1. Which of the following holds true for the writer of a bond call option if interest rates decrease?

Makes profits limited to call premium

Makes losses limited to call premium

Potential to make large losses

Potential to make unlimited profits

Answers B and D only

2. A bank has assets of $500,000,000 and equity of $40,000,000. The assets have an average duration of 5.5 years, and the liabilities have an average duration of 2.5 years. An 8-year fixed-rate T-bond with the same coupon as the fixed-rate on the swap has a duration of 6 years, and the duration of a floating-rate bond that reprices annually is one year. The bank wishes to hedge its balance sheet with swap contracts that have notional contracts of $100,000. What is the optimal number of swap contracts into which the bank should enter?

2,500 contracts.

2,760 contracts.

13,800 contracts.

3,200 contracts.

None of the above.