国际货币与金融经济学05

Chapter5:

InterestYields, Interest Rate Risk, and Derivative Securities

I. Chapter Overview

Chapter5 begins with a presentation of the concept of discounted presentvalue and how it relates the market price of a bond to its yield. This discussion is followed by an explanation of how term to maturityaffects interest-rate risk.

Thenext section introduces the term structure of interest rates and therepresentation of the yield curve. This section proceeds with adiscussion of various theories of the term structure and with anevaluation of the extent to which they are able to explain regularfeatures of the yield curve, such as its upward slope. The theoriesdiscussed are (1) the segmented markets theory, (2) the expectationstheory and (3) the preferred habitat theory. Finally, the sectionends with an elaboration of the various sources of interest raterisk, and other reasons for interest rate differentials betweeninstruments with similar maturities. These include (1) differencesin the degree of default risk, (2) differences in the degree ofliquidity and (3) differences in tax obligations.

Thefollowing section examines how excess returns arising from failure ofuncovered interest parity contribute to differences among nationalinterest rates. It explains the concept of excess returns, discussesrecent evidence concerning excess returns for various

interestrate differentials. powerparity and uncovered interest parity conditions leads to a realinterest parity
condition,which in principle can be used to provide a measure of internationalmarket
arbitrage.

Thechapter then turns to a discussion of ways in which investors canhedge against interest rate risk using derivatives. The sectionpoints out that forward exchange
contractsare simply one example of a derivative security. Just as investorsuse forward exchange rate markets to hedge against exchange risk,investors can use derivative securities that are based on forwardinterest rates to hedge against interest rate risk. The chapter thendescribes some of the most common forms of available derivatives,such as interest rate futures, stock index futures, and currencyfutures. The uses of currency futures, options and swaps are alsodiscussed. The chapter ends with a brief discussion of the types ofrisks associated with derivatives.

a. Interest Rates and Discounted Present Value
b. Discounted Present Value and the Market Price of Bonds
c. Perpetuities and the Relationship between Interest Yields and BondPrices 2. Term to Maturity and Interest-Rate Risk
3. Term Structure of Interest Rates
a. Yield Curves
b. Segmented Markets Theory
c. The Expectations Theory
d. The Preferred Habitat Theory
4. Risk Structure of Interest Rates
a. Default Risk
b. Liquidity
c. Tax Differences

B. Interest Rate Differentials—Excess Returns and Failure ofUncovered Interest Parity
1. Breakdowns of Uncovered Interest Parity and Excess Returns
a. Excess Returns
b. Evidence on Excess Returns
2. Accounting for Differences in Excess Returns to Help ExplainInterest Rate

C. Real Interest Rates and Real Interest Parity 1. Real Interest Rates: The Fisher Equation Differences

D. Hedging, Speculation, and Derivative Securities
1. Possible Responses to Interest Rate Risk
a. Some Strategies for Limiting Interest Rate Risk b. Hedging
2. Derivative Securities
a. Hedging with Forward Contracts
b. Speculation with Derivatives
c. Speculative Gains and Losses

E. Common Derivative Securities and Their Risks
1. Forward Contracts
2. Futures
a. Interest-Rate Futures

3. Options
a. Stock Options and Futures Options
b. Currency Options
1) Limited Losses and Potential Profits from Using Currency Call Options
2) Limited Losses and Potential Profits from Using Currency Put Options 3) Netting
4. Swaps
a. Currency Swaps
b. Types of Swaps
5. Derivatives Risks and Regulation
a. Measuring Derivatives Risks
b. Types of Derivatives Risks

F. Chapter Summary

III. Fundamental Issues

1. How are interest yields, financial instrument prices, andinterest-rate risk interrelated?

2. Why do market interest yields vary with differences in financialinstruments' terms tomaturity and risks?
indicatorsof the extent to which international markets are open to arbitrage?

