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Chapter+18+Answers+to+end-of-chapter+questions

Chapter+18+Answers+to+end-of-chapter+questions - CHAPTER 18...

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CHAPTER 18 FUTURES AND FORWARDS Chapter outline Forward and Futures Contracts Spot Contracts Forward Contracts Futures Contracts Forward Contracts and Hedging Interest Rate Risk Creating a Synthetic Fixed Rate loan with Forward Contracts Hedging Interest Rate Risk with Futures Contracts Microhedging Macrohedging Routine Hedging versus Selective Hedging Macrohedging with Futures The Problem of Basis Risk Hedging Foreign Exchange Risk Forwards Futures Estimating the Hedge Ratio Hedging Credit Risk with Futures and Forward Contracts Futures Contracts and Credit Risk Hedging Accounting Treatment of Forward and Futures Contracts Forward Contracts Futures and Forward Policies of Regulators Instructor’s Resource Manual t/a Financial Institutions Management 2e by Lange, Saunders, Anderson, Thomson & Cornett 1
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Solutions for end-of-chapter questions QUESTIONS AND PROBLEMS 1. What are derivative contracts? How are derivatives useful to managers of FIs? Derivatives are financial assets whose value is determined by the value of some underlying asset. As such, derivative contracts are instruments that provide the opportunity to take some action at a later date based on an agreement to do so at the current time. Although the contracts differ, the price, timing, and extent of the later actions usually are agreed upon at the time the contracts are arranged. Normally the contracts depend on the activity of some underlying asset. Derivatives have value to the managers of FIs because they aid in managing the various types of risk prevalent in the institutions. 2. What has been the regulatory result of some of the misuses by FIs of derivative products? In many cases the accounting requirements for the use of derivative contracts have been tightened. Specifically, Australian Accounting Standards now require that all derivatives be marked to market and that all gains and losses immediately be identified on financial statements. 3. What are some of the major differences between futures and forward contracts? How do these contracts differ from a spot contract? A spot contract is an exchange of cash, or immediate payment, for financial assets, or any other type of assets, at the time the agreement to transact business is made, i.e. at time 0. Futures and forward contracts both are agreements between a buyer and a seller at time 0 to exchange the asset for cash (or some other type of payment) at a later time in the future. The specific grade and quantity of asset is identified, as is the specific price and time of transaction. One of the differences between futures and forward contracts is the uniqueness of forward contracts because they are negotiated between two parties. On the other hand, futures contracts are standardised because they are offered by and traded on an exchange. Futures contracts are marked to market daily by the exchange, and the exchange guarantees the performance of the contract to both parties. Thus the risk of default by the either party is minimised from the viewpoint of the other party. No such guarantee exists for a forward contract. Finally, delivery of
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