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CH1 Study online at https://quizlet.com/_5bi54j Aone-yearforwardcontractisanagree- mentwhere A. One side has the right to buy an asset for a certain price in one year's time. B. One side has the obligation to buy an asset for a certain price in one year's time. C. One side has the obligation to buy an asset for a certain price at some time during the next year. D. One side has the obligation to buy an asset for the maret price in one year's time. B. One side has the obligation to buy an asset for a certain price in one year's time. Which of the following is true A. $hen a CBO' call option onIBM is ex- ercised" IBM issues more stoc B. An American option can be exercised at any time during its life C. An call option will always be exercised at maturity if the underlying asset price is greater than the strie price D. A put option will always be exercised at maturity if the strie price is greater than the underlying asset price. A. $hen a CBOE call option onIBM is exercised" IBM issues more stoc 1 / 1
CH2 Study online at https://quizlet.com/_5bfmbn Which of the following is true A. Both forward and futures contracts are traded on exchanges. B. Forward contracts are traded on ex- changes, but futures contracts are not. C. Futures contracts are traded on ex- changes, but forward contracts are not. D. Neither futures contracts nor forward contracts are traded on exchanges. C. Futures contracts are traded on ex- changes, but forward contracts are not. Which of the following is NOT true A. Futures contracts nearly always last longer than forward contracts B. Futures contracts are standardized; forward contracts are not. C. Delivery or final cash settlement usu- ally takes place with forward contracts; the same is not true of futures contracts. D. Forward contracts usually have one specified delivery date; futures contract often have a range of delivery dates. A. Futures contracts nearly always last longer than forward contracts 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 increase the fu- tures price. B. This flexibility tends decrease the fu- tures price. C. This flexibility may increase and may decrease the futures price. D. This flexibility has no effect on the futures price B. This flexibility tends decrease the fu- tures price. The party with the short position choos- es between the alternatives. The alterna- tives 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 alter- natives available to the party with the short position is therefore compensated for by the futures price being lower than it would otherwise be. 1 / 6
CH2 Study online at https://quizlet.com/_5bfmbn A company enters into a short futures contract to sell 50,000 units of a com- modity for 70 cents per unit. The initial margin is $4,000 and the maintenance margin is $3,000. What is the futures price per unit above which there will be a margin call? A. 78 cents B. 76 cents C. 74 cents D. 72 cents D. 72 cents There will be a margin call when more than $1000 has been lost from the mar- gin account so that the balance in the account is below the maintenance mar- gin level. Because the company is short, each one cent rise in the price leads to a loss or 0.01×50,000 or $500. A greater than 2 cent rise in the futures price will therefore lead to a margin call. The fu- ture price is currently 70 cents. When the price rises above 72 cents there will be a margin call. A company enters into a long futures contract to buy 1,000 units of a com- modity for $60 per unit. The initial margin is $6,000 and the maintenance margin is $4,000. What futures price will allow $2,000 to be withdrawn from the margin account? A. $58 B. $62 C. $64 D. $66 B. $62 Amounts in the margin account in excess of the initial margin can be withdrawn. Each $1 increase in the futures price leads to a gain of $1000. When the fu- tures price increases by $2 the gain will be $2000 and this can be withdrawn. The futures price is currently $60. The answer is therefore $62. One futures contract is traded where both the long and short parties are clos- ing out existing positions. What is the resultant change in the open interest? A. No change B. Decrease by one C. Decrease by two D. Increase by one B. Decrease by one Who initiates delivery in a corn futures contract A. The party with the long position B. The party with the short position C. Either party D. The exchange B. The party with the short position 2 / 6
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CH2 Study online at https://quizlet.com/_5bfmbn You sell one December futures contracts when the futures price is $1,010 per unit. Each contract is on 100 units and the initial margin per contract that you pro- vide is $2,000. The maintenance margin per contract is $1,500. During the next day the futures price rises to $1,012 per unit. What is the balance of your margin account at the end of the day? A. $1,800 B. $3,300 C. $2,200 D. $3,700 B. $3,300 The price has increased by $2. Because you have a short position you lose 2×100 or $200. The balance in the margin ac- count therefore goes down from $3,500 to $3,300. A hedger takes a long position in a fu- tures contract on a commodity on No- vember 1, 2012 to hedge an exposure on March 1, 2013. The initial futures price is $60. On December 31, 2012 the fu- tures price is $61. On March 1, 2013 it is $64. The contract is closed out on March 1, 2013. What gain is recognized in the accounting year January 1 to December 31, 2013? Each contract is on 1000 units of the commodity. A. $0 B. $1,000 C. $3,000 D. $4,000 D. $4,000 Hedge accounting is used. The whole of the gain or loss on the futures is therefore recognized in 2013. None is recognized in 2012. In this case the gain is $4 per unit or $4,000 in total. A speculator takes a long position in a futures contract on a commodity on No- vember 1, 2012 to hedge an exposure on March 1, 2013. The initial futures price is $60. On December 31, 2012 the fu- tures price is $61. On March 1, 2013 it is $64. The contract is closed out on March 1, 2013. What gain is recognized in the C. $3,000 In this case there is no hedge account- 3 / 6
CH2 Study online at https://quizlet.com/_5bfmbn accounting year January 1 to December 31, 2013? Each contract is on 1000 units of the commodity. A. $0 B. $1,000 C. $3,000 D. $4,000 ing. Gains or losses are accounted for as they are accrued. The price per unit increases by $3 in 2013. The total gain in 2013 is therefore $3,000. .The frequency with which futures mar- gin accounts are adjusted for gains and losses is A. Daily B. Weekly C. Monthly D. Quarterly a Margin accounts have the effect of A. Reducing the risk of one party regret- ting the deal and backing out B. Ensuring funds are available to pay traders when they make a profit C. Reducing systemic risk due to col- lapse of futures markets D. All of the above D. All of the above Initial margin requirements dramatically reduce the risk that a party will walk away from a futures contract. As a result they reduce the risk that the exchange clear- ing house will not have enough funds to pays profits to traders. Furthermore, if traders are less likely to suffer losses because of counterparty defaults there is less systemic risk. Which entity in the United States takes primary responsibility for regulating fu- tures market? A. Federal Reserve Board B. Commodities Futures Trading Com- mission (CFTC) C. Security and Exchange Commission (SEC) D. US Treasury B. Commodities Futures Trading Com- mission (CFTC) For a futures contract trading in April 2012, the open interest for a June 2012 contract, when compared to the open in- 4 / 6
CH2 Study online at https://quizlet.com/_5bfmbn terest for Sept 2012 contracts, is usually A. Higher B. Lower C. The same D. Equally likely to be higher or lower A. higher The contracts which are close to maturity tend to have the highest open interest. However, during the maturity month itself the open interest declines. Clearing houses are A. Never used in futures markets and sometimes used in OTC markets B. Used in OTC markets, but not in fu- tures markets C. Always used in futures markets and sometimes used in OTC markets D. Always used in both futures markets and OTC markets C. Always used in futures markets and sometimes used in OTC A haircut of 20% means that A. A bond with a market value of $100 is considered to be worth $80 when used to satisfy a collateral request B. A bond with a face value of $100 is considered to be worth $80 when used to satisfy a collateral request C. A bond with a market value of $100 is considered to be worth $83.3 when used to satisfy a collateral request D. A bond with a face value of $100 is considered to be worth $83.3 when used to satisfy a collateral request A. A bond with a market value of $100 is considered to be worth $80 when used to satisfy a collateral request A haircut is the amount the market price of asset is reduced by for the purposes of determining its value for collateral pur- poses With bilateral clearing, the number of agreements between four dealers, who trade with each other, is A. 12 B. 1 C. 6 D. 2 C. 6 5 / 6
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CH2 Study online at https://quizlet.com/_5bfmbn .Which of the following best describes central clearing parties A. Help market participants to value de- rivative transactions B. Must be used for all OTC derivative transactions C. Are used for futures transactions D. Perform a similar function to exchange clearing houses D. Perform a similar function to exchange clearing houses .Which of the following are cash settled A. All futures contracts B. All option contracts C. Futures on commodities D. Futures on stock indices D. Futures on stock indices A limit order A. Is an order to trade up to a certain number of futures contracts at a certain price B. Is an order that can be executed at a specified price or one more favorable to the investor C. Is an order that must be executed within a specified period of time D. None of the above B. Is an order that can be executed at a specified price or one more favorable to the investor 6 / 6
chapter 3 Study online at https://quizlet.com/_6fq16a 1. The basis is defined as spot minus futures. A trader is hedging the sale of an asset with a short futures position. The basis increases unexpectedly. Which of the following is true? A. The hedger's position improves. B. The hedger's position worsens. C. The hedger's position sometimes worsens and sometimes improves. D. The hedger's position stays the same. A. The hedger's position improves. The price received by the trader is the futures price plus the basis. It follows that the trader's position improves when the basis increases. 2. 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 C. The May contract D. The August contract B. The July contract 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. 3. On March 1 a commodity's spot price is $60 and its August futures price is $59. On July 1 the spot price is $64 and the August futures price is $63.50. A com- pany entered into futures contracts on March 1 to hedge its purchase of the commodity on July 1. It closed out its position on July 1. What is the effective price (after taking account of hedging) paid by the company? A. $59.50 B. $60.50 C. $61.50 D. $63.50 A. $59.50 The user of the commodity takes a long futures position. The gain on the futures is 63.5059 or $4.50. The effective paid realized is therefore 644.50 or $59.50. This can also be calculated as the March 1 futures price (=59) plus the basis on July 1 (=0.50). 4. 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 1 / 7
chapter 3 Study online at https://quizlet.com/_6fq16a entered into a December futures con- tracts 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 D. $1,014 The producer of the commodity takes a short futures position. The gain on the futures is 1015981 or $34. The effec- tive price realized is therefore 980+34 or $1014. This can also be calculated as the March 1 futures price (=1015) plus the November 1 basis (=1). 5. Suppose that the standard deviation of monthly changes in the price of com- modity A is $2. The standard deviation of monthly changes in a futures price for a contract on commodity B (which is similar to commodity A) is $3. The cor- relation between the futures price and the commodity price is 0.9. What hedge ratio should be used when hedging a one month exposure to the price of commod- ity A? A. 0.60 B. 0.67 C. 1.45 D. 0.90 A. 0.60 The optimal hedge ratio is 0.9×(2/3) or 0.6. 6. 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 D. Short 48 contracts To reduce the beta by 0.3 we need to short 0.3×36,000,000/(900×250) or 48 contracts. 7. A company has a $36 million portfolio with a beta of 1.2. The futures price for 2 / 7
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chapter 3 Study online at https://quizlet.com/_6fq16a a contract on an index is 900. Futures contracts on $250 times the index can be traded. What trade is necessary to increase beta to 1.8? A. Long 192 contracts B. Short 192 contracts C. Long 96 contracts D. Short 96 contracts C. Long 96 contracts To increase beta by 0.6 we need to go long 0.6×36,000,000/(900×250) or 96 contracts 8. Which of the following is true? A. The optimal hedge ratio is the slope of the best fit line when the spot price (on the y-axis) is regressed against the futures price (on the x-axis). B. The optimal hedge ratio is the slope of the best fit line when the futures price (on the y-axis) is regressed against the spot price (on the x-axis). C. The optimal hedge ratio is the slope of the best fit line when the change in the spot price (on the y-axis) is regressed against the change in the futures price (on the x-axis). D. The optimal hedge ratio is the slope of the best fit line when the change in the futures price (on the y-axis) is regressed against the change in the spot price (on the x-axis). C. The optimal hedge ratio is the slope of the best fit line when the change in the spot price (on the y-axis) is regressed against the change in the futures price (on the x-axis). The optimal hedge ratio reflects the ratio of movements in the spot price to move- ments in the futures price. 9. 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 D. None of the above Tailing the hedge is a calculation appro- priate when futures are used for hedging. It corrects for daily settlement 3 / 7
chapter 3 Study online at https://quizlet.com/_6fq16a hedging D. None of the above 10. A company due to pay a certain amount of a foreign currency in the future decides to hedge with futures contracts. Which of the following best describes the advantage of hedging? A. It leads to a better exchange rate be- ing paid B. It leads to a more predictable ex- change rate being paid C. It caps the exchange rate that will be paid D. It provides a floor for the exchange rate that will be paid B. It leads to a more predictable ex- change rate being paid Hedging is designed to reduce risk not increase expected profit. Options can be used to create a cap or floor on the price. Futures attempt to lock in the price 11. Which of the following best describes the capital asset pricing model? A. Determines the amount of capital that is needed in particular situations B. Is used to determine the price of fu- tures contracts C. Relates the return on an asset to the return on a stock index D. Is used to determine the volatility of a stock index C. Relates the return on an asset to the return on a stock index CAPM relates the return on an asset to its beta. The parameter beta measures the sensitivity of the return on the asset to the return on the market. The latter is usually assumed to be the return on a stock index such as the S&P 500. 12. Which of the following best describes "stack and roll"? A. Creates long-term hedges from short term futures contracts B. Can avoid losses on futures contracts by entering into further futures contracts C. Involves buying a futures contract with one maturity and selling a futures con- tract with a different maturity D. Involves two different exposures si- multaneously A. Creates long-term hedges from short term futures contracts Stack and roll is a procedure where short maturity futures contracts are entered into. When they are close to maturity they are replaced by more short maturity fu- tures contracts and so on. The result is the creation of a long term hedge from short-term futures contracts. B. Dissimilarity between the underlying asset of the futures contract and the 4 / 7
chapter 3 Study online at https://quizlet.com/_6fq16a 13. Which of the following increases ba- sis risk? A. A large difference between the futures prices when the hedge is put in place and when it is closed out B. Dissimilarity between the underlying asset of the futures contract and the hedger's exposure C. A reduction in the time between the date when the futures contract is closed and its delivery month D. None of the above hedger's exposure Basis is the difference between spot and futures at the time the hedge is closed out. This increases as the time between the date when the futures contract is put in place and the delivery month increas- es. (C is not therefore correct). It also increases as the asset underlying the futures contract becomes more different from the asset being hedged. (B is there- fore correct.) 14. Which of the following is a reason for hedging a portfolio with an index futures? A. The investor believes the stocks in the portfolio will perform better than the market but is uncertain about the future performance of the market B. The investor believes the stocks in the portfolio will perform better than the market and the market is expected to do well C. The portfolio is not well diversified and so its return is uncertain D. All of the above A. The investor believes the stocks in the portfolio will perform better than the market but is uncertain about the future performance of the market Index futures can be used to remove the impact of the performance of the overall market on the portfolio. If the market is expected to do well hedging against the performance of the market is not appro- priate. Hedging cannot correct for a poor- ly diversified portfolio. 15. Which of the following does NOT de- scribe 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 D. Measures correlation between futures prices and spot prices for a commodity A, B, and C all describe beta but beta has nothing to do with the correlation between futures and spot prices for a commodity 5 / 7
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chapter 3 Study online at https://quizlet.com/_6fq16a 16. Which of the following is true? A. Hedging can always be done more easily by a company's shareholders than by the company itself B. If all companies in an industry hedge, a company in the industry can some- times reduce its risk by choosing not to hedge C. If all companies in an industry do not hedge, a company in the industry can reduce its risk by hedging D. If all companies in an industry do not hedge, a company is liable increase its risk by hedging D. If all companies in an industry do not hedge, a company is liable increase its risk by hedging If all companies in a industry hedge, the price of the end product tends to reflect movements in relevant market variables. Attempting to hedge those movements can therefore increase risk. Which of the following is necessary for tailing a hedge? A. Comparing the size in units of the position being hedged with the size in units of the futures contract B. Comparing the value of the position being hedged with the value of one fu- tures contract C. Comparing the futures price of the asset being hedged to its forward price D. None of the above B. Comparing the value of the position being hedged with the value of one fu- tures contract When tailing a hedge the optimal hedge ratio is applied to the ratio of the value of the position being hedged to the value of one futures contract. 19. 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 prob- lems if the price of silver falls dramatical- ly B. It is liable to experience liquidity prob- lems if the price of silver rises dramati- cally C. It is liable to experience liquidity prob- lems if the price of silver rises dramati- B. It is liable to experience liquidity prob- lems if the price of silver rises dramati- cally The mining company shorts futures. It gains on the futures when the price de- creases and loses when the price in- creases. It may get margin calls which lead to liquidity problems when the price rises even though the silver in the ground is worth more. 6 / 7
chapter 3 Study online at https://quizlet.com/_6fq16a cally or falls dramatically D. The operation of futures markets pro- tects it from liquidity problems Which of the following is true? A. Gold producers should always hedge the price they will receive for their pro- duction of gold over the next three years B. Gold producers should always hedge the price they will receive for their pro- duction of gold over the next one year C. The hedging strategies of a gold producer should depend on whether it shareholders want exposure to the price of gold D. Gold producers can hedge by buying gold in the forward market C. The hedging strategies of a gold producer should depend on whether it shareholders want exposure to the price of gold Some shareholders buy gold stocks to gain exposure to the price of gold. They do not want the company they invest in to hedge. In practice gold mining compa- nies make their hedging strategies clear to shareholders. 20. A company will buy 1000 units of a certain commodity in one year. It decides to hedge 80% of its exposure using fu- tures contracts. The spot price and the futures price are currently $100 and $90, respectively. The spot price and the fu- tures price in one year turn out to be $112 and $110, respectively. What is the average price paid for the commodity? A. $92 B. $96 C. $102 D. $106 B. $96 On the 80% (hedged) part of the com- modity purchase the price paid will 112(11090) or $92. On the other 20% the price paid will be the spot price of $112. The weighted average of the two prices is 0.8×92+0.2×112 or $96. 7 / 7
CH4 Study online at https://quizlet.com/_5bfl46 1. The compounding frequency for an interest rate defines A. The frequency with which inter- est is paid B. A unit of measurement for the interest rate C. The relationship between the an- nual interest rate and the monthly interest rate D. None of the above B. A unit of measurement for the inter- est rate 2. An interest rate is 6% per annum with annual compounding. What is the equivalent rate with continu- ous compounding? A. 5.79% B. 6.21% C. 5.83% D. 6.18% Answer: C The equivalent rate with continuous compounding is ln(1.06) = 0.0583 or 5.83%. 3. An interest rate is 5% per an- num with continuous compound- ing. What is the equivalent rate with semiannual compounding? A. 5.06% B. 5.03% C. 4.97% D. 4.94% A. The equivalent rate with semiannual compounding is 2×(e0.05/21) = 0.0506 or 5.06%. 4. An interest rate is 12% per an- num with semiannual compound- ing. What is the equivalent rate with quarterly compounding? A. 11.83% B. 11.66% C. 11.77% D. 11.92% A. 11.83% The equivalent rate per quarter is 1.06- 1 2.956% . The annualized rate with quarterly compounding is four times this or 11.83%. 5. The two-year zero rate is 6% and the three year zero rate is 6.5%. What is the forward rate for the D: 1 / 7
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CH4 Study online at https://quizlet.com/_5bfl46 third year? All rates are continu- ously compounded. A. 6.75% B. 7.0% C. 7.25% D. 7.5% The forward rate for the third year is (3×0.0652×0.06)/(32) = 0.075 or 7.5%. 6. The six-month zero rate is 8% per annum with semiannual com- pounding. 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% C. If the rate is R we must have R = ln(1/0.9137) = 0.0902 or 9.02%. 7. 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 semiannu- ally. A. $9.12 B. $9.02 C. $8.88 D. $8.63 D. The value of the FRA is the value of re- ceiving an extra 0.5×(0.080.06)×1000 = $10 in 2.5 years. This is 10/(1.035) = $8.63. 8. Under liquidity preference theory, which of the following is always true? A. The forward rate is higher than the spot rate when both have the same maturity. B. Forward rates are unbiased pre- dictors of expected future spot D. Forward rates are higher than ex- pected future spot rates. 2 / 7
CH4 Study online at https://quizlet.com/_5bfl46 rates. C. The spot rate for a certain matu- rity is higher than the par yield for that maturity. D. Forward rates are higher than expected future spot rates. 9. The zero curve is upward sloping. Define X as the 1-year par yield, Y as the 1- year zero rate and Z as the forward rate for the period between 1 and 1.5 year. Which of the following is true? A. XislessthanYwhichislessthanZ B. YislessthanXwhichislessthanZ C. X is less than Z which is less than Y D. Z is less than Y which is less than X Answer: A When the zero curve is upward sloping, the one-year zero rate is higher than the one-year par yield and the forward rate corresponding to the period be- tween 1.0 and 1.5 years is higher than the one-year zero rate. The correct an- swer is therefore A. 10. Which of the following is true of the fed funds rate A. It is the same as the Treasury rate B. It is an overnight interbank rate C. It is a rate for which collateral is posted D. It is a type of repo rate B. It is an overnight interbank rate 11. 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? B. Decrease of $2,500 When yields increase bond prices decrease. The proportional decrease is the modified duration times the yield increase. In this case, it is 3 / 7
CH4 Study online at https://quizlet.com/_5bfl46 A. Increase of $2,500 B. Decrease of $2,500 C. Increase of $25,000 D. Decrease of $25,000 5×0.0005=0.0025. The decrease is therefore 0.0025×1,000,000 or $2,500. 12. A company invests $1,000 in a five-year zero-coupon bond and $4,000 in a ten-year zero-coupon bond. What is the duration of the portfolio? A. 6 years B. 7 years C. 8 years D. 9 years D. 9 years The duration of the first bond is 5 years and the duration of the second bond is 10 years. The duration of the portfolio is a weighted average with weights cor- responding to the amounts invested in the bonds. It is 0.2×5+0.8×10=9 years. 13. Which of the following is true of LIBOR A. The LIBOR rate is free of credit risk B. A LIBOR rate is lower than the Treasury rate when the two have the same maturity C. It is a rate used when borrowing and lending takes place between banks D. It is subject to favorable tax treatment in the U.S. C. It is a rate used when borrowing and lending takes place between banks 14. Which of following describes for- ward rates? A. Interest rates implied by current zero rates for future periods of time B. Interest rate earned on an in- vestment that starts today and last for n-years in the future without A. Interest rates implied by current zero rates for future periods of time 4 / 7
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CH4 Study online at https://quizlet.com/_5bfl46 coupons C. The coupon rate that causes a bond price to equal its par (or prin- cipal)value D. A single discount rate that gives the value of a bond equal to its mar- ket price when applied to all cash flows 15. 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 D. Maturity preference theory 16. A repo rate is A.An uncollateralized rate B.A rate where the credit risk is relative high C.The rate implicit in a transac- tion where securities are sold and bought back later at a higher price D.None of the above C.The rate implicit in a transaction where securities are sold and bought back later at a higher price 17. Bootstrapping involves A.Calculating the yield on a bond B.Working from short maturity in- struments to longer maturity in- struments determining zero rates at each step C.Working from long maturity in- struments to shorter maturity in- struments determining zero rates at each B. Working from short maturity instru- ments to longer maturity instruments determining zero rates at each step 5 / 7
CH4 Study online at https://quizlet.com/_5bfl46 step D.The calculation of par yields 18. The zero curve is downward slop- ing. Define X as the 1-year par yield, Y as the 1-year zero rate and Z as the forward rate for the period between 1 and 1.5 year. Which of the following is true? A. XislessthanYwhichislessthanZ B. YislessthanXwhichislessthanZ C. X is less than Z which is less than Y D. Z is less than Y which is less than X D. Z is less than Y which is less than X 19. .Which of the following is true? A. When interest rates in the econ- omy increase, all bond prices in- crease B. As its coupon increases, a bond's price decreases C. Longer maturity bonds are al- ways worth more that shorter ma- turity bonds when the coupon rates are the same D. None of the above D. None of the above When interest rates increase the im- pact of discounting is to make future cash flows worth less. Bond prices therefore decline. A is therefore wrong. As coupons increase a bond becomes more valuable because higher cash flows will be received. B is therefore wrong. When the coupon is higher than prevailing interest rates, longer maturi- ty bonds are worth more than shorter maturity bonds. When it is less than prevailing interest rates, longer matu- rity bonds are worth less than shorter maturity bonds. C is therefore not true. The correct answer is therefore D 20. The six month and one-year rates are 3% and 4% per annum with semiannual compounding. Which A. The six month rate is 1.5% per six 6 / 7
