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1. Which of the following holds true for the writer of a bond call option if interest rates decrease?
Makes profits limited to call premium
Makes losses limited to call premium
Potential to make large losses
Potential to make unlimited profits
Answers B and D only
2. A bank has assets of $500,000,000 and equity of $40,000,000. The assets have an average duration of 5.5 years, and the liabilities have an average duration of 2.5 years. An 8-year fixed-rate T-bond with the same coupon as the fixed-rate on the swap has a duration of 6 years, and the duration of a floating-rate bond that reprices annually is one year. The bank wishes to hedge its balance sheet with swap contracts that have notional contracts of $100,000. What is the optimal number of swap contracts into which the bank should enter?
2,500 contracts.
2,760 contracts.
13,800 contracts.
3,200 contracts.
None of the above.
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