Review questions - midterm

docx

School

California Polytechnic State University, San Luis Obispo *

*We aren’t endorsed by this school

Course

442

Subject

Economics

Date

Feb 20, 2024

Type

docx

Pages

Uploaded by handyandyisdandy

REVIEW QUESTIONS for Chapters 1-4 1. Which of the following is true of derivatives? A. Derivatives allow many large companies to eliminate their financial risks B. You have to own the underlying asset to trade a derivative on it C. All derivatives are regulated instruments and trade on public exchanges D. Derivatives are tools for fine-tuning investment returns, cash flows, risks, etc. 2. A one-year call option on a stock with a strike price of $30 costs $3; a one-year put option on the stock with a strike price of $30 costs $4. Suppose that a trader buys two call options and one put option . If the stock moves up by expiration, the breakeven stock price above which the trader makes a profit is: A. $35 Premium cost: 6+4=10 Breakeven: 10 = 2(x-30) x = 35 B. $40 C. $30 D. $36 3. Derivatives can be used for all of these purposes, EXCEPT A. Offsetting the risks in other securities B. Changing the terms of a liability C. Generating income on existing assets D. Issuing public securities 4. Which of the following describes European options? A. Sold in Europe B. Priced in Euros C. Exercisable only at maturity D. Calls (there are no European puts) 5. Arbitrage is all of the following, EXCEPT A. A process by which derivatives are cleared and settled B. An activity that exploits securities mispricings C. A trading activity that can often be essentially riskless D. Conducted globally 6. The price of a stock on July 1 is $57. A trader buys 100 call options on the stock with a strike price of $60 when the option price is $2. The options are exercised when the stock price is $65. The trader’s net profit is: A. $700 B. $500 C. $300 D. $600

7. The price of a stock on February 1 is $124 . A trader sells 200 put options on the stock with a strike price of $120 when the option price is $5. The options are exercised when the stock price is $110. The trader’s net profit or loss is: A. Gain of $1,000 B. Loss of $2,000 C. Loss of $2,800 D. Loss of $1,000  Loss of 200 * (120-110) = $2000, but $1000 premium = $1000 loss 8. Which of the following is NOT true of options vs. futures? A. Only a fraction of both result in delivery or exercise B. They are traded on the same exchanges C. Shorting either incurs an obligation D. They are regulated by different entities 9. Which of the following is approximately true when size is measured in terms of the underlying principal amounts or value of the underlying assets? A. The exchange-traded market is twice as big as the over-the-counter market. B. The over-the-counter market is twice as big as the exchange-traded market. C. The exchange-traded market is about ten times as big as the over-the-counter market. D. The over-the-counter market is about ten times as big as the exchange-traded market. 10. In the corn futures contract, a number of different types of corn can be delivered (with price adjustments specified by the exchange) and there are a number of different delivery locations. Which of the following is true? A. This flexibility tends to increase the futures price. B. This flexibility tends to decrease the futures price. C. This flexibility may increase and may decrease the futures price. D. This flexibility has no effect on the futures price. 11. Who initiates delivery in a corn futures contract? A. The party with the long position. B. The party with the short position. “Notice of Intention to Deliver” to exchange C. Either party D. The exchange 12. For a futures contract trading in April, the open interest for a June contract, when compared to the open interest for Sept contract, is usually: A. Higher B. Lower C. The same D. Equally likely to be higher or lower

13. Futures contracts trade with every month as a delivery month. A company is hedging the purchase of the underlying asset on June 15. Which futures contract should it use? A. The June contract B. The July contract  1 month after purchase C. The May contract D. The August contract 14. On March 1 the price of a commodity is $1,000 and the December futures price is $1,015. On November 1, the price is $980 and the December futures price is $981. A producer of the commodity entered into a December futures contracts on March 1 to hedge the sale of the commodity on November 1. It closed out its position on November 1. What is the effective price (after taking account of hedging) received by the company for the commodity? A. $1,016 B. $1,001 C. $981 D. $1,014: 1015 – 981 = 34, 34+980=1014 15. A company has a $36 million portfolio with a beta of 1.2. The futures price for a contract on an index is 900. Futures contracts on $250 times the index can be traded. What trade is necessary to reduce beta to 0.9? A. Long 192 contracts B. Short 192 contracts C. Long 48 contracts D. Short 48 contracts: 1.2-0.9=0.3  0.3*36m/(900*250) 16. Which of the following describes tailing the hedge? A. A strategy where the hedge position is increased at the end of the life of the hedge. B. A strategy where the hedge position is increased at the end of the life of the futures contract. C. A more exact calculation of the hedge ratio when forward contracts are used for hedging. D. None of the above. : When futures are used for hedging  correct daily settlement 17. Which of the following does NOT describe beta? A. A measure of the sensitivity of the return on an asset to the return on an index. B. The slope of the best fit line when the return on an asset is regressed against the return on the market. C. The hedge ratio necessary to remove market risk from a portfolio. D. Measures correlation between futures prices and spot prices for a commodity. 18. A silver mining company has used futures markets to hedge the price it will receive for everything it will produce over the next 5 years. Which of the following is true? A. It is liable to experience liquidity problems if the price of silver falls dramatically.

