IS MONTS’ STATEMENT 4 MOST LIKELY CORRECT

36. Is Monts’ Statement 4 most likely correct? A. Yes. B. No, because callable bonds would underperform. C. No, because putable bonds would not provide protection. By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currently-registered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose. Stewart Mink Case Scenario Stewart Mink manages the interest rate risk for Casford Bank, a small bank operating in the retail and small business market. It is January 1 and Mink is evaluating various exposures of the bank for the coming year. Given the bank’s overall interest rate exposure, Mink’s primary goal is to protect the bank should interest rates decline but retain the upside should interest rates go up. Mink is concerned about an upcoming reset on a floating rate loan to Texmaco. Details on the loan and other relevant information are provided in Exhibit 1. Exhibit 1 Texmaco Loan Information Face Value $60 million Loan Due Date One year from now Rate 180-day LIBOR + 200 bps Reset frequency Every six months Next reset June 30

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Current spot 180 day LIBOR 5 percent He gathers the following information on European style interest rate option contracts that could be used to hedge the Texmaco loan. Exhibit 2 Information on Interest Rate Options Notional Amount $60 million Underlying 180-day spot LIBOR Day count convention 30/360 Call exercise rate 6.0 percent Call premium $100,000 Put exercise rate 4.5 percent Put premium $130,000 Exercise date for both put and call June 30

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Mink evaluates a put hedging strategy and a collar hedging strategy. He also examines methods to lower the cost of the collar. Finally, Mink discusses the collar with Stan Peters, the bank’s Chief Financial Officer, who indicates that the board of directors is concerned with potential volatility in the bank’s earnings. Peters proposes that Mink initiate a long straddle at exercise rates of 5.0% instead of the collar. Mink responds: “I did not use a straddle for the following reasons: Reason 1: The straddle will not protect against significant decreases in the LIBOR rate. Reason 2: The straddle is more expensive to implement than the collar.”