Chapter 4 Interest Rate, Stock Index, and foreign Currency Futures

Question 1

Debt Securities

Answer 1

Sold by an issuer as means to raise money.

Question 2

Who is the borrower of debt securities?

Answer 2

the issuer

Question 3

The buyer of the debt security is:

Answer 3

the lender and expects to earn interest and have the principal returned when the debt security matures.

Question 4

Who issues debt

Answer 4

• Federal Governments
• Municipal governments
• corporations

Question 5

Coupon Rate

Answer 5

annual payments paid by the issuer relative to the bonds face (par) value.

Question 6

If interest rates fall, bond prices:

Answer 6

rise

Question 7

Default risk

Answer 7

the risk that the issuer may lack the means to pay interest and principal on its debt.

Question 8

Normal (positive) yield curve

Answer 8

Lower yields for short-term debt and higher yields for long-term debt are typical, and the curve they produce when depicted on a graph is a normal (positive) yield curve.

Question 9

Why does a normal (positive) yield curve have an upward or positive slope?

Answer 9

this is normal because of risk: The shorter the maturity, the less volatile (hence safer): the longer the maturity, the more volatile (hence riskier).

Question 10

Inverted (negative) yield curve

Answer 10

indicates that short term debt securities provide higher yields than long-term debt securities.

Question 11

When does an inverted yield curve typically occur?

Answer 11

temporary phenomenon when the supply of money is tight.

Question 12

Positive carry

Answer 12

when the short term interest rates are lower than the long term interest rates, thereby creating a positive yield curve.

Question 13

Why are interest rate future prices progressively discounted on a monthly basis in the normal, positive carrying charge environment?

Answer 13

Financial institutions can profitably offer lower quotes on the more distant money market vehicles, thereby creating a situation where the further-out contracts are quoted at a discount to the nearbys.

Question 14

Inverted (negative) yield curve

Answer 14

as the term of the security increases, the yield decreases

Question 15

Humped yield curve

Answer 15

a humped curve occurs when short-term and long-term yields are nearly equal and medium-term yields are higher than short-term and long-term.

Question 16

Positive yield curve summary

Answer 16

Long term rates greater than short term rates

Question 17

negative yield curve

Answer 17

long term rates less than short term rates

Question 18

flat yield curve

Answer 18

long term rates and short term rates about the same

Question 19

humped yield curve

Answer 19

short term and long term yields are nearly equal, and medium-term yields are higher.

Question 20

Why are short term yields more volatile than long term

Answer 20

interest rates on new 3 month t-bills vary from week to week, depending on economic expectations. Conversely, a 20 year bond yields react less to daily events because short-term events mean little relative to the bonds 20 year life.

Question 21

Why are long term prices more volatile

Answer 21

Interest rate changes have little effect on the price of short-term bills because they mature quickly. Because of the long time framce and the subsequesnt risk to the buying power of the bond income and principal due to inflation, long-term securities have greater interest rate risk.

Question 22

Short term debt obligations 2

Answer 22

t-bills

eurodollar futures

Question 23

T-Bill and Eurodollar Futures similar features (4)

Answer 23

Contract size based on $1 million par values

2. have three-month maturities
3. are priced at a discount and mature at par (100%);
4. Reflect that the underlying commodity is a discount debt obligation.

Question 24

What is the yield of a t-bill

Answer 24

difference between the discount price and par.

Question 25

What is the yield for debt instruments stated in?

Answer 25

annualized terms

Question 26

Futures pricing of debt

Answer 26

100% of price-the annualized yield.

Question 27

What are eurodollars

Answer 27

CME contracts on short-term, $1 million, eurodollar deposits, U.S. dollar-denominated time deposits at banks anywhere outside the U.S.

Question 28

how is the Final settlement price of Eurodollar calculated

Answer 28

subtracting the three-month London Interbank Offered Rate (LIBOR) from 100.

Question 29

What is the Libor rate

Answer 29

the rate at which banks lend to one another in the London interbank market.

Question 30

Long term debt obligation futures (2)

Answer 30

T-Bonds

T-Notes

Question 31

T-bonds and T-notes common specs (3)

Answer 31

• 100k par value
• are treated as having 6% coupon rates
• Delivery months of march, June, September, and December.

Question 32

What does the settlement price at delivery depend on for t-bonds and t-notes?

Answer 32

the coupon rate on the bonds and the appropriate adjustment factor.

Question 33

How do you calculate the amount the long futures holder who takes deliver would have to pay

Answer 33

Contract settlement price X adjustment factor.

Question 34

How do you qualify for delivery of t-bond?

Answer 34

securities mush have 15 years or more remaining until matruity or the first call date. Delivery can be made by depositing the appropriate dollar amount of T-bonds in any Federal Reserve System bank for wire transfer over the federal reserve wire. T-Bond futures are the most actively traded of all futures contracts.

Question 35

T-note futures

Answer 35

are contracts on intermediate-term U.S. government debt.

Question 36

How do T-Notes qualify for delivery

Answer 36

Treasury securities must have at least 6.5 years, but no more than 10 years, remaining until their maturity date or first call date.

Question 37

Intermaturity spreads

Answer 37

Example: Buying T-bill futures while selling t-bond futures.