A savings and loan association has long-term fixed-rate mortgages financed by short-term funds. It hedges by...
A savings and loan association has long-term fixed-rate mortgages financed by short-term funds. It hedges by selling Treasury bond futures. If interest rates decline, and many mortgages are prepaid
Group of answer choices:
1)the gain on the futures contracts offsets the loss on the mortgages.
2)the gain on the mortgages offsets the loss on the futures contracts.
3)the gain on the futures contracts more than offsets any unfavorable effects on mortgages.
4)a loss on the futures contracts more than offsets the favorable effect on the mortgage portfolio.
Homework Answers
Answer is 4) a loss on the futures contracts more than offsets the favorable effect on the mortgage portfolio.
In the given case , if the interest rates decline and mortgages are prepaid , then, a loss on the futures contracts more than offsets the favorable effect on the mortgage portfolio.
The savings and loan association will incur a loss from its futures position without a corresponding gain from its fixed rate mortgage position because they are prepaid.
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