CH4 Study online at https://quizlet.com/_5bfl46 of the following is closest to the one-year par yield expressed with semiannual compounding? A. 3.99% B. 3.98% C. 3.97% D. 3.96% months. The one year rate is 2% per six months. The one year par yield is the coupon that leads to a bond being worth par. A is the correct answer because (3.99/2)/1.015+(100+3.99/2)/1.022 = 100. The formula in the text can also be used to give the par yield as [(100-100/1.022)×2]/(1/1.015+1.022)=3.99. 7 / 7
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Chapter 5 Study online at https://quizlet.com/_6fqc31 1. Which of the following is a consump- tion asset? A. The S&P 500 index B. The Canadian dollar C. Copper D. IBM stock C. Copper A, B, and D are investment assets (held by at least some investors purely for in- vestment purposes). C is a consumption asset. 2. An investor shorts 100 shares when the share price is $50 and closes out the position six months later when the share price is $43. The shares pay a dividend of $3 per share during the six months. How much does the investor gain? A. $1,000 B. $400 C. $700 D. $300 B. $400 The investor gains $7 per share because he or she sells at $50 and buys at $43. However, the investor has to pay the $3 per share dividend. The net profit is therefore 73 or $4 per share. 100 shares are involved. The total gain is therefore $400. 3. The spot price of an investment as- set that provides no income is $30 and the risk-free rate for all maturities (with continuous compounding) is 10%. What is the three-year forward price? A. $40.50 B. $22.22 C. $33.00 D. $33.16 A. $40.50 The 3-year forward price is the spot price grossed up for 3 years at the risk-free rate. It is 30e0.1×3 =$40.50. 4. The spot price of an investment as- set is $30 and the risk-free rate for all maturities is 10% with continuous com- pounding. The asset provides an income of $2 at the end of the first year and at the end of the second year. What is the three-year forward price? A. $19.67 B. $35.84 C. $45.15 D. $40.50 B. $35.84 The present value of the income is 2e-0.1×1+2e-0.1×2= $3.447. The three year forward price is obtained by sub- tracting the present value of the income from the current stock price and then grossing up the result for three years at the risk-free rate. It is (303.447)e0.1×3 = $35.84. 1 / 7
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Chapter 5 Study online at https://quizlet.com/_6fqc31 5. An exchange rate is 0.7000 and the six-month domestic and foreign risk-free interest rates are 5% and 7% (both ex- pressed with continuous compounding). What is the six-month forward rate? A. 0.7070 B. 0.7177 C. 0.7249 D. 0.6930 D. 0.6930 The six-month forward rate is 0.7000e^(0.050.07)×0.5=0.6930. 6. Which of the following is true? A. The convenience yield is always posi- tive or zero. B. The convenience yield is always posi- tive for an investment asset. C. The convenience yield is always neg- ative for a consumption asset. D. The convenience yield measures the average return earned by holding futures contracts. A. The convenience yield is always posi- tive or zero. The convenience yield measures the benefit of owning an asset rather than having a forward/futures contract on an asset. For an investment asset it is al- ways zero. For a consumption asset it is greater than or equal to zero. 7. A short forward contract that was ne- gotiated some time ago will expire in three months and has a delivery price of $40. The current forward price for three-month forward contract is $42. The three month risk-free interest rate (with continuous compounding) is 8%. What is the value of the short forward contract? A. +$2.00 B. $2.00 C. +$1.96 D. $1.96 D. $1.96 The contract gives one the obligation to sell for $40 when a forward price negoti- ated today would give one the obligation to sell for $42. The value of the contract is the present value of $2 or 2e-0.08×0.25 = $1.96. 8. The spot price of an asset is positively correlated with the market. Which of the following would you expect to be true? A. The forward price equals the expected future spot price. B. The forward price is greater than the expected future spot price. C. The forward price is less than the ex- pected future spot price. When the spot price is positively corre- lated with the market the forward price is less than the expected future spot price. This is because the spot price is expect- 2 / 7
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Chapter 5 Study online at https://quizlet.com/_6fqc31 C. The forward price is less than the ex- pected future spot price. D. The forward price is sometimes greater and sometimes less than the ex- pected future spot price. ed to provide a return greater than the risk-free rate and the forward price is the spot price grossed up at the risk-free rate. 9. Which of the following describes the way the futures price of a foreign curren- cy is quoted by the CME group? A. The number of U.S. dollars per unit of the foreign currency B. The number of the foreign currency per U.S. dollar C. Some futures prices are always quot- ed as the number of U.S. dollars per unit of the foreign currency and some are always quoted the other way round D. There are no quotation conventions for futures prices A. The number of U.S. dollars per unit of the foreign currency The futures price is quoted as the num- ber of US dollars per unit of the for- eign currency. Spot exchange rates and forward exchange rates are sometimes quoted this way and sometimes quoted the other way round. 10. Which of the following describes the way the forward price of a foreign curren- cy is quoted? A. The number of U.S. dollars per unit of the foreign currency B. The number of the foreign currency per U.S. dollar C. Some forward prices are quoted as the number of U.S. dollars per unit of the foreign currency and some are quoted the other way round D. There are no quotation conventions for forward prices C. Some forward prices are quoted as the number of U.S. dollars per unit of the foreign currency and some are quoted the other way round The futures price is quoted as the num- ber of US dollars per unit of the for- eign currency. Spot exchange rates and forward exchange rates are sometimes quoted this way and sometimes quoted the other way round. 11. Which of the following is NOT a rea- son why a short position in a stock is closed out? A. The investor with the short position chooses to close out the position B. The lender of the shares issues in- structions to close out the position B. The lender of the shares issues in- structions to close out the position A, C, and D are all reasons why the short position might be closed out. B is not. The 3 / 7
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Chapter 5 Study online at https://quizlet.com/_6fqc31 C. The broker is no longer able to borrow shares from other clients D. The investor does not maintain mar- gins required on his/her margin account lender of shares cannot issue instruc- tions to close out the short position. 12. Which of the following is NOT true? A. Gold and silver are investment assets B. Investment assets are held by signifi- cant numbers of investors for investment purposes C. Investment assets are never held for consumption D. The forward price of an investment as- set can be obtained from the spot price, interest rates, and the income paid on the asset C. Investment assets are never held for consumption Investment assets are sometimes held for consumption. Silver is an example. To be an investment asset, an asset has to be held for investment by at least some traders 13. What should a trader do when the one-year forward price of an asset is too low? Assume that the asset provides no income. A. The trader should borrow the price of the asset, buy one unit of the asset and enter into a short forward contract to sell the asset in one year. B. The trader should borrow the price of the asset, buy one unit of the asset and enter into a long forward contract to buy the asset in one year. C. The trader should short the asset, in- vest the proceeds of the short sale at the risk-free rate, enter into a short forward contract to sell the asset in one year D. The trader should short the asset, in- vest the proceeds of the short sale at the risk-free rate, enter into a long forward contract to buy the asset in one year D. The trader should short the asset, in- vest the proceeds of the short sale at the risk-free rate, enter into a long forward contract to buy the asset in one year If the forward price is too low relative to the spot price the trader should short the asset in the spot market and buy it in the forward market. 14. Which of the following is NOT true about forward and futures contracts? A. Forward contracts are more liquid than 4 / 7
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Chapter 5 Study online at https://quizlet.com/_6fqc31 futures contracts B. The futures contracts are traded on exchanges while forward contracts are traded in the over-the-counter market C. In theory forward prices and futures prices are equal when there is no uncer- tainty about future interest rates D. Taxes and transaction costs can lead to forward and futures prices being dif- ferent A. Forward contracts are more liquid than futures contracts Futures contracts are more liquid than forward contracts. To unwind a futures position it is simply necessary to take an offsetting position. The statements in B, C, and D are correct 15. As the convenience yield increases, which of the following is true? A. The one-year futures price as a per- centage of the spot price increases B. The one-year futures price as a per- centage of the spot price decreases C. The one-year futures price as a per- centage of the spot price stays the same D. Any of the above can happen B. The one-year futures price as a per- centage of the spot price decreases As the convenience yield increases, the futures price declines relative to the spot price. This is because the convenience of owning the asset (as opposed to having a futures contract) becomes more impor- tant. 16. As inventories of a commodity de- cline, which of the following is true? A. The one-year futures price as a per- centage of the spot price increases B. The one-year futures price as a per- centage of the spot price decreases C. The one-year futures price as a per- centage of the spot price stays the same D. Any of the above can happen B. The one-year futures price as a per- centage of the spot price decreases When inventories decline, the conve- nience yield increases and the futures price as a percentage of the spot price declines. 17. Which of the following describes a known dividend yield on a stock? A. The size of the dividend payments each year is known B. Dividends per year as a percentage of today's stock price are known C. Dividends per year as a percentage of the stock price at the time when divi- dends are paid are known C. Dividends per year as a percentage of the stock price at the time when divi- dends are paid are known The dividend yield is the dividend per year as a percent of the stock price at the time when the dividend is paid. 5 / 7
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Chapter 5 Study online at https://quizlet.com/_6fqc31 D. Dividends will yield a certain return to a person buying the stock today 18. Which of the following is an argument used by Keynes and Hicks? A. If hedgers hold long positions and speculators holds short positions, the fu- tures price will tend to be higher than the expected future spot price B. If hedgers hold long positions and speculators holds short positions, the fu- tures price will tend to be lower than the expected future spot price C. If hedgers hold long positions and speculators holds short positions, the fu- tures price will tend to be lower than today's spot price D. If hedgers hold long positions and speculators holds short positions, the fu- tures price will tend to be higher than today's spot price A. If hedgers hold long positions and speculators holds short positions, the fu- tures price will tend to be higher than the expected future spot price Keynes and Hicks argued that hedgers will be prepared to accept negative re- turns on average because of the benefits of hedging whereas speculators require positive returns on average. This leads to A. 19. Which of the following describes con- tango? A. The futures price is below the expect- ed future spot price B. The futures price is below today's spot price C. The futures price is a declining func- tion of the time to maturity D. The futures price is above the expect- ed future spot price D. The futures price is above the expect- ed future spot price Contango is defined as the futures price being above the expected future spot price. It is also sometimes used to de- scribe the situation where the futures price is above the spot price. 20. Which of the following is true for a consumption commodity? A. There is no limit to how high or low the futures price can be, except that the futures price cannot be negative C. There is an upper limit to the futures price but no lower limit, except that the futures price cannot be negative If the futures price of a consumption com- modity becomes too high an arbitrageur will buy the commodity and sell futures to lock in a profit. An arbitrageur can- 6 / 7
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Chapter 5 Study online at https://quizlet.com/_6fqc31 B. There is a lower limit to the futures price but no upper limit C. There is an upper limit to the futures price but no lower limit, except that the futures price cannot be negative D. The futures price can be determined with reasonable accuracy from the spot price and interest rates not follow the opposite strategy of buying futures and selling or shorting the as- set when the futures price is low. This is because consumption assets cannot be shorted . Furthermore, people who hold the asset in general do so because they need the asset for their business. They are not prepared to swap their position in the asset for a similar position in a futures. Consequently, there is an upper limit but no lower limit to the futures price. 7 / 7
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CH7 Study online at https://quizlet.com/_5bfohg Which of the following is a use of a cur- rency swap? A. To exchange an investment in one cur- rency for an investment in another currency B. To exchange borrowing in one curren- cy for borrowings in another currency C. To take advantage situations where the tax rates in two countries are different D. All of the above D. All of the above A company can invest funds for five years at LIBOR minus 30 basis points. The five-year swap rate is 3%. What fixed rate of interest can the company earn by using the swap? A. 2.4% B. 2.7% C. 3.0% D. 3.3% B. 2.7% When the company invests at LIBOR mi- nus 0.3% and then enters into a swap where it pays LIBOR and receives 3% it earns 2.7% per annum. Note that it is the bid rate that will apply to the swap. Which of the following is true? A. Principals are not usually exchanged in a currency swap B. The principal amounts usually flow in the opposite direction to interest pay- ments at the beginning of a currency swap and in the same direction as inter- est payments at the end of the swap. C. The principal amounts usually flow in the same direction as interest payments at the beginning of a currency swap and in the opposite direction to interest payments at the end of the swap. D. Principals are not usually specified in a currency swap B. The principal amounts usually flow in the opposite direction to interest pay- ments at the beginning of a currency swap and in the same direction as inter- est payments at the end of the swap. 1 / 8
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CH7 Study online at https://quizlet.com/_5bfohg Company X and Company Y have been offered the following rates Fixed Rate Floating Rate Co. X: 3.5% 3-month LIBOR plus 10bp Co Y: 4.5% 3-month LIBOR plus 30 bp Suppose that Company X borrows fixed and company Y borrows floating. If they enter into a swap with each other where the apparent benefits are shared equally, what is company X's effective borrowing rate? A. 3-month LIBOR30bp B. 3.1% C. 3-month LIBOR10bp D. 3.3% A. 3-month LIBOR30bp The interest rate differential between the fixed rates is 100 basis points. The inter- est rate differential between the floating rates is 20 basis points. The difference between the interest rates differentials is 100 - 20 = 80 basis points. This is the total apparent gain from the swap to the two sides. Since the benefits are shared equally company X should be able to borrow at 40 bp less than it is currently offered in the floating rate market, i.e., at LIBOR minus 30 bp. Which of the following describes the five-year swap rate? A. The fixed rate of interest which a swap market maker is prepared to pay in ex- change for LIBOR on a 5-year swap B. The fixed rate of interest which a swap market maker is prepared to receive in exchange for LIBOR on a 5-year swap C. The average of A and B D. The higher of A and B C. The average of A and B The reference entity in a credit default swap is A. The buyer of protection B. The seller of protection C. The company or country whose de- fault is being insured against D. None of the above C. The company or country whose de- fault is being insured against Which of the following describes an inter- est rate swap? A. The exchange of a fixed rate bond for 2 / 8
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CH7 Study online at https://quizlet.com/_5bfohg a floating rate bond B. A portfolio of forward rate agreements C. An agreement to exchange interest at a fixed rate for interest at a floating rate D. All of the above D. All of the above Which of the following is true for an inter- est rate swap? A. A swap is usually worth close to zero when it is first negotiated B. Each forward rate agreement underly- ing a swap is worth close to zero when the swap is first entered into C. Comparative advantage is a valid rea- son for entering into the swap D. None of the above A. A swap is usually worth close to zero when it is first negotiated Which of the following is true for the party paying fixed in a newly negotiated inter- est rate swap when the yield curve is upward sloping? A. The early forward contracts underlying the swap have a positive value and the later ones have a negative value B. The early forward contracts underlying the swap have a negative value and the later ones have a positive value C. The swap is designed so that all for- ward rates have zero value D. Sometimes A is true and sometimes B is true B. The early forward contracts underlying the swap have a negative value and the later ones have a positive value A bank enters into a 3-year swap with company X where it pays LIBOR and re- ceives 3.00%. It enters into an offsetting swap with company Y where is receives LIBOR and pays 2.95%. Which of the following is true: C. If company X defaults, the swap with company Y continues 3 / 8
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CH7 Study online at https://quizlet.com/_5bfohg A. If company X defaults, the swap with company Y is null and void B. If company X defaults, the bank will be able to replace company X at no cost C. If company X defaults, the swap with company Y continues D. The bank's bid-offer spread is 0.5 ba- sis points The bank`s bid-offer spread is 5 basis points not 0.5 basis points. The bank has quite separate transactions with X and Y. If one defaults, it still has to honor the swap with the other. When LIBOR is used as the discount rate: A. The value of a swap is worth zero immediately after a payment date B. The value of a swap is worth zero immediately before a payment date C. The value of the floating rate bond un- derlying a swap is worth par immediately after a payment date D. The value of the floating rate bond un- derlying a swap is worth par immediately before a payment date C. The value of the floating rate bond un- derlying a swap is worth par immediately after a payment date A company enters into an interest rate swap where it is paying fixed and receiv- ing LIBOR. When interest rates increase, which of the following is true? A. The value of the swap to the company increases B. The value of the swap to the company decreases C. The value of the swap can either in- crease or decrease D. The value of the swap does not change providing the swap rate remains the same A. The value of the swap to the company increases 4 / 8
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CH7 Study online at https://quizlet.com/_5bfohg A floating for floating currency swap is equivalent to A. Two interest rate swaps, one in each currency B. A fixed-for-fixed currency swap and one interest rate swap C. A fixed-for-fixed currency swap and two interest rate swaps, one in each currency D. None of the above C. A fixed-for-fixed currency swap and two interest rate swaps, one in each cur- rency A floating-for-floating currency swap where the currency paid is X and the cur- rency received is Y is equivalent to (a) a fixed-for-fixed currency swap where, say, 5% in currency X is paid and say, say, 4% in currency Y is received, (b) a regular interest rate swap where 5% in currency X is received and floating in currency X is paid and (c) a regular interest rate swap where 4% in currency Y is paid and floating in currency Y is received. A floating-for-fixed currency swap is equivalent to A. Two interest rate swaps, one in each currency B. A fixed-for-fixed currency swap and one interest rate swap C. A fixed-for-fixed currency swap and two interest rate swaps, one in each currency D. None of the above B. A fixed-for-fixed currency swap and one interest rate swap A floating-for-fixed currency swap where the floating rate is paid in currency X and the fixed rate is received in currency Y is equivalent to (a) a fixed-for-fixed curren- cy swap where, say, 5% in currency X is paid and the fixed rate in currency Y is received, (b) a regular interest rate swap where 5% in currency X is received and floating in currency X is paid. An interest rate swap has three years of remaining life. Payments are ex- changed annually. Interest at 3% is paid and 12-month LIBOR is received. A exchange of payments has just taken place. The one-year, two-year and three- year LIBOR/swap zero rates are 2%, 3% and 4%. All rates an annually compound- ed. What is the value of the swap as a percentage of the principal when LIBOR discounting is used. B. 2.66 Suppose the principal 100. The val- ue of the floating rate bond underly- ing the swap is 100. The value of the fixed rate bond is 3/1.02+3/(1.03)2+103/ (1.04)3=97.34. The value of the swap is 5 / 8
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CH7 Study online at https://quizlet.com/_5bfohg A. 0.00 B. 2.66 C. 2.06 D. 1.06 therefore 10097.34 = 2.66 or 2.66% of the principal .A semi-annual pay interest rate swap where the fixed rate is 5.00% (with semi-annual compounding) has a re- maining life of nine months. The six- month LIBOR rate observed three months ago was 4.85% with semi-annu- al compounding. Today's three and nine month LIBOR rates are 5.3% and 5.8% (continuously compounded) respective- ly. From this it can be calculated that the forward LIBOR rate for the peri- od between three- and nine-months is 6.14% with semi-annual compounding. If the swap has a principal value of $15,000,000, what is the value of the swap to the party receiving a fixed rate of interest? A. $74,250 B. $70,760 C. $11,250 D. $103,790 B. $70,760 C. $11,250 D. $103,790 The forward rates for the floating payment at time 9 months is 6.14%. The swap can be valued assuming that the fixed payments are 2.5% of principal at 3 months and 9 months and that the floating payments are 2.425% and 3.07% of the principal at 3 months and 9 months. The value of the swap to the party receiving fixed is therefore 1,000,000(0.025-0.02425)e-0.053×0.25+1,0 = - $70,760 Which of the following describes the way a LIBOR-in-arrears swap differs from a plain vanilla interest rate swap? A. Interest is paid at the beginning of the accrual period in a LIBOR-in- arrears swap B. Interest is paid at the end of the accru- al period in a LIBOR-in-arrears swap C. No floating interest is paid until the end of the life of the swap in a LIBOR-in-ar- A. Interest is paid at the beginning of the accrual period in a LIBOR-in- arrears swap 6 / 8
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CH7 Study online at https://quizlet.com/_5bfohg rears swap, but fixed payments are made throughout the life of the swap D. Neither floating nor fixed payments are made until the end of the life of the swap In a fixed-for-fixed currency swap, 3% on a US dollar principal of $150 million is received and 4% on a British pound prin- cipal of 100 million pounds is paid. The current exchange rate is 1.55 dollar per pound. Interest rates in both countries for all maturities are currently 5% (contin- uously compounded). Payments are ex- changed every year. The swap has 2.5 years left in its life. What is the value of the swap? A. $7.15 B. $8.15 C. $9.15 D. $10.15 C. $9.15 The value of the British pound bond un- derlying the swap is in millions of pounds 4e-0.05×0.5+4e-0.05×1.5+104e-0.05×2.5 = 99.39 The value of the U.S. dollar bond is in millions of dollars 4.5e-0.05×0.5+4.5e-0.05×1.5+154.5e-0.05× = 144.91 The value of the swap is 144.91 - 99.39×1.55 = -9.15 Which of the following is a typical bid-of- fer spread on the swap rate for a plain vanilla interest rate swap? A. 3 basis points B. 8 basis points C. 13 basis points D. 18 basis points A. 3 basis points 3 basis points is a typical spread be- tween the bid and the offer on a plain vanilla interest rate swap. Which of the following describes the five-year swap rate? A. The rate on a five-year loan to a AA-rated company B. The rate on a five-year loan to an A-rated company C. The rate that can be earned over five years from a series of short-term C. The rate that can be earned over five years from a series of short-term loans to AA-rated companies 7 / 8
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CH7 Study online at https://quizlet.com/_5bfohg loans to AA-rated companies D. The rate that can be earned over five years from a series of short-term loans to A-rated companies 8 / 8
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CoboCards App FAQ & Wishes Feedback Language: English Sign up for free Login Get these flashcards, study & pass exams. For free! Even on iPhone/Android! Enter your e-mail address and import flashcard set for free. Go! All main topics / Finance & Investment / Derivatives Derivatives (239 Cards) Say thanks Tweet 1 Cardlink 0 1.A one-year forward contract is an agreement where A.One side has the right to buy an asset for a certain price in one year’s time. B.One side has the obligation to buy an asset for a certain price in one year’s time. C.One side has the obligation to buy an asset for a certain price at some time during the next year. D.One side has the obligation to buy an asset for the market price in one year’s time. Answer: B A one-year forward contract is an obligation to buy or sell in one year’s time for a predetermined price. By contrast, an option is the right to buy or sell. 2 Cardlink 1 2.Which of the following is NOT true A.When a CBOE call option on IBM is exercised, IBM issues more stock B.An American option can be exercised at any time during its life C.An call option will always be exercised at maturity if the underlying asset price is greater than the strike price D.A put option will always be exercised at maturity if the strike price is greater than the underlying asset price. Answer: A When an IBM call option is exercised the option seller must buy shares in the market to sell to the option buyer. IBM is not involved in any way. Answers B, C, and D are true. Flashcard set info: Author: CoboCards-User Main topic: Finance & Investment Topic: Derivatives Published: 27.10.2015 Card tags: All cards (239) no tags Report abuse
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3 Cardlink 0 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. The breakeven stock price above which the trader makes a profit is A.$35 B.$40 C.$30 D.$36 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. 4 Cardlink 1 4.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. The breakeven stock price below which the trader makes a profit is A.$25 B.$28 C.$26 D.$20 Answer: D When the stock price is $20 the two call options provide no payoff. The put option provides a payoff of 30−20 or $10. The total cost of the options is 2×3+ 4 or $10. The stock price in D, $20, is therefore the breakeven stock price below which the position is profitable because it is the price for which the cost of the options equals the payoff.
