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Finance
Q:
Vulture funds specialize in buying distressed loans.
Q:
Loans sold to correspondent banks are predominantly sales of distressed HLT loans.
Q:
More than 90% of loan sales are via assignments.
Q:
A loan sold without recourse generates a contingent liability for the selling bank.
Q:
The buyer of a loan in a participation has a double-risk exposure: one to the borrower and one to the selling bank.
Q:
In 2008, loan sales primarily consisted of sales of distressed loans.
Q:
A mortgage pass-through security is a bond issue backed by a group of mortgages that pays fixed semi-annual coupon payments where the principle is repaid only at maturity.
Q:
What loans, other than mortgages, are currently being securitized?
Q:
Explain the payment pattern on a GNMA pass-through and a new Class B CMO when interest rates fall. Which has more predictable payments, and why would an investor care?
Q:
What are the major factors that are likely to contribute to continued growth in the loan sale market?
Q:
How does a PAC CMO differ from a sequential pay CMO?
Q:
Why are MBBs the least used form of mortgage securitization?
Q:
A three-class (Class A, B, and C) sequential pay CMO starts with an $80 million principle amount in each class. The mortgages in the pool have a 7% interest rate. The CMO classes receive monthly payments. During the first month $1 million in interest is received from mortgage holders and $1.5 million in principle. What principle amounts are outstanding for each class during the second month? How will this affect the total payment each class receives? Explain.
Q:
How does mortgage securitization reduce the regulatory tax burden of a depository institution?
Q:
Why has securitization progressed most rapidly for home mortgages?
Q:
What are the major differences in the traditional and HLT segments of the loan sale market with respect to the types of loans sold?
Q:
Why are most loan sales on an assignment basis rather than a participation basis?
Q:
How does a mortgage pass-through differ from a CMO?
Q:
The bank keeps a capital-to-asset ratio of 8%. If the bank does not securitize the mortgages, they will be fully funded with demand deposits that have a reserve requirement of 10%. The demand deposits also have a deposit insurance premium of 0.20 cents per $100 of deposits. If the bank securitizes the mortgages, how much less capital will the bank require? If the savings from not having the required reserves and the deposit insurance premiums could be invested at 5%, what is the dollar opportunity cost of not securitizing?
Q:
What is the total amount of net fee revenue generated from the mortgages over the year?
Q:
A bank wishes to reduce its duration gap from 1.2 years to zero by using put options. The bank has $800 million in assets. The underlying bonds on the puts are valued at $115,000 and have a duration of 4 years. The put options have a delta of 0.58. How many put options are needed? Assume that there is no basis risk on the hedge.
Q:
A $995 million bank has a negative repricing gap equal to 6% of assets. The bank is currently paying 4.5% on its rate-sensitive liabilities. These rates will vary as interest rates move. The managers wish to reduce the effective repricing gap to zero with an interest rate cap or floor. A one-year cap is available with a 5% cap rate and a one-year floor is available at a floor rate of 4%.
a) Suggest a position using either the cap or the floor (but not both) that will limit the bank's interest rate risk. Explain.
b) Suppose that interest rates are volatile this year and the cap costs $275,000 and the floor costs $195,000. Suggest a collar that helps limit the bank's cost of hedging. How does the collar affect the bank's risk?
Q:
A bank wishes to hedge its $25 million face value bond portfolio (currently priced at 106% of par). The bond portfolio has a duration of 5 years. They will hedge with put options that have a delta of 0.67. The bond underlying the option contract has a market value of $112,000 and a duration of 8 years. How many put options are needed? Assume that there is no basis risk on the hedge.
Q:
An FI has DA = 2.45 years and kDL = 0.97 years. The FI has total assets equal to $375 million. The FI wishes to effectively reduce the duration gap to one year by hedging with T-Bond futures that have a market value of $115,000 and a DFut = 8 years. How many contracts are needed and should the FI buy or sell them? (D = Duration)
Q:
In terms of direct costs, are futures or options likely to be a more expensive form of hedging? Why? In terms of opportunity costs, which is more expensive? Why?
Q:
What are the advantages and disadvantages of forwards versus futures contracts?
Q:
Figure 23-2 A U.S. bank has deposit liabilities denominated in euros that must be repaid in 2 years. The deposits pay a fixed interest rate of 4%. The bank took the money raised and converted it to dollars, whereupon it lent the dollars to a corporate customer who will repay the bank over the next two years in dollars at a variable rate of interest equal to LIBOR +3%. The interest rate earned may change every six months.A U.S. corporation is bidding on a revenue-generating contract in England. If the corporation gets the bid, they will be paid in pounds. A) If the managers are risk averse, can hedging increase the likelihood that the U.S. firm gets the bid? Explain. B) In this situation, should the corporation hedge with options, futures, or forwards? Explain.
