a floating-rate payment equal to LIBOR to A. What are the resulting net payments of A and B?

a. A pays a fixed rate of 9%, B pays LIBOR + 1.5%.
b. A pays a fixed rate of 8.95%, B pays LIBOR + 1.45%.
c. A pays LIBOR plus 1%, B pays a fixed rate of 9.4%.
d. A pays a fixed rate of 7.95%, B pays LIBOR.
e. None of the above answers is correct.

(24.6) Treasury bond futures contracts CP Answer: c MEDIUM
12. Suppose the September CBOT Treasury bond futures contract has a quoted price of 89’09. What is the implied annual interest rate inherent in this
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