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Hull: Options, Futures, and Other Derivatives, Ninth Edition Chapter 9: OIS Discounting, Credit Issues, and Funding Costs Multiple Choice Test Bank: Questions with Answers 1. Prior to the credit crisis that started in 2007 which of the following was used by derivatives traders for the discount rate when derivatives were valued A. The Treasury rate B. The LIBOR rate C. The repo rate D. The overnight indexed swap rate Answer: B Derivatives markets used LIBOR as the discount rate pre-crisis. 2. Sin
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  Hull: Options, Futures, and Other Derivatives, Ninth EditionChapter 9: OIS Discounting, Credit Issues, and Funding CostsMultiple Choice Test an!: uestions #ith $ns#ers 1.Prior to the credit crisis that started in 2007 which of the following was used by derivatives traders for the discount rate when derivatives were valued A.The Treasury rateB.The LIB! rate .The re#o rate $.The overnight inde%ed swa# rateAnswer& B$erivatives 'ar(ets used LIB! as the discount rate #re)crisis.2.*ince the credit crisis that started in 2007 which of the following have derivatives traders used as the ris()free discount rate for collaterali+ed transactionsA.The Treasury rate B.The LIB! rate .The re#o rate $.The overnight inde%ed swa# rateAnswer& $$erivatives 'ar(ets have used the I* rate as the discount rate for collaterali+ed transactions since the crisis.,.-hich of the following is trueA.I* rates are less than the corres#onding LIB!swa# rates B.I* rates are greater than corres#onding LIB!swa# rates .I* rates are so'eti'es greater and so'eti'es less than LIB!swa# rates$.I* rates are e/uivalent to one)day LIB! rates Answer& A I* rates are less than LIB! swa# rates when both have the sa'e 'aturity..-hich of the following describes a ,)'onth overnight inde%ed swa# I*3 A.A 4%ed rate is e%changed for the overnight rate every day for three 'onthsB.LIB! is e%changed for the overnight rate every day for three 'onths .The arith'etic average of overnight rates is e%changed for a 4%ed rate at the end of three 'onths  $.The geo'etric average of overnight rates is e%changed for a 4%ed rate at the end of three 'onthsAnswer& $  The I* rate is the rate e%changed for the geo'etric average of overnight rates. In the 5.*. the overnight rate is the fed funds rate 6.*u##ose that I* rates for all 'aturities are 2.6 and swa# rates for all 'aturities are ,. -hich of the following is true3A.8orward LIB! rates are greater when I* discounting is used than when LIB! discounting is usedB.8orward LIB! rates are less when I* discounting is used than when LIB! discounting is used .8orward LIB! rates are the sa'e for both I* discounting and LIB! discounting$.9ither A or B can be trueAnswer& -hen the yield curves are :at; all forward LIB! rates are , regardless of whether I* or LIB! discounting is used. This is because; when all forward LIB! rates e/ual ,; all e%changes on all swa#s are worth +ero regardless of the discount rate used.<. =A stands forA. ollateral value ad>ust'entB. redit value ad>ust'ent . redit value agree'ent$. ollateral value agree'entAnswer& B =A stands for credit value ad>ust'ent7.In a fully collaterali+ed transaction which of the following leads to a #ricing ad>ust'entA.The rate #aid on cash collateral is the fed funds rateB.The rate #aid on cash collateral is greater than the fed funds rate .The rate #aid on cash collateral is less than the fed funds rate$.Both B and Answer& $If the rate #aid on cash collateral is di?erent fro' the fed funds rate then an ad>ust'ent is necessary. The I* rate is lin(ed to the fed funds rate and is the rate used for discounting fully collaterali+ed transactions.@.-hen a ban(s borrowing rate goes u#; which of the following is trueA.$=A increases so that the ban(s #ro4t goes downB.$=A increases so that the ban(s #ro4t goes u# .$=A declines so that the ban(s #ro4t goes down  $.$=A declines so that the ban(s #ro4t goes u#Answer& B The ban( is considered 'ore li(ely to default. Its $=A therefore increases and this increases its #ro4t because it is then considered 'ore li(ely that it will default and not have to 'eet derivatives obligations..In ctober 200@ the three)'onth LIB!)I* s#read rose toA.2,1 basis #ointsB.,< basis #oints .60 basis #oints$.620 basis #ointsAnswer& BIn ctober 200@ the three)'onth LIB!)I* s#read rose to ,< basis #oint; a record.10.As a ban(Cs borrowing rate increases; which of the following is true if a ban( calculates 8=AA.8=A increasesB.8=A declines .8=A stays the sa'e$.8=A 'ay increase or decline. Answer& A 8=A is the funding value ad>ust'ent. As borrowing costs increase it costs the ban( 'ore to fund its o#erations and 8=A increases. In theory; as e%#lained in the te%t; funding value ad>ust'ents should not be 'ade but in #ractice they are often 'ade.11.-hich of the following is trueA. =A and $=A can be calculated deal by dealB. =A and $=A 'ust both be calculated for the whole #ortfolio a ban( has with a counter#arty . =A can be calculated deal by deal but $=A 'ust be calculated for a #ortfolio$.$=A can be calculated deal by deal but =A 'ust be calculated for a #ortfolioAnswer& BBecause of netting; all derivatives in a #ortfolio are considered to be a single derivative in the event of a default. =A which 'easures the cost of a counter#arty default and $=A which 'easures the bene4t of the ban( defaulting 'ust therefore be calculated on a #ortfolio basis.  12.-hich of the following is true when a ban( uses I* discounting for valuing a LIB!)for)4%ed swa#A.The LIB!swa# +ero curve is calculated before the I* +ero curveB.The I* +ero curve is calculated before the LIB!swa# +ero curve . The swa# is valued using I* forward rates and I* discounting$.The forward rates are calculated fro' the ban(s borrowing costsAnswer& B 8irst the I* +ero curve is calculated. LIB! forward rates are then calculated so that all swa#s when entered into at 'id)'ar(et swa# rates have +ero value1,.It is assu'ed that a co'#any can default after one year or after two years.  The #robability of default at each ti'e is 1.6. The #resent value of the e%#ected loss to a ban( on a derivatives #ortfolio if the co'#any defaults after one year is esti'ated to be D1 'illion. The #resent value of the e%#ected loss if it defaults after two years is esti'ated to be D2 'illion. -hich of the following is the ban(s =A 3A. D,;000;000B.D,00;000 .D60;000$.D160;000Answer&  The #resent value of the e%#ected loss is 0.016ED1;000;000 F 0.016ED2;000;000 or D60;000. This is the =A.1.Accountants li(e to value a derivatives #ortfolio at A.The bid #riceB.The o?er #rice .The e%it #rice$.riginal cost less de#reciationAnswer& Accountants li(e to value a derivatives #osition at the e%it #rice. This is the #rice at which the ban( could trade out of the #osition or enter into an o?setting transaction.16.In the 5.*.; which of the following is true about Treasury instru'entsA.Their inco'e is not sub>ect to ta% at the state levelB.Their inco'e is not sub>ect to ta% at the federal level .Both A and B are true$.They are not sub>ect to ca#ital gains ta% at the federal levelAnswer& AInco'e fro' Treasury instru'ents is not sub>ect to ta% at the state level. This is one of the reasons why the yield on Treasuries is lower than the yield on other instru'ents that have very little credit ris(.
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