Q:
Draw a graph of the gains and losses from owning a bond and simultaneously buying a put on the bond.
Q:
Is it safer to hedge a contingent liability with options, futures, forwards, or swaps? Explain.
Q:
Why is the credit risk on a plain vanilla interest rate swap generally less than the credit risk of a loan with an equivalent (notional) principle amount?
Q:
A U.S. firm is earning British pounds from its foreign subsidiary. A U.K. firm is earning dollars from its U.S. subsidiary. Neither firm can borrow at a cost-effective rate outside of its home country/currency. What kind of swap could be used to limit the FX risk of both firms and explain the payment flows involved (be specific)?
Q:
After conducting a rate sensitive analysis, a bank finds itself with the following amounts of rate- sensitive assets and liabilities (RSAs and RSL) and fixed-rate assets and liabilities (FRAs and FRLs), the rate of return and cost rates on the accounts are also given: The primary federal banks regulators have established guidelines for derivatives usage at banks including:I. banks must establish internal guidelines regarding hedging activity.II. banks must establish trading limits.III. banks are prohibited from using derivatives to speculate.IV. banks must disclose large derivatives positions that may materially affect stakeholders in their financial statements.A. I and II onlyB. I, III, and IV onlyC. I, II, and IV onlyD. II, III, and IV onlyE. I, II, III, and IV
Q:
Plain vanilla interest rate swaps are exchanges of
A. principle only.
B. interest only.
C. principle and interest.
D. principle and currency.
E. interest rate and currency.
Q:
The profits on a derivatives position are fixed when a bond's price falls below a certain point, but above that point the profits fall when the bond price rises. This profit profile fits which of the following positions?
A. Purchased call option
B. Written call option
C. Purchased put option
D. Written put option
Q:
An FI has long-term, fixed-rate assets funded by short-term, variable-rate liabilities. To protect the equity value, the FI may engage in a swap to pay a _____ rate and receive a _____ interest.
A. fixed; variable
B. variable; variable
C. variable; fixed
D. fixed; fixed
Q:
A bondholder owns 15-year government bonds with a $5 million face value and a 6% coupon that is paid annually. The bonds are currently priced at $550,018.73 with a yield of 5.034%. The bonds have a duration of 10.53 years. If interest rates are projected to increase by 50 basis points, how much will the bondholder gain or lose?
A. $27,571
B. $25,063
C. -$27,571
D. -$25,063
E. $5,313
Q:
The largest two categories of swaps are
A. credit risk and interest rate swaps.
B. currency and commodity swaps.
C. interest rate and currency swaps.
D. equity and interest rate swaps.
E. none of the above
Q:
An FI with DA > kDL could do which of the following to reduce the duration gap?
A. Engage in a swap and pay a variable rate and receive a fixed rate of interest
B. Sell bond futures contracts
C. Buy bonds forward
D. Buy bond call options
E. None of the above
Q:
The safest way to hedge a bond liability with options is to
A. purchase a call option on the bond.
B. write a call option on the bond.
C. purchase a put option on the bond.
D. write a put option on the bond.
Q:
The safest way to hedge a bond asset with options is to
A. purchase a call option on the bond.
B. write a call option on the bond.
C. purchase a put option on the bond.
D. write a put option on the bond.
Q:
For a bond put option, the _____ the exercise price, the greater the cost of the put, and for a bond call option, the _____ the exercise price, the higher the cost of the call option.
A. higher; higher
B. lower; lower
C. higher; lower
D. lower; higher
Q:
Which of the following bond option positions increase in value when interest rates increase?
A. Long call; written put
B. Long put; written call
C. Long put; long call
D. Written put; written call
Q:
A _____ position in T-bond futures should be used to hedge falling interest rates and a _____ position in T-bond futures should be used to hedge falling bond prices.
A. long; short
B. long; long
C. short; long
D. short; short
Q:
The price of a bond rises from 98 to par. Even if you do nothing, this would still result in an immediately recognized loss on a _____________ on a bond, and a paper gain on a bond ______________.
A. long forward contract; call option
B. short futures contract; call option
C. call option; put option
D. short futures contract; put option
E. short forward contract; call option
Q:
A forward contract
A. is marked to market.
B. has significant default risk.
C. is standardized.
D. is traded over the counter.
E. is highly liquid.
Q:
Which of the following are potentially subject to risk-based capital requirements?
A. Swaps and futures
B. Swaps and forwards
C. Forwards and futures
D. Purchased option positions and futures
E. Purchased option positions and swaps
Q:
A bond portfolio manager has a $25 million market value bond portfolio with a 6-year duration. The manager believes interest rates may increase 50 basis points. Which of the following could be used to help limit his risk?
I. Sell the bonds forward.
II. Buy bond futures contracts.
III. Buy call options on the bonds.
IV. Buy put options on the bonds.
A. I only
B. II only
C. I and III only
D. I and IV only
E. II and III only
Q:
Basis risk occurs because it is generally impossible to
A. hedge unanticipated rate changes.
B. exactly predict interest rate changes.
C. exactly match the terms of the hedging instrument with the terms of the asset or liability at risk.
D. find negatively correlated asset prices.
E. all of the above
Q:
A microhedge is a
A. hedge of a particular asset or liability.
B. hedge against a change in a particular macro variable.
C. hedge of an entire balance sheet.
D. hedge using options.
E. hedge without basis risk.
Q:
A macrohedge is a
A. hedge of a particular asset or liability.
B. hedge of an entire balance sheet.
C. hedge using options.
D. hedge without basis risk.
E. hedge using futures on macroeconomic variables.
Q:
Which of the following requires daily cash flow settlements between the parties?
A. Forward contract
B. Futures contract
C. Purchased options contract
D. Swap contract
E. Collars
Q:
A bank has a positive repricing gap and wishes to protect its profits from an unfavorable interest rate move. Purchasing a cap will help limit this bank's interest rate risk.
Q:
A bank with a negative repricing gap could enter into a swap to pay a fixed rate of interest and receive a variable rate of interest to effectively reduce its repricing gap.
Q:
An FI with DA < kDL may choose to enter into a long-term swap where it pays a fixed rate of interest and receives a variable rate in order to effectively reduce the duration gap.
Q:
A fixed-floating interest rate swap is called a plain vanilla swap.
Q:
The maximum gain (ignoring commissions and taxes) from buying an at-the-money bond put option is the bond price at time of option purchase less the put premium. The maximum loss is the put premium.
Q:
The writer of an American-style bond call option has the right, but not the obligation, to buy the bond at a preset price until the option expires.
Q:
The buyer of an American-style bond call option has the right, but not the obligation, to sell the bond at a set price until the option expires.
Q:
Swaps and forwards are subject to contingent risk; exchange-traded futures and options are not.
Q:
As interest rates fall, bond prices and call option potential profits increase.
Q:
A purchaser of a bond call option gains if interest rates fall.
Q:
A U.S. corporation has a yen-denominated loan it must repay in 6 months. A long position in yen futures could help offset the corporation's foreign exchange risk.
Q:
Swaps are usually the best hedging tool to use to hedge long-term risks of 4 or 5 years or more.
Q:
Futures contracts are not subject to capital requirements for banks, but many forward contracts are.
Q:
Writing a call option on a bond pays off if interest rates rise.
Q:
Basis risk is the risk that the prices or value of the underlying spot and the derivatives instrument used to hedge do not move predictably relative to one another.
Q:
A macro hedge is a hedge of a particular asset or liability exposure to a change in a macroeconomic variable.
Q:
Buying a cap is similar to buying a call option on bond prices.
Q:
Gains and losses on a futures contract must be recognized daily.
Q:
The lack of perfect correlation between spot and futures prices implies that most hedges will have some basis risk.
Q:
A spot contract is an immediate delivery versus payment contract.
Q:
What are arguments for and against requiring banks to mark all assets and liabilities to market continuously? Relate your arguments to managing credit risk and interest rate risk.
Q:
What factors can cause a bank's book value of equity to differ from its market value? What widely available ratio is typically used to measure the difference between the two?
Q:
Explain how interest rate risk could change at banks, thrifts, and other institutions that originate and sell fixed-rate mortgages but are funded with deposits if these institutions lose the ability to securitize and sell mortgages. What could be the effect on the economy?
Q:
Explain how an FI's capital protects against credit risk and interest rate risk.
Q:
A bank has DA = 2.5 years, DL= 0.80 years, and k = 92%. Assets are equal to $1,200 million. According to the duration gap model, what size interest rate change would make the institution insolvent if rates are currently 5%?
Q:
The effect of an interest rate change on the market value of an FI's equity is a function of three things. What are they and how do they affect the equity value change?
Q:
What are four major weaknesses of the repricing model?
Q:
A thrift has an annual CGAP of -$25 million. A credit union has an annual CGAP of +$5 million. The thrift has total assets of $500 million and net income of $7.5 million and the credit union has total assets of $40 million and net income of $0.7 million.In each of the following cases indicate whether the change in profits due to the spread effect was i) greater than ii) less than, or iii) equal to the change in profitability due to the repricing GAP. In some cases you may not be able to tell; indicate which ones. ∆ spread
Q:
Figure 22-3 A thrift has an annual CGAP of -$25 million. A credit union has an annual CGAP of +$5 million. The thrift has total assets of $500 million and net income of $7.5 million and the credit union has total assets of $40 million and net income of $0.7 millionCalculate each institution's CGAP as a percent of assets. Based on the gap, which institution's NII is more sensitive to interest rates? Explain.