Financial Risk Management Derivatives and Risk Hedging 2

Question 1

A company with floating-rate debt enters a pay-fixed, receive-floating interest rate swap. This hedge protects against:

Accepted Answer

Rising interest rates

Answer

Paying fixed and receiving floating means the company's net cost is fixed; when rates rise, the higher floating receipts offset increased floating debt costs.

Question 2

Which Greek letter measures the rate of change of delta with respect to the underlying asset price?

Accepted Answer

Gamma

Answer

Gamma measures how quickly delta changes as the underlying price moves, indicating the convexity of the option's value and the difficulty of maintaining a delta-neutral hedge.

Question 3

A portfolio manager holds a large equity portfolio and wants to reduce market exposure without selling shares. The most efficient strategy is to:

Accepted Answer

Sell equity index futures contracts

Answer

Selling equity index futures creates a short position that offsets losses in the long equity portfolio when markets decline, reducing net market exposure.

Question 4

The optimal hedge ratio in a futures hedge is calculated as:

Accepted Answer

The correlation between spot and futures returns multiplied by the ratio of their standard deviations

Answer

The optimal hedge ratio h* = ρ × (σS / σF), where ρ is the correlation and σS/σF is the ratio of standard deviations of spot and futures returns.

Question 5

A cross-currency swap differs from a plain vanilla interest rate swap primarily because it:

Accepted Answer

Involves exchange of principal amounts in two different currencies

Answer

Cross-currency swaps involve exchanging principal and interest payments in two different currencies, unlike interest rate swaps which involve a single currency.

Financial Risk Management Practice Test

Financial Risk Management Practice Test

Financial Risk Management Derivatives and Risk Hedging 2