Podcast
Questions and Answers
Which action can a firm take using interest-rate forward and futures contracts in the bond market?
Which action can a firm take using interest-rate forward and futures contracts in the bond market?
- Directly influence the prevailing market interest rates.
- Lock in a future price for buying or selling a bond. (correct)
- Avoid exposure to interest rate fluctuations.
- Speculate on interest rate movements without any underlying asset.
In the context of interest rate movements and bond prices, what generally happens when market interest rates increase?
In the context of interest rate movements and bond prices, what generally happens when market interest rates increase?
- Bond prices rise, making them more attractive to investors.
- Bond prices remain stable due to fixed coupon rates.
- There is no impact on bond prices from interest rate fluctuations.
- Bond prices fall, reflecting decreased attractiveness. (correct)
How can a company use interest-rate futures contracts to mitigate potential losses from issuing corporate bonds when interest rates are volatile?
How can a company use interest-rate futures contracts to mitigate potential losses from issuing corporate bonds when interest rates are volatile?
- By converting assets into liquid cash.
- By ignoring interest-rate futures, focusing instead on diversifying their investment portfolio.
- By buying interest-rate futures to profit if rates rise, offsetting increased borrowing costs. (correct)
- By selling interest-rate futures, thus ensuring they benefit if the rates increase.
What financial instrument is commonly used in Canada for interest-rate hedging, particularly those related to government bonds?
What financial instrument is commonly used in Canada for interest-rate hedging, particularly those related to government bonds?
If a company plans to issue bonds in two years and is concerned about rising interest rates. What strategy should they employ using forward contracts?
If a company plans to issue bonds in two years and is concerned about rising interest rates. What strategy should they employ using forward contracts?
What impact does an increase in market interest rates have on the profitability of selling forward contracts on government bonds?
What impact does an increase in market interest rates have on the profitability of selling forward contracts on government bonds?
What is the primary objective when a firm uses interest-rate futures to offset potential losses or gains from corporate bond issues?
What is the primary objective when a firm uses interest-rate futures to offset potential losses or gains from corporate bond issues?
Which scenario would likely prompt a firm to use interest-rate futures to hedge against future financial risks?
Which scenario would likely prompt a firm to use interest-rate futures to hedge against future financial risks?
How does hedging with interest-rate forward contracts help a company planning a future bond issue?
How does hedging with interest-rate forward contracts help a company planning a future bond issue?
A company plans to issue $10 million in bonds in two years and decides to sell forward contracts to hedge against rising interest rates. If rates rise and the company profits $1,236,004 from the forward contracts, what is the effect of this profit?
A company plans to issue $10 million in bonds in two years and decides to sell forward contracts to hedge against rising interest rates. If rates rise and the company profits $1,236,004 from the forward contracts, what is the effect of this profit?
What characterizes 'cross-hedging' in the context of interest rate risk management?
What characterizes 'cross-hedging' in the context of interest rate risk management?
What happens to the present value of savings from reduced annual interest payments if interest rates fall?
What happens to the present value of savings from reduced annual interest payments if interest rates fall?
In the example, if the market interest rate falls to 8% and leads to a loss of $1,479,571.81 on the forward position, how is this loss offset.
In the example, if the market interest rate falls to 8% and leads to a loss of $1,479,571.81 on the forward position, how is this loss offset.
What action should a firm take if it decides to issue bonds in two years and wants to protect itself from rising interest rates?
What action should a firm take if it decides to issue bonds in two years and wants to protect itself from rising interest rates?
A firm sells forward contracts to deliver 13,259 government bonds. If interest rates rise, causing the market price of government bonds to decline. How does this affect the firm's position?
A firm sells forward contracts to deliver 13,259 government bonds. If interest rates rise, causing the market price of government bonds to decline. How does this affect the firm's position?
A company sells a forward contract on government bonds. If, at the contract's maturity, the market interest rates are higher than anticipated, what is the most likely outcome?
A company sells a forward contract on government bonds. If, at the contract's maturity, the market interest rates are higher than anticipated, what is the most likely outcome?
How does a decrease in interest rates affect a company that has sold forward contracts on government bonds?
How does a decrease in interest rates affect a company that has sold forward contracts on government bonds?
What is the role of a financial calculator in the context of hedging interest rate risk with government bonds?
What is the role of a financial calculator in the context of hedging interest rate risk with government bonds?
How might a firm adjust its financial strategy if short-term money market interest rates are lower than long-term debt interest rates?
How might a firm adjust its financial strategy if short-term money market interest rates are lower than long-term debt interest rates?
How can a company effectively manage interest rate risk associated with issuing $10 million in bonds in two years??
How can a company effectively manage interest rate risk associated with issuing $10 million in bonds in two years??
Flashcards
Interest-Rate Forwards/Futures
Interest-Rate Forwards/Futures
Contracts that lock in a future price for buying/selling a bond.
Hedging Against Rising Rates
Hedging Against Rising Rates
Selling a forward contract to deliver bonds at a future date.
Cross-Hedging
Cross-Hedging
When the asset in the forward contract differs from the asset being hedged.
Bond Price Relationship
Bond Price Relationship
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Hedging with Futures
Hedging with Futures
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Canadian interest-rate futures are written on...
Canadian interest-rate futures are written on...
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Study Notes
Interest-Rate Futures
- Interest-rate forward and futures contracts lock in a future bond price for buying or selling.
- In Canada, interest-rate futures are based on 10-year, 6% coupon, annual-pay Canadian government bonds and similar securities traded on the Montreal Exchange.
- Bond and debt security prices increase when market interest rates decrease, and vice versa.
- Buying or selling interest-rate forwards/futures on government bonds can yield gains or losses due to market interest rate changes.
- These gains/losses can offset those from corporate bond issues via futures contracts.
Example Scenario: Hedging Against Rising Interest Rates
- A firm plans a project requiring $10 million in two years, to be raised via a 20-year bond issue.
- The firm worries that rates for long-term debt in two years could exceed the current 10%.
- Raising funds now at a lower rate isn't ideal, as the funds would sit for two years at a lower short-term rate.
- To hedge against rising rates, the firm can use the two-year forward price of 10-year, 6% coupon government bonds.
Solution: Selling a Forward Contract
- The firm sells a forward contract to deliver 13,259 government bonds in two years.
- If rates rise( e.g., to 12%), government bond prices fall (e.g., to $660.99).
- This generates a profit of $1,236,004 from the forward sale, offsetting the value loss.
Impact of Higher Coupon Interest Payments
- The firm faces higher coupon interest payments on its $10 million bonds.
- A 2% rate increase means an extra $200,000 payment annually.
- The present value of these payments at a 12% rate is $1,493,992.39.
- This is mostly offset by the $1,236,004 profit from the forward sale.
Scenario: Interest Rates Fall
- If rates fall to 8%, the government bond price rises( e.g., to $865.80).
- This leads to a $1,479,571.81 loss on the forward position.
- However, a 2% rate decrease reduces annual interest payments by $200,000 for 20 years.
- The present value of these savings at 8% equals $1,963,844, offsetting the forward sale loss.
Imperfect Hedging and Cross-Hedging
- Imperfect hedging occurs due to cross-hedging, using government bonds instead of the firm's bonds.
- Approximate offsetting still occurs if rates decrease.
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