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5 Cardlink 0 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 ten times as big as the over- the-counter market. D.The over-the-counter market is ten times as big as the exchange-traded market. Answer: D The OTC market is about $600 trillion whereas the exchange-traded market is about $60 trillion. 6 Cardlink 0 Which of the following best describes the term “spot price” A.The price for immediate delivery B.The price for delivery at a future time C.The price of an asset that has been damaged D.The price of renting an asset Answer: A The spot price is the price for immediate delivery. The futures or forward price is the price for delivery in the future
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7 Cardlink 0 Which of the following is true about a long forward contract A.The contract becomes more valuable as the price of the asset declines B.The contract becomes more valuable as the price of the asset rises C.The contract is worth zero if the price of the asset declines after the contract has been entered into D.The contract is worth zero if the price of the asset rises after the contract has been entered into Answer: B A long forward contract is an agreement to buy the asset at a predetermined price. The contract becomes more attractive as the market price of the asset rises. The contract is only worth zero when the predetermined price in the forward contract equals the current forward price (as it usually does at the beginning of the contract). 8 Cardlink 0 An investor sells a futures contract an asset when the futures price is $1,500. Each contract is on 100 units of the asset. The contract is closed out when the futures price is $1,540. Which of the following is true A.The investor has made a gain of $4,000 B.The investor has made a loss of $4,000 C.The investor has made a gain of $2,000 D.The investor has made a loss of $2,000 Answer: B An investor who buys (has a long position) has a gain when a futures price increases. An investor who sells (has a short position) has a loss when a futures price increases. 9 Cardlink 0 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)
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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. 10 Cardlink 0 Which of the following is NOT true A.A call option gives the holder the right to buy an asset by a certain date for a certain price B.A put option gives the holder the right to sell an asset by a certain date for a certain price C.The holder of a call or put option must exercise the right to sell or buy an asset D.The holder of a forward contract is obligated to buy or sell an asset Answer: C The holder of a call or put option has the right to exercise the option but is not required to do so. A, B, and C are correct 11 Cardlink 0 Which of the following is NOT true about call and put options: A.An American option can be exercised at any time during its life B. A European option can only be exercised only on the maturity date C.Investors must pay an upfront price (the option premium) for an option contract D.The price of a call option increases as the strike price increases Answer: D A call option is the option to buy for the strike price. As the strike price increases this option becomes less attractive and is therefore less valuable. A, B, and C are true.
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12 Cardlink 0 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 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. 13 Cardlink 0 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 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.
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14 Cardlink 0 The price of a stock on February 1 is $84. A trader buys 200 put options on the stock with a strike price of $90 when the option price is $10. The options are exercised when the stock price is $85. The trader’s net profit or loss is A.Loss of $1,000 B.Loss of $2,000 C.Gain of $200 D.Gain of $1000 Answer: A The payoff is 90−85 or $5 per option. For 200 options the payoff is therefore 5×200 or $1000. However the options cost 10×200 or $2000. There is therefore a net loss of $1000. 15 Cardlink 0 The price of a stock on February 1 is $48. A trader sells 200 put options on the stock with a strike price of $40 when the option price is $2. The options are exercised when the stock price is $39. The trader’s net profit or loss is A. Loss of $800 B.Loss of $200 C. Gain of $200 D.Loss of $900 Answer: C The payoff is 40−39 or $1 per option. For 200 options the payoff is therefore 1×200 or $200. However the premium received by the trader is 2×200 or $400. The trader therefore has a net gain of $200.
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16 Cardlink 1 16.A speculator can choose between buying 100 shares of a stock for $40 per share and buying 1000 European call options on the stock with a strike price of $45 for $4 per option. For second alternative to give a better outcome at the option maturity, the stock price must be above A.$45 B.$46 C.$55 D.$50 Answer: D When the stock price is $50 the first alternative leads to a position in the stock worth 100×50 or $5000. The second alternative leads to a payoff from the options of 1000×(50−45) or $5000. Both alternatives cost $4000. It follows that the alternatives are equally profitable when the stock price is $50. For stock prices above $50 the option alternative is more profitable. 17 Cardlink 1 A company knows it will have to pay a certain amount of a foreign currency to one of its suppliers in the future. Which of the following is true A.A forward contract can be used to lock in the exchange rate B.A forward contract will always give a better outcome than an option C.An option will always give a better outcome than a forward contract D.An option can be used to lock in the exchange rate Answer: A A forward contract ensures that the effective exchange rate will equal the current forward exchange rate. An option provides insurance that the exchange rate will not be worse than a certain level, but requires an upfront premium. Options sometimes give a better outcome and sometimes give a worse outcome than forwards. 18 Cardlink 0 A short forward contract on an asset plus a long position in a European call option on the asset with a strike price equal to the forward price is equivalent to A. A short position in a call option
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B.A short position in a put option C. A long position in a put option D.None of the above Answer: C Suppose that ST is the final asset price and K is the strike price/forward price. A short forward contract leads to a payoff of K−ST. A long position in a European call option leads to a payoff of max(ST−K, 0). When added together we see that the total position leads to a payoff of max(0, K−ST), which is the payoff from a long position in a put option. C can also be seen to be true by plotting the payoffs as a function of the final stock price. 19 Cardlink 0 A trader has a portfolio worth $5 million that mirrors the performance of a stock index. The stock index is currently 1,250. Futures contracts trade on the index with one contract being on 250 times the index. To remove market risk from the portfolio the trader should A. Buy 16 contracts B.Sell 16 contracts C.Buy 20 contracts D.Sell 20 contracts Answer: B One futures contract protects a portfolio worth 1250×250. The number of contract required is therefore 5,000,000/(1250×250)=16. To remove market risk we need to gain on the contracts when the market declines. A short futures position is therefore required. 20 Cardlink 0 Which of the following best describes a central clearing party A.It is a trader that works for an exchange B.It stands between two parties in the over-the-counter market C.It is a trader that works for a bank D.It helps facilitate futures trades Answer: B A central clearing party (CCP) is a clearing house that stands between two parties in the over-the-counter market. It serves the same purpose as an exchange clearing house.
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21 Cardlink 0 Which of the following is true A.Both forward and futures contracts are traded on exchanges. B. Forward contracts are traded on exchanges, but futures contracts are not. C.Futures contracts are traded on exchanges, but forward contracts are not. D.Neither futures contracts nor forward contracts are traded on exchanges. Answer: C Futures contracts trade only on exchanges. Forward contracts trade only in the over-the-counter market. 22 Cardlink 0 Which of the following is NOT true A.Futures contracts nearly always last longer than forward contracts B.Futures contracts are standardized; forward contracts are not. C.Delivery or final cash settlement usually takes place with forward contracts; the same is not true of futures contracts. D.Forward contracts usually have one specified delivery date; futures contract often have a range of delivery dates. Answer: A Forward contracts often last longer than futures contracts. B, C, and D are true
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23 Cardlink 0 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 increase the futures price. B.This flexibility tends 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 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. 24 Cardlink 1 A company enters into a short futures contract to sell 50,000 units of a commodity for 70 cents per unit. The initial margin is $4,000 and the maintenance margin is $3,000. What is the futures price per unit above which there will be a margin call? A.78 cents B.76 cents C.74 cents D.72 cents Answer: D There will be a margin call when more than $1000 has been lost from the margin account so that the balance in the account is below the maintenance margin level. Because the company is short, each one cent rise in the price leads to a loss or 0.01×50,000 or $500. A greater than 2 cent rise in the futures price will therefore lead to a margin call. The future price is currently 70 cents. When the price rises above 72 cents there will be a margin call.
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25 Cardlink 0 A company enters into a long futures contract to buy 1,000 units of a commodity for $60 per unit. The initial margin is $6,000 and the maintenance margin is $4,000. What futures price will allow $2,000 to be withdrawn from the margin account? A. $58 B. $62 C. $64 D. $66 Answer: B Amounts in the margin account in excess of the initial margin can be withdrawn. Each $1 increase in the futures price leads to a gain of $1000. When the futures price increases by $2 the gain will be $2000 and this can be withdrawn. The futures price is currently $60. The answer is therefore $62. 26 Cardlink 0 One futures contract is traded where both the long and short parties are closing out existing positions. What is the resultant change in the open interest? A. No change B.Decrease by one C.Decrease by two D.Increase by one Answer: B The open interest goes down by one. There is one less long position and one less short position. 27 Cardlink 0 Who initiates delivery in a corn futures contract A.The party with the long position B.The party with the short position C.Either party
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D.The exchange 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. 28 Cardlink 0 You sell one December futures contracts when the futures price is $1,010 per unit. Each contract is on 100 units and the initial margin per contract that you provide is $2,000. The maintenance margin per contract is $1,500. During the next day the futures price rises to $1,012 per unit. What is the balance of your margin account at the end of the day? A.$1,800 B.$3,300 C.$2,200 D.$3,700 Answer: B The price has increased by $2. Because you have a short position you lose 2×100 or $200. The balance in the margin account therefore goes down from $3,500 to $3,300. 29 Cardlink 0 A hedger takes a long position in a futures contract on a commodity on November 1, 2012 to hedge an exposure on March 1, 2013. The initial futures price is $60. On December 31, 2012 the futures price is $61. On March 1, 2013 it is $64. The contract is closed out on March 1, 2013. What gain is recognized in the accounting year January 1 to December 31, 2013? Each contract is on 1000 units of the commodity. A. $0 B.$1,000 C.$3,000 D.$4,000
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Answer: D Hedge accounting is used. The whole of the gain or loss on the futures is therefore recognized in 2013. None is recognized in 2012. In this case the gain is $4 per unit or $4,000 in total. 30 Cardlink 0 A speculator takes a long position in a futures contract on a commodity on November 1, 2012 to hedge an exposure on March 1, 2013. The initial futures price is $60. On December 31, 2012 the futures price is $61. On March 1, 2013 it is $64. The contract is closed out on March 1, 2013. What gain is recognized in the accounting year January 1 to December 31, 2013? Each contract is on 1000 units of the commodity. A. $0 B. $1,000 C.$3,000 D.$4,000 Answer: C In this case there is no hedge accounting. Gains or losses are accounted for as they are accrued. The price per unit increases by $3 in 2013. The total gain in 2013 is therefore $3,000. 31 Cardlink 0 The frequency with which futures margin accounts are adjusted for gains and losses is A.Daily B.Weekly C.Monthly D.Quarterly Answer: A In futures contracts margin accounts are adjusted for gains or losses daily.
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32 Cardlink 0 Margin accounts have the effect of A.Reducing the risk of one party regretting the deal and backing out B. Ensuring funds are available to pay traders when they make a profit C.Reducing systemic risk due to collapse of futures markets D.All of the above Answer: D Initial margin requirements dramatically reduce the risk that a party will walk away from a futures contract. As a result they reduce the risk that the exchange clearing house will not have enough funds to pays profits to traders. Furthermore, if traders are less likely to suffer losses because of counterparty defaults there is less systemic risk. 33 Cardlink 0 Which entity in the United States takes primary responsibility for regulating futures market? A.Federal Reserve Board B.Commodities Futures Trading Commission (CFTC) C.Security and Exchange Commission (SEC) D.US Treasury Answer: B The CFTC has primary responsibility for regulating futures markets
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34 Cardlink 0 For a futures contract trading in April 2012, the open interest for a June 2012 contract, when compared to the open interest for Sept 2012 contracts, is usually A.Higher B.Lower C.The same D.Equally likely to be higher or lower 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. 35 Cardlink 0 15.Clearing houses are A.Never used in futures markets and sometimes used in OTC markets B.Used in OTC markets, but not in futures markets C.Always used in futures markets and sometimes used in OTC markets D.Always used in both futures markets and OTC markets Answer: C Clearing houses are always used by exchanges trading futures. Increasingly, OTC products are cleared through CCPs, which are a type of clearing house. 36 Cardlink 2 A haircut of 20% means that A.A bond with a market value of $100 is considered to be worth $80 when used to satisfy a collateral request
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B. A bond with a face value of $100 is considered to be worth $80 when used to satisfy a collateral request C.A bond with a market value of $100 is considered to be worth $83.3 when used to satisfy a collateral request D.A bond with a face value of $100 is considered to be worth $83.3 when used to satisfy a collateral request Answer: A A haircut is the amount the market price of asset is reduced by for the purposes of determining its value for collateral purposes. A is therefore correct. 37 Cardlink 0 With bilateral clearing, the number of agreements between four dealers, who trade with each other, is A.12 B.1 C.6 D.2 Answer: C Suppose the dealers are W, X, Y , and Z. The agreements are between W and X, W and Y, W and Z, X and Y, X and Z, and Y and Z. There are therefore a total of 6 agreements. 38 Cardlink 0 Which of the following best describes central clearing parties A.Help market participants to value derivative transactions B.Must be used for all OTC derivative transactions C.Are used for futures transactions D.Perform a similar function to exchange clearing houses Answer: D CCPs do for the OTC market what exchange clearing houses do for the exchange-traded market. The correct answer is therefore D.
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CCPs must be used for most standard OTC derivatives transactions, but not for all derivatives transactions. 39 Cardlink 0 Which of the following are cash settled A.All futures contracts B.All option contracts C.Futures on commodities D.Futures on stock indices Answer: D Futures on stock indices are usually cash settled. The rest are settled by delivery of the underlying assets 40 Cardlink 0 A limit order A.Is an order to trade up to a certain number of futures contracts at a certain price B. Is an order that can be executed at a specified price or one more favorable to the investor C.Is an order that must be executed within a specified period of time D.None of the above Answer: B In a limit order a trader specifies the worst price (from the trader’s perspective) at which the trade can be carried out.
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41 Cardlink 0 The compounding frequency for an interest rate defines A.The frequency with which interest is paid B. A unit of measurement for the interest rate C.The relationship between the annual interest rate and the monthly interest rate D.None of the above Answer: B The compounding frequency is a unit of measurement. The frequency with which interest is paid may be different from the compounding frequency used for quoting the rate. 42 Cardlink 0 An interest rate is 6% per annum with annual compounding. What is the equivalent rate with continuous compounding? A.5.79% B.6.21% C.5.83% D.6.18% Answer: C The equivalent rate with continuous compounding is ln(1.06) = 0.0583 or 5.83%. Rc= mln(1+ Rm/m) 43 Cardlink 3 An interest rate is 5% per annum with continuous compounding. What is the equivalent rate with semiannual compounding? A.5.06% B.5.03%
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C.4.97% D.4.94% Answer: A The equivalent rate with semiannual compounding is 2×(e0.05/2−1) = 0.0506 or 5.06%. m(eRc/m -1) =Rm 44 Cardlink 0 An interest rate is 12% per annum with semiannual compounding. What is the equivalent rate with quarterly compounding? A. 11.83% B.11.66% C.11.77% D.11.92% Answer: A The equivalent rate per quarter is 1.06^0.5 -1=2.956% . The annualized rate with quarterly compounding is four times this or 11.83%. 45 Cardlink 0 The two-year zero rate is 6% and the three year zero rate is 6.5%. What is the forward rate for the third year? All rates are continuously compounded. A.6.75% B.7.0% C.7.25% D.7.5% Answer: D The forward rate for the third year is (3×0.065−2×0.06)/(3−2) = 0.075 or 7.5%
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46 Cardlink 1 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% Answer: C If the rate is R we must have 97= 3/1.04+103e^-R*1 or e^-R= (97-3/1.04)/103 =0.9137 so that R = ln(1/0.9137) = 0.0902 or 9.02%. 47 Cardlink 0 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 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/(1.035) = $8.63
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48 Cardlink 0 Under liquidity preference theory, which of the following is always true? A.The forward rate is higher than the spot rate when both have the same maturity. B.Forward rates are unbiased predictors of expected future spot rates. C.The spot rate for a certain maturity is higher than the par yield for that maturity. D.Forward rates are higher than expected future spot rates. Answer: D Liquidity preference theory argues that individuals like their borrowings to have a long maturity and their deposits to have a short maturity. To induce people to lend for long periods forward rates are raised relative to what expected future short rates would predict. 49 Cardlink 0 The zero curve is upward sloping. Define X as the 1-year par yield, Y as the 1-year zero rate and Z as the forward rate for the period between 1 and 1.5 year. Which of the following is true? A.X is less than Y which is less than Z B.Y is less than X which is less than Z C.X is less than Z which is less than Y D.Z is less than Y which is less than X E.X is less than Y which is less than Z F.Y is less than X which is less than Z G.X is less than Z which is less than Y H.Z is less than Y which is less than X Answer: A When the zero curve is upward sloping, the one-year zero rate is higher than the one-year par yield and the forward rate corresponding to the period between 1.0 and 1.5 years is higher than the one-year zero rate. The correct answer is therefore A.
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50 Cardlink 0 10.Which of the following is true of the fed funds rate A.It is the same as the Treasury rate B.It is an overnight interbank rate C.It is a rate for which collateral is posted D.It is a type of repo rate Answer: B At the end of each day some banks have surplus reserves on deposit with the Federal Reserve others have deficits. They use overnight borrowing and lending at what is termed the fed funds rate to rectify this. 51 Cardlink 0 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 C.Increase of $25,000 D.Decrease of $25,000 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. 52 Cardlink 0 A company invests $1,000 in a five-year zero-coupon bond and $4,000 in a ten-year zero-coupon bond. What is the duration of the portfolio? A. 6 years B. 7 years
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C. 8 years D. 9 years Answer: D The duration of the first bond is 5 years and the duration of the second bond is 10 years. The duration of the portfolio is a weighted average with weights corresponding to the amounts invested in the bonds. It is 0.2×5+0.8×10=9 years. 53 Cardlink 0 Which of the following is true of LIBOR A.The LIBOR rate is free of credit risk B.A LIBOR rate is lower than the Treasury rate when the two have the same maturity C.It is a rate used when borrowing and lending takes place between banks D.It is subject to favorable tax treatment in the U.S. Answer: C LIBOR is a rate used for interbank transactions. 54 Cardlink 0 Which of following describes forward rates? A.Interest rates implied by current zero rates for future periods of time B.Interest rate earned on an investment that starts today and last for n-years in the future without coupons C.The coupon rate that causes a bond price to equal its par (or principal) value D.A single discount rate that gives the value of a bond equal to its market price when applied to all cash flows Answer: A
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The forward rate is the interest rate implied by the current term structure for future periods of time. For example, earning the zero rate for one year and the forward rate for the period between one and two years gives the same result as earning the zero rate for two years. 55 Cardlink 0 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 Answer: C Maturity preference theory is not a theory of the term structure. The other three are. 56 Cardlink 0 A repo rate is A.An uncollateralized rate B.A rate where the credit risk is relative high C.The rate implicit in a transaction where securities are sold and bought back later at a higher price D.None of the above Answer: C A repo transaction is one where a company agrees to sell securities today and buy them back at a future time. It is a form of collateralized borrowing. The credit risk is very low.
