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What role did the swap market play in the financial crisis of 2008-2009?
The following information is available on a three-year swap contract. One-year maturity zero coupon discount yields are currently priced at par and pay a coupon rate of 5 percent. Two-year maturity
Distinguish between a swap buyer and a swap seller. In which markets does each have the comparative advantage?
In a swap arrangement, the variable-rate swap cash flow streams often do not fully hedge the variable-rate cash flow streams from the balance sheet due to basis risk. a. What are the possible
A commercial bank has $200 million of four-year maturity floating-rate loans yielding the T-bill rate plus 2 percent. These loans are financed with $200 million of four-year maturity fixed-rate
First Bank can issue one-year, floating-rate CDs at prime plus 1 percent or fixed-rate CDs at 12.5 percent. Second Bank can issue one-year, floating-rate CDs at prime plus 0.5 percent or fixed-rate
Two multinational FIs enter their respective debt markets to issue $100 million of two-year notes. FI A can borrow at a fixed annual rate of 11 percent or a floating rate of LIBOR plus 50 basis
What are the difficulties in completing a loan assignment?
Who are the buyers of U.S. loans and why do they participate in this activity?The buyers of loans include (1) investment banks because they are often involved with the initial transaction that leads
Who are the sellers of U.S. loans and why do they participate in this activity?
What are factors that may deter the growth of the loan sale market in the future? Discuss.
In addition to hedging credit risk, what are five factors that are expected to encourage loan sales in the future? Discuss the impact of each factor.
Why are yields higher on loan sales than on commercial paper issues with similar maturity and issue size?
How do the characteristics of an HLT loan differ from those of a short-term loan that is sold?
What is a possible reason why the spreads on HLT loans perform differently than do the spreads on junk bonds?
City Bank has made a 10-year, $2 million loan that pays annual interest of 10 percent. The principal is expected to be paid at maturity. a. What should City Bank expect to receive from the sale of
What has been the effect of securitization on the asset portfolios of financial institutions?
Consider the mortgage pass-through example presented in Table 26-3. The total monthly payment by the borrowers reflecting a 12 percent mortgage rate is $1,028,610. The payment passed through to the
What would be the impact on GNMA pricing if the pass through was not fully amortized? What is the present value of a $10 million pool of 15-year mortgages with an 8.5 percent per year monthly
Under what conditions do mortgage holders have a call option on their mortgages? When is the call option in the money?
What are the benefits of market yields that are less than the average rate in the GNMA mortgage pool? What are the disadvantages of this rate inversion? To whom do the good news and bad news accrue?
What is the weighted-average life (WAL) of a mortgage pool supporting pass-through securities? How does WAL differ from duration?
If 150 $200,000 mortgages in a $60 million 15-year mortgage pool are expected to be prepaid in three years and the remaining 150 $200,000 mortgages are to be prepaid in four years, what is the
An FI originates a pool of 500 30-year mortgages, each averaging $150,000 with an annual mortgage coupon rate of 8 percent. Assume that the GNMA credit risk insurance fee is 6 basis points and that
What are the primary functions of GNMA? What is timing insurance?
What is the difference between the yield spread to average life and the option-adjusted spread on mortgage-backed securities?
Explain precisely the prepayment assumptions of the Public Securities Association prepayment model.
What factors may cause the actual prepayment pattern to differ from the assumed PSA pattern? How would an FI adjust for the presumed occurrence of some of these factors?
What is the burnout factor? How is it used in modeling prepayment behavior? What other factors may be helpful in modeling the prepayment behavior of a given mortgage pool?
What is the goal of prepayment models that use option pricing theory? How do these models differ from the PSA or empirical models? What criticisms often are directed toward these models?
How does the price on a GNMA bond relate to the yield on a GNMA option from the perspective of the investor? What is the option-adjusted spread (OAS)?
Use the options prepayment model to calculate the yield on a $30 million, three-year, fully amortized mortgage pass through where the mortgage coupon rate is 6 percent paid annually. Market yields
Use the options prepayment model to calculate the yield on a $12 million, five-year, fully amortized mortgage passthrough where the mortgage coupon rate is 7 percent paid annually. Market yields are
What conditions would cause the yield on pass-through securities with prepayment risk to be less than the yield on pass-through securities without prepayment risk?
How does FNMA differ from GNMA?
Consider $100 million of 30-year mortgages with a coupon of 5 percent per year paid quarterly. a. What is the quarterly mortgage payment?b. What are the interest and principal repayments over the
How does a class Z tranche of a CMO differ from a class R tranche? What causes a Z class to have characteristics of both a zero-coupon bond and a regular bond? What factors can cause an R class to
What are mortgage-backed bonds (MBBs)? How do MBBs differ from pass-through securities and CMOs?
From the perspective of risk-management, how does the use of MBBs by an FI assist the FI in managing credit and interest rate risk?
