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Organizational Behavior 1st Edition OpenStax - Solutions
20. Suppose that a basket default swap covers four reference entities and the losses realized over the tenor of the swap on the four reference entities are as follows:Loss resulting from default of first reference entity = $7 million Loss result from default of second reference entity = $14 million
19.a. Why is a basket default swap rather than a single-name credit default swap used in a synthetic CDO?b. If a credit event occurs requiring a payout, what is the impact on investors in a synthetic CDO?
18.a. In a synthetic collateralized debt obligation, what type of credit derivative is used?b. In a synthetic collateralized debt obligation is the collateral manager the protection buyer or protection seller?c. In what types of securities will the collateral manager invest?d. Assuming that the
17. In 1999, Standard&Poor’s developed two credit spread indices—one for the investmentgrade corporates and one for the high-yield corporates. The index for the high-yield market is called the S&P U.S. Industrial Speculative Grade Credit Index. Beginning in April 2000, S&P published the average
16. A high-yield portfolio manager wants to protect her portfolio frommacroeconomic shocks that might increase credit spreads. Her portfolio market value is $500 million, and has an average credit spread to the 5-year U.S. Treasury note of 250 basis points. The risk factor of her portfolio is
15. On January 1, a portfolio manager purchases a 5-year bond from Company Y with a par value of $1,000. The bonds are issued at par on January 1 at a credit spread of 200 basis points over a comparable 5-year U.S. Treasury note rate of 6.5%. The first semiannual coupon payment is due on July 1.On
14. Suppose the 10-year bond of Izzobaf.com was trading to yield 8.2%. The 10-year Treasury bond was yielding 6.2% at the time for a credit spread of 200 basis points.a. Suppose that a portfolio manager felt that the issue was overvalued and that the credit spread would be at least 300 basis points
13. What is the purpose of the ‘‘risk factor’’ in credit derivatives where the payout is based on a change in the credit spread?
12. Jonathan Rivers ofWeHave YouCovered Insurance Inc. (WHYCI) manages the insurance company’s asset portfolio. He is concerned about a large position in one credit—bond MMM, a high-yield corporate bond issue. For certain reasons, this position cannot be disposed of for another six months. More
11. A portfolio manager purchases a binary credit put option on a bond of Company X. The option pays out only if the credit rating of Company X declines below investment grade.At the maturity of the option at time T, the payout to the option buyer per $1,000 par value is expressed as:Payout = $1,
10. All other factors constant, for a given reference obligation and a given scheduled term, explain whether a credit default swap using full (old) restructuring or modified restructuring would be more expensive.
9.a. What is meant by a restructuring in a credit derivative?b. How can restructuring be treated in a credit default swap?
8. Gary Lawrence manages a corporate bond portfolio. He is interested in seeking credit protection for one bond issue in his portfolio, XYX Senior Bonds that mature in 7 years.The par value of XYX Senior Bonds in the portfolio is $25 million and the market value of the bonds is 60.Mr. Lawrence is
7. Raul Martinez is a fixed-income portfolio manager. His firm’s credit research group has just released a credit report on M&L Global Comm-Tech Corporation. The credit research group feels strongly that within one year the firm’s credit fundamentals will strengthen such that the market will
6. How can a total return swap be used to short a corporate bond?
5. Why is a total return swap more transactionally efficient than cash market transactions to obtain exposure to a diversified portfolio of corporate bonds?
4. Explain the risk exposures the total return receiver accepts in a total return swap.
3. If a portfolio manager wants to estimate a portfolio’s credit spread risk exposure what analytical measure can be used?
2. Explain the relationship between credit spread risk and downgrade risk.
1. Why would a portfolio manager be willing to assume the credit risk of a bond or an issuer?
• compare the different types of basket default swaps in terms of credit protection provided.
• explain the different types of basket default swaps.
• explain a synthetic collateralized debt obligation and how a credit default swap is used in this structured credit product.
• reproduce the payoff function for a credit spread option where the underlying is a credit spread.
• reproduce the payoff function for a credit spread option where the underlying is a credit risky asset.
• explain the two types of credit default options written on an underlying asset (binary credit option on a credit risk asset and binary credit option on a credit spread).
• compare the use of a credit default swap and a total return swap.
• explain the types of credit events that can be included in a credit default swap to trigger a payout.
• explain what a credit default swap is and how it can be used to acquire credit protection.
