US 2 YR yield
US 10 YR yield
2-10 YR spread
March 2nd 2020
0.84%
1.10%
26 bps
March 9th 2020
0.38%
0.54%
16 bps
Shift in basis points
-46 bps
-56 bps
-10bps
• Fill in the blank boxes – bp move and yield curve spread
• What has happened to interest rates?
THEY HAVE FALLEN
• How would you describe the yield curve movement (up/down, steeper/flatter, parallel/non-parallel)?
THE YIELD CURVE HAS FLATTENED (bullishly because interest rates have fallen)
• What do you think happened between March 2nd and March 9th? (not required knowledge for exam)
THE CENTRAL BANK HAS LOWERED OFFICIAL RATES (DRAMATICALLY BY 50 BPS- THE FEDERAL RESERVE)
• Who might do an outright FX forward hedge and why?
AN EXPORTING OR IMPORTING COMPANY WHO HAVE FOREIGN CURRENCY RECEIVABLES OR PAYABLES DUE AT A FUTURE DATE
• What is basis risk?
IN A CASH VERSUS FUTURES POSITION, IT IS THE RISK THAT THE HEDGE (FUTURES) DOESN’T EXACTLY TRACK THE CASH PRICE, THUS LEADING TO AN IMPERFECT HEDGE.
• Explain a US T- bond delivery process
IF YOU ARE LONG FUTURES GOING INTO EXPIRY MONTH, YOU WILL BE DELIVERED A CASH BOND AGAINST YOUR FUTURES POSITION ($100,000 NOMINAL VS EACH 1 CONTRACT). IT COULD BE ANY FROM A BASKET OF ELIGIBLE BONDS. THIS CAN TAKE PLACE FROM THE FIRST OF THE MONTH ON TO THE LAST DAY IN THE MONTH.
IF YOU ARE SHORT FUTURES YOU WILL HAVE TO DELIVER AN ELIGIBLE BOND FROM THE FIRST DELIVERY DAY IN THE MONTH TO THE LAST DAY (PENULTIMATE BUSINESS DAY OF THE MONTH)
THIS PROCESS IS ADMINISTERED BY THE FUTURES EXCHANGE E.G. CME CLEARING
• Explain the difference between forward FX and FX futures
• If you are long Eurodollar futures do you profit from rising or falling interest rates?
FALLING RATES
• If you pay fix and receive floating do you want interest rates to rise or fall?
RISE – BECAUSE YOUR INCOME WILL INCREASE (RECEIVE FLOATING RATES), BUT YOUR OUTGOING INTEREST COST IS FIXED.
• Explain how buying a CDS protects you from credit losses
WHEN YOU BUY A CREDIT DEFAULT SWAP YOU PAY A PREMIUM TO THE SELLER.
IF YOU WERE LONG A CREDIT BOND AND BOUGHT A CDS, IN THE EVENT OF A DEFAULT THE BOND WOULD LOSE MONEY, BUT THE CDS SELLER WOULD PAY OUT THE EQUIVALENT MONEY TO COVER YOUR LOSSES.
• What is an ETF? How does it differ from a conventional investment fund?
EXCHANGE TRADED FUND – ISSUED BY A FINANCIAL ENTITY TO TRACK AN ASSET OR GROUP OF ASSETS. TRADES AS A STOCK WITH BID-ASK PRICES. CONVENTIONAL FUND POOLS MONEY FROM INVESTORS AND BUYS THE UNDERLYING ASSETS. TRADES ON A DAILY BID-ASK SPREAD USUALLY.
LOW COST/LIQUID/CONVENIENT/TRACKING ERROR/CREDIT RISK ETC.
• If you are long options what is your maximum profit and loss?
LIMITED LOSS TO THE PREMIUM PAID, UNLIMITED PROFITS
• Explain ITM and OTM calls and puts
OPTION DELTA VERSUS MONEYNESS
• Explain net delta
THE TOTAL EXPOSURE OF YOUR POSITIONS TO THE MOVEMENT IN THE UNDERLYING.
MADE UP OF OPTION DELTA AND UNDERLYING DELTA (DIRECTION).
• If you are short an ATM straddle, what do you want the market to do?
STAY STILL, EXPIRE AT THE MONEY, VOLATILITY FALL, DO NOTHING ALL SO PREMIUMS DROP
• What is a credit event?
USUALLY A DEFAULT, BANCRUPCTY, DOWNGRADE OR RESTRUCTURING
• Bond duration example – $100mm portfolio, 10-year futures 120.00 ( face value of contract is $100,000). CTD duration is 7 years, Portfolio duration is 9 years – how many contracts needed to hedge?
100MM*9/120,000*7=1071 CONTRACTS TO SELL
• Equity portfolio hedge example – value of portfolio is $10mm, S+P 500 futures are 2500, 1 contract is worth $250 * index, beta of portfolio is 1 – how many contracts needed to hedge?
1*[10MM/(2500*250)]=16 CONTRACTS TO SELL
• When might it be advantageous to write covered calls?
POSITION = LONG UNDERLYING
SELL OTM CALLS = RECEIVE PREMIUM:
• ENHANCES RETURNS
• LOWERS AVERAGE COSTS
• MAKES MONEY IF NOTHING HAPPENS IN QUIET MARKET
• QUIET MARKET = NO MOVEMENT IN UNDERLYING/FALLING VOLTILITY