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57 Cardlink 0 Bootstrapping involves A.Calculating the yield on a bond B.Working from short maturity instruments to longer maturity instruments determining zero rates at each step C.Working from long maturity instruments to shorter maturity instruments determining zero rates at each step D.The calculation of par yields Answer: B Bootstrapping is a way of constructing the zero coupon yield curve from coupon-bearing bonds. It involves working from the shortest maturity bond to progressively longer maturity bonds making sure that the calculated zero coupon yield curve is consistent with the market prices of the instruments. 58 Cardlink 0 The zero curve is downward sloping. Define X as the 1-year par yield, Y as the 1-year zero rate and Z as the forward rate for the period between 1 and 1.5 year. Which of the following is true? A.X is less than Y which is less than Z B.Y is less than X which is less than Z C.X is less than Z which is less than Y D.Z is less than Y which is less than X Answer: D The forward rate accentuates trends in the zero curve. The par yield shows the same trends but in a less pronounced way. 59 Cardlink 0 Which of the following is true? A.When interest rates in the economy increase, all bond prices
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increase B. As its coupon increases, a bond’s price decreases C.Longer maturity bonds are always worth more that shorter maturity bonds when the coupon rates are the same D.None of the above Answer: D When interest rates increase the impact of discounting is to make future cash flows worth less. Bond prices therefore decline. A is therefore wrong. As coupons increase a bond becomes more valuable because higher cash flows will be received. B is therefore wrong. When the coupon is higher than prevailing interest rates, longer maturity bonds are worth more than shorter maturity bonds. When it is less than prevailing interest rates, longer maturity bonds are worth less than shorter maturity bonds. C is therefore not true. The correct answer is therefore D. 60 Cardlink 0 The six month and one-year rates are 3% and 4% per annum with semiannual compounding. Which of the following is closest to the one-year par yield expressed with semiannual compounding? A.3.99% B.3.98% C.3.97% D.3.96% Answer: A The six month rate is 1.5% per six months. The one year rate is 2% per six months. The one year par yield is the coupon that leads to a bond being worth par. A is the correct answer because (3.99/2)/1.015+(100+3.99/2)/1.022 = 100. The formula in the text can also be used to give the par yield as [(100- 100/1.022)×2]/(1/1.015+1.022)=3.99. 61 Cardlink 0 Which of the following is a consumption asset? A.The S&P 500 index B.The Canadian dollar C.Copper D.IBM stock Answer: C
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A, B, and D are investment assets (held by at least some investors purely for investment purposes). C is a consumption asset. 62 Cardlink 0 An investor shorts 100 shares when the share price is $50 and closes out the position six months later when the share price is $43. The shares pay a dividend of $3 per share during the six months. How much does the investor gain? A. $1,000 B. $400 C. $700 D. $300 Answer: B The investor gains $7 per share because he or she sells at $50 and buys at $43. However, the investor has to pay the $3 per share dividend. The net profit is therefore 7−3 or $4 per share. 100 shares are involved. The total gain is therefore $400. 63 Cardlink 0 The spot price of an investment asset that provides no income is $30 and the risk-free rate for all maturities (with continuous compounding) is 10%. What is the three-year forward price? A. $40.50 B. $22.22 C. $33.00 D.$33.16 Answer: A The 3-year forward price is the spot price grossed up for 3 years at the risk-free rate. It is 30e0.1×3 =$40.50.
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64 Cardlink 0 The spot price of an investment asset is $30 and the risk-free rate for all maturities is 10% with continuous compounding. The asset provides an income of $2 at the end of the first year and at the end of the second year. What is the three-year forward price? A. $19.67 B. $35.84 C. $45.15 D. $40.50 Answer: B The present value of the income is 2e-0.1×1+2e-0.1×2= $3.447. The three year forward price is obtained by subtracting the present value of the income from the current stock price and then grossing up the result for three years at the risk-free rate. It is (30−3.447)e0.1×3 = $35.84. 65 Cardlink 0 An exchange rate is 0.7000 and the six-month domestic and foreign risk-free interest rates are 5% and 7% (both expressed with continuous compounding). What is the six-month forward rate? A. 0.7070 B.0.7177 C.0.7249 D.0.6930
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Answer: D The six-month forward rate is 0.7000e−(0.05−0.07)×0.5=0.6930. 66 Cardlink 0 Which of the following is true? A.The convenience yield is always positive or zero. B.The convenience yield is always positive for an investment asset. C.The convenience yield is always negative for a consumption asset. D.The convenience yield measures the average return earned by holding futures contracts. Answer: A The convenience yield measures the benefit of owning an asset rather than having a forward/futures contract on an asset. For an investment asset it is always zero. For a consumption asset it is greater than or equal to zero. 67 Cardlink 0 A short forward contract that was negotiated some time ago will expire in three months and has a delivery price of $40. The current forward price for three-month forward contract is $42. The three month risk-free interest rate (with continuous compounding) is 8%. What is the value of the short forward contract? A. +$2.00 B. −$2.00 C. +$1.96 D. −$1.96 Answer: D The contract gives one the obligation to sell for $40 when a forward price negotiated today would give one the obligation to sell for $42.
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The value of the contract is the present value of −$2 or −2e- 0.08×0.25 = −$1.96. 68 Cardlink 0 The spot price of an asset is positively correlated with the market. Which of the following would you expect to be true? A.The forward price equals the expected future spot price. B.The forward price is greater than the expected future spot price. C.The forward price is less than the expected future spot price. D.The forward price is sometimes greater and sometimes less than the expected future spot price. Answer: C When the spot price is positively correlated with the market the forward price is less than the expected future spot price. This is because the spot price is expected to provide a return greater than the risk-free rate and the forward price is the spot price grossed up at the risk-free rate. 69 Cardlink 0 Which of the following describes the way the futures price of a foreign currency is quoted by the CME group? A.The number of U.S. dollars per unit of the foreign currency B.The number of the foreign currency per U.S. dollar C.Some futures prices are always quoted as the number of U.S. dollars per unit of the foreign currency and some are always quoted the other way round D.There are no quotation conventions for futures prices Answer: A The futures price is quoted as the number of US dollars per unit of the foreign currency. Spot exchange rates and forward exchange rates are sometimes quoted this way and sometimes quoted the other way round.
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70 Cardlink 0 Which of the following describes the way the forward price of a foreign currency is quoted? A.The number of U.S. dollars per unit of the foreign currency B.The number of the foreign currency per U.S. dollar C.Some forward prices are quoted as the number of U.S. dollars per unit of the foreign currency and some are quoted the other way round D.There are no quotation conventions for forward prices Answer: C The futures price is quoted as the number of US dollars per unit of the foreign currency. Spot exchange rates and forward exchange rates are sometimes quoted this way and sometimes quoted the other way round. 71 Cardlink 0 Which of the following is NOT a reason why a short position in a stock is closed out? A.The investor with the short position chooses to close out the position B.The lender of the shares issues instructions to close out the position C.The broker is no longer able to borrow shares from other clients D.The investor does not maintain margins required on his/her margin account Answer: B A, C, and D are all reasons why the short position might be closed out. B is not. The lender of shares cannot issue instructions to close out the short position.
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72 Cardlink 0 Which of the following is NOT true? A.Gold and silver are investment assets B.Investment assets are held by significant numbers of investors for investment purposes C.Investment assets are never held for consumption D.The forward price of an investment asset can be obtained from the spot price, interest rates, and the income paid on the asset Answer: C Investment assets are sometimes held for consumption. Silver is an example. To be an investment asset, an asset has to be held for investment by at least some traders 73 Cardlink 0 What should a trader do when the one-year forward price of an asset is too low? Assume that the asset provides no income. A.The trader should borrow the price of the asset, buy one unit of the asset and enter into a short forward contract to sell the asset in one year. B.The trader should borrow the price of the asset, buy one unit of the asset and enter into a long forward contract to buy the asset in one year. C.The trader should short the asset, invest the proceeds of the short sale at the risk-free rate, enter into a short forward contract to sell the asset in one year D.The trader should short the asset, invest the proceeds of the short sale at the risk-free rate, enter into a long forward contract to buy the asset in one year
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Answer: D If the forward price is too low relative to the spot price the trader should short the asset in the spot market and buy it in the forward market. 74 Cardlink 0 Which of the following is NOT true about forward and futures contracts? A.Forward contracts are more liquid than futures contracts B.The futures contracts are traded on exchanges while forward contracts are traded in the over-the-counter market C.In theory forward prices and futures prices are equal when there is no uncertainty about future interest rates D.Taxes and transaction costs can lead to forward and futures prices being different Answer: A Futures contracts are more liquid than forward contracts. To unwind a futures position it is simply necessary to take an offsetting position. The statements in B, C, and D are correct 75 Cardlink 0 As the convenience yield increases, which of the following is true? A.The one-year futures price as a percentage of the spot price increases B.The one-year futures price as a percentage of the spot price decreases C.The one-year futures price as a percentage of the spot price stays the same D.Any of the above can happen Answer: B As the convenience yield increases, the futures price declines relative to the spot price. This is because the convenience of owning the asset (as opposed to having a futures contract) becomes more important.
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76 Cardlink 0 As inventories of a commodity decline, which of the following is true? A.The one-year futures price as a percentage of the spot price increases B.The one-year futures price as a percentage of the spot price decreases C.The one-year futures price as a percentage of the spot price stays the same D.Any of the above can happen Answer: B When inventories decline, the convenience yield increases and the futures price as a percentage of the spot price declines. 77 Cardlink 0 Which of the following describes a known dividend yield on a stock? A.The size of the dividend payments each year is known B.Dividends per year as a percentage of today’s stock price are known C.Dividends per year as a percentage of the stock price at the time when dividends are paid are known D.Dividends will yield a certain return to a person buying the stock today Answer: C The dividend yield is the dividend per year as a percent of the stock price at the time when the dividend is paid.
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78 Cardlink 0 Which of the following is an argument used by Keynes and Hicks? A.If hedgers hold long positions and speculators holds short positions, the futures price will tend to be higher than the expected future spot price B.If hedgers hold long positions and speculators holds short positions, the futures price will tend to be lower than the expected future spot price C.If hedgers hold long positions and speculators holds short positions, the futures price will tend to be lower than today’s spot price D.If hedgers hold long positions and speculators holds short positions, the futures price will tend to be higher than today’s spot price Answer: A Keynes and Hicks argued that hedgers will be prepared to accept negative returns on average because of the benefits of hedging whereas speculators require positive returns on average. This leads to A. 79 Cardlink 0 19.Which of the following describes contango? A.The futures price is below the expected future spot price B.The futures price is below today’s spot price C.The futures price is a declining function of the time to maturity D.The futures price is above the expected future spot price Answer: D Contango is defined as the futures price being above the expected future spot price. It is also sometimes used to describe the situation where the futures price is above the spot price.
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80 Cardlink 0 Which of the following is true for a consumption commodity? A.There is no limit to how high or low the futures price can be, except that the futures price cannot be negative B.There is a lower limit to the futures price but no upper limit C.There is an upper limit to the futures price but no lower limit, except that the futures price cannot be negative D.The futures price can be determined with reasonable accuracy from the spot price and interest rates Answer: C If the futures price of a consumption commodity becomes too high an arbitrageur will buy the commodity and sell futures to lock in a profit. An arbitrageur cannot follow the opposite strategy of buying futures and selling or shorting the asset when the futures price is low. This is because consumption assets cannot be shorted . Furthermore, people who hold the asset in general do so because they need the asset for their business. They are not prepared to swap their position in the asset for a similar position in a futures. Consequently, there is an upper limit but no lower limit to the futures price. 81 Cardlink 0 A company can invest funds for five years at LIBOR minus 30 basis points. The five-year swap rate is 3%. What fixed rate of interest can the company earn by using the swap? A.2.4% B.2.7% C.3.0% D.3.3% Answer: B When the company invests at LIBOR minus 0.3% and then enters into a swap where it pays LIBOR and receives 3% it earns 2.7% per annum. Note that it is the bid rate that will apply to the swap.
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82 Cardlink 1 Which of the following is true? A.Principals are not usually exchanged in a currency swap B.The principal amounts usually flow in the opposite direction to interest payments at the beginning of a currency swap and in the same direction as interest payments at the end of the swap. C.The principal amounts usually flow in the same direction as interest payments at the beginning of a currency swap and in the opposite direction to interest payments at the end of the swap. D.Principals are not usually specified in a currency swap Answer: B The correct answer is B. There are two principals in a currency swap, one for each currency. They flow in the opposite direction to the corresponding interest payments at the beginning of the life of the swap and in the same direction as the corresponding interest payments at the end of the life of the swap. 83 Cardlink 0 Company X and Company Y have been offered the following rates Fixed Rate Floating Rate Company X3.5% 3-month LIBOR plus 10bp Company Y4.5% 3-month LIBOR plus 30 bp Suppose that Company X borrows fixed and company Y borrows floating. If they enter into a swap with each other where the apparent benefits are shared equally, what is company X’s effective borrowing rate? A.3-month LIBOR−30bp B.3.1% C.3-month LIBOR−10bp D.3.3% Answer: A The interest rate differential between the fixed rates is 100 basis points. The interest rate differential between the floating rates is 20 basis points. The difference between the interest rates differentials is 100 – 20 = 80 basis points. This is the total apparent gain from the swap to the two sides. Since the benefits are shared equally company X should be able to borrow at 40 bp less than it is currently offered in the floating rate market, i.e., at LIBOR minus 30 bp.
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84 Cardlink 0 Which of the following describes the five-year swap rate? A.The fixed rate of interest which a swap market maker is prepared to pay in exchange for LIBOR on a 5-year swap B.The fixed rate of interest which a swap market maker is prepared to receive in exchange for LIBOR on a 5-year swap C.The average of A and B D.The higher of A and B Answer: C The swap rate is the average of the bid swap rate (i.e. A) and the offer swap rate (i.e. B) 85 Cardlink 0 Which of the following is a use of a currency swap? A.To exchange an investment in one currency for an investment in another currency B.To exchange borrowing in one currency for borrowings in another currency C.To take advantage situations where the tax rates in two countries are different D.All of the above Answer: D A currency swap can be used for any of A, B, and C. 86 Cardlink 0 The reference entity in a credit default swap is A.The buyer of protection B.The seller of protection C.The company or country whose default is being insured
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against D.None of the above Answer: C In a credit default swap the buyer of protection pays a CDS spread to the seller of protection and the protection seller has to make a payoff if there is a default by the reference entity. 87 Cardlink 0 Which of the following describes an interest rate swap? A.The exchange of a fixed rate bond for a floating rate bond B.A portfolio of forward rate agreements C.An agreement to exchange interest at a fixed rate for interest at a floating rate D.All of the above Answer: D The answer is D because all of A, B, and C are true for an interest rate swap. 88 Cardlink 0 Which of the following is true for an interest rate swap? A.A swap is usually worth close to zero when it is first negotiated B. Each forward rate agreement underlying a swap is worth close to zero when the swap is first entered into C.Comparative advantage is a valid reason for entering into the swap D.None of the above Answer: A A swap is worth close to zero at the beginning of its life. (It may not be worth exactly zero because of the impact of the market maker’s bid-offer spread.) It is not true that each of the forward contracts underlying the swap are worth zero. (The sum of the value of the
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forward contracts is zero, but this does not mean that each one is worth zero.) The remaining floating payments on a swap are worth the notional principal immediately after a swap payment date, but this is not necessarily true for the remaining fixed payments. 89 Cardlink 0 Which of the following is true for the party paying fixed in a newly negotiated interest rate swap when the yield curve is upward sloping? A.The early forward contracts underlying the swap have a positive value and the later ones have a negative value B.The early forward contracts underlying the swap have a negative value and the later ones have a positive value C.The swap is designed so that all forward rates have zero value D.Sometimes A is true and sometimes B is true Answer: B The forward contracts are contracts where fixed is paid and floating is received. They can be valued assuming that forward rates are realized. Forward rates increase with maturity. This means that the value of the forward contracts increase with maturity. The total value of the forward contracts is zero. This means that the value of the early contracts is negative and the value of the later contracts is positive. 90 Cardlink 0 A bank enters into a 3-year swap with company X where it pays LIBOR and receives 3.00%. It enters into an offsetting swap with company Y where is receives LIBOR and pays 2.95%. Which of the following is true: A.If company X defaults, the swap with company Y is null and void B.If company X defaults, the bank will be able to replace company X at no cost C.If company X defaults, the swap with company Y continues D.The bank’s bid-offer spread is 0.5 basis points Answer: C The bank`s bid-offer spread is 5 basis points not 0.5 basis points. The bank has quite separate transactions with X and Y. If one defaults, it still has to honor the swap with the other.
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91 Cardlink 0 When LIBOR is used as the discount rate: A.The value of a swap is worth zero immediately after a payment date B. The value of a swap is worth zero immediately before a payment date C.The value of the floating rate bond underlying a swap is worth par immediately after a payment date D.The value of the floating rate bond underlying a swap is worth par immediately before a payment date Answer: C The value of the floating rate bond underlying an interest rate swap is worth par immediately after a swap payment date. This result is used when the swap is valued as the difference between two bonds. 92 Cardlink 0 A company enters into an interest rate swap where it is paying fixed and receiving LIBOR. When interest rates increase, which of the following is true? A.The value of the swap to the company increases B.The value of the swap to the company decreases C.The value of the swap can either increase or decrease D.The value of the swap does not change providing the swap rate remains the same Answer: A It is receiving the floating rate. When interest rates increase the floating rate can be expected to be higher and so the swap becomes more valuable. The answer is therefore A.
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93 Cardlink 0 A floating for floating currency swap is equivalent to A.Two interest rate swaps, one in each currency B.A fixed-for-fixed currency swap and one interest rate swap C.A fixed-for-fixed currency swap and two interest rate swaps, one in each currency D.None of the above Answer: C A floating-for-floating currency swap where the currency paid is X and the currency received is Y is equivalent to (a) a fixed-for-fixed currency swap where, say, 5% in currency X is paid and say, say, 4% in currency Y is received, (b) a regular interest rate swap where 5% in currency X is received and floating in currency X is paid and (c) a regular interest rate swap where 4% in currency Y is paid and floating in currency Y is received. 94 Cardlink 3 A floating-for-fixed currency swap is equivalent to A.Two interest rate swaps, one in each currency B.A fixed-for-fixed currency swap and one interest rate swap C.A fixed-for-fixed currency swap and two interest rate swaps, one in each currency D.None of the above Answer: B A floating-for-fixed currency swap where the floating rate is paid in currency X and the fixed rate is received in currency Y is equivalent to (a) a fixed-for-fixed currency swap where, say, 5% in currency X is paid and the fixed rate in currency Y is received, (b) a regular interest rate swap where 5% in currency X is received and floating in currency X is paid. 95 Cardlink 0 An interest rate swap has three years of remaining life. Payments are exchanged annually. Interest at 3% is paid and 12-month LIBOR is received. A exchange of payments has just taken place. The one-year, two-year and three-year LIBOR/swap zero rates are 2%, 3% and 4%. All rates an annually
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compounded. What is the value of the swap as a percentage of the principal when LIBOR discounting is used. A. 0.00 B.2.66 C. 2.06 D.1.06 Answer: B Suppose the principal 100. The value of the floating rate bond underlying the swap is 100. The value of the fixed rate bond is 3/1.02+3/(1.03)2+103/(1.04)3=97.34. The value of the swap is therefore 100−97.34 = 2.66 or 2.66% of the principal 96 Cardlink 0 A semi-annual pay interest rate swap where the fixed rate is 5.00% (with semi-annual compounding) has a remaining life of nine months. The six-month LIBOR rate observed three months ago was 4.85% with semi-annual compounding. Today’s three and nine month LIBOR rates are 5.3% and 5.8% (continuously compounded) respectively. From this it can be calculated that the forward LIBOR rate for the period between three- and nine-months is 6.14% with semi-annual compounding. If the swap has a principal value of $15,000,000, what is the value of the swap to the party receiving a fixed rate of interest? A.$74,250 B.−$70,760 C.−$11,250 D.$103,790 Answer: B The forward rates for the floating payment at time 9 months is 6.14%. The swap can be valued assuming that the fixed payments are 2.5% of principal at 3 months and 9 months and that the floating payments are 2.425% and 3.07% of the principal at 3 months and 9 months. The value of the swap to the party receiving fixed is therefore 1,000,000(0.025-0.02425)e-0.053×0.25+1,000,000(0.025-0.0307)e- 0.058×0.75 = –$70,760 97 Cardlink 0 Which of the following describes the way a LIBOR-in-arrears swap differs from a plain vanilla interest rate swap?
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A.Interest is paid at the beginning of the accrual period in a LIBOR-in-arrears swap B.Interest is paid at the end of the accrual period in a LIBOR-in- arrears swap C.No floating interest is paid until the end of the life of the swap in a LIBOR-in-arrears swap, but fixed payments are made throughout the life of the swap D.Neither floating nor fixed payments are made until the end of the life of the swap Answer: A In a LIBOR-in-arrears swap interest is observed for an accrual period and paid at the beginning of that accrual period (not at the end of the accrual period which is normal) 98 Cardlink 2 In a fixed-for-fixed currency swap, 3% on a US dollar principal of $150 million is received and 4% on a British pound principal of 100 million pounds is paid. The current exchange rate is 1.55 dollar per pound. Interest rates in both countries for all maturities are currently 5% (continuously compounded). Payments are exchanged every year. The swap has 2.5 years left in its life. What is the value of the swap? A. −$7.15 B.−$8.15 C.−$9.15 D.−$10.15 Answer: C The value of the British pound bond underlying the swap is in millions of pounds 4e-0.05×0.5+4e-0.05×1.5+104e-0.05×2.5 = 99.39 The value of the U.S. dollar bond is in millions of dollars 4.5e-0.05×0.5+4.5e-0.05×1.5+154.5e-0.05×2.5 = 144.91 The value of the swap is 144.91 – 99.39×1.55 = –9.15 99 Cardlink 0 19.Which of the following is a typical bid-offer spread on the swap rate for a plain vanilla interest rate swap? A.3 basis points
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B.8 basis points C.13 basis points D.18 basis points Answer: A 3 basis points is a typical spread between the bid and the offer on a plain vanilla interest rate swap. 100 Cardlink 0 Which of the following describes the five-year swap rate? A.The rate on a five-year loan to a AA-rated company B.The rate on a five-year loan to an A-rated company C.The rate that can be earned over five years from a series of short-term loans to AA-rated companies D.The rate that can be earned over five years from a series of short-term loans to A-rated companies Answer: C By considering the effect of making a series of LIBOR loans to AA- rated companies and entering into a swap we see that the swap rate corresponds to the risk in a series of short-term loans. 101 Cardlink 0 The basis is defined as spot minus futures. A trader is hedging the sale of an asset with a short futures position. The basis increases unexpectedly. Which of the following is true? A. The hedger’s position improves. B.The hedger’s position worsens. C.The hedger’s position sometimes worsens and sometimes improves. D.The hedger’s position stays the same. Answer: A The price received by the trader is the futures price plus the basis. It follows that the trader’s position improves when the basis increases.
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102 Cardlink 0 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 C.The May contract D.The August contract 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. 103 Cardlink 0 On March 1 a commodity’s spot price is $60 and its August futures price is $59. On July 1 the spot price is $64 and the August futures price is $63.50. A company entered into futures contracts on March 1 to hedge its purchase of the commodity on July 1. It closed out its position on July 1. What is the effective price (after taking account of hedging) paid by the company? A.$59.50 B.$60.50 C.$61.50 D.$63.50 Answer: A The user of the commodity takes a long futures position. The gain on the futures is 63.50−59 or $4.50. The effective paid realized is therefore 64−4.50 or $59.50. This can also be calculated as the March 1 futures price (=59) plus the basis on July 1 (=0.50).
