Week 6 HW

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Chapter 7  Problem 2 (page 239) What are the four major categories of mortgages and what percentage of the overall market does each entail? (LG 7-2) Four basic categories of mortgages are issued by financial institutions: home, multifamily dwelling, commercial, and farm. Home mortgages (one to four families) are the largest loan category (70.5 percent of all mortgages in 2018), followed by commercial mortgages (used to finance specific projects that are pledged as collateral for the mortgage—18.4 percent), multifamily dwellings (9.6 percent), and farms (1.6 percent). Chapter 9  Problems 5 and 6 (pages 309-310) 5. How are foreign exchange markets open 24 hours per day? (LG 9-2) Foreign exchange markets are open 24 hours due to the global nature of the market and the presence of multiple time zones. This allows participants from different countries and regions to trade currencies at any time of the day or night. The market operates continuously as trading shifts from one financial center to another, ensuring that there is always an active market for foreign exchange transactions. 6. What is the spot market for FX? What is the forward market for FX? What is the position of being net long in a currency? (LG 9-4, 9-6) Spot market for foreign exchange involves the transactions for immediate delivery of a currency, while the forward market involves agreements to deliver a currency at a later time for a price or exchange rate that is determined at the time the agreement is reached. The net exposure of a foreign currency is the net foreign asset position plus the net foreign currencyposition.Net long in a currency means that the amount of foreign assets exceeds the amount of foreign liabilities. Chapter 10  Problems 2, 7, and 18 (pages 351–352) 2. Suppose you purchase a Treasury bond futures contract at a price of 95 percent of the face value, $100,000. (LG 10-3) a. What is your obligation when you purchase this futures contract? When you purchase a Treasury bond futures contract at a price of 95 percent of the face value ($100,000), your obligation is to buy the underlying Treasury bond at the agreed-upon price and date in the future. In this case, you have the obligation to buy a Treasury bond with a

face value of $100,000. b. Assume that the Treasury bond futures price falls to 94 percent. What is your loss or gain? Loss or Gain = (Initial Futures Price - Current Futures Price) x Face Value Loss or Gain = (95% - 94%) x $100,000 = 1% x $100,000 = $1,000 You would incur a loss of $1,000. c. Assume that the Treasury bond futures price rises to 97. What is your loss or gain? Loss or Gain = (Current Futures Price - Initial Futures Price) x Face Value Loss or Gain = (97% - 95%) x $100,000 = 2% x $100,000 = $2,000 7. You have taken a long position in a call option on IBM common stock. The option has an exercise price of $176 and page 352IBM’s stock currently trades at $180. The option premium is $5 per contract. (LG 10-4) a. How much of the option premium is due to intrinsic value versus time value? Intrinsic Value = Current Market Price - Exercise Price Intrinsic Value= $180−$176=$4 Time Value = Option Premium - Intrinsic Value Time Value = $5−$4=$1 Therefore, $1 of the option premium is due to intrinsic value versus time value . b. What is your net profit on the option if IBM’s stock price increases to $190 at expiration of the option and you exercise the option? Net Profit = New Price - Exercise Price - Option Premium Net Profit = $190−$176−$5=$9 $9 is the net profit on the option if IBM stock price increases to $190 at expiration of the option and you exercise the option. c. What is your net profit if IBM’s stock price decreases to $170? Net loss = premium = -5 18. A commercial bank has $200 million of floating-rate loans yielding the T-bill rate plus 2 percent. These loans are financed with $200 million of fixed-rate deposits costing 9 percent. A savings bank has $200 million of mortgages with a fixed rate of 13 percent. They are financed with $200 million in CDs with a variable rate of T-bill rate plus 3 percent. (LG 10-7) a. Discuss the type of interest rate risk each institution faces. The commercial bank is exposed to a decrease in rates that would lower interest income, while the savings bank is exposed to an increase in rates that would increase interest expense. In either case, profit performance would suffer. b. Propose a swap that would result in each institution having the same type of asset and liability cash flows.

One possible swap would be for the commercial bank to send variable-rate payments of the T-bill rate + 1 percent (T-bill + 1%) to the savings bank and to receive fixed-rate payments of 9 percent from the savings bank. c. Show that this swap would be acceptable to both parties. Remember to submit your assignment for grading when finished.

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