5. What are derivative securities?

6. What are the most commonly traded derivative securities?

IV. Chapter Features

1. Management Notebook: "Why Uncovered Interest Parity May Hold,But Not for Very Long"

Thismanagement notebook considers one theory for why uncovered interestparity rarely appears to hold, which is that the time immediatelybefore interest returns are about to be received by holders offinancial instruments is when the greatest arbitrage opportunityexists. It discusses recent research by two Federal Reserveeconomists indicating that the uncovered interest parity conditionindeed appears more likely to be satisfied during the last fewminutes before instruments mature.

ForCritical Analysis: The interest rate on this financial instrument andthe interest rate on a similar foreign instrument cannot changeduring this time just before transmission of interest payments to theholders of these instruments. Exchange rates can still adjust inforeign exchange markets, however.

2. Management Notebook: "Bad Days for the Badla"

Thesubject of this management notebook is a traditional method used inIndian financial markets to carry forward trades of commodities,stocks, or currencies without engaging in final settlement. Itdiscusses the fact that recently introduced Western-style futurescontracts appear to be gradually replacing this informal type offutures mechanism.

ForCritical Analysis: Traders tend to prefer lower prices (and hencehigher returns) but also are averse to risk. If Western-stylefutures contracts are sufficiently less risky, this can help explainwhy they have tended to crowd out badlaeven when the latter instruments trade at lower prices.

3. Management Notebook: "Following the Money in DerivativesMarkets"

Thismanagement notebook provides comparative data on derivatives tradedin organized

typesof derivatives are most commonly used.

ForCritical Analysis: The three key factors are likely to be the priceof the derivative
exchangesand in over-the-counter (OTC) markets. It provides information aboutwhich

1. Given that: PB= C/(1+R) + C/(1+R)2+ C/(1+R)3+ C/(1+R)4+...;
multiplyeach side by (1+R): PB(1+R) = C + C/(1+R) + C/(1+R)2+...;
andsubtract PBfrom each side: PB(1+R) - PB= [C + C/(1+R) + C/(1+R)2+...] - [C/(1+R)+ C/(1+R)2+...];
Simplifying:PB* R = C.

Therefore,PB= C/R.

2. In this situation, annual yields decline as the term to maturityincreases, which means that the yield curve slopes downward. According to the expectations theory of the term structure ofinterest rates, this situation arises because bond-market tradersanticipates that short-term interest rates will fall sharply. Thus,an average of current and future short-term rates, which, when addedto any term premium applicable to a longer maturity, is lower thanthe current short-term rate.

3. Yes, the excess return on the German government bond equals 3.5percent – (5 percent– 3 percent) = 1.5 percent.

4. Parity Conditions:
a. Using uncovered interest parity, R - R* = (S+1e-S) / S. Because the left-hand- sideis negative, we would expect the right-hand side to be negative,indicating a domesticcurrency appreciation.

b. Using relative PPP, -*= %S. Because the left -hand-side is negative, we would expect theright-hand side to be negative, indicating a domestic currencyappreciation.

5. The domestic real interest rate is 5 percent less 2 percent, or 3percent. The foreign real interest rate is 6 percent less 4 percent,or 2 percent. Real interest rates are not equal, so the realinterest parity condition does not hold. We would expect funds toflow into the domestic country and out of the foreign country, whichwould drive the domestic real interest rate down and the foreign realinterest rate up.

6. In contrast to forward currency contracts, currency futures requiredelivery of standard quantities of currencies. In addition, holdersof currency futures experience profits of losses on the contractsduring the entire period before the contracts expire, whereas profitsor losses occur only at the expiration date of a forward currencycontract.

rate. The value of a currency futures option, in turn, depends on theunderlying value ofa currency futures contract, so its value is derived from the futuresderivative. In thisway, a currency futures option is a "derivative of aderivative."
7. A currency future already is a derivative, because its value varieswith the exchange

b. The Sfr is purchased in 125,000 franc increments. Therefore, thefirm would
wantto purchase 500,000/125,000 = 4 futures contracts. Given the initialmargin
ona franc contract, the total initial margin the firm establishes is:4($1,688) =
$6,752.

Thedaily margin changes are as follows:
First: (0.6252 - 0.6251)(125,000)(4) = +$50. Therefore its marginequals $6,802.