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104 Cardlink 0 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 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 $1014. This can also be calculated as the March 1 futures price (=1015) plus the November 1 basis (=−1). 105 Cardlink 0 5.Suppose that the standard deviation of monthly changes in the price of commodity A is $2. The standard deviation of monthly changes in a futures price for a contract on commodity B (which is similar to commodity A) is $3. The correlation between the futures price and the commodity price is 0.9. What hedge ratio should be used when hedging a one month exposure to the price of commodity A? A. 0.60 B. 0.67 C. 1.45 D.0.90 Answer: A The optimal hedge ratio is 0.9×(2/3) or 0.6.
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106 Cardlink 0 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 Answer: D To reduce the beta by 0.3 we need to short 0.3×36,000,000/(900×250) or 48 contracts. 107 Cardlink 0 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 increase beta to 1.8? A.Long 192 contracts B.Short 192 contracts C.Long 96 contracts D.Short 96 contracts
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Answer: C To increase beta by 0.6 we need to go long 0.6×36,000,000/(900×250) or 96 contracts 108 Cardlink 0 Which of the following is true? A.The optimal hedge ratio is the slope of the best fit line when the spot price (on the y-axis) is regressed against the futures price (on the x-axis). B.The optimal hedge ratio is the slope of the best fit line when the futures price (on the y-axis) is regressed against the spot price (on the x-axis). C.The optimal hedge ratio is the slope of the best fit line when the change in the spot price (on the y-axis) is regressed against the change in the futures price (on the x-axis). D.The optimal hedge ratio is the slope of the best fit line when the change in the futures price (on the y-axis) is regressed against the change in the spot price (on the x-axis). Answer: C The optimal hedge ratio reflects the ratio of movements in the spot price to movements in the futures price. 109 Cardlink 1 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 Answer: D
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Tailing the hedge is a calculation appropriate when futures are used for hedging. It corrects for daily settlement 110 Cardlink 0 A company due to pay a certain amount of a foreign currency in the future decides to hedge with futures contracts. Which of the following best describes the advantage of hedging? A.It leads to a better exchange rate being paid B.It leads to a more predictable exchange rate being paid C.It caps the exchange rate that will be paid D.It provides a floor for the exchange rate that will be paid Answer: B Hedging is designed to reduce risk not increase expected profit. Options can be used to create a cap or floor on the price. Futures attempt to lock in the price 111 Cardlink 0 11.Which of the following best describes the capital asset pricing model? A.Determines the amount of capital that is needed in particular situations B.Is used to determine the price of futures contracts C.Relates the return on an asset to the return on a stock index D.Is used to determine the volatility of a stock index Answer: C CAPM relates the return on an asset to its beta. The parameter beta measures the sensitivity of the return on the asset to the return on the market. The latter is usually assumed to be the return on a stock index such as the S&P 500.
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112 Cardlink 0 Which of the following best describes “stack and roll”? A.Creates long-term hedges from short term futures contracts B.Can avoid losses on futures contracts by entering into further futures contracts C.Involves buying a futures contract with one maturity and selling a futures contract with a different maturity D.Involves two different exposures simultaneously Answer: A Stack and roll is a procedure where short maturity futures contracts are entered into. When they are close to maturity they are replaced by more short maturity futures contracts and so on. The result is the creation of a long term hedge from short-term futures contracts. 113 Cardlink 0 Which of the following increases basis risk? A.A large difference between the futures prices when the hedge is put in place and when it is closed out B.Dissimilarity between the underlying asset of the futures contract and the hedger’s exposure C.A reduction in the time between the date when the futures contract is closed and its delivery month D.None of the above Answer: B Basis is the difference between futures and spot at the time the hedge is closed out. This increases as the time between the date when the futures contract is put in place and the delivery month increases. (C is not therefore correct). It also increases as the asset underlying the futures contract becomes more different from the asset being hedged. (B is therefore correct.)
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114 Cardlink 0 Which of the following is a reason for hedging a portfolio with an index futures? A.The investor believes the stocks in the portfolio will perform better than the market but is uncertain about the future performance of the market B.The investor believes the stocks in the portfolio will perform better than the market and the market is expected to do well C.The portfolio is not well diversified and so its return is uncertain D.All of the above Answer: A Index futures can be used to remove the impact of the performance of the overall market on the portfolio. If the market is expected to do well hedging against the performance of the market is not appropriate. Hedging cannot correct for a poorly diversified portfolio. 115 Cardlink 0 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 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 116 Cardlink 0 Which of the following is true? A.Hedging can always be done more easily by a company’s
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shareholders than by the company itself B.If all companies in an industry hedge, a company in the industry can sometimes reduce its risk by choosing not to hedge C.If all companies in an industry do not hedge, a company in the industry can reduce its risk by hedging D.If all companies in an industry do not hedge, a company is liable increase its risk by hedging Answer: D If all companies in a industry hedge, the prices of the end product tends to reflect movements in relevant market variables. Attempting to hedge those movements can therefore increase risk. 117 Cardlink 0 Which of the following is necessary for tailing a hedge? A.Comparing the size in units of the position being hedged with the size in units of the futures contract B.Comparing the value of the position being hedged with the value of one futures contract C.Comparing the futures price of the asset being hedged to its forward price D.None of the above Answer: B When tailing a hedge the optimal hedge ratio is applied to the ratio of the value of the position being hedged to the value of one futures contract. 118 Cardlink 0 Which of the following is true? A.Gold producers should always hedge the price they will receive for their production of gold over the next three years B.Gold producers should always hedge the price they will receive for their production of gold over the next one year C.The hedging strategies of a gold producer should depend on
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whether it shareholders want exposure to the price of gold D.Gold producers can hedge by buying gold in the forward market Answer: C Some shareholders buy gold stocks to gain exposure to the price of gold. They do not want the company they invest in to hedge. In practice gold mining companies make their hedging strategies clear to shareholders. 119 Cardlink 0 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 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 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. 120 Cardlink 0 A company will buy 1000 units of a certain commodity in one year. It decides to hedge 80% of its exposure using futures contracts. The spot price and the futures price are currently $100 and $90, respectively. If the spot price and the futures price in one year turn out to be $112 and $110, respectively. What is the average price paid for the commodity? A.$92 B.$96
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C.$102 D.$106 Answer: B On the 80% (hedged) part of the commodity purchase the price paid will 112−(110−90) or $92. On the other 20% the price paid will be the spot price of $112. The weighted average of the two prices is 0.8×92+0.2×112 or $96. 121 Cardlink 0 Which of following is applicable to corporate bonds in the United States? A.Actual/360 B.Actual/Actual C.30/360 D.Actual/365 Answer: C Corporate bonds in the U.S are usually quoted with a 30/360 day count. This means that there are assumed to be 30 days per month and 360 days per year when the length of an accrual period is calculated. 122 Cardlink 4 It is May 1. The quoted price of a bond with an Actual/Actual (in period) day count and 12% per annum coupon (paid semiannually) in the United States is 105. It has a face value of 100 and pays coupons on April 1 and October 1. What is the cash price? A.106.00 B. 106.02 C.105.98 D. 106.04 Answer: C The cash price is the quoted price plus accrued interest. There are
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30 actual days between April 1 and May 1 and 183 actual days between April 1 and October 1. In this case the quoted price is 105 and the accrued interest is 0.06×100×30/183=0.98. The answer is therefore 105.98. 123 Cardlink 2 It is May 1. The quoted price of a bond with a 30/360 day count and 12% per annum coupon in the United States is 105. It has a face value of 100 and pays coupons on April 1 and October 1. What is the cash price? A. 106.00 B. 106.02 C.105.98 D. 106.04 Answer: A The cash price is the quoted price plus accrued interest. There are 30 assumed days between April 1 and May 1 and 180 assumed days between April 1 and October 1. In this case the quoted price is 105 and the accrued interest is 0.06×100×30/180 = 1.00. The answer is therefore 106.00. 124 Cardlink 2 The most recent settlement bond futures price is 103.5. Which of the following four bonds is cheapest to deliver? A.Quoted bond price = 110; conversion factor = 1.0400. B.Quoted bond price = 160; conversion factor = 1.5200. C.Quoted bond price = 131; conversion factor = 1.2500. D.Quoted bond price = 143; conversion factor = 1.3500. Answer: C The cost of delivering a bond is the quoted bond price minus the most recent settlement price times the conversion factor. This is 2.36, 2.68, 1.625, and 3.275 for bonds in A, B, C, and D, respectively. The bond in C is therefore cheapest to deliver.
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125 Cardlink 0 Which of the following is NOT an option open to the party with a short position in the Treasury bond futures contract? A.The ability to deliver any of a number of different bonds B.The wild card play C.The fact that delivery can be made any time during the delivery month D.The interest rate used in the calculation of the conversion factor Answer: D A, B, and C describe options that the party with the short position has. D does not 126 Cardlink 0 A trader enters into a long position in one Eurodollar futures contract. How much does the trader gain when the futures price quote increases by 6 basis points? A. $6 B. $150 C.$60 D. $600
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Answer: B The trader gains $25 for each basis point. The gain is therefore 25×6 or $150. 127 Cardlink 0 The bonds that can be delivered in a Treasury bond futures contract are A.Assets that provide no income B.Assets that provide a known cash income C.Assets that provide a known yield D.None of the above Answer: B A bond is an asset that provides a known cash income (the coupons) 128 Cardlink 0 An ultra T-bond futures contract is one where A.Bonds with maturities less than 3 years can be delivered B.Bonds with maturities less than 10 years can be delivered C.Bonds with maturities greater than 15 years can be delivered D.Bonds with maturities greater than 25 year can be delivered Answer: D In the ultra T-bond futures contract bonds with maturities over 25 years can be delivered.
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129 Cardlink 0 A portfolio is worth $24,000,000. The futures price for a Treasury note futures contract is 110 and each contract is for the delivery of bonds with a face value of $100,000. On the delivery date the duration of the bond that is expected to be cheapest to deliver is 6 years and the duration of the portfolio will be 5.5 years. How many contracts are necessary for hedging the portfolio? A.100 B.200 C.300 D.400 Answer: B The contract price is 110,000. The number of contracts is (24,000,000×5.5)/(110,000×6.0)=200 130 Cardlink 0 Which of the following is true? A.The futures rates calculated from a Eurodollar futures quote are always less than the corresponding forward rate B.The futures rates calculated from a Eurodollar futures quote are always greater than the corresponding forward rate C.The futures rates calculated from a Eurodollar futures quote should equal the corresponding forward rate D.The futures rates calculated from a Eurodollar futures quote are sometimes greater than and sometimes less than the corresponding forward rate Answer: B The futures rate must be reduced by what is known as a convexity adjustment to get the forward rate.
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131 Cardlink 0 How much is a basis point? A.1.0% B.0.1% C.0.01% D.0.001% Answer: C A basis point is 0.01%. 132 Cardlink 0 Which of the following day count conventions applies to a US Treasury bond? A.Actual/360 B.Actual/Actual (in period) C.30/360 D.Actual/365 Answer: B Actual/Actual (in period) is used for US Treasury bonds. This means that the interest earned during a period that lies between two coupon payment dates is calculated by dividing the actual number of days in the period by the number of days between the coupon payments and multiplying the result by the next coupon payment 133 Cardlink 0 What is the quoted discount rate on a money market instrument? A.The interest rate earned as a percentage of the final face value of a bond
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B.The interest rate earned as a percentage of the initial price of a bond C.The interest rate earned as a percentage of the average price of a bond D.The risk-free rate used to calculate the present value of future cash flows from a bond Answer: A The quoted discount rate is the interest earned as a percentage of the final face value 134 Cardlink 0 Which of the following is closest to the duration of a 2-year bond that pays a coupon of 8% per annum semiannually? The yield on the bond is 10% per annum with continuous compounding. A.1.82 B.1.85 C.1.88 D.1.92 Answer: C The duration of the bond is the weighted average of the times when cash flows are received with weights proportional to the present values of the cash flows. 135 Cardlink 0 Which of the following is NOT true about duration? A.It equals the years-to-maturity for a zero coupon bond B.It equals the weighted average of payment times for a bond, where weights are proportional to the present value of payments C.Equals the weighted average of individual bond durations for a portfolio, where weights are proportional to the present value of bond prices
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D.The prices of two bonds with the same duration change by the same percentage amount when interest rate moves up by 100 basis points Answer: D D is only approximately true. A, B, and C are exactly true. 136 Cardlink 0 16.The conversion factor for a bond is approximately The price it would have if all cash flows were discounted at 6% per annum B.The price it would have if it paid coupons at 6% per annum C.The price it would have if all cash flows were discounted at 8% per annum D.The price it would have if it paid coupons at 8% per annum Answer: A The calculation of the conversion factor involves discounting the cash flows on the bond at 6%. 137 Cardlink 0 The time-to-maturity of a Eurodollars futures contract is 4 years and the time-to-maturity of the rate underlying the futures contract is 4.25 years. The standard deviation of the change in the short term interest rate, ± = 0.011. What does the model in the text estimate as the difference between the futures and the forward interest rate? A. 0.105% B. 0.103% C. 0.098% D. 0.093%
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Answer: B With the notation in the text, the futures rate exceeds the forward rate by 0.5±2T1T2. In this case ±=0.011, T1=4 and T2=4.25 so the difference between the forward and futures price is 0.5×0.011×4×4.25=0.00103. 138 Cardlink 0 A trader uses 3-month Eurodollar futures to lock in a rate on $5 million for six months. How many contracts are required? A.5 B.10 C.15 D.20 Answer: B Each contract locks in the rate on $1 million dollars for three months. A six month instrument is approximately twice as sensitive to rate movements as a three month instrument because it has twice the duration. 2×5 = 10 contracts are therefore required 139 Cardlink 0 In the U.S. what is the longest maturity for 3-month Eurodollar futures contracts? A: 2 years B: 5 years C: 10 years D: 20 years Answer: C Eurodollar futures have maturities out to 10 years.
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140 Cardlink 0 Duration matching immunizes a portfolio against A.Any parallel shift in the yield curve B.All shifts in the yield curve C.Changes in the steepness of the yield curve D.Small parallel shifts in the yield curve Answer: D Duration matching only protects against small parallel shifts. It does not provide protection against large parallel shifts and non-parallel shifts. 141 Cardlink 0 Which of the following describes a call option? A.The right to buy an asset for a certain price B.The obligation to buy an asset for a certain price C.The right to sell an asset for a certain price D.The obligation to sell an asset for a certain price Answer: A A call option is the right, but not the obligation to buy. 142 Cardlink 0 2.Which of the following is true? A.A long call is the same as a short put
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B.A short call is the same as a long put C.A call on a stock plus a stock the same as a put D.None of the above Answer: D None of the statements are true. Long calls, short calls, long puts, and short puts all have different payoffs as indicated by Figure 10.5. A put on a stock plus the stock provides a payoff that is similar to a call, as explained in Chapters 11 and 12. But a call on a stock plus a stock does not provide a similar payoff to a put. 143 Cardlink 0 3.An investor has exchange-traded put options to sell 100 shares for $20. There is a 2 for 1 stock split. Which of the following is the position of the investor after the stock split? A.Put options to sell 100 shares for $20 B.Put options to sell 100 shares for $10 C.Put options to sell 200 shares for $10 D.Put options to sell 200 shares for $20 Answer: C When there is a stock split the number of shares increases and the strike price decreases. In this case, because it is a 2 for 1 stock split, the number of shares doubles and the strike price halves. 144 Cardlink 0 4.An investor has exchange-traded put options to sell 100 shares for $20. There is 25% stock dividend. Which of the following is the position of the investor after the stock dividend? A.Put options to sell 100 shares for $20 B.Put options to sell 75 shares for $25 C.Put options to sell 125 shares for $15 D.Put options to sell 125 shares for $16 Answer: D The stock dividend is equivalent to a 5 for 4 stock split. The number
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of shares goes up by 25% and the strike price is reduced to 4/5 of its previous value. 145 Cardlink 0 5.An investor has exchange-traded put options to sell 100 shares for $20. There is a $1 cash dividend. Which of the following is then the position of the investor? A.The investor has put options to sell 100 shares for $20 B.The investor has put options to sell 100 shares for $19 C.The investor has put options to sell 105 shares for $19 D.The investor has put options to sell 105 shares for $19.05 Answer: A Cash dividends unless they are unusually large have no effect on the terms of an option. 146 Cardlink 0 6.Which of the following describes a short position in an option? A.A position in an option lasting less than one month B.A position in an option lasting less than three months C.A position in an option lasting less than six months D.A position where an option has been sold Answer: D A short position is a position where the option has been sold (the opposite to a long position).
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147 Cardlink 0 7.Which of the following describes a difference between a warrant and an exchange-traded stock option? A.In a warrant issue, someone has guaranteed the performance of the option seller in the event that the option is exercised B.The number of warrants is fixed whereas the number of exchange-traded options in existence depends on trading C.Exchange-traded stock options have a strike price D.Warrants cannot be traded after they have been purchased Answer: B A warrant is a fixed number of options issued by a company. They often trade on an exchange after they have been issued. 148 Cardlink 0 1.Which of the following describes LEAPS? A.Options which are partly American and partly European B.Options where the strike price changes through time C.Exchange-traded stock options with longer lives than regular exchange-traded stock options D.Options on the average stock price during a period of time Answer: C LEAPS are long-term equity anticipation securities. They are exchange-traded options with relatively long maturities.
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149 Cardlink 0 8.Which of the following is an example of an option class? A.All calls on a certain stock B.All calls with a particular strike price on a certain stock C.All calls with a particular time to maturity on a certain stock D.All calls with a particular time to maturity and strike price on a certain stock Answer: A An option class is all calls on a certain stock or all puts on a certain stock. 150 Cardlink 0 9.Which of the following is an example of an option series? A.All calls on a certain stock B.All calls with a particular strike price on a certain stock C.All calls with a particular time to maturity on a certain stock D.All calls with a particular time to maturity and strike price on a certain stock Answer: D All options on a certain stock of a certain type (calls or put) with a certain strike price and time to maturity are referred to as an option series 151 Cardlink 0 10.Which of the following must post margin? A.The seller of an option B.The buyer of an option C.The seller and the buyer of an option D.Neither the seller nor the buyer of an option Answer: A
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The seller of the option must post margin as a guarantee that the payoff on the option (if there is one) will be made. The buyer of the option usually pays for the option upfront and so no margin is required. 152 Cardlink 0 11.Which of the following describes a long position in an option? A.A position where there is more than one year to maturity B.A position where there is more than five years to maturity C.A position where an option has been purchased D.A position that has been held for a long time Answer: C A long position is a position where an option has been purchased. It can be contrasted with a short position which is a position where an option has been sold. 153 Cardlink 0 12.Which of the following is NOT traded by the CBOE? A.Weeklys B.Monthlys C.Binary options D.DOOM options Answer: B Monthlys are not a CBOE product. The others are.
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154 Cardlink 0 13.When a six-month option is purchased A.The price must be paid in full B.Up to 25% of the option price can be borrowed using a margin account C.Up to 50% of the option price can be borrowed using a margin account D.Up to 75% of the option price can be borrowed using a margin account Answer: A Only options lasting more than 9 months can be bought on margin. 155 Cardlink 0 14.Which of the following are true for CBOE stock options? A.There are no margin requirements B.The initial margin and maintenance margin are determined by formulas and are equal C.The initial margin and maintenance margin are determined by formulas and are different D.The maintenance margin is usually about 75% of the initial margin Answer: B Margin accounts for options must be brought up to the initial/maintenance margin level every day.
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156 Cardlink 0 15.The price of a stock is $67. A trader sells 5 put option contracts on the stock with a strike price of $70 when the option price is $4. The options are exercised when the stock price is $69. What is the trader’s net profit or loss? A.Loss of $1,500 B.Loss of $500 C.Gain of $1,500 D.Loss of $1,000 Answer: C The option payoff is 70−69 = $1. The amount received for the option is $4. The gain is $3 per option. In total 5×100 = 500 options are sold. The total gain is therefore $3 × 500 = $1,500. 157 Cardlink 0 16.A trader buys a call and sells a put with the same strike price and maturity date. What is the position equivalent to? A.A long forward B.A short forward C.Buying the asset D.None of the above Answer: A From adding up the two payoffs we see that A is true: max(ST−K,0)−max(K−ST,0)= ST−K 158 Cardlink 0 17.The price of a stock is $64. A trader buys 1 put option contract on the stock with a strike price of $60 when the option price is $10. When does the trader make a profit? A.When the stock price is below $60 B.When the stock price is below $64 C.When the stock price is below $54 D.When the stock price is below $50
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Answer: D The payoff must be more than the $10 paid for the option. The stock price must therefore be below $50. 159 Cardlink 5 18.Consider a put option and a call option with the same strike price and time to maturity. Which of the following is true? A.It is possible for both options to be in the money B.It is possible for both options to be out of the money C.One of the options must be in the money D.One of the options must be either in the money or at the money Answer: D If the stock price is greater than the strike price the call is in the money and the put is out of the money. If the stock price is less than the strike price the call is out of the money and the put is in the money. If the stock price is equal to the strike price both options are at the money. 160 Cardlink 0 19.In which of the following cases is an asset NOT considered constructively sold? A.The owner shorts the asset B.The owner buys an in-the-money put option on the asset C.The owner shorts a forward contract on the asset D.The owner shorts a futures contract on the stock Answer: B Profits on the asset have to be recognized in A, C, and D. The holder of the asset cannot defer recognition of profits with the trades indicated. In the case of B the asset is not considered constructively sold. Buying a deep-in-the-money put option is a way of almost certainly locking in a profit on an asset without triggering an immediate tax liability.
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161 Cardlink 0 1.When the stock price increases with all else remaining the same, which of the following is true? A.Both calls and puts increase in value B.Both calls and puts decrease in value C.Calls increase in value while puts decrease in value D.Puts increase in value while calls decrease in value Answer: C Stock price increases cause the values of calls to increase and the values of puts to decline. 162 Cardlink 0 2.When the strike price increases with all else remaining the same, which of the following is true? A.Both calls and puts increase in value B.Both calls and puts decrease in value C.Calls increase in value while puts decrease in value D.Puts increase in value while calls decrease in value Answer: D Strike price increases cause the values of puts to increase and the values of calls to decline.