Your preview ends here

Eager to read complete document? Join bartleby learn and gain access to the full version

Access to all documents
Unlimited textbook solutions
24/7 expert homework help

B. It is liable to experience liquidity problems if the price of silver rises dramatically. C. It is liable to experience liquidity problems if the price of silver rises dramatically or falls dramatically. D. The operation of futures markets protects it from liquidity problems. 19. The six-month zero rate is 8% per annum with semiannual compounding. The price of a one- year bond that provides a coupon of 6% per annum semiannually is 97. What is the one-year continuously compounded zero rate? A. 8.02% B. 8.52% C. 9.02% D. 9.52% 20. Which of the following is NOT true about term structure? A. It is important for determining forward rates B. It always rises over time C. It changes as the market reassesses the economic situation D. The short-term is determined by the Federal Reserve and the long-term is determined by the market 21. The modified duration of a bond portfolio worth $1 million is 5 years. By approximately how much does the value of the portfolio change, if all yields increase by 5 basis points? A. Increase of $2,500 B. Decrease of $2,500 5 × 0.0005 = 0.0025  0.0025 × 1,000,000 = $2,500. C. Increase of $25,000 D. Decrease of $25,000 22. Which of the following is NOT a theory of the term structure? A. Expectations theory B. Market segmentation theory C. Liquidity preference theory D. Maturity preference theory 23. The yield curve is flat at 6% per annum. What is the value of an FRA where the holder receives interest at the rate of 8% per annum for a six-month period on a principal of $1,000 starting in two years? All rates are compounded semiannually. A. $9.12 B. $9.02 C. $8.88 D. $8.63 6/12 *(0.08-0.06)*1000=$10  10/1 + ((0.08+0.06)/2)/2)

ANSWERS: 1. Answer: D 2. Answer: A When the stock price is $35, the two call options provide a payoff of 2 × (35 − 30) or $10. The put option provides no payoff. The total cost of the options is 2 × 3 + 4 or $10. The stock price in A, $35, is therefore the breakeven stock price above which the position is profitable because it is the price for which the cost of the options equals the payoff. 3. Answer: D 4. Answer: C European options can be exercised only at maturity. This is in contrast to American options which can be exercised at any time. The term “European” has nothing to do with geographical location, currencies, or whether the option is a call or a put. 5. Answer: A 6. Answer: C The payoff from the options is 100 × (65 − 60) or $500. The cost of the options is 2 × 100 or $200. The net profit is therefore 500 − 200 or $300. 7. Answer: D The payoff that must be made on the options is 200 × (120 − 110) or $2000. The amount received for the options is 5 × 200 or $1000. The net loss is therefore 2000 − 1000 or $1000. 8. Answer: B 9. Answer: D The over-the-counter market is about $600 trillion whereas the exchange-traded market is about $60 trillion. 10. Answer: B The party with the short position chooses between the alternatives. The alternatives therefore make the futures contract more attractive to the party with the short position. The lower the futures price, the less attractive it is to the party with the short position. The benefit of the alternatives available to the party with the short position is therefore compensated for by the futures price being lower than it would otherwise be. 11. Answer: B The party with the short position initiates delivery by sending a “Notice of Intention to Deliver” to the exchange. The exchange has a procedure for choosing a party with a long position to take delivery. 12. Answer: A The contracts which are close to maturity tend to have the highest open interest. However, during the maturity month itself, the open interest declines. 13. Answer: B

As a general rule, the futures maturity month should be as close as possible to, but after the month when the asset will be purchased. In this case, the asset will be purchased in June and so the best contract is the July contract. 14. Answer: D The producer of the commodity takes a short futures position. The gain on the futures is 1015 − 981 or $34. The effective price realized is therefore 980 + 34 or $1,014. This can also be calculated as the March 1 futures price (=1015) plus the November 1 basis (=−1). 15. Answer: D To reduce the beta by 0.3 we need to short 0.3 × 36,000,000/(900 × 250) or 48 contracts. 16. Answer: D Tailing the hedge is a calculation appropriate when futures are used for hedging. It corrects for daily settlement. 17. Answer: D A, B, and C all describe beta but beta has nothing to do with the correlation between futures and spot prices for a commodity. 18. Answer: B The mining company shorts futures. It gains on the futures when the price decreases and loses when the price increases. It may get margin calls which lead to liquidity problems when the price rises even though the silver in the ground is worth more. 19. Answer: C If the rate is R we must have 3 1.04 + 103 e − R × 1 = 97 20. Answer: B 21. Answer: B When yields increase, bond prices decrease. The proportional decrease is the modified duration times the yield increase. In this case, it is 5 × 0.0005 = 0.0025. The decrease is therefore 0.0025 × 1,000,000 or $2,500. 22. Answer: C Maturity preference theory is not a theory of the term structure. The other three are. 23. Answer: D The value of the FRA is the value of receiving an extra 0.5 × (0.08 − 0.06) × 1000 = $10 in 2.5 years. This is 10/(1.03 5 ) = $8.63.

Your preview ends here

Eager to read complete document? Join bartleby learn and gain access to the full version

Access to all documents
Unlimited textbook solutions
24/7 expert homework help

Review questions - midterm

Related Documents