Financial Markets And Institutes Question and Answer 2022

FINANCIAL
MARKETS AND
INSTITUTES
STUDENT ID:
[Pick the date]

Question 1
It is evident from the article that the interest rates are expected to rise. As a result, it would be
difficult for the existing borrowers to meet their debt obligations. In wake of the potential
increase in credit risk, I would alter the lending norms so that the businesses that are
vulnerable are given credit only if stringent screening criteria are met. Further, with respect to
the current borrowers, a watchlist would be created for the accounts which can potentially
default on the repayments and attempts would be made to recover the loan amount at the
earliest. Also, rising interest rates would have adverse impact on the prices of the bonds. As a
result, bond holdings would be trimmed and also the duration of the holdings would be made
short so as to reduce the adverse impact of higher interest rates on bond prices (Arnold,
2015).
Question 2
a) Hedging would involve assuming position that would offset the position taken under the
futures contract so as limit the underlying risk. Based on the relevant facts, it is evident
that for hedging their position the future contracts should be sold. With an increase in the
interest rate, the value of both the equity and future contract would decrease. However, it
is essential that the bank should proceed with buyback of future to ensure the gains by
balancing the decrease in equity (Brealey & Myers, 2016).
(b) Number of contracts which are necessary to fully hedge the bank needs to find.