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163 Cardlink 0 3.When volatility increases with all else remaining the same, which of the following is true? A.Both calls and puts increase in value B.Both calls and puts decrease in value C.Calls increase in value while puts decrease in value D.Puts increase in value while calls decrease in value Answer: A Volatility increases the likelihood of a high payoff from either a call or a put option. The payoff can never be negative. It follows that as volatility increases the value of all options increase. 164 Cardlink 2 4.When dividends increase with all else remaining the same, which of the following is true? A.Both calls and puts increase in value B.Both calls and puts decrease in value C.Calls increase in value while puts decrease in value D.Puts increase in value while calls decrease in value Answer: D Dividends during the life of an option reduce the final stock price. As a result dividend increases cause puts to increase in value and calls to decrease in value. 165 Cardlink 0 5.When interest rates increase with all else remaining the same, which of the following is true? A.Both calls and puts increase in value B.Both calls and puts decrease in value C.Calls increase in value while puts decrease in value D.Puts increase in value while calls decrease in value Answer: C
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Calls increase and puts decrease in value. As explained in the text an increase in interest rates causes the growth rate of the stock price to increase and the discount rate to increase. An increase in interest rates therefore reduces the value of puts because puts are hurt by both a discount rate increase and a growth rate increase. For calls it turns out that the growth rate increase is more important than the discount rate increase so that their values increase when interest rates increase. (Note that we are assuming all else equal and so the asset price does not change.) 166 Cardlink 0 6.When the time to maturity increases with all else remaining the same, which of the following is true? A.European options always increase in value B.The value of European options either stays the same or increases C.There is no effect on European option values D.European options are liable to increase or decrease in value Answer: D When the time to maturity increases from X to Y, European options usually increase in value. But they can decrease in value if a big dividend expected between X and Y. 167 Cardlink 0 7.The price of a stock, which pays no dividends, is $30 and the strike price of a one year European call option on the stock is $25. The risk-free rate is 4% (continuously compounded). Which of the following is a lower bound for the option such that there are arbitrage opportunities if the price is below the lower bound and no arbitrage opportunities if it is above the lower bound? A.$5.00 B.$5.98 C.$4.98 D.$3.98 Answer: B The lower bound in S0 − Ke-rT. In this case it is 30 – 25e-0.04×1 = $5.98.
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168 Cardlink 1 8.A stock price (which pays no dividends) is $50 and the strike price of a two year European put option is $54. The risk-free rate is 3% (continuously compounded). Which of the following is a lower bound for the option such that there are arbitrage opportunities if the price is below the lower bound and no arbitrage opportunities if it is above the lower bound? A.$4.00 B.$3.86 C.$2.86 D.$0.86 Answer: D The lower bound in Ke-rT −S0 In this case it is 54e−0.03×2 – 50= $0.86. 169 Cardlink 0 9.Which of the following is NOT true? (Present values are calculated from the end of the life of the option to the beginning.) A.An American put option is always worth less than the present value of the strike price B.A European put option is always worth less than the present value of the strike price C.A European call option is always worth less than the stock price D.An American call option is always worth less than the stock price Answer: A If it is optimal to exercise an American option today and the stock price is very low the option will be worth more than the present value of the strike price
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170 Cardlink 0 10.Which of the following best describes the intrinsic value of an option? A.The value it would have if the owner had to exercise it immediately or not at all B.The Black-Scholes-Merton price of the option C.The lower bound for the option’s price D.The amount paid for the option Answer: A The intrinsic value of an option is the value it would have if it were about the expire which is the same as the value in A. 171 Cardlink 0 11.Which of the following describes a situation where an American put option on a stock becomes more likely to be exercised early? A.Expected dividends increase B.Interest rates decrease C.The stock price volatility decreases D.All of the above Answer: C As the volatility of the option decreases the time value declines and the option becomes more likely to be exercised early. In the case of A and B, time value increases and the option is less likely to be exercised early.
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172 Cardlink 0 12.Which of the following is true? A.An American call option on a stock should never be exercised early B.An American call option on a stock should never be exercised early when no dividends are expected C.There is always some chance that an American call option on a stock will be exercised early D.There is always some chance that an American call option on a stock will be exercised early when no dividends are expected Answer: B An American call option should never be exercised early when the underlying stock does not pay dividends. There are two reasons. First, it is best to delay paying the strike price. Second the insurance provided by the option (that the stock price will fall below the strike price) is lost. 173 Cardlink 0 13.Which of the following is the put-call parity result for a non- dividend-paying stock? A.The European put price plus the European call price must equal the stock price plus the present value of the strike price B.The European put price plus the present value of the strike price must equal the European call price plus the stock price C.The European put price plus the stock price must equal the European call price plus the strike price D.The European put price plus the stock price must equal the European call price plus the present value of the strike price
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Answer: D The put-call parity result is c+Ke-rT=p+S0. 174 Cardlink 0 14.Which of the following is true when dividends are expected? A.Put-call parity does not hold B.The basic put-call parity formula can be adjusted by subtracting the present value of expected dividends from the stock price C.The basic put-call parity formula can be adjusted by adding the present value of expected dividends to the stock price D.The basic put-call parity formula can be adjusted by subtracting the dividend yield from the interest rate Answer: B Put call parity still holds for European options providing the present value of the dividends is subtracted from the stock price. 175 Cardlink 0 15.The price of a European call option on a non-dividend- paying stock with a strike price of $50 is $6. The stock price is $51, the continuously compounded risk-free rate (all maturities) is 6% and the time to maturity is one year. What is the price of a one-year European put option on the stock with a strike price of $50? A.$9.91 B.$7.00 C.$6.00 D.$2.09 Answer: D Put-call parity is c+Ke-rT=p+S0. In this case K=50, S0=51, r=0.06,
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T=1, and c=6. It follows that p=6+50e-0.06×1−51 = 2.09. 176 Cardlink 0 16.The price of a European call option on a stock with a strike price of $50 is $6. The stock price is $51, the continuously compounded risk-free rate (all maturities) is 6% and the time to maturity is one year. A dividend of $1 is expected in six months. What is the price of a one-year European put option on the stock with a strike price of $50? A.$8.97 B.$6.97 C.$3.06 D.$1.12 Answer: C Put-call parity is c+Ke-rT=p+S0. In this case K=50, S0=51, r=0.06, T=1, and c=6. The present value of the dividend is 1×e−0.06×0.5 = 0.97. It follows that p=6+50e-0.06×1−(51-0.97) = 3.06 177 Cardlink 0 17. A European call and a European put on a stock have the same strike price and time to maturity. At 10:00am on a certain day, the price of the call is $3 and the price of the put is $4. At 10:01am news reaches the market that has no effect on the stock price or interest rates, but increases volatilities. As a result the price of the call changes to $4.50. Which of the following is correct? A.The put price increases to $6.00 B.The put price decreases to $2.00 C.The put price increases to $5.50 D.It is possible that there is no effect on the put price Answer: C The price of the call has increased by $1.50. From put-call parity the
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price of the put must increase by the same amount. Hence the put price will become 4.00 +1.50 = $5.50. 178 Cardlink 0 18.Interest rates are zero. A European call with a strike price of $50 and a maturity of one year is worth $6. A European put with a strike price of $50 and a maturity of one year is worth $7. The current stock price is $49. Which of the following is true? A.The call price is high relative to the put price B.The put price is high relative to the call price C.Both the call and put must be mispriced D.None of the above Answer: D In this case because interest rates are zero c+K=p+S0. The left side of this equation is 50+6=56. The right side is 49+7=56. There is no mispricing. 179 Cardlink 0 19.Which of the following is true for American options? A.Put-call parity provides an upper and lower bound for the difference between call and put prices B.Put call parity provides an upper bound but no lower bound for the difference between call and put prices C.Put call parity provides an lower bound but no upper bound for the difference between call and put prices D.There are no put-call parity results Answer: A Put call parity provides both an upper and lower bound for the difference between call and put prices. See equation (11.11).
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180 Cardlink 0 20.Which of the following can be used to create a long position in a European put option on a stock? A.Buy a call option on the stock and buy the stock B.Buy a call on the stock and short the stock C.Sell a call option on the stock and buy the stock D.Sell a call option on the stock and sell the stock Answer: B As payoff diagrams show a call on a stock combined with a short position in the stock gives a payoff similar to a put option. Alternatively we can use put-call parity, which shows that a call minus the stock equals the put minus the present value of the strike price. 181 Cardlink 0 Which of the following creates a bull spread? A.Buy a low strike price call and sell a high strike price call B.Buy a high strike price call and sell a low strike price call C.Buy a low strike price call and sell a high strike price put D.Buy a low strike price put and sell a high strike price call Answer: A A bull spread is created by buying a low strike call and selling a high strike call. Alternatively, it can be created by buying a low strike put and selling a high strike put. 182 Cardlink 0 2.Which of the following creates a bear spread? A.Buy a low strike price call and sell a high strike price call
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B.Buy a high strike price call and sell a low strike price call C.Buy a low strike price call and sell a high strike price put D.Buy a low strike price put and sell a high strike price call Answer: B A bear spread is created by buying a high strike call and selling a low strike call. Alternatively, it can be created by buying a high strike put and selling a low strike put 183 Cardlink 0 3.Which of the following creates a bull spread? A.Buy a low strike price put and sell a high strike price put B.Buy a high strike price put and sell a low strike price put C.Buy a high strike price call and sell a low strike price put D.Buy a high strike price put and sell a low strike price call Answer: A A bull spread is created by buying a low strike call and selling a high strike call. Alternatively, it can be created by buying a low strike put and selling a high strike put. 184 Cardlink 0 4. Which of the following creates a bear spread? A.Buy a low strike price put and sell a high strike price put B.Buy a high strike price put and sell a low strike price put C.Buy a high strike price call and sell a low strike price put D.Buy a high strike price put and sell a low strike price call Answer: B A bear spread is created by buying a high strike call and selling a low strike call. Alternatively, it can be created by buying a high strike put and selling a low strike put.
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185 Cardlink 0 5.What is the number of different option series used in creating a butterfly spread? A.1 B.2 C.3 D.4 Answer: C Three different options all with the same maturity are involved in creating a butterfly spread. The strike prices are usually equally spaced. The creator buys the low strike option, buys the high strike option, and sells two of the intermediate strike option 186 Cardlink 0 1.A stock price is currently $23. A reverse (i.e short) butterfly spread is created from options with strike prices of $20, $25, and $30. Which of the following is true? A.The gain when the stock price is greater that $30 is less than the gain when the stock price is less than $20 B.The gain when the stock price is greater that $30 is greater than the gain when the stock price is less than $20 C.The gain when the stock price is greater that $30 is the same as the gain when the stock price is less than $20 D.It is incorrect to assume that there is always a gain when the stock price is greater than $30 or less than $20 Answer: C The gain from a very high stock price or a very low stock price is the same. Suppose calls are used. In the case of a very low stock price none are exercised and the gain is c1+c3−2c2 from the option premium. In the case of a very high stock price all options are exercised. The net payoff is zero and the gain is the same.
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187 Cardlink 0 7.Which of the following is correct? A.A calendar spread can be created by buying a call and selling a put when the strike prices are the same and the times to maturity are different B.A calendar spread can be created by buying a put and selling a call when the strike prices are the same and the times to maturity are different C.A calendar spread can be created by buying a call and selling a call when the strike prices are different and the times to maturity are different D.A calendar spread can be created by buying a call and selling a call when the strike prices are the same and the times to maturity are different Answer: D A calendar spread is created by buying an option with one maturity and selling an option with another maturity when the strike prices are the same and the option types (calls or puts) are the same. 188 Cardlink 0 8.What is a description of the trading strategy where an investor sells a 3-month call option and buys a one-year call option, where both options have a strike price of $100 and the underlying stock price is $75? A.Neutral Calendar Spread B.Bullish Calendar Spread C.Bearish Calendar Spread D.None of the above
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Answer: B This is a bullish calendar spread because a big increase in the stock price between three months and one year is necessary for the trading strategy to be profitable. 189 Cardlink 0 9.Which of the following is correct? A.A diagonal spread can be created by buying a call and selling a put when the strike prices are the same and the times to maturity are different B.A diagonal spread can be created by buying a put and selling a call when the strike prices are the same and the times to maturity are different C.A diagonal spread can be created by buying a call and selling a call when the strike prices are different and the times to maturity are different D.A diagonal spread can be created by buying a call and selling a call when the strike prices are the same and the times to maturity are different Answer: C Both the strike prices and times to maturity are different in a diagonal spread. 190 Cardlink 0 10.Which of the following is true of a box spread? A.It is a package consisting of a bull spread and a bear spread B.It involves two call options and two put options C.It has a known value at maturity D.All of the above Answer: D A, B, and C are all true.
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191 Cardlink 0 11.How can a straddle be created? A.Buy one call and one put with the same strike price and same expiration date B.Buy one call and one put with different strike prices and same expiration date C.Buy one call and two puts with the same strike price and expiration date D.Buy two calls and one put with the same strike price and expiration date Answer: A A straddle consists of one call and one put where the strike price and time to maturity are the same. It has a V-shaped payoff. 192 Cardlink 0 12.How can a strip trading strategy be created? A.Buy one call and one put with the same strike price and same expiration date B.Buy one call and one put with different strike prices and same expiration date C.Buy one call and two puts with the same strike price and expiration date D.Buy two calls and one put with the same strike price and expiration date Answer: C A strip consists of one call and two puts with the same strike price and time to maturity.
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193 Cardlink 0 13.How can a strap trading strategy be created? A.Buy one call and one put with the same strike price and same expiration date B.Buy one call and one put with different strike prices and same expiration date C.Buy one call and two puts with the same strike price and expiration date D.Buy two calls and one put with the same strike price and expiration date Answer: D A strap consists of two calls and one put with the same strike price and time to maturity. 194 Cardlink 0 14.How can a strangle trading strategy be created? A.Buy one call and one put with the same strike price and same expiration date B.Buy one call and one put with different strike prices and same expiration date C.Buy one call and two puts with the same strike price and expiration date D.Buy two calls and one put with the same strike price and expiration date Answer: B A straddle consists of one call and one put where the times to maturity are the same but the call strike price is greater than the put strike price.
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195 Cardlink 0 15.Which of the following describes a protective put? A.A long put option on a stock plus a long position in the stock B.A long put option on a stock plus a short position in the stock C.A short put option on a stock plus a short call option on the stock D.A short put option on a stock plus a long position in the stock Answer: A A protective put consists of a long put plus the stock. The holder of the put owns the stock that might become deliverable. 196 Cardlink 0 16.Which of the following describes a covered call? A.A long call option on a stock plus a long position in the stock B.A long call option on a stock plus a short put option on the stock C.A short call option on a stock plus a short position in the stock D.A short call option on a stock plus a long position in the stock Answer: D A covered call consists of a short call plus a long position in the stock. The if the call is exercised the owner of the position has the stock ready to deliver if the other side exercises the call.
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197 Cardlink 0 17.When the interest rate is 5% per annum with continuous compounding, which of the following creates a principal protected note worth $1000? A.A one-year zero-coupon bond plus a one-year call option worth about $59 B.A one-year zero-coupon bond plus a one-year call option worth about $49 C.A one-year zero-coupon bond plus a one-year call option worth about $39 D.A one-year zero-coupon bond plus a one-year call option worth about $29 Answer: B A one-year zero-coupon bond is worth 1000e-0.05×1 or about $951. This leaves 1000−951 = $49 for buying the option. 198 Cardlink 0 18.A trader creates a long butterfly spread from options with strike prices $60, $65, and $70 by trading a total of 400 options. The options are worth $11, $14, and $18. What is the maximum net gain (after the cost of the options is taken into account)? A.$100 B.$200 C.$300 D.$400 Answer: D The butterfly spread involves buying 100 options with strike prices $60 and $70 and selling 200 options with strike price $65. The maximum gain is when the stock price equals the middle strike price, $65. The payoffs from the options are then, $500, 0, and 0, respectively. The total payoff is $500. The cost of setting up the butterfly spread is 11×100+18×100−14×200 = $100. The gain is 500−100 or $400. 199 Cardlink 0 19.A trader creates a long butterfly spread from options with strike prices $60, $65, and $70 by trading a total of 400 options.
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The options are worth $11, $14, and $18. What is the maximum net loss (after the cost of the options is taken into account)? A.$100 B.$200 C.$300 D.$400 Answer: A The butterfly spread involves buying 100 options with strike prices $60 and $70 and selling 200 options with strike price $65. The maximum loss is when the stock price is less than $60 or greater than $70. The total payoff is then zero. The cost of setting up the butterfly spread is 11×100+18×100−14×200 = $100. The loss is therefore $100. 200 Cardlink 0 20.Six-month call options with strike prices of $35 and $40 cost $6 and $4, respectively. What is the maximum gain when a bull spread is created by trading a total of 200 options? A.$100 B.$200 C.$300 D.$400 Answer: C The bull spread involves buying 100 calls with strike $35 and selling 100 calls with strike price $40. The cost is 6×100−4×100=$200. The maximum payoff (when the stock price is greater than or equal to $40 is $500. The maximum gain is therefore 500 −200 = $300. 201 Cardlink 0 1.The current price of a non-dividend-paying stock is $30. Over the next six months it is expected to rise to $36 or fall to $26. Assume the risk-free rate is zero. An investor sells call options with a strike price of $32. Which of the following hedges the position? A.Buy 0.6 shares for each call option sold B.Buy 0.4 shares for each call option sold
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C.Short 0.6 shares for each call option sold D.Short 0.6 shares for each call option sold Answer: B The value of the option will be either $4 or zero. If ± is the position in the stock we require 36±−4=26± so that ±=0.4. it follows that 0.4 shares should be purchased for each option sold. 202 Cardlink 0 2.The current price of a non-dividend-paying stock is $30. Over the next six months it is expected to rise to $36 or fall to $26. Assume the risk-free rate is zero. What is the risk-neutral probability of that the stock price will be $36? A.0.6 B.0.5 C.0.4 D.0.3 Answer: C The formula for the risk-neutral probability of an up movement is In this case u=36/30 or 1.2 and d=26/30 =0.8667. Also r=0 and T=0.5. The formula gives p=(1-0.8667/(1.2-0.8667) =0.4. 203 Cardlink 0 3.The current price of a non-dividend-paying stock is $30. Over the next six months it is expected to rise to $36 or fall to $26. Assume the risk-free rate is zero. An investor sells call options with a strike price of $32. What is the value of each call option? A.$1.6 B.$2.0 C.$2.4 D.$3.0 Answer: A The formula for the risk-neutral probability of an up movement is
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In this case u=36/30 or 1.2 and d=26/30 =0.8667. Also r=0 and T=0.5. The formula gives p=(1-0.8667/(1.2-0.8667) =0.4. The payoff from the call option is $4 if there is an up movement and $0 if there is a down movement. The value of the option is therefore 0.4×4 +0.6×0 = $1.6. (We do not do any discounting because the interest rate is zero.) 204 Cardlink 0 4.The current price of a non-dividend-paying stock is $40. Over the next year it is expected to rise to $42 or fall to $37. An investor buys put options with a strike price of $41. Which of the following is necessary to hedge the position? A.Buy 0.2 shares for each option purchased B.Sell 0.2 shares for each option purchased C.Buy 0.8 shares for each option purchased D.Sell 0.8 shares for each option purchased Answer: C The payoff from the put option is zero if there is an up movement and 4 if there is a down movement. Suppose that the investor buys one put option and buys ± shares. If there is an up movement the value of the portfolio is ±×42. If there is a down movement it is worth ±×37+4. These are equal when 37±+4=42± or ±=0.8. The investor should therefore buy 0.8 shares for each option purchased. 205 Cardlink 0 5.The current price of a non-dividend-paying stock is $40. Over the next year it is expected to rise to $42 or fall to $37. An investor buys put options with a strike price of $41. What is the value of each option? The risk-free interest rate is 2% per annum with continuous compounding. A.$3.93 B.$2.93 C.$1.93 D.$0.93 Answer: D The formula for the risk-neutral probability of an up movement is In this case r=0.02, T= 1, u=42/40=1.05 and d=37/40=0.925 so that p=0.76 and the value of the option is (0.76×0+0.24×4)e- 0.02×1=0.93
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206 Cardlink 0 6.Which of the following describes how American options can be valued using a binomial tree? A.Check whether early exercise is optimal at all nodes where the option is in-the-money B.Check whether early exercise is optimal at the final nodes C.Check whether early exercise is optimal at the penultimate nodes and the final nodes D.None of the above Answer: A For an American option we must check whether exercising is better than not exercising at each node where the option is in the money. (It is clearly not worth exercising when the option is out of the money) 207 Cardlink 0 7.In a binomial tree created to value an option on a stock, the expected return on stock is A.Zero B.The return required by the market C.The risk-free rate D.It is impossible to know without more information Answer: C The expected return on the stock on the tree is the risk-free rate. This is an application of risk-neutral valuation.
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208 Cardlink 0 8.In a binomial tree created to value an option on a stock, what is the expected return on the option? A.Zero B.The return required by the market C.The risk-free rate D.It is impossible to know without more information Answer: C The expected return on the option on the tree is the risk-free rate. This is an application of risk-neutral valuation. The expected return on all assets in a risk-neutral world is the risk-free rate. 209 Cardlink 0 9.A stock is expected to return 10% when the risk-free rate is 4%. What is the correct discount rate to use for the expected payoff on an option in the real world? A.4% B.10% C.More than 10% D.It could be more or less than 10% Answer: D The correct answer is D. There is no easy way of determining the correct discount rate for an option’s expected payoff in the real world. For a call option the correct discount rate in the real world is often quite high and for a put option it is often quite low (even negative). The example in the text illustrates this 210 Cardlink 0 10.Which of the following is true for a call option on a stock worth $50 A.As a stock’s expected return increases the price of the option increases B.As a stock’s expected return increases the price of the option decreases C.As a stock’s expected return increases the price of the option
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might increase or decrease D.As a stock’s expected return increases the price of the option on the stock stays the same Answer: D The option price when expressed in terms of the underlying stock price is independent of the return on the stock. To put this another way, everything relevant about the expected return is incorporated in the stock price. 211 Cardlink 0 11.Which of the following are NOT true A.Risk-neutral valuation and no-arbitrage arguments give the same option prices B.Risk-neutral valuation involves assuming that the expected return is the risk-free rate and then discounting expected payoffs at the risk-free rate C.A hedge set up to value an option does not need to be changed D.All of the above Answer: C The hedge set up to value an option needs to be changed as time passes. A and B are true. 212 Cardlink 0 12.The current price of a non-dividend paying stock is $30. Use a two-step tree to value a European call option on the stock with a strike price of $32 that expires in 6 months. Each step is 3 months, the risk free rate is 8% per annum with continuous compounding. What is the option price when u = 1.1 and d = 0.9. A.$1.29 B.$1.49 C.$1.69 D.$1.89
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Answer: B The probability of an up movement is The tree is 213 Cardlink 0 13.The current price of a non-dividend paying stock is $30. Use a two-step tree to value a European put option on the stock with a strike price of $32 that expires in 6 months with u = 1.1 and d = 0.9. Each step is 3 months, the risk free rate is 8%. A.$2.24 B.$2.44 C.$2.64 D.$2.84 Answer: A The probability of an up movement is The tree is 214 Cardlink 0 14.Which of the following is NOT true in a risk-neutral world? A.The expected return on a call option is independent of its strike price B.Investors expect higher returns to compensate for higher risk C.The expected return on a stock is the risk-free rate D.The discount rate used for the expected payoff on an option is the risk-free rate Answer: B In a risk-neutral world investors require an expected return equal to the risk-free rate and the discount rate that should be used for all expected payoffs is the risk-free rate.
