FIN 3403 Chapter Notes - Chapter 14: United States Treasury Security, Financial Institution, Open Interest

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fuchsiawalrus922

11 Apr 2018

School

University of Oklahoma

Department

Finance

Course

FIN 3403

Professor

Josh Mc Cowen

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Document Summary

Engage in a financial transaction that reduces or eliminates risk. Hedging risk involves engaging in a financial transaction that offsets a long position by taking an additional short position, or offsets a short position by taking an additional long position. When a financial institution has bought an asset, said to have taken a long position. If it has sold an asset that it has agreed to deliver to another party at a future date, said to have taken a short position. Agreement between two parties to engage in a financial transaction at a future (forward) point in time. Specification of the actual debt instrument that will be delivered on a future date. The amount of debt instrument to be delivered. The price or interest rate to be paid on the debt instrument when it is delivered. The date on which delivery will take place.

Related Questions

1. Futures Contracts Describe the general charac- teristics of a futures contract. How does a clearinghouse facilitate the trading of financial futures contracts?

2. Futures Pricing How does the price of a financial futures contract change as the market price of the security it represents changes? Why?

3. Hedging with Futures Explain why some futures contracts may be more suitable than others for hedging exposure to interest rate risk.

4. Treasury Bond Futures Will speculators buy or sell Treasury bond futures contracts if they expect interest rates to increase? Explain

7. Hedging with Futures Assume a financial institution has more rate-sensitive assets than rate-sensitive liabilities. Would it be more likely to be adversely affected by an increase or a decrease in interest rates? Should it purchase or sell interest rate futures contracts in order to hedge its exposure?

8. Hedging with Futures Assume a financial institution has more rate-sensitive liabilities than rate- sensitive assets. Would it be more likely to be adversely affected by an increase or a decrease in interest rates.

Should it purchase or sell interest rate futures contracts in order to hedge its exposure?

9. Hedging Decision Why do some financial insti- tutions remain exposed to interest rate risk, even when they believe that the use of interest rate futures could reduce their exposure?

10. Long versus Short Hedge Explain the difference between a long hedge and a short hedge used by financial institutions. When is a long hedge more appropriate than a short hedge?

11. Impact of Futures Hedge Explain how the probability distribution of a financial institutionâs returns is affected when it uses interest rate futures to hedge. What does this imply about its risk?

12. Cross-Hedging Describe the act of cross-hedging. What determines the effectiveness of a cross-hedge?

ivorywombat545

Which following statement is INCORRECT?

		When the market is not in equilibrium, the potential for ârisk-lessâ or arbitrage profit exists.
		The theories about how exchange rate always work out to be âtrueâ when compared to what students and practitioners observe in the real world.
		A forward exchange agreement between currencies states the rate of exchange at which a foreign currency will be bought forward or sold forward at a specific date in the future
		RPPP holds that PPP is not particularly helpful in determining what the spot rate is today, but that the relative change in prices between two countries over a period of time determines the change in the exchange rate over that period.
		While hedging can protect the owner of an asset from a loss, it also eliminates any gain from an increase in the value of the asset hedged against.

graywater-buffalo134

Air Jethro was organized on January 1, 2015, and expected to be able to begin providing air service in eighteen months, with the first flight scheduled for July 1, 2016.

At the time Air Jethro was organized, there was great uncertainty about the future price of oil (i.e. fuel). Since fuel will be a significant portion of Air Jethroâs operating expenditures, Air Jethro had to decide an appropriate fuel strategy. Air Jethro expects to use the equivalent of 250,000 barrels of oil during the period July 1, 2016 to December 31, 2016. One possibility under consideration was purchasing 250,000 barrels of oil on January 1, 2015, and then hedging its âfair valueâ so that if the scheduled flights never took place, Air Jethro would not lose money on the oil that had been purchased.

On January 1, 2015, the spot price for a barrel of Texas Crude is $ 50.00 per barrel. Drysdale Financial is a financial institution currently offering eighteen-month derivative oil contracts, each denominated in 100,000 barrels of oil. These contracts may be settled at any time prior to June 30, 2016, but must be settled on that date if they had not been closed previously. (Denote âSPâ as the spot price of oil on the date a contract is settled.)

Party A receives: 100,000 x ($50 â SP) per contract if SP < $ 50 on the date the contract is settled

Party A pays: 100,000 x (SP - $50) per contract if SP > $50 on the date the contract is settled

Party B will have the exact opposite cash flows as Party A. Air Jethro may elect to take the position of Party A or Party B, with Drysdale Financial serving as the counterparty. (While Drysdale Financial would ordinarily charge a fee for accepting this type of contract, this fee is ignored for purposes of this problem.)

For purposes of the following problems, assume that the spot price of oil on December 31, 2015 is $ 40.00 per barrel and that the spot price of oil on June 30, 2016 is $ 35.00 per barrel. (Note that these amounts are not known on January 1, 2015, and only become known as time passes.)

Assume that Air Jethro purchases 250,000 barrels of oil from Clampett Oil on January 1, 2015 at a price of $ 50.00 per barrel. Further, assume that on January 1, 2015, Air Jethro also enters into three oil derivative contracts with Drysdale Financial, and designates the contracts as âfair value hedgesâ.

First Question: In order to create a fair value hedge, should Air Jethro take the position of Party A or Party B in the contract with Drysdale Financial?

Given your answer to the previous question, with respect to the transactions described above, please indicate the numbers that would appear on Air Jethroâs financial statements for the following items (if the item will not appear on a financial statement, please indicate this by putting $ 0 in the applicable line(s)).

Oil Inventory â December 31, 2015: $ _______________

Derivative Asset / Liability (circle one)

on December 31, 2015: $ _______________

Net Income: Year-Ending Dec. 31, 2015: $ _______________

Comprehensive Income: Year-Ending Dec. 31, 2015: $ _______________

FIN 3403 Chapter Notes - Chapter 14: United States Treasury Security, Financial Institution, Open Interest

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