Consider a bank with $50 million in long-term mortgages as assets. It is financing these mortgages with $30 million in short-term uninsured deposits and $20 million in insured deposits. To reduce its
What are four reasons why an FI may prefer the use of either pass-through securities or CMOs to the use of MBBs?
What is an interest only (IO) strip? How do the discount effect and the prepayment effect of an IO create a negative duration asset? What macroeconomic effect is required for this negative duration
How does FHLMC differ from FNMA? How are they the same?
What is a principal only (PO) strip? What causes the price-yield profile of a PO strip to have a steeper slope than a normal bond?
An FI originates a pool of real estate loans worth $20 million with maturities of 10 years and paying interest rates of 9 percent per year.a. What is the average payment received by the FI, including
What are the factors that, in general, allow assets to be securitized? What are the costs involved in the securitization process?
How does an FI use securitization to manage interest rate, credit and liquidity risks? Summarize how each of the possible methods of securitization products affects the balance sheet and
What three levels of regulatory taxes do FIs face when making loans? How does securitization reduce the levels of taxation?
An FI is planning to issue $100 million in BB-rated commercial loans. The FI will finance the loans by issuing demand deposits. a. What is the minimum capital required under Basle III? b. What is
Consider the FI in problem (6).a. What additional risk exposure problems does the FI face?b. What are some possible solutions to the duration mismatch and the illiquidity problems?c. What advantages
How are investors in pass-through securities protected against default risk emanating from the mortgagees and the FI/trustee?
Heating degree-day and cooling degree-day futures contracts make payments based on whether the temperature is abnormally hot or cold. Explain why the following businesses might be interested in such
Short interest is a measure of the aggregate short positions on a stock. Check an online brokerage or other financial service for the short interest on several stocks of your choice. Can you guess
Suppose that you go to a bank and borrow $100. You promise to repay the loan in 90 days for $102. Explain this transaction using the terminology of short-sales. Discuss.
Suppose your bank's loan officer tells you that if you take out a mortgage (i.e., you borrow money to buy a house), you will be permitted to borrow no more than 80% of the value of the house.
Pick a derivatives exchange such as CME Group, Eurex, or the Chicago Board Options Exchange. Go to that exchange's website and try to determine the following:a. What products the exchange trades.b.
Consider the widget exchange. Suppose that each widget contract has a market value of $0 and a notional value of $100. There are three traders, A, B, and C. Over one day, the following trades occur:A
Suppose the businesses in the previous problem use futures contracts to hedge their temperature-related risk. Who do you think might accept the opposite risk? Discuss.
ABC stock has a bid price of $40.95 and an ask price of $41.05. Assume there is a $20 brokerage commission.a. What amount will you pay to buy 100 shares?b. What amount will you receive for selling
Repeat the previous problem supposing that the brokerage fee is quoted as 0.3% of the bid or ask price.a. What amount will you pay to buy 100 shares?b. What amount will you receive for selling 100
Suppose a security has a bid price of $100 and an ask price of $100.12. At what price can the market-maker purchase a security? At what price can a market-maker sell a security? What is the spread in
Suppose you short-sell 300 shares of XYZ stock at $30.19 with a commission charge of 0.5%. Supposing you pay commission charges for purchasing the security to cover the short-sale, how much profit
Suppose you desire to short-sell 400 shares of JKI stock, which has a bid price of $25.12 and an ask price of $25.31. You cover the short position 180 days later when the bid price is $22.87 and the
When you open a brokerage account, you typically sign an agreement giving the broker the right to lend your shares without notifying or compensating you. Why do brokers want you to sign this
Suppose a stock pays a quarterly dividend of $3. You plan to hold a short position in the stock across the dividend ex-date. What is your obligation on that date? If you are a taxable investor, what
Suppose XYZ stock has a price of $50 and pays no dividends. The effective annual interest rate is 10%. Draw payoff and profit diagrams for a long position in the stock. Verify that profit is 0 at a
For Figure 2.6, verify the following:a. The S&R index price at which the call option diagram intersects the x-axis is $1095.68.b. The S&R index price at which the call option and forward
For Figure 2.8, verify the following:a. The S&R index price at which the put option diagram intersects the x-axis is $924.32.b. The S&R index price at which the put option and forward
For each entry in Table 2.5, explain the circumstances in which the maximum gain or loss occurs.In table 2.5
Suppose the stock price is $40 and the effective annual interest rate is 8%.a. Draw on a single graph payoff and profit diagrams for the following options:(i) 35-strike call with a premium of
Suppose the stock price is $40 and the effective annual interest rate is 8%. Draw payoff and profit diagrams for the following options: a. 35-strike put with a premium of $1.53. b. 40-strike put with
The profit calculation in the chapter assumes that you borrow at a fixed interest rate to finance investments. An alternative way to borrow is to short-sell stock. What complications would arise in
Using the same information as the previous question, draw payoff and profit diagrams for a short position in the stock. Verify that profit is 0 at a price in 1 year of $55. Discuss.