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215 Cardlink 0 15.If the volatility of a non-dividend paying stock is 20% per annum and a risk-free rate is 5% per annum, which of the following is closest to the Cox, Ross, Rubinstein parameter u for a tree with a three-month time step? A.1.05 B.1.07 C.1.09 D.1.11 Answer: D The formula for u is 216 Cardlink 0 16.If the volatility of a non-dividend-paying stock is 20% per annum and a risk-free rate is 5% per annum, which of the following is closest to the Cox, Ross, Rubinstein parameter p for a tree with a three-month time step? A.0.50 B.0.54 C.0.58 D.0.62 The formula for p is =0.538
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217 Cardlink 0 17.The current price of a non-dividend paying stock is $50. Use a two-step tree to value an American put option on the stock with a strike price of $48 that expires in 12 months. Each step is 6 months, the risk free rate is 5% per annum, and the volatility is 20%. Which of the following is the option price? A.$1.95 B.$2.00 C.$2.05 D.$2.10 Answer: B In this case The tree is 218 Cardlink 0 18.Which of the following describes delta? A.The ratio of the option price to the stock price B.The ratio of the stock price to the option price C.The ratio of a change in the option price to the corresponding change in the stock price D.The ratio of a change in the stock price to the corresponding change in the option price Answer: C Delta is ±f/±S where ±S is a small change in the stock price (with nothing else changing) and ±f is the corresponding change in the option price.
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219 Cardlink 0 When moving from valuing an option on a non-dividend paying stock to an option on a currency which of the following is true? A.The risk-free rate is replaced by the excess of the domestic risk-free rate over the foreign risk-free rate in all calculations B.The formula for u changes C.The risk-free rate is replaced by the excess of the domestic risk-free rate over the foreign risk-free rate for discounting D.The risk-free rate is replaced by the excess of the domestic risk-free rate over the foreign risk-free rate when p is calculated Answer: D The formula for u does not change. The discount rate does not change. The formula for p becomes showing that D is correct. 220 Cardlink 0 20.A tree is constructed to value an option on an index which is currently worth 100 and has a volatility of 25%. The index provides a dividend yield of 2%. Another tree is constructed to value an option on a non-dividend-paying stock which is currently worth 100 and has a volatility of 25%. Which of the following are true? A.The parameters p and u are the same for both trees B.The parameter p is the same for both trees but u is not C.The parameter u is the same for both trees but p is not D.None of the above Answer: C The formula for u is the same in the two cases so that the values of the index on its tree are the same as the values of the stock on its tree. However, in the formula for p, r is replaced by r−q. 221 Cardlink 0 1.A variable x starts at 10 and follows the generalized Wiener process
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dx = a dt + b dz where time is measured in years. If a = 2 and b =3 what is the expected value after 3 years? A.12 B.14 C.16 D.18 Answer: C The drift is 2 per year and so the expected increase over three years is 2×3 = 6 and the expected value at the end of 3 years is 10+6 = 16. 222 Cardlink 0 2.A variable x starts at 10 and follows the generalized Wiener process dx = a dt + b dz where time is measured in years. If a = 3 and b =4 what is the standard deviation of the value in 4 years? A.4 B.8 C.12 D.16 Answer: B The variance per year is 42 or 16. The variance over four years is 16×4 = 64. The standard deviation is . 223 Cardlink 0 3.A variable x starts at 10 and follows the generalized Wiener process dx = a dt + b dz If a = 3 and b =4 what is the standard deviation of the value in three months? A.1 B.2
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C.3 D.4 Answer: B The variance per year is 42 or 16. The variance over three months is 16×0.25 = 4. The standard deviation is . 224 Cardlink 0 4.The variance of a Wiener process in time t is A. t B. t squared C. the square root of t D. t to the power of 4 Answer: A The variance of a Wiener process is 1 per unit time or t in time t. 225 Cardlink 0 5.The process followed by a variable X is dX = mX dt+sX dz What is the coefficient of dz in the process for the square of X. A.sX B.sX2 C.2sX2 D.msX Answer: C From Ito’s lemma, the coefficient of dz is where f = X2. Because , the coefficient of dz is 2sX2.
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226 Cardlink 0 6.The process followed by a variable X is dX = mX dt+sX dz What is the coefficient of dt in the process for the square of X. A.2mX2+s2X2 B.2mX2 C.mX2+2s2X2 D.mX2+s2X2 Answer: A From Ito’s lemma, the coefficient of dt is where f = X2. Because and the coefficient of dt is 2mX2+s2X2 227 Cardlink 0 7.Which of the following is true when the stock price follows geometric Brownian motion A.The future stock price has a normal distribution B.The future stock price has a lognormal distribution C.The future stock price has geometric distribution D.The future stock price has a truncated normal distribution Answer: B Ito’s lemma show that the log of the stock price follows a generalized Wiener process. This means that the log of the stock price is normally distributed so that the stock price is lognormally distributed.
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228 Cardlink 0 8.If a stock price follows a Markov process which of the following could be true A.Whenever the stock price has gone up for four successive days it has a 70% chance of going up on the fifth day. B.Whenever the stock price has gone up for four successive days there is almost certain to be a correction on the fifth day. C.The way the stock price moves on a day is unaffected by how it moved on the previous four days. D.Bad years for stock price returns are usually followed by good years. Answer: C A Markov process is a particular type of stochastic process where only the current value of a variable is relevant for predicting the future. Stock prices are usually assumed to follow Markov processes. This corresponds to a weak form market efficiency assumption. 229 Cardlink 0 9.A variable x starts at zero and follows the generalized Wiener process dx = a dt + b dz where time is measured in years. During the first two years a=3 and b=4. During the following three years a=6 and b=3. What is the expected value of the variable at the end of 5 years A.16 B.20 C.24 D.30 Answer: C During the first two years, the drift per year is 3 and so the total drift is 3×2 or 6. During the next three years, the drift per year is 6 and the total drift is 6×3 = 18. The total drift over the five years is 6+18 =24. Given that the variable starts at zero, its expected value at the end of the five years is therefore 24.
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230 Cardlink 0 10.A variable x starts at zero and follows the generalized Wiener process dx = a dt + b dz where time is measured in years. During the first two years a=3 and b=4. During the following three years a=6 and b=3. What the standard deviation of the value of the variable at the end of 5 years A.6.2 B.6.7 C.7.2 D.7.7 Answer: D The variance per year for the first two years is 42 or 16. The variance per year for the next three years is 32 or 9. The total variance of the change over five years is 2×16+3×9= 59. The standard deviation of the value of the variable at the end of the five years is therefore 231 Cardlink 0 11.If a variable x follows the process dx = b dz where dz is a Wiener process, which of the following is the process followed by y = exp(x). A.dy = by dz B.dy = 0.5b2y dt+by dz C.dy = (y+0.5b2y) dt+by dz D.dy = 0.5b2y dt+b dz Answer: B Ito’s lemma shows that the process followed by y is dy = 0.5b2exp(x) dt +bexp(x) dz. Substituting y = exp(x) we get the answer in B. 232 Cardlink 0 12.If the risk-free rate is r and price of a nondividend paying stock grows at rate m±with volatility s, at what rate does a forward price of the stock grow for a forward contract maturing at a future time T.
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A.m B.m−s2/2 C.m−r D.r−s2/2 Answer: C This is the application of Ito’s lemma in Section 14.6. 233 Cardlink 0 13.When a stock price, S, follows geometric Brownian motion with mean return m and volatility s what is the process follows by X where X = ln S. A.dX = m dt + s dz B.dX = (m−r) dt + s dz C.dX = (m±−s2) dt + s dz D.dX = (m − s2/2) dt + s dz Answer: D This is the example in Section 14.7 234 Cardlink 0 15.Which of the following defines an Ito process? A.A process where the drift is non-constant and can be stochastic B.A process where the coefficient of dz is non-constant and can be stochastic C.A process where either the drift or the coefficient of dz or both are non-constant and can be stochastic D.A process where proportional changes follow a generalized Wiener process
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Answer: C In a generalized Wiener process the drift and coefficient of dz are both constant. In an Ito process they are not both constant . 235 Cardlink 0 16.A stock price is $20. It has an expected return of 12% and a volatility of 25%. What is the standard deviation of the change in the price in one day. (For this question assume that there are 365 days in the year.) A.$0.20 B.$0.23 C.$0.26 D.$0.29 Answer: C The standard deviation of the change in one day is 236 Cardlink 0 17. A stock price is $20. It has an expected return of 12% and a volatility of 25%. What is the stock price that has a 2.5% chance of being exceeded in one day? (For this question assume that there are 365 days in the year.) A.$20.41 B.$20.51 C.$20.61 D.$20.71 Answer: B From the previous question the standard deviation of the change in one day is $0.26. There is a 2.5% chance that the stock price will increase by more than 1.96 standard deviations. The answer is
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therefore 20+1.96×0.26 = $20.51. The expected return in one day is small and can be ignored. 237 Cardlink 0 18.Which of the following is NOT a property of a Wiener process? A.The change during a short period of time dt has a variance dt B.The changes in two different short periods of time are independent C.The mean change in any time period is zero D.The standard deviation over two consecutive time periods is the sum of the standard deviations over each of the periods Answer D Variances of Wiener processes are additive but standard deviations are not. 238 Cardlink 0 19. If e is a random sample from a standard normal distribution, which of the following is the change in a Wiener process in time dt . A.e times the square root of dt B.e times dt C.dt times the square root of e D.The square root of e times the square root of dt Answer: A The change is . This result is used when the process is simulated.
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239 Cardlink 0 20. For what value of the correlation between two Wiener processes is the sum of the processes also a Wiener process? A.0.5 B.−0.5 C.0 D.1 Answer: B The variance of each process is 1 per unit time. The variance of the sum is 1+1+2±±where ±±is the correlation. This is 1 when ±=−0.5. Deutsch English
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu An investor sells a futures contract an asset when the futures price is $1,500. Each contract is on 100 units of the as- set. The contract is closed out when the futures price is $1,540. Which of the fol- lowing is true The investor has made a gain of $4,000 The investor has made a loss of $4,000 The investor has made a gain of $2,000 The investor has made a loss of $2,000 The investor has made a loss of $4,000 In contrast to contingent claims, forward commitments provide the: right to buy or sell the underlying asset in the future. obligation to buy or sell the underlying asset in the future. promise to provide credit protection in the event of default. obligation to buy or sell the underlying asset in the future. Compared with the underlying spot mar- ket, derivative markets are more likely to have: greater liquidity. higher transaction costs. higher capital requirements. greater liquidity. Derivative markets typically have greater liquidity than the underlying spot market as a result of the lower capital required to trade derivatives compared with the underlying. Derivatives also have lower transaction costs and lower capital re- quirements than the underlying. The law of one price is best described as: the true fundamental value of an asset. earning a risk-free profit without commit- ting any capital. two assets that will produce the same cash flows in the future must sell for equivalent prices. two assets that will produce the same cash flows in the future must sell for equivalent prices. 1 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu An interest rate swap is a derivative con- tract in which: two parties agree to exchange a series of cash flows. the credit seller provides protection to the credit buyer. the buyer has the right to purchase the underlying from the seller. two parties agree to exchange a series of cash flows. "two parties" is correct. An interest rate swap is defined as a derivative in which two parties agree to exchange a series of cash flows: One set of cash flows is vari- able, and the other set can be variable or fixed. "the credit seller ..." is incorrect because a credit derivative is a derivative contract in which the credit protection seller provides protection to the credit protection buyer. Choice "the buyer ..." is incorrect because a call option, not a swap, gives the buyer the right to pur- chase the underlying from the seller. Which of the following is approximately true when size is measured in terms of the underlying principal amounts or val- ue of the underlying assets The exchange-traded market is twice as big as the over-the-counter market. The over-the-counter market is twice as big as the exchange-traded market. The exchange-traded market is ten times as big as the over-the-counter market. The over-the-counter market is ten times as big as the exchange-traded market. The over-the-counter market is ten times as big as the exchange-traded market. Which of the following is the best exam- ple of a derivative? A global equity mutual fund A non-callable government bond A contract to purchase Apple Computer at a fixed price A contract to purchase Apple Computer at a fixed price Mutual funds and government bonds are *not* derivatives. A government bond is a fundamental asset on which derivatives might be created, but it is not a derivative itself. A mutual fund can technically meet the definition of a derivative, it's value is determined by the value of the "under- 2 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu lying"stocks it contains, but derivatives transform the value of a payoff of an un- derlying asset. Mutual funds merely pass those payoffs through to their holders. Which of the following characteristics is not associated with exchange-traded de- rivatives? Margin or performance bonds are re- quired. The exchange guarantees all payments in the event of default. All terms except the price are cus- tomized to the parties' individual needs. All terms except the price are customized to the parties' individual needs. Exchange-traded contracts are stan- dardized, meaning that the exchange de- termines the terms of the contract ex- cept the price. The exchange guarantees against default and requires margins or performance bonds. Which of the following statements most accurately describes exchange-traded derivatives relative to over-the-counter derivatives? Exchange-traded deriva- tives are more likely to have: greater credit risk. standardized contract terms. greater risk management uses. standardized contract terms. Standardization of contract terms is a characteristic of exchange-traded deriv- atives. Credit risk is well-controlled in ex- change markets. Risk management uses are not limited by being traded over the counter. Which of the following characteristics is least likely to be a benefit associated with using derivatives? More effective management of risk Payoffs similar to those associated with the underlying Greater opportunities to go short com- pared with the spot market Payoffs similar to those associated with the underlying 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. The breakeven stock price below which $20 When the stock price is $20 the two call options provide no payoff. The put option provides a payoff of 3020 or $10. The 3 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu the trader makes a profit is $25 $28 $26 $20 total cost of the options is 2×3+ 4 or $10. The stock price in D, $20, is therefore the breakeven stock price below which the position is profitable because it is the price for which the cost of the options equals the payoff. A derivative is best described as a fi- nancial instrument that derives its perfor- mance by: passing through the returns of the under- lying. replicating the performance of the under- lying. transforming the performance of the un- derlying. transforming the performance of the un- derlying. Answer "transforming the performance of the underlying" is correct. A deriva- tive is a financial instrument that trans- forms the performance of the underlying. The transformation of performance func- tion of derivatives is what distinguishes it from mutual funds and exchange traded funds that pass through the returns of the underlying. Answer "passing through ..." is incorrect because derivatives, in contrast to mutual funds and exchange traded funds, do not simply pass through the returns of the underlying at payout. Answer "replicating the ..." is incorrect because a derivative transforms rather than replicates the performance of the underlying Exchange-traded derivatives are: largely unregulated. traded through an informal network. guaranteed by a clearinghouse against default. guaranteed by a clearinghouse against default. A trader has a portfolio worth $5 million that mirrors the performance of a stock index. The stock index is currently 1,250. Futures contracts trade on the index with one contract being on 250 times the in- dex. To remove market risk from the port- folio the trader should Sell 16 contracts 4 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu Buy 16 contracts Sell 16 contracts Buy 20 contracts Sell 20 contracts Which of the following derivatives is least likely to have a value of zero at initiation of the contract? Futures Options Forwards Options "Options" is correct. The buyer of the option pays the option premium to the seller of the option at the initiation of the contract. The option premium represents the value of the option, whereas futures and forwards have a value of zero at the initiation of the contract. Answer "futures" is incorrect because no money changes hands between parties at the initiation of the futures contract, thus the value of the futures contract is zero at initiation. Same for forwards. Which of the following is *not* a charac- teristic of a derivative An underlying A low degree of leverage Two parties - a buyer and a seller A low degree of leverage All derivatives have an underlying and must have a buyer and a seller. More im- portantly, derivatives have high degrees of leverage, not low degrees of leverage. 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 $700 $500 $300 $600 $300 Which of the following best describes the term "spot price" The price for immediate delivery The price for delivery at a future time The price for immediate delivery 5 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu The price of an asset that has been dam- aged The price of renting an asset Which of the following is NOT true A call option gives the holder the right to buy an asset by a certain date for a certain price A put option gives the holder the right to sell an asset by a certain date for a certain price The holder of a call or put option must exercise the right to sell or buy an asset The holder of a forward contract is oblig- ated to buy or sell an asset The holder of a call or put option must exercise the right to sell or buy an asset A company knows it will have to pay a certain amount of a foreign currency to one of its suppliers in the future. Which of the following is true? A forward contract can be used to lock in the exchange rate A forward contract will always give a bet- ter outcome than an option An option will always give a better out- come than a forward contract An option can be used to lock in the exchange rate A forward contract can be used to lock in the exchange rate The price of a stock on February 1 is $84. A trader buys 200 put options on the stock with a strike price of $90 when the option price is $10. The options are exercised when the stock price is $85. The trader's net profit or loss is Loss of $1,000 Loss of $2,000 Loss of $1,000 The payoff is 9085 or $5 per option. For 200 options the payoff is therefore 5×200 or $1000. However the options cost 10×200 or $2000. There is therefore a net loss of $1000 6 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu Gain of $200 Gain of $1000 Which of the following derivatives pro- vide payoffs that are non-linearly related to the payoffs of the underlying? Options Forwards Interest rate swaps Options "Options" is correct. Options are clas- sified as a contingent claim which pro- vides payoffs that are non-linearly relat- ed to the performance of the underlying. "Forwards" is incorrect because forwards are classified as a forward commitment, which provides payoffs that are linearly related to the performance of the under- lying. "Interest rate swaps" is incorrect because interest-rate swaps are classi- fied as a forward commitment, which pro- vides payoffs that are linearly related to the performance of the underlying. Which of the following describes Euro- pean options? Sold in Europe Priced in Euros Exercisable only at maturity Calls (there are no European puts) Exercisable only at maturity A short forward contract on an asset plus a long position in a European call option on the asset with a strike price equal to the forward price is equivalent to A short position in a call option A short position in a put option A long position in a put option None of the others A long position in a put option A credit derivative is a derivative contract in which the: clearinghouse provides a credit guaran- tee to both the buyer and the seller. seller provides protection to the buyer against the credit risk of a third party. seller provides protection to the buyer against the credit risk of a third party. 7 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu the buyer and seller provide a perfor- mance bond at initiation of the contract. 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 Gain of $1,000 Loss of $2,000 Loss of $2,800 Loss of $1,000 Loss of $1,000 The payoff that must be made on the options is 200×(120110) or $2000. The amount received for the options is 5×200 or $1000. The net loss is therefore 20001000 or $1000. Which of the following derivatives is clas- sified as a contingent claim? Futures contracts Interest rate swaps Credit default swaps Credit default swaps Which of the following is most likely to be a destabilizing consequence of specula- tion using derivatives? Increased defaults by speculators and creditors Market price swings resulting from arbi- trage activities The creation of trading strategies that result in asymmetric performance Increased defaults by speculators and creditors The benefits of derivatives, such as low transaction costs, low capital require- ments, use of leverage, and the ease in which participants can go short, also can result in excessive speculative trad- ing. These activities can lead to defaults on the part of speculators and creditors. Arbitrage activities tend to bring about a convergence of prices to intrinsic val- ue. Asymmetric performance is not itself destabilizing. Market makers earn a profit in both ex- change and over-the-counter derivatives markets by: charging a commission on each trade. a combination of commissions and buying at one price, selling at a higher price, and hedging any risk. Market makers buy at one price (the bid), sell at a higher price (the ask), and 8 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu markups. buying at one price, selling at a higher price, and hedging any risk. hedge whatever risk they otherwise as- sume. Market makers do not charge a commission. Which of the following statements about derivatives is *not* true? They are created in the spot market. They are used in the practice of risk man- agement. They take their values from the value of something else. They are created in the spot market. Derivatives are used to practice risk management and they take (derive) their values from the value of something else, the underlying. They are not created in the spot market, which is where the un- derlying trades. 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. The breakeven stock price above which the trader makes a profit is: $35 $40 $30 $36 $35 The price of a stock on February 1 is $48. A trader sells 200 put options on the stock with a strike price of $40 when the option price is $2. The options are exercised when the stock price is $39. The trader's net profit or loss is Loss of $800 Loss of $200 Gain of $200 Loss of $900 Gain of $200 Arbitrage opportunities exist when: two identical assets or derivatives sell for different prices. combinations of the underlying asset and a derivative earn the risk-free rate. arbitrageurs simultaneously buy two identical assets or derivatives sell for different prices. 9 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu takeover targets and sell takeover ac- quirers. A one-year forward contract is an agree- ment where One side has the right to buy an asset for a certain price in one year's time. One side has the obligation to buy an asset for a certain price in one year's time. One side has the obligation to buy an asset for a certain price at some time during the next year. One side has the obligation to buy an asset for the market price in one year's time. One side has the obligation to buy an asset for a certain price in one year's time. A one-year forward contract is an obliga- tion to buy or sell in one year's time for a predetermined price. By contrast, an option is the right to buy or sell. Which of the following best describes a central clearing party It is a trader that works for an exchange It stands between two parties in the over-the-counter market It is a trader that works for a bank It helps facilitate futures trades It stands between two parties in the over-the-counter market Which of the following is NOT true about call and put options: An American option can be exercised at any time during its life A European option can only be exercised only on the maturity date Investors must pay an upfront price (the option premium) for an option contract The price of a call option increases as the strike price increases The price of a call option increases as the strike price increases Which of the following characteristics is associated with over-the-counter deriva- tives? They are less transparent than ex- change-listed derivatives. OTC derivatives have a lower degree of transparency than exchange-listed deriv- 10 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu Trading occurs in a central location. They are more regulated than ex- change-listed derivatives. They are less transparent than ex- change-listed derivatives. atives. Trading does not occur in a central location but, rather, is quite dispersed. Al- though new national securities laws are tightening the regulation of OTC deriv- atives, the degree of regulation is less than that of exchange-listed derivatives. Forward commitments subject to default are: forwards and futures. futures and interest rate swaps. interest rate swaps and forwards. interest rate swaps and forwards. Choice "interest rate swaps and for- wards" is correct. Interest rate swaps and forwards are over-the-counter con- tracts that are privately negotiated and are both subject to default. Futures con- tracts are traded on an exchange, which provides a credit guarantee and pro- tection against default. Futures are ex- change-traded contracts which provide daily settlement of gains and losses and a credit guarantee by the exchange through its clearinghouse. Which of the following is true about a long forward contract The contract becomes more valuable as the price of the asset declines The contract becomes more valuable as the price of the asset rises The contract is worth zero if the price of the asset declines after the contract has been entered into The contract is worth zero if the price of the asset rises after the contract has been entered into The contract becomes more valuable as the price of the asset rises Compared with exchange-traded deriva- tives, over-the-counter derivatives would most likely be described as: standardized. less transparent. more transparent. less transparent. 