Second:(0.6127 - 0.6252)(125,000)(4) = -$6250. Therefore the margin wouldfall to $552. However, the maintenance margin is equal to $1,250. Thus, the margin will equal $1,250.

Third:(0.6115 - 0.6127)(125,000)(4) = -$600. Again, the margin must remainat $1,250.

Fourth:(0.6806 - 0.6115)(125,000)(4) = -$1450. Again, this daily changewould fallbeneath the maintenance margin. Thus, it remains at $1,250.

c. As the dollar continues to appreciate relative to the Swiss franc,the value of the futurescontract falls. However, the cost of 500,000 franc payment isbecoming cheaperon terms of the U.S. dollar.

b. (0.0188)(62,500) = $1,175
($1,175)(8contracts) = $9,400

NetProfit

10,600

0.960

0.980

0.9988

1.02

0

BreakEven

c. At S = $0.96/ € the option is not exercised and the firm is out$9,400 AtS = $1.02/ € the option is exercised. The firm earns $10,600
AtS = $0.9657/€, the firm does not exercise the option and is out$9,400 d. Break even: $0.9988/€
e. See Diagram given in part (b).

10.The pros and cons of forward contracts and swaps lie within how eachworks. A forward contract can be arranged between a purchaser and aseller, and is dependent upon each participant's beliefs of what willhappen in the future. Sometimes it can be difficult to matchcounterparties to such contracts. Swaps, on the other hand, directlymatch traders who require flows of currencies held by one another. Swaps may also allow borrowers to receive better loan rates byissuing debt in their home currency rather than in a foreigncurrency; thereby potentially avoiding a risk premium. Considerationsof the reason for the long position on a currency and which currencyis at issue will influence the decision of which derivative to use.

VI. Multiple Choice Questions
1. The amount of credit extended via the purchase of a financialinstrument is the A. principal.

B. front load.

C. sum of the coupons.

D. present discounted value.

Answer: A
2. To calculate the price of a financial instrument, one must find the
A. present discounted value of the stream of coupon payments andprincipal.

B. principal plus the present discounted value of the coupons.

C. sum of the coupons divided by the principal.

D. sum of the coupons plus the principal.

Answer: A
3. A bond with no fixed maturity date is called a A. discount bond.
Answer: D
4. A bond with an infinite payment life will have a price
A. equal to the present discounted value of its principal.

B. equal to the coupon amount divided by the interest rate.

C. equal to the coupon amount divided by one plus the interest rate.

D. that is arbitrarily high, as it will produce coupon paymentsforever.

Answer: B
5. Suppose the price of a perpetuity is $1,000 and that the perpetuitypays a coupon of $60per year. The interest rate on this bond is

Answer:C

6. Suppose the interest rate on a perpetuity is 5 percent, and itsprice is $1,500. The annualcoupon must therefore equal

A. $75.

B. $300.

C. $750.

D. $30,000.

Answer:A

7. Suppose a perpetuity pays $100 per year and its interest rate is8%. Its price is equal to

A. $80.

B. $125.

C. $800.

D. $1,250.

8. Zero coupon bonds have the distinguishing feature that they Answer: D

B. pay a lump sum at maturity.

D. pay only coupons that carry an interest rate equal to the realinterest rate. A. have an indefinite life.

Answer: B

9. Interest-rate risk arises because

A. shorter terms to maturity expose bonds to greater risk of capitalloss when interest ratesrise.

B. shorter terms to maturity expose bonds to greater risk of capitalloss when interest ratesfall.

C. longer terms to maturity expose bonds to greater risk of capitalloss when interest ratesrise.

D. longer terms to maturity expose bonds to greater risk of capitalloss when interest ratesfall.

Answer: C

10.The yield curve displays the relationship among yields on bonds thatdiffer only in their

A. country of origin.
B. terms to maturity.
C. bond rating.

D. default risk.

Answer: B

11.The segmented markets theory is grounded in the assumption that

A. inflation will be prevalent in only certain long-term bonds. B. investors have identical preferences for all bond maturities. C. bonds with different maturities are nonsubstitutable.