What position is the opposite of a purchased call? The opposite of a purchased put? Discuss.
a. Suppose you enter into a long 6-month forward position at a forward price of $50. What is the payoff in 6 months for prices of $40, $45, $50, $55, and $60?b. Suppose you buy a 6-month call option
a. Suppose you enter into a short 6-month forward position at a forward price of $50. What is the payoff in 6 months for prices of $40, $45, $50, $55, and $60?b. Suppose you buy a 6-month put option
A default-free zero-coupon bond costs $91 and will pay $100 at maturity in 1 year. What is the effective annual interest rate? What is the payoff diagram for the bond? The profit diagram?
Suppose XYZ stock pays no dividends and has a current price of $50. The forward price for delivery in 1 year is $55. Suppose the 1-year effective annual interest rate is 10%.a. Graph the payoff and
Suppose XYZ stock pays no dividends and has a current price of $50. The forward price for delivery in one year is $53. If there is no advantage to buying either the stock or the forward contract,
An off-market forward contract is a forward where either you have to pay a premium or you receive a premium for entering into the contract. (With a standard forward contract, the premium is zero.)
Suppose that you buy the S&R index for $1000, buy a 1000-strike put, and borrow $980.39. Perform a payoff and profit calculation mimicking Table 3.1. Graph the resulting payoff and profit
Construct payoff and profit diagrams for the purchase of a 1050-strike S&R call and sale of a 950-strike S&R call. Verify that you obtain exactly the same profit diagram for the purchase of a
Suppose you invest in the S&R index for $1000, buy a 950-strike put, and sell a 1050 strike call. Draw a profit diagram for this position. What is the net option premium? If you wanted to construct a
Suppose you invest in the S&R index for $1000, buy a 950-strike put, and sell a 1107 strike call. Draw a profit diagram for this position. How close is this to a zero-cost collar? Discuss.
Draw profit diagrams for the following positions:a. 1050-strike S&R straddle.b. Written 950-strike S&R straddle.c. Simultaneous purchase of a 1050-strike straddle and sale of a 950-strike
Suppose you buy a 950-strike S&R call, sell a 1000-strike S&R call, sell a 950-strike S&R put, and buy a 1000-strike S&R put.a. Verify that there is no S&R price risk in this
Compute profit diagrams for the following ratio spreads: a. Buy 950-strike call, sell two 1050-strike calls. b. Buy two 950-strike calls, sell three 1050-strike calls. c. Consider buying n 950-strike
In the previous problem we saw that a ratio spread can have zero initial premium. Can a bull spread or bear spread have zero initial premium? A butterfly spread? Why or why not? Discuss.
Construct an asymmetric butterfly using the 950-, 1020-, and 1050-strike options. How many of each option do you hold? Draw a profit diagram for the position.
Verify that the butterfly spread in Figure 3.14 can be duplicated by the following transactions (use the option prices in Table 3.4):In Figure 3.14a. Buy 35 call, sell two 40 calls, buy 45 call. b.
Here is a quote from an investment website about an investment strategy using options: One strategy investors are applying to the XYZ options is using "synthetic stock."Asynthetic stock is created
Suppose that you short the S&R index for $1000 and sell a 1000-strike put. Construct a table mimicking Table 3.1 that summarizes the payoff and profit of this position. Verify that your table
Construct a spreadsheet for which you can input up to five strike prices and quantities of put and call options bought or sold at those strikes, and which will automatically construct the total
Suppose you buy the S&R index for $1000 and buy a 950-strike put. Construct payoff and profit diagrams for this position. Verify that you obtain the same payoff and profit diagram by investing
Suppose you short the S&R index for $1000 and buy a 950-strike call. Construct payoff and profit diagrams for this position. Verify that you obtain the same payoff and profit diagram by borrowing
Suppose you short the S&R index for $1000 and buy a 1050-strike call. Construct payoff and profit diagrams for this position. Verify that you obtain the same payoff and profit diagram by borrowing
Verify that you earn the same profit and payoff by (a) buying the S & R index for $1000 and (b) buying a 950-strike S&R call, selling a 950-strike S&R put, and lending $931.37.
Verify that you earn the same profit and payoff by (a) Shorting the S&R index for $1000 (b) Selling a 1050-strike S&R call, buying a 1050-strike put, and borrowing $1029.41.
Suppose the premium on a 6-month S&R call is $109.20 and the premium on a put with the same strike price is $60.18. What is the strike price? Discuss.
Construct payoff and profit diagrams for the purchase of a 950-strike S&R call and sale of a 1000-strike S&R call. Verify that you obtain exactly the same profit diagram for the purchase of a

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