Interest Rate Risk

INTEREST RATE RISK
Q1. Which of the following correctly defines Basis Risk? (MCQ)A company having a variable interest rate for a specific loanA company having a fixed interest rate for all loansThe risk of the difference of interest rate amount set on assets & liabilitiesA company has a similar quantity of assets & liabilities, having a different basis for their floating rate(2 marks)
This information relates to Q2 & Q3.Rotec Co wants to borrow $30,800 in two months’ time ; is seeking to save them from any interest risk. The bank has explained an agreement to provide hedging for Rotec Co. This agreement can lock interest rates for future. The borrowing will be for three months. The forward rate agreement is as follows: 2 months V 3 months 3% – 4.5%2 months V 5 months 4.2% – 5.1%

Q2. Calculate the interest amount to be paid if the actual rate will be 3% in two months’ time? (MCQ)$161.7$231$392.7$924(2 marks)
Q3. Calculate the refund amount by the bank if the actual rate will be 6.3% in two months’ time? (MCQ) $46.2$92.4$138.6$161.7(2 marks)
Q4. A company is looking at the following options to hedge itself from interest risks. Which of the following will support the cause? (MRQ) SmoothingMoney market agreementsMatchingDealing with home currency(2 marks)
Q5. A yield curve is a relationship between yield ; maturity dates of similar bonds. Select the appropriate yield curve. (P;D)Short-term bonds have lower yield due to their risk Long-term yields have lower yield due to the downfall in the economy Short/Long – term bonds provide a close equal yield FLAT YIELD CURVE NORMAL YIELD CURVE INVERTED YIELD CURVE(2 marks)
Q6. Select the appropriate theories in relation to different interest rates on different securities. (P;D)Investors needing high returns for long-term security contracts The assumption by an investor that higher interest rates are due to future inflation Security markets are separate from each other ; have distinct customers GOVERNMENT POLICY MARKET SEGMENTATION THEORY LIQUIDITY PREFERENCE THEORY EXPECTATION THEORY(2 marks)
Q7. Select the appropriate option relating to the usefulness of the yield curve. (HA)Yield curve may indicate the economy position TRUE FALSEYield curve may be helpful in decision making with respect to loan ; but not interest TRUE FALSE(2 marks)
Q8. Which of the following contract have long-term validity? (MCQ)Currency FuturesInterest rate OptionsInterest rate Swaps Forward rate agreements(2 marks)
Q9. Select the appropriate option in relation to interest rate futures. (HA)If the need for Borrowing, Selling the futures now ; Buying them back at the close date TRUE FALSEIf the need for Deposit, Selling the futures now ; Buying them back at the close date TRUE FALSE(2 marks)
Q10. Which of the following statements is correct? (MCQ)Currency futures have a range of closeout datesInterest rate options are cheaper than Forwarding rate agreementsForward rate agreements lapse if unused in the given time periodSwaps are unable to be exercised if the amount ; time periods are different(2 marks)
Q11. Yakut wants to borrow money from the bank in three months’ time by using a collar transaction. Which of the following statements are true in relation to the collar transaction? (MRQ) Yakut will buy a cap agreementBank will buy a cap agreementYakut will sell a flooring agreementBank will sell a flooring agreement(2 marks)
Q12. Uma Co wants to deposit money into Hale Ltd, a banking institution. Hale has offered a collar transaction. Which of the following statements are correct? (MRQ) Bank will sell a cap agreementUma Co will sell a cap agreementUma Co will sell a flooring agreementBank will buy a flooring agreement(2 marks)
INTEREST RATE RISK (ANSWERS)
Q1. DA company having a variable interest rate for a specific loan (Floating interest rate risk)A company having a fixed interest rate for all loans (Fixed interest rate risk)The risk of the difference of interest rate amount set on assets & liabilities (Gap risk)A company has a similar quantity of assets & liabilities, having a different basis for their floating rate (Basis risk)
Q2. CInterest Payment = [30,800 × (3% × 3/12)] = $231Payment Extra = [30,800 × ({5.1 – 3} % × 3/12)] = $161.7Total cost = 231 + 161.7 = $392.7
Q3. BInterest Payment = [30,800 × (6.3% × 3/12)] = $485.1Refund = [30,800 × ({6.3 – 5.1} % × 3/12)] = $92.4Total cost = 485.1 – 92.4 = $392.7
Q4.Smoothing, Maintaining a balance between fixed & floating borrowing rates (Correct)Money market agreements not exist (Incorrect)Matching, Matching assets & liabilities with same interest rates (Correct)Dealing in home currency, the technique of dealing foreign currency risk (Incorrect)
Q5.Short-term bonds have lower yield due to their riskNORMAL YIELD CURVE  Long-term yields have lower yield due to the downfall in the economy INVERTED YIELD CURVE Short/Long – term bonds provide a close equal yield FLAT YIELD CURVENORMAL YIELD = Sign of economic boom INVERTED YIELD = Sign of economic recessionFLAT YIELD = Sign of transition from boom to recession or vice versa
Q6.Investors needing high returns for long-term security contracts LIQUIDITY PREFERENCE THEORY
The assumption by an investor that higher interest rates are due to future inflation   EXPECTATION THEORY
Security markets are separate from each other & have distinct customers  MARKET SEGMENTATION THEORY
The government policy of keeping interest rates high may effect in keeping short-term interest rates higher than long-term rates. Similarly, a government may also keep very low short-term interest rates.
Q7.Yield curve may indicate the economy position TRUE Yield curve may be helpful in decision making with respect to loan & but not interest FALSEYield curves help in both loan & interest decision making.
Q8. CAll other agreements are less than a year.
Q9. If the need for Borrowing, Selling the futures now & Buying them back at the close date TRUE If the need for Deposit, Selling the futures now & Buying them back at the close date FALSEIf the need for Deposit, Buying the futures now & Sell them back at the close date
Q10.Currency futures have a range of closeout dates, has specified date (False)Interest rate options are cheaper than Forwarding rate agreements, are expensive (False)Forward rate agreements lapses if unused in the given time period, have to close out at the given time (False)Swaps are unable to be exercised if the amount & time periods are different, it can only be exercised if timing & the amount are same hence (True)
Q11. Yakut will buy a cap agreementYakut will sell a flooring agreementCap is an interest rate ceiling limiting the interest rate. Floor sets a lower limit of interest rates.
Q12.Bank will sell a cap agreementBank will buy a flooring agreementCap is an interest rate ceiling limiting the interest rate. Floor sets a lower limit of interest rates.