Allright Insurance Has Total Assets of $140 Million Consisting of $50

question 22

Multiple Choice

Allright Insurance has total assets of $140 million consisting of $50 million in 2-year, 6 percent Treasury notes and $90 million in 10-year, 7.2 percent fixed-rate Baa bonds. These assets are funded by $100 million 5-year, 5 percent fixed rate GICs and equity.
-If Allright wanted to hedge the balance sheet position, what is the interest rate risk exposure and what hedge would be appropriate?

• A)The balance sheet position is exposed to interest rate increases; use a short hedge.
• B)The balance sheet position is exposed to interest rate increases; use a long hedge.
• C)The balance sheet position is exposed to interest rate decreases; use a long hedge.
• D)The balance sheet position is exposed to interest rate decreases; use a short hedge.
• E)There is no interest rate risk exposure.

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Definitions:

Spread

The difference between two prices, rates, or yields, often referring to the gap between bid and ask prices of a security.

Underwriters' Buying Price

The price at which underwriters purchase securities from the issuer before selling them to the public.

Offering Price

The price at which new shares are offered to the public by an issuer or an underwriter in initial public offerings or secondary offerings.

Dilution

Loss in existing shareholders’ value, in terms of either ownership, market value, book value, or EPS.