• illustrate what a total return swap is and how it can be used by a portfolio manager to hedge or acquire credit exposure.
• explain the three ways credit risk can affect a portfolio (default risk, credit spread risk, and downgrade risk).
• identify the different types of credit derivatives: total return swaps, credit default products, and credit spread products.
8.a. What is meant by a ‘‘cuspy-coupon mortgage security’’?b. What modification to the two-bond hedge is recommended for hedging a cuspy-coupon mortgage security?
7. What are the critical assumptions underlying the hedging of a mortgage security?
6. Carol Ryan manages an MBS portfolio. She is considering the purchase of $10 million par value of a Freddie Mac passthrough selling at 99.895 because of its attractive optionadjusted spread. She would like to hedge against an adverse movement in interest rates in order to lock in the benefit
5. What is the problem of using duration only to hedge a mortgage security?
4. You are the portfolio manager of a mortgage portfolio. A new junior portfolio manager, Alexander Coffee, wants you to explain risk management strategies for the mortgage portfolio. Mr. Coffee understands that there are several risk exposures associated with the portfolio but is especially
3. James Neutron is a trustee for a pension fund. In a recent report he received from one of the fund’s assetmanagers, he noticed the overweighting ofmortgage passthrough securities relative to the manager’s benchmark. Mr. Neutron was concerned by the overweighting for the reason described in
2. Laura Sze is the fixed-income strategist for a brokerage firm. She is responsible for setting the allocation of funds among the major sectors of the investment-grade fixedincome market. Her economic forecast is that interest rates will decline dramatically and that prepayments on mortgages will
1. Roger McFee is a fixed income portfolio manager for Wells Asset Management Partners.In a meeting with his firm’s client, Mr.McFee discussed his current strategy.He explained that it is his firm’s view that there are a number of opportunities available in the mortgage sector of the
• discuss the modification of a two-bond hedge when hedging cuspy-coupon mortgage securities.
• define ‘‘cuspy-coupon’’ mortgage securities.
• contrast a hedge using two hedging instruments from two maturity sectors of the yield curve to a hedge using one hedging instrument from one maturity sector of the yield curve.
• appraise hedging a mortgage security using only a duration-based framework.
• distinguish between an individual mortgage security and a Treasury security with respect to the importance of hedging yield curve risk.
• explain why a portfolio manager avoids hedging spread risk when hedging a mortgage security.
• demonstrate how a mortgage security’s negative convexity will affect the performance of a hedge.
• explain why a mortgage security can exhibit both positive and negative convexity.
• identify the risks associated with investing in mortgage securities.
23. A commercial bank owns a portfolio of floating-rate notes. All of the notes have as their reference rate 3-month LIBOR and they all have a cap of 9%.a. Suppose the portfolio manager is concerned that interest rates will rise so that the cap on the floating-rate notes will be realized. Explain
22. Suppose that a manager owns a portfolio of bonds with a current market value of $100 million. There are no options in the current portfolio. The manager wants to purchase put options on the Treasury bond futures contract to protect against a decline in the value of the portfolio. Suppose that,
21. Mr. Zhao is a corporate bond portfolio manager. He is interested in hedging a bond with a 20-year maturity and an 8% coupon rate, paid semiannually. The corporate issue is option free (i.e., it is a bullet bond). Mr. Zhao owns $10 million par value of this issue.The bond is trading at par
20. Why does the payoff of a collar strategy using options have the elements of a protective put buying strategy, a covered call writing strategy, and an unhedged position?
19. The investment guidelines of the Wycoff Pension Fund prohibit the fund’s external bond managers from using options in any capacity. At a meeting between the trustees of the Wycoff Pension Fund, its consultant, and one of its external portfolio managers, the issue of relaxing this restriction
18. Why would a bond portfolio manager employ a protective put buying strategy?
17. Explain, in terms of equivalent cash market positions, the effect on the dollar duration of a bond portfolio of adding an interest rate swap in which the portfolio manager agrees to pay floating and receive fixed.
16. Mr. Eddy is a portfolio manager for a finance company. The company has a portfolio of consumer loans with a par value of $500 million. Unlike typical auto loans, the borrowers for the loans in the portfolio make no periodic principal payments. Instead, the borrowers make quarterly interest
15. Mr. Elmo is a portfolio manager who has recently begun to use interest rate futures for risk control. In his first attempt to hedge a long position in a particular bond, he did partially offset the loss associated with a decline in the value of that bond. However, the hedge did not perform as
14. A portfolio manager estimated that the duration for his $1 billion portfolio is 5.2. Suppose that the manager wants to hedge this portfolio with a Treasury bond futures contract and that the dollar duration of the Treasury bond futures contract for a 50 basis point change in rates is $4,000.
13. In cross hedging, what is meant by a ‘‘yield beta’’ and how is it used in constructing a hedge (i.e., computing the number of contracts to buy or sell when hedging)?
12. Mr. Denton has a $20 million par value position in an investment-grade corporate bond. He has decided to hedge the position for one month using Treasury bond futures contracts that settle in one month. Mr. Denton’s research assistant provided the following information:Information about the
11. What are the two important relationships in cross hedgingmortgage passthrough securities using Treasury note futures contracts?
10. Explain what is meant by a cross hedge?
9.a. In a hedging strategy, what is meant by basis risk?b. Explain why hedging substitutes basis risk for price risk?c. Explain why a manager would be willing to substitute basis risk for price risk?
8. Mr. Ulston is a bond portfolio manager who, although familiar with interest rate futures, has not previously used them in managing a portfolio. Recently, Mr. Ulston received authorization from several clients to use interest rate futures and so contacted one of his brokers to obtain information
7.a. What is meant by the ‘‘target price’’ for a hedge?b. How does a manager use information about the target price for a hedge when deciding whether or not to hedge?
6. What factors should a portfolio manager consider when selecting which futures contract will best control a portfolio’s interest rate risk?
5. Why is hedging a special case of interest rate risk management?
4. Suppose that the dollar duration for the cheapest-to-deliver issue for the Treasury bond futures contract is $6,000 per 50 basis point change in rates and the conversion factor for that issue is 0.90. What is the dollar duration for the futures contract per 50 basis point change in rates?
3. Ms. Marcus is a portfolio manager who is responsible for a $200 million portion of the bond portfolio of UltraChip.com’s pension fund. The current investment guidelines specify that the duration for the portfolio can be in a range of minus one and plus one of the benchmark. Currently, the
2. The trustees of the Egg Craters pension fund are discussing with their consultant, Mr.William, about establishing a new benchmark for the fund’s external bond managers. The benchmark would be based on the projected duration of the fund’s liabilities. Currently, the investment guidelines of
1. Mr.Dawson is a portfoliomanager who is responsible for the account of the Pizza Delivery Personnel Union (PDPU). At this time, the trustees have not authorized Mr. Dawson to take positions in Treasury bond futures contracts. At his quarterly meeting with PDPU’s board of trustees, Mr. Dawson
• explain how interest rate caps and floors can be used in asset/liability management.
• compute the number of futures options required to hedge a position.
• compute the appropriate strike price when using futures options to hedge a nondeliverable bond.
• describe a collar strategy.
• explain the limitations of a covered call writing strategy for hedging.
• explain how the outcome of a protective put buying strategy differs from that of a hedge using futures contracts.
• describe the basic hedging strategies that use options.
• explain how positions in an interest rate swap change the dollar duration of an entity.
• compute the dollar duration of an interest rate swap.
• calculate the cash flows of an entity that has taken a position in an interest rate swap.
• show how the cash flows of an entity can be altered using an interest rate swap.
• identify the major sources of hedging error.
• describe yield beta and explain how it is used to adjust the number of futures contracts in a hedge.
• explain why an assumption must be made about the yield spread between a bond to be hedged and the hedging instrument.
• explain how the position in a Treasury bond futures contract is adjusted for the cheapest-to-deliver issue.
• calculate the number of futures contracts that must be sold to hedge a position against a rise in interest rates.
• describe convergence for a futures contract.
• describe which price or rate is locked in when hedging with a futures contract.
• describe basis risk and explain why hedging with futures substitutes basis risk for price risk.
• identify the factors that are important for determining the appropriate hedging instrument.
• identify the steps in the hedging process.
• explain what a cross hedge is.
• describe a short hedge and a long hedge and explain when each hedge is used.
• explain why hedging is a special case of controlling interest rate risk.
• compute the dollar duration of a futures contract.
• calculate the number of futures contracts that must be bought or sold in order to achieve a portfolio’s target duration.
• determine the position in a futures contract that adjusts the current dollar duration of a portfolio to that of the target dollar duration.
• explain the basic principles of controlling interest rate risk.
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