Risk Latte - Quiz # 2

1) The forward spread between risk free rate and corporate yield is 85 basis points and an option is struck at 90 basis points(bp). The spread volatility is 65% per annum and the risk free rate is 5.75%. The value of a six month call on the forward spread will be:

a) 13.16 bp
b) 24.56 bp
c) 12.28 bp
d) None of the above.

2) The value of the put on the spread will be:

a) 11.00 bp
b) 24.56 bp
c) 12.28 bp
d) 18.02 bp

3) A floating rate spread over LIBOR, which is stated on a money market basis, is 1.500%. The equivalent of this spread on bond basis is:

a) 1.673%
b) 1.591%
c) 1.586%
d) 1.521%

4) Suppose that a seven year $100 par value bond having a coupon of 8.5% is priced to yield 8.00% (semi-annual bond basis). The present value of this bond is $102.64078. The bond's Dollar Value of a basis point change (DV01) is:

a) $0.1278
b) $0.05367
c) $0.00245
d) $0.08745

5) A portfolio of swaps has a 5 year T-Note baseline equivalent of positive $12.766 million. Thus to macro-hedge this portfolio of swaps the dealer needs to:

a) Sell $12.766 million of T-Notes short;
b) Buy $12.766 million short;
c) Sell 128 contracts of T-Note futures;
d) Sell $12.766 million of T-Notes short and Sell 128 contracts of T-Note futures.

6) If a short dated swap is to have a tenor of n years and is to bepriced off three month Eurodollar futures, then the pricing will require m sequential futures contracts, where:

a) m = 2n
b) m = 4n
c) m = 6n
d) m = 8n

7) Pure hedge accounting is the process whereby:

a) Changes in the value of the hedged item and the hedge security, from the date of          the hedge, are reported and affect income in the same period;
b) Changes in the value of the hedge security is reported from the date of the hedge          and the changes in the value of the hedged item is reported at a later date;
c) Changes in the value of the hedge security is reported from the date of the hedge          and reporting the changes in the value of the hedged item isleft to the discretion of          the company;
d) Only the historical value of the hedge security is shown and neither the changes in          the value of the hedged item nor that of the hedge security is reported but totally left          to the discretion of the company

8) A steel corporation has invested in an oil corporation. For the purposes of accounting this transaction will not be considered a hedge because:

a) The steel corporation will tend to have expected return (profits) from the transaction;
b) There are no derivatives involved in this transaction;
c) The transaction will have to pass through the balance sheet of the steel corporation;
d) None of the above.

9)A necessary, but not sufficient, condition for a hedge to exist from an accounting point of view is:

a) The likelihood of a high correlation of value changes based on the economic characteristics of the item being hedged and the hedge item;
b) Empirical evidence through time that substantiaties a.
c) Either of the above or both a and b
d) Financial derivatives should be involved in the transaction.

10) A fund manager is managing a portfolio of emerging market bonds. Due to crsis in some emerging markets there has been a sell off in these bonds and the 10-year spread on these BBB/Baa rated bond s has widened from 100 basis points to 155 basis points over US Treasuries. The rise in spreads is accompanied by a rise in volatility of these instruments. If the investor believes that this phenomenon is going to be short lived and does not want to sell his bonds, then a prefereed strategy for hime would be:

a) Buy one year put option on the forward credit spread with strike 175 bp;
b) Buy one year put option on the forward credit spread with strike 100 bp;
c) Sell a one year put option on the forward credit spread with strike 175 bp;
d) Sell a one year put option on the forward credit spread with strike 100 bp;