D. domestic investors prefer domestic bonds.

Answer: C

12.An investor using the expectations theory would buy a two-year bondat the present

A. greater than or equal to the average of the one-year spot rate andthe expected spot ratea year later.
timeonly if its yield is

Answer: A

13.The preferred habitat theory suggests that investors

A. have a preference for domestic over foreign bonds.

B. will only select bonds over a small range of terms to maturity.

C. have a preferred maturity length but are willing to move away fromthis if the interestrate differential is high enough.

D. prefer, all else being equal, to hold the bonds issued by aparticular group of firmsin a region of the world with a shallow yield curve.

Answer: C

14.Because of the possibility of default and low liquidity, some bondscarry

A. no premium.

B. a risk premium.

C. a margin account.

D. a lower interest rate.

Answer: B

15.The primary reason that municipal bonds earn a lower interest ratethan treasury bondsis that

A. municipal bonds have less risk.

B. treasury bonds are in greater supply.

C. municipal bonds are often serial type bonds.

D. the interest earned on municipal bonds is tax-exempt.

Answer: D

16.Reinvestment risk arises from a situation in which

A. long-term instruments prevent investors from acting to takeadvantage of increasesin interest rates.

B. an investor cannot be guaranteed the same interest rate when rollingover short-

C. the investor suffers from an inability to liquidate short-terminstruments at

D. an instrument cannot be transferred back into the domestic currencyimmediately. opportunetimes.
terminstruments.

A. nominal interest rate plus the expected rate of price inflation.

B. expected rate of price inflation minus the nominal interest rate.

C. nominal interest rate minus the expected rate of price inflation.D. nominal interest rate divided by the expected rate of priceinflation.

Answer: C

18.Using the expression for purchasing power parity, we can show thatthe difference in expectedrates of inflation between countries is equal to the

A. future spot rates on the currency exchange market.

B. sum of nominal interest rate plus expected inflation.

C. sum of the nominal interest rates in the two countries.

D. expected rate of deprecation or appreciation of the domesticcurrency.

Answer: D

19.Deviations from real interest parity can be decomposed intodeviations from

A. absolute purchasing power parity and relative purchasing powerparity. B. relative purchasing power parity and uncovered interestrate parity.

C. covered interest parity and relative purchasing power parity. D. covered and uncovered interest parity.

Answer: B

20.A swap is a contract between parties in which the parties

A. exchange flows of payments.

B. agree to the future price of a currency exchange.

C. exchange future cash flows for past cash flows.

D. have the right to buy an underlying asset at a fixed price.

Answer: A

21.One way to lock in a future interest rate is to buy

B. a series of short-term bonds. C. an interest rate forwardcontract. D. a currency exchange forward contract.A. a stock index option.

A. $5 million.

B. $50 million.

C. $100 million.

D. $1,500 million.

Answer: D

23.A long position is an obligation to ______ whereas a short positionis an obligation to ______.

A. sell; purchase.

B. purchase; sell.

C. exercise a call; exercise a put.

24.A major difference between a forward contract and a future contractis that only a futurecontract is

A. a standardized contract that is traded over an exchange. B. available exclusively from commercial banks.
C. available for any amount and maturity.

D. limited to large contracts.

Answer: A

25.If an investor wants to speculate on the direction of the entirestock market, the most efficientmethod would be to acquire

A. a portfolio containing stocks of all traded companies. B. aportfolio of stocks and bonds.
C. an exchange forward.

D. a stock index future.

Answer: D

A. right to purchase or sell an underlying financial instrument at agiven price. B. obligation to purchase or sell an underlying financial instrument ata given price.
26.An option on a financial instrument gives the holder the

Answer: A

27.A call option gives the holder the right to ______an instrumentwhereas a put option givesthe holder the right to ________.

A. exercise; confiscate.
B. sell; purchase.
C. purchase; sell.
D. transfer; sell.

Answer: C

28.The process of combining separate risk exposures that a firm faces inits foreign- currency-denominatedpayments and receipts into a single net risk exposure is

C. consolidating.
D. diversifying.

Answer: A