11 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu A haircut of 20% means that A bond with a market value of $100 is considered to be worth $80 when used to satisfy a collateral request A bond with a face value of $100 is con- sidered to be worth $80 when used to satisfy a collateral request A bond with a market value of $100 is considered to be worth $83.3 when used to satisfy a collateral request A bond with a face value of $100 is con- sidered to be worth $83.3 when used to satisfy a collateral request A bond with a market value of $100 is considered to be worth $80 when used to satisfy a collateral request 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 This flexibility tends increase the futures price. This flexibility tends decrease the futures price. This flexibility may increase and may de- crease the futures price. This flexibility has no effect on the futures price This flexibility tends decrease the futures price. One futures contract is traded where both the long and short parties are clos- ing out existing positions. What is the resultant change in the open interest? No change Decrease by one Decrease by two Decrease by one 12 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu Increase by one Which of the following best describes central clearing parties Help market participants to value deriva- tive transactions Must be used for all OTC derivative transactions Are used for futures transactions Perform a similar function to exchange clearing houses Perform a similar function to exchange clearing houses You sell one December futures contracts when the futures price is $1,010 per unit. Each contract is on 100 units and the initial margin per contract that you pro- vide is $2,000. The maintenance margin per contract is $1,500. During the next day the futures price rises to $1,012 per unit. What is the balance of your margin account at the end of the day? $1,800 $3,300 $2,200 $3,700 $1,800 Which of the following are cash settled All futures contracts All option contracts Futures on commodities Futures on stock indices Futures on stock indices The frequency with which margin ac- counts are adjusted for gains and losses is Daily Daily 13 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu Weekly Monthly Quarterly A speculator takes a long position in a futures contract on a commodity on No- vember 1, 2012 to hedge an exposure on March 1, 2013. The initial futures price is $60. On December 31, 2012 the fu- tures price is $61. On March 1, 2013 it is $64. The contract is closed out on March 1, 2013. What gain is recognized in the accounting year January 1 to December 31, 2013? Each contract is on 1000 units of the commodity. $0 $1,000 $3,000 $4,000 $3,000 Which of the following is true? Both forward and futures contracts are traded on exchanges. Forward contracts are traded on ex- changes, but futures contracts are not. Futures contracts are traded on ex- changes, but forward contracts are not. Neither futures contracts nor forward contracts are traded on exchanges. Futures contracts are traded on ex- changes, but forward contracts are not. A company enters into a long futures contract to buy 1,000 units of a com- modity for $60 per unit. The initial margin is $6,000 and the maintenance margin is $4,000. What futures price will allow $2,000 to be withdrawn from the margin $62 14 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu account? $58 $62 $64 $66 Which entity in the United States takes primary responsibility for regulating fu- tures market? Federal Reserve Board Commodities Futures Trading Commis- sion (CFTC) Security and Exchange Commission (SEC) US Treasury Commodities Futures Trading Commis- sion (CFTC) A hedger takes a long position in a fu- tures contract on a commodity on No- vember 1, 2012 to hedge an exposure on March 1, 2013. The initial futures price is $60. On December 31, 2012 the fu- tures price is $61. On March 1, 2013 it is $64. The contract is closed out on March 1, 2013. What gain is recognized in the accounting year January 1 to December 31, 2013? Each contract is on 1000 units of the commodity. $0 $1,000 $3,000 $4,000 $4,000 A company enters into a short futures contract to sell 50,000 units of a com- modity for 70 cents per unit. The initial margin is $4,000 and the maintenance margin is $3,000. What is the futures price per unit above which there will be a 72 cents Margin call when $1000 or more has been lost 15 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu margin call? 78 cents 76 cents 74 cents 72 cents Because the company is short, each one cent rise in the price leads to a loss of 0.01x50,000 = $500 Margin accounts have the effect of Reducing the risk of one party regretting the deal and backing out Ensuring funds are available to pay traders when they make a profit Reducing systemic risk due to collapse of futures markets All the answers All the answers Which of the following is NOT true Futures contracts nearly always last longer than forward contracts Futures contracts are standardized; for- ward contracts are not. Delivery or final cash settlement usually takes place with forward contracts; the same is not true of futures contracts. Forward contracts usually have one specified delivery date; futures contract often have a range of delivery dates. Futures contracts nearly always last longer than forward contracts For a futures contract trading in April 2012, the open interest for a June 2012 contract, when compared to the open in- terest for Sept 2012 contracts, is usually Higher Lower The same Equally likely to be higher or lower Higher Who initiates delivery in a corn futures contract 16 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu The party with the long position The party with the short position Either party The exchange The party with the short position On a particular day, there were 2,000 trades in a particular futures contract. This means that there were 2000 buy- ers (going long) and 2000 sellers (going short). Of the 2,000 buyers, 1,400 were closing out positions and 600 were enter- ing into new positions. Of the 2,000 sell- ers, 1,200 were closing out positions and 800 were entering into new positions. What is the impact of the day's trading on open interest? down by 1200 down by 1400 up by 800 down by 600 down by 600 The open interest went down by 600. We can see this in two ways. First, 1,400 shorts closed out and there were 800 new shorts. Second, 1,200 longs closed out and there were 600 new longs. A company enters into a short futures contract to sell 5,000 bushels of wheat for 750 cents per bushel. The initial mar- gin is $3,000 and the maintenance mar- gin is $2,000. What price change would lead to a margin call? Price up by 30 cents Price down by 20 cents Price up by 20 cents Price down by 25 cents Price up by 20 cents The open interest usually decline during the month preceding the delivery month. True False True Open interest is the number of contract outstanding. Many traders close out their positions just before the delivery month is reached. This is why the open interest 17 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu declines during the month preceding the delivery month. Trader A enters into futures contracts to buy 1 million euros for 1.1 million dollars in three months. Trader B enters in a forward contract to do the same thing. The exchange rate (dollars per euro) de- clines sharply during the first two months and then increases for the third month to close at 1.1300. Which of the following in NOT true. Trader A's profit is realized day-by-day during the three months. Substantial losses are made during the first two months and profits are made during the final month. The total profit of each trader in dollars is $3,000. Trader B's profit is realized at the end of the three months. It is likely that Trader B has done better because Trader A had to finance its loss- es during the first two months. The total profit of each trader in dollars is $3,000. Suppose that there are no storage costs for crude oil and the interest rate for borrowing or lending is 4% per annum. Could you make money risk free if the June and December futures contracts for a particular year trade at $50 and $56? True False True You could go long one June oil con- tract and short one December contract. In June you take delivery of the oil bor- rowing $50 per barrel at 4% to meet cash outflows. The interest accumulated in six months is about 50×0.04×1/2 or $1 per barrel. In December the oil is sold for $56 per barrel which is more than the $51 that has to be repaid on the loan. The strategy therefore leads to a profit. Note that this profit is independent of the actual price of oil in June and December. It will be 18 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu slightly affected by the daily settlement procedures. A company has derivatives transactions with Banks A, B, and C which are worth +$20 million, $15 million, and $25 mil- lion, respectively to the company. How much margin or collateral does the com- pany have to provide? The transactions are cleared bilaterally and are subject to one-way collateral agreements where the company posts variation margin, but no initial margin. The banks do not have to post collateral. $20 million $10 million $60 million $40 million $30 million $40 million If the transactions are cleared bilaterally, the company has to provide collateral to Banks A, B, and C of (in millions of dollars) 0, 15, and 25, respectively. The total collateral required is $40 million. If the transactions are cleared centrally they are netted against each other and the company's total variation margin (in millions of dollars) is -20 + 15 + 25 or $20 million in total. The total margin required (including the initial margin) is therefore $30 million. A company has derivatives transactions with Banks A, B, and C which are worth +$20 million, $15 million, and $25 mil- lion, respectively to the company. How much margin or collateral does the com- pany have to provide? The transactions are cleared bilaterally and are subject to one-way collateral agreements where the company posts variation margin, but no initial margin. The transactions are cleared centrally through the same CCP and the CCP requires a total initial mar- gin of $10 million. $20 million $10 million $60 million $40 million $30 million $30 million If the transactions are cleared bilaterally, the company has to provide collateral to Banks A, B, and C of (in millions of dollars) 0, 15, and 25, respectively. The total collateral required is $40 million. If the transactions are cleared centrally they are netted against each other and the company's total variation margin (in millions of dollars) is -20 + 15 + 25 or $20 million in total. The total margin required (including the initial margin) is therefore $30 million. 19 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu The forward price on the Swiss franc for delivery in 45 days is quoted as 1.1000. The futures price for a contract that will be delivered in 45 days is 0.9000. Ex- plain these two quotes. Which is more fa- vorable for a trader wanting to sell Swiss francs? The forward market is more attractive for a trader wanting to sell Swiss francs. The futures market is more attractive for a trader wanting to sell Swiss francs. The forward and futures market are equally attractive for a trader wanting to sell Swiss francs. The Swiss frank is expected to decline relative to the US dollar. The forward market is more attractive for a trader wanting to sell Swiss francs. 1) The forward price on the Swiss franc for delivery in 45 days is quoted as 1.1000. Here, The 1.1000 forward quote is the number of Swiss francs per dollar. 2) The futures price for a contract that will be delivered in 45 days is 0.9000. But here, The 0.9000 futures quote is the number of dollars per Swiss franc. so, if we quote forward price in the same way of futures price then, =1/1.1000 =0.9091 Therefore Swiss francs is more valu- able in the forward market than futures market. Therefore the forward market is more favorable for a trader wanting to sell Swiss francs. .9091 is more favorable because the trader can get more units of USD for each unit of francs when using the forward contract A speculator sells a July 2013 wheat fu- tures contract at 721 cents per bushel. Each futures contract is for 5,000 bushels. The futures price drops to 676 on December 31, 2012 and rises to 712 in May 2013 when she closes the con- tract. What is the gain or loss for account- ing purposes in 2013? $45,000 gain $45,000 loss $225,000 gain $180,000 loss $180,000 gain $180,000 loss 20 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu In July 2012, a small chocolate factory receives a large order for chocolate bars to be delivered in November. The spot price for Cocoa is $2,400 per metric ton. It will need 10 metric tons of Cocoa in September to fill this order. Because of limited storage capacity and volatility in the world cocoa prices, the company de- cides the best strategy is to buy 10 call options for $53 each with strike price of $2,400 (equal to the current price) with a maturity date of September 2012. When the options expire in September, how much will the company pay (including the cost of the options) for cocoa if the spot price in September proves to be $2,600 $22,470 $23,000 $24,530 $23,530 $23,470 $24,530 In July 2012, a small chocolate factory receives a large order for chocolate bars to be delivered in November. The spot price for Cocoa is $2,400 per metric ton. It will need 10 metric tons of Cocoa in September to fill this order. Because of limited storage capacity and volatility in the world cocoa prices, the company de- cides the best strategy is to buy 10 call options for $53 each with strike price of $2,400 (equal to the current price) with a maturity date of September 2012. When the options expire in September, how much will the company pay (including the cost of the options) for cocoa if the spot price in September proves to be $2,300. $23,530 21 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu $23,000 $23,530 $24,530 $22,470 $23,470 A company has a $36 million portfolio with a beta of 1.2. The index futures price is 900. Futures contracts on $250 times the index can be traded. What trade is necessary to increase beta to 1.8? Long 192 contracts Short 192 contracts Long 96 contracts Short 96 contracts Long 96 contracts Which of the following does NOT de- scribe beta? A measure of the sensitivity of the return on an asset to the return on an index The slope of the best fit line when the return on an asset is regressed against the return on the market The hedge ratio necessary to remove market risk from a portfolio Measures correlation between futures prices and spot prices Measures correlation between futures prices and spot prices Which of the following is true? Gold producers should always hedge the price they will receive for their production of gold over the next three years Gold producers should always hedge the price they will receive for their production of gold over the next one year The hedging strategies of a gold produc- er should depend on whether it share- The hedging strategies of a gold produc- er should depend on whether it share- holders want exposure to the price of gold 22 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu holders want exposure to the price of gold Gold producers can hedge by buying gold in the forward market Which of the following is a reason for hedging a portfolio with an index futures? The investor believes the stocks in the portfolio will perform better than the mar- ket but is uncertain about the future per- formance of the market The investor believes the stocks in the portfolio will perform better than the mar- ket and the market is expected to do well The portfolio is not well diversified and so its return is uncertain All The investor believes the stocks in the portfolio will perform better than the mar- ket but is uncertain about the future per- formance of the market Futures contracts trade with every month as a delivery month. A company is hedg- ing the purchase of the underlying as- set on June 15. Which futures contract should it use? The June contract The July contract The May contract The August contract The July contract Which of the following increases basis risk? A large difference between the futures prices when the hedge is put in place and when it is closed out Dissimilarity between the underlying as- 23 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu set of the futures contract and the hedgerâ s exposure A reduction in the time between the date when the futures contract is closed and its delivery month None of the other Dissimilarity between the underlying as- set of the futures contract and the hedger's exposure The basis is defined as spot minus fu- tures. A trader is hedging the sale of an asset with a short futures position. The basis increases unexpectedly. Which of the following is true? The hedgerâ s position improves. The hedgerâ s position worsens. The hedgerâ s position sometimes wors- ens and sometimes improves. The hedgerâ s position stays the same. The hedgerâ s position improves. The price received by the trader is the futures price plus the basis. It follows that the trader's position improves when the basis increases. Net amount received: S2 + (F1 - F2) Which of the following is true? Hedging can always be done more easily by a company's shareholders than by the company itself If all companies in an industry hedge, a company in the industry can sometimes reduce its risk by choosing not to hedge If all companies in an industry do not hedge, a company in the industry can reduce its risk by hedging If all companies in an industry do not hedge, a company is liable increase its risk by hedging If all companies in an industry do not hedge, a company is liable increase its risk by hedging A silver mining company has used fu- tures markets to hedge the price it will 24 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu receive for everything it will produce over the next 5 years. Which of the following is true? It is liable to experience liquidity prob- lems if the price of silver falls dramatical- ly It is liable to experience liquidity prob- lems if the price of silver rises dramati- cally It is liable to experience liquidity prob- lems if the price of silver rises dramati- cally or falls dramatically The operation of futures markets pro- tects it from liquidity problems It is liable to experience liquidity prob- lems if the price of silver rises dramati- cally A company will buy 1000 units of a cer- tain commodity in one year. It decides to hedge 80% of its exposure using futures contracts. Spot price and futures price are currently $100 and $90. The one year futures price of the commodity is $90. If the spot price and the futures price in one year turn out to be $112 and $110, respectively. What is the average price paid for the commodity? $92 $96 $102 $106 $96 Hedged portion price: S2 - (F2 - F1) = $112 - ($110 - $90) = $92 Unhedged portion price: $112 ($92 x .8) + ($112 x .2) = $96 Which of the following best describes the capital asset pricing model? Determines the amount of capital that is needed in particular situations 25 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu Is used to determine the price of futures contracts Relates the return on an asset to the return on a stock index Is used to determine the volatility of a stock index Relates the return on an asset to the return on a stock index Which of the following is true? The optimal hedge ratio is the slope of the best fit line when the spot price (on the y-axis) is regressed against the fu- tures price (on the x-axis). The optimal hedge ratio is the slope of the best fit line when the futures price (on the y-axis) is regressed against the spot price (on the x-axis). The optimal hedge ratio is the slope of the best fit line when the change in the spot price (on the y-axis) is regressed against the change in the futures price (on the x-axis). The optimal hedge ratio is the slope of the best fit line when the change in the futures price (on the y-axis) is regressed against the change in the spot price (on the x-axis). The optimal hedge ratio is the slope of the best fit line when the change in the spot price (on the y-axis) is regressed against the change in the futures price (on the x-axis). A company has a $36 million portfolio with a beta of 1.2. The index futures price is 900. Futures contracts on $250 times the index can be traded. What trade is necessary to reduce beta to 0.9? Long 192 contracts Short 192 contracts Short 48 contracts 26 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu Long 48 contracts Short 48 contracts On March 1 a commodity's spot price is $60 and its August futures price is $59. On July 1 the spot price is $64 and the August futures price is $63.50. A com- pany entered into futures contracts on March 1 to hedge its purchase of the commodity on July 1. It closed out its position on July 1. What is the effective price (after taking account of hedging) paid by the company? $59.50 $60.50 $61.50 $63.50 $59.50 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 con- tracts 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? $1,016 $1,001 $981 $1,014 $1,014 A company due to pay a certain amount of a foreign currency in the future de- cides to hedge with futures contracts. Which of the following best describes the 27 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu advantage of hedging? It leads to a better exchange rate being paid It leads to a more predictable exchange rate being paid It caps the exchange rate that will be paid It provides a floor for the exchange rate that will be paid It leads to a more predictable exchange rate being paid Suppose that the standard deviation of monthly changes in the price of com- modity A is $2. The standard deviation of monthly changes in a futures price for a contract on commodity B (which is similar to commodity A) is $3. The cor- relation between the futures price and the commodity price is 0.9. What hedge ratio should be used when hedging a one month exposure to the price of commod- ity A? 0.60 0.67 1.45 0.90 0.60 Beta * (SD of change in price / SD of change in futures price) Which of the following best describes â stack and rollâ ? Creates long-term hedges from short term futures contracts Can avoid losses on futures contracts by entering into further futures contracts Involves buying a futures contract with one maturity and selling a futures con- tract with a different maturity Involves two different exposures simulta- neously Creates long-term hedges from short term futures contracts 28 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu Which of the following is true for a con- sumption commodity? There is no limit to how high or low the futures price can be, except that the fu- tures price cannot be negative There is a lower limit to the futures price but no upper limit There is an upper limit to the futures price but no lower limit, except that the futures price cannot be negative The futures price can be determined with reasonable accuracy from the spot price and interest rates There is an upper limit to the futures price but no lower limit, except that the futures price cannot be negative The spot price of an investment asset is $30 and the risk-free rate for all maturi- ties is 10% with continuous compound- ing. The asset provides an income of $2 at the end of the first year and at the end of the second year. What is the three-year forward price? $19.67 $35.84 $45.15 $40.50 $35.84 Income to subtract: 2*e^(-.1*1) + 2*e^(-.1*2) = $3.45 F0: ($30-$3.45)*e^(.1*3) = 35.84 Which of the following describes the way the futures price of a foreign currency is quoted? The number of U.S. dollars per unit of the foreign currency The number of the foreign currency per U.S. dollar Some futures prices are always quoted as the number of U.S. dollars per unit The number of U.S. dollars per unit of the foreign currency 29 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu of the foreign currency and some are always quoted the other way round There are no quotation conventions for futures prices Which of the following describes the way the forward price of a foreign currency is quoted? The number of U.S. dollars per unit of the foreign currency The number of the foreign currency per U.S. dollar Some forward prices are always quoted as the number of U.S. dollars per unit of the foreign currency and some are always quoted the other way round There are no quotation conventions for forward prices Some forward prices are always quoted as the number of U.S. dollars per unit of the foreign currency and some are always quoted the other way round Which of the following is true? The convenience yield is always positive or zero. The convenience yield is always positive for an investment asset. The convenience yield is always nega- tive for a consumption asset. The convenience yield measures the av- erage return earned by holding futures contracts. The convenience yield is always positive or zero. As the convenience yield increases, which of the following is true? The one-year futures price as a percent- age of the spot price increases 30 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu The one-year futures price as a percent- age of the spot price decreases The one-year futures price as a percent- age of the spot price stays the same Any of the above can happen The one-year futures price as a percent- age of the spot price decreases An investor shorts 100 shares when the share price is $50 and closes out the position six months later when the share price is $43. The shares pay a dividend of $3 per share during the six months. How much does the investor gain? $1,000 $400 $700 $300 $400 (100 * 50) - (100 * 43) - (100 * 3) = 400 A short forward contract that was ne- gotiated some time ago will expire in three months and has a delivery price of $40. The current forward price for three-month forward contract is $42. The three month risk-free interest rate (with continuous compounding) is 8%. What is the value of the short forward contract? +$2.00 -$2.00 +$1.96 -$1.96 -$1.96 (40-42)*e^(-.08 * 3/12) = -1.96 Which of the following describes contan- go? The futures price is below the expected future spot price The futures price is below todayâ s spot The futures price is above the expected future spot price 31 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu price The futures price is a declining function of the time to maturity The futures price is above the expected future spot price Which of the following is a consumption asset? The S&P 500 index The Canadian dollar Copper IBM stock Copper As inventories of a commodity decline, which of the following is true? The one-year futures price as a percent- age of the spot price increases The one-year futures price as a percent- age of the spot price decreases The one-year futures price as a percent- age of the spot price stays the same Any of the above can happen The one-year futures price as a percent- age of the spot price decreases ^^ Because storage costs included in the futures will reduce Which of the following is NOT true? Gold and silver are investment assets Investment assets are held by significant numbers of investors for investment pur- poses Investment assets are never held for consumption The forward price of an investment asset can be obtained from the spot price, in- terest rates and the income paid on the asset Investment assets are never held for con- sumption An exchange rate is 0.7000 and the six-month domestic and foreign risk-free 32 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu interest rates are 5% and 7% (both ex- pressed with continuous compounding). What is the six-month forward rate? 0.7070 0.7177 0.7249 0.6930 0.6930 .7000 * e^((.05 - .07) * (6/12)) = .6930 Which of the following is an argument used by Keynes and Hicks? If hedgers hold long positions and spec- ulators holds short positions, the futures price will tend to be higher than expected future spot prices If hedgers hold long positions and spec- ulators holds short positions, the futures price will tend to be lower than expected future spot prices If hedgers hold long positions and spec- ulators holds short positions, the futