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FIN 3303 Exam 3 Review

Terms in this set (41)

Commercial Banks
Take position in futures contracts to hedge against interest rate risk
Saving Institutions
Take position in futures contracts to hedge against interest rate risk
Securities Firms
Execute futures transactions for individuals and firms
Take positions in futures contracts to hedge their own portfolios against stock market or interest rate movements
Mutual Funds
Take positions in futures contracts to speculate on future stock market or interest rate movements
Take positions in futures contracts to hedge their portfolios against stock market or interest rate movements
Pension Funds
Take positions in futures contracts to hedge their portfolios against stock market or interest rate movements
Insurance Companies
Take positions in futures contracts to hedge their portfolios against stock market or interest rate movements
Short Bond Futures
Invest if you think the interest rates will rise in the future
Long Bond Futures
Invest if you think the Interest Rates will decline in the future
Short Stock Index Futures
Invest if you think Stock Prices are going to rise in the future
Long Stock Index Futures
Invest if you think Stock Prices are going to decline in the future
Interest Rate (Bond) Futures
Use to create a Short and Long Hedge
Short Bond Futures (Hedging)
Protects your bond portfolio from losses due to rising interest rates
As Intrest Rates rise, your bond portfolio ____, but your _____ in the bond portfolio are offset by the ____ in your bonds futures short position
Declines/Losses/Gain
Stock Index Arbitrage
The simultaneous trading of Stock Index Futures and the underlying Stock Portfolio
Securities firms act as ______ by capitalizing on discrepancies between prices of stock index futures and the underlying stock
Arbitrageurs
Owns Stock (Arbitrage with Stock Index Futures)
Receives dividends, but no interest
Owns Stock Index Futures (Arbitrage with Stock Index Futures)
Receives no dividends, but do receive interest
If the actual futures contract is over-priced relative to the underlying stock portfolio, an arbitrageur could sell (short) the ________, and purchase the ________
Over-Priced Stock Index Futures / Underlying Stock Index
If the actual futures contract is underpriced, relative to the underlying stock stock portfolio, the arbitrageur could buy the ______, and sell (short) the _______
Underpriced Stock Index Futures / Corresponding Stock Index Portfolio
Risks of Trading Future Contracts
Market Risk
Basis Risk
Liquidity Risk
Credit Risk
Prepayment Risk
Operational Risk
Market Risk
Fluctuations in the value of the instrument as a result of market conditions
Basis Risk
The risk that the position being hedged by the futures contract is not affected in the same way as the instrument underlying the futures contract
Liquidity Risk
Refers to the potential price distortions due to lack of liquidity (availability of willing buyers or sellers when you wish to liquidate the contract)
Credit Risk
The risk that a loss will occur because a counter-party defaults on the contract
Prepayment Risk
The risk from the possibility that the assets to be hedged may be prepaid earlier than the designated maturity
Operational Risk
The risk of losses due to inadequate management or controls
Interest Rate Swap
An arrangment whereby one party exchanges one set of interest rate payments for a different set of interest rate payments
The most typical interest rate swap involves exchanging
Fixed-Rate interest payments for Floating-Rate interest payments
How Banks Generate Profit
1.) Take Deposits
2.) Pay Interest on these Deposits
3.) Make loans from these Deposits
4.) Charge Interest on these loans
Banks gauge Profit using
Net Interest Margin
Net Interest Margin
(Interest Revenues - Interest Expense) / Assets
Provisions of Interest Rate Swap
Notional Principal Value
Fixed Interest Rate
Formula and Type of Index
Frequency of Payments
Lifetime of Swap
Notional Principal Value
The reference value to which the interest rates are applied to determine the interest payments to the respective participating parties
Swaps are facilitated by:
Over-The-Counter Trading
Swaps are ______ standardized than other derivative instruments
Less
Telecommunications network is more appropriate for Swaps than an Exchange? (T/F)
True
Commercial banks in the United States are adversely affected by ____ interest rates
Increasing
Commercial banks in Europe are adversely affected by ______ interest rates
Declining
When do financial institutions hedge their positions?
When they anticipate that interest rates will move in an unfavorable direction
Who uses swaps for hedging and speculating purposes?
Commercial Banks
Pension Funds
Insurance Companies
Types of Swaps
...
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