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1、 97 CHAPTER 7 USING FINANCIAL FUTURES AND OPTIONS,SWAPS,AND OTHER HEDGING TOOLS IN ASSET-LIABILITY MANAGEMENT Goal of This Chapter:The purpose of this chapter is to examine how financial futures,options,and swap contracts,as well as selected other asset-liability management techniques can be employe
2、d to help reduce a banks potential exposure to loss as market conditions change.We will also discover how swap contracts and other hedging tools can generate additional revenues for banks by providing risk-hedging services to their customers.Key Topics in this Chapter Use of Derivatives by Commercia
3、l Banks Financial Futures Contracts:Purpose and Mechanics Short and Long Hedges Interest-Rate Options:Nature and Types of Contracts Interest-Rate Swaps Regulations and Accounting Rules Caps,Floors,and Collars Chapter Outline I.Introduction:Several of the Most Widely Used Tools to Manage Risk Exposur
4、e II.Commercial Banks use of Derivative Contracts III.Financial Futures Contracts:Promises of Future Security Trades at a Set Price A.Background on Futures B.Purposes of Financial Futures Trading C.Most Popular Types of Futures Contracts D.The Short Hedge in Futures E.The Long Hedge in Futures F.Usi
5、ng Long and Short Hedges to Protect Income and Value G.Basis Risk H.Basis Risk with a Short Hedge I.Basis Risk with a Long Hedge J.Number of Futures Contracts Needed IV.Interest Rate Options A.Nature of Interest-Rate Options B.How They Differ from Futures Contracts C.Most Popular Types of Options D.
6、Purpose of Interest-Rate Options V.Regulations and Accounting Rules for Bank Futures and Options Trading VI.Interest Rate swaps A.Nature of swaps 98 B.Quality swaps C.Advantages of Swaps Over Other Hedging Methods D.Reverse swaps E.Potential Disadvantages of Swaps VII.Caps,Floors,and Collars A.Inter
7、est Rate Caps B.Interest Rate Floors C.Interest Rate Collars VIII.Summary of the Chapter Concept Checks 7-1.What are financial futures contracts?Which banks and other financial institutions use futures and other derivatives for risk management?Financial futures are contracts calling for the delivery
8、 of specific types of securities at a set price on a specific future date.Financial futures contract help to hedge interest rate risk and are thus,used by any bank or financial institution that is subject to interest rate risk.7-2.How can financial futures help banks and competing financial service
9、firms deal with interest-rate risk?Financial futures allow banks and other financial institutions to deal with interest-rate risk by reducing risk exposure from unexpected price changes.The financial futures markets are designed to shift the risk of interest rate fluctuations from risk-averse invest
10、ors to speculators willing to accept and possibly profit from such risks.7-3.What is a long hedge in financial futures?A short hedge?A long hedger offsets risk by buying financial futures contracts around the time new deposits are expected,when a loan is to be made,or when securities are added to th
11、e banks portfolio.Later,as deposits and loans approach maturity or securities are sold,a like amount of futures contracts is sold.A short hedger offsets risk by selling futures contracts when the bank is expecting a large cash inflow in the near future.Later,as deposits come flowing in,a like amount
12、 of futures contracts is purchased.7-4.What financial futures transactions would most likely be used in a period of rising interest rates?Falling interest rates?Rising interest rates generally call for a short hedge,while falling interest rates usually call for some form of long hedge.7-5.How do you
13、 interpret the quotes for financial futures in The Wall Street Journal?99 The first column gives you the opening price,the second and third the daily high and low price,respectively.The fourth column shows the settlement price followed by the change in the settlement price from the previous day.The
14、next two columns show the historic high and low price and the last column points out the open interest in the contract.7-6.A futures contract calling for delivery of Treasury Bills in 90 days is currently selling at an interest yield of 4 percent,while yields on Treasury bills available for immediat
15、e delivery are currently at 4.60 percent.What is the basis for the T-Bill futures contracts?The basis for these bill contracts is currently 4.60%4%or 60 basis points.7-7.Suppose a bank wishes to sell$150 million in new deposits next month.Interest rates today on comparable deposits stand at 8 percen
16、t,but are expected to rise to 8.25 percent next month.Concerned about the possible rise in borrowing costs,management wishes to use a futures contract.What type of contract would you recommend?If the bank does not cover the interest rate risk involved,how much in lost potential profits could the ban
17、k experience?At an interest rate of 8 percent:$150 million x 0.08 x 30360=$1 million At an interest rate of 8.25 percent:$150 million x 0.0825 x 30360=$1.031 million The potential loss in profit without using futures is$0.0313 million or$31.3 thousand.In this case the bank should use a short hedge.7
18、-8.What kind of futures hedge would be appropriate in each of the following situations?a.A bank fears that rising deposit interest rates will result in losses on fixed-rate loans?b.A bank holds a large block of floating-rate loans and market interest rates are falling?c.A projected rise in market ra
19、tes of interest threatens the value of the banks bond portfolio?a.The rising deposit interest rates could be offset with a short hedge in futures contracts(for example,using Eurodollar deposit futures).b.Falling interest yields on floating-rate loans could be at least partially offset by a long hedg
20、e in Treasury bonds or bills.c.The banks bond portfolio could be protected through appropriate short hedges using Treasury bond and note futures contracts.100 7-9.Explain what is involved in a put option?A put option allows its holder to sell securities to the option writer at a specified price.The
21、buyer of a put option expects market prices to decline in the future or market interest rates to increase.The writer of the contract expects market prices to stay the same or rise in the future.7-10.What is a call option?A call option permits the option holder to purchase specific securities at a gu
22、aranteed price from the writer of the option contract.The buyer of the call option expects market prices to rise in the future or expects interest rates to fall in the future.The writer of the contract expects market prices to stay the same or fall in the future.7-11.What is an option on a futures c
23、ontract?An option on a futures contract does not differ from any other kind of option except that the underlying asset is not a security,but a futures contract.7-12.What information do T-bond and Eurodollar futures option quotes contain?The quotes contain information about the strike prices and the
24、call and put prices at each different strike price for given months.7-13.Suppose market interest rates were expected to rise?What type of option would normally be used?If interest rates were expected to rise,a put option would normally be used.A put option allows the option holder to deliver securit
25、ies to the option writer at a price which is now above market and make a profit.7-14.If market interest rates were expected to fall,what type of option would a bank or financial institutions manager be likely to employ?If interest rates were expected to fall,a call option would likely be employed.Wh
26、en interest rates fall,the market value of a security increases.The security can then be purchased at the option price and sold at a profit at the higher market price.7-15.What rules and regulations have recently been imposed on the use of futures,options,and other derivatives by banks?What does the
27、 Financial Accounting Standards Board(FASB)require banks and other publicly traded firms to do in accounting for derivative transactions?Each bank has to implement a proper risk management system comprised of(1)policies and procedures to control financial risk taking,(2)risk measurement and reportin
28、g systems and(3)independent oversight and control processes.In addition,FASB introduced statement 133 which requires that all derivatives are recorded on the balance sheet as assets or liabilities at their fair 101 value.Furthermore,the change in the fair value of a derivative and a fair value hedge
29、 must be reflected on the income statement.7-16.What is the purpose of an interest rate swap?The purpose of an interest rate swap is to change an institutions exposure to interest rate fluctuations and achieve lower borrowing costs.7-17.What are the principal advantages and disadvantages of rate swa
30、ps?The principal advantage of an interest-rate swap is the reduction of interest-rate risk of both parties to the swap by allowing each party to better balance asset and liability maturities and cash-flow patterns.Another advantage of swaps is that they usually reduce interest costs for one or both
31、parties to the swap.The principal disadvantage of swaps is they may carry substantial brokerage fees,credit risk and some basis risk.7-18.How can a bank or other financial institution get itself out of a swap agreement?The usual way to offset an existing swap is to undertake another swap agreement w
32、ith opposite characteristics.7-19.How can banks and other financial-service providers make use of interest rate caps,floors,and collars to generate revenue and help manage interest rate risk?Banks and other financial institutions can generate revenue by charging up-front fees for interest rate caps
33、on loans and interest rate floors on securities.In addition,a positive net premium on interest rate collars will add to a banks fee income.Caps,floors,and collars help manage interest rate risk by setting maximum and minimum interest rates on loans and securities.They allow the lender and borrower t
34、o share interest rate risk.7-20.Suppose a bank enters into an agreement to make a$10 million,three-year floating-rate loan to one of its corporate customers at an initial rate of 8 percent.The bank and the customer agree to a cap and a floor arrangement in which the customer reimburses the bank if t
35、he floating loan rate drops below 6 percent and the bank reimburses the customers if the loan rate rises above 10 percent.Suppose that,at the beginning of the loans second year,the floating loan rate drops to 4 percent for a year and then,at the beginning of the third year,the loan rate increases to
36、 11 percent for the year.What rebates must be paid by each party to the agreement?The rebate owed by the bank for the third year must be:(11%-10%)x$10 million=$100,000.The rebate that must be forwarded to the bank for the second year must be:(6%-4%)x$10 million=$200,000.102 Problems 7-1.You hedged y
37、our banks exposure to declining interest rates by buying one March Treasury bond futures contract at the opening price on December 18,2002(see exhibit 7-2).It is now January 6,and you discover that on Friday,January 3 March T-bond futures opened at 110-08 and settled at 110-09.a.What are the profits
38、/losses on your long position as of settlement on January 3?Buy at 109-08 or 109 8/32 per contract=109,250 Value at settlement on January 3,110-09 or 110 9/32=110,281.25 Gain=110,281.25 109,250=$1031.25 b.If you deposited the required initial margin on 12/18 and have not touched the equity account s
39、ince making that cash deposit,what is your equity account balance?The equity account balance will increase by the gain in the position,thus$2,000+1,031.25=$3,031.25 7-2 Use the quotes of Eurodollar futures contracts traded on the Chicago Mercantile Exchange on January 3,2002 to answer the following
40、questions:a.What is the dollar price for the underlying securities($1 million in 90-day Eurodollar time deposits)based on the low IMM index for the nearest June contract?The price is(1,000,000 x1-(1.51/100)x(90/360)=$996,225 b.If your bank took a short position at the high price for the day for 15 c
41、ontracts,what would be the dollar gain/loss at settlement on January 3,2003?Sell at high price:(1,000,000 x1-(1.47/100)x90/360)x15=14,944,875 Value at settlement:996,300 x15=14,944,500 Profit:14,944,875 14,944,500=$375 c.If you deposited the initial required hedging margin in your equity account upo
42、n taking the position described in b,what would be the marked to market value of your equity account at settlement?Initial margin=$600 x15=$9,000 You realize a$25 gain for every basis point decrease in the IMM index.Thus:1($25)(15)=375 in profits and the value of the equity account is$9,375.7-3.What
43、 kind of futures or options hedges would be called for in the following situations?103 a.Market rates are expected to decline and First National Banks asset and liability manager expects to liquidate a portion of their bond portfolio to meet depositors demands for funds in the upcoming quarter.First
44、 National can expect lower loan revenue unless it uses long futures hedges in which contracts for government securities are first purchased and then sold at a profit as security prices rise provided interest rate really do fall.A similar gain could be made using call options on government securities
45、 or on financial futures contracts.b.Silsbee Savings Bank has interest-sensitive assets of$79 million and interest-sensitive liabilities of$88 million over the next 30 days and market interest rates are expected to rise.Silsbee Savings Banks interest-sensitive liabilities exceed its interest-sensiti
46、ve assets by$11 million which means the bank will be open to losses if interest rates rise.The bank could sell financial futures contracts or use a put option on government securities or financial futures contracts approximately equal in dollar volume to the$11 million interest-sensitive gap.c.A sur
47、vey of Tuskee Banks corporate loan customers this month(January)indicates that,on balance,this group of firms will need to draw$165 million from their credit lines in February and March,which is$65 million more than the banks management has forecasted and prepared for.The banks economist has predict
48、ed a significant increase in money market rates over the next 60 days.The forecast of higher interest rates means the bank must borrow at a higher interest cost which,other things held equal,will lower its net interest margin.To offset the expected higher borrowing costs the banks management should
49、consider a short sale of financial futures contracts or a put option approximately equal in volume to the additional loan demand.Either government securities or EuroCDs would be good instruments to consider using in the futures market or in the option market.d.Monarch National Bank has interest-sens
50、itive assets greater than interest sensitive liabilities by$24 million.If interest rates fall(as suggested by data from the Federal Reserve Board)the banks net interest margin may be squeezed due to the decrease in loan and security revenue.Monarch National Bank has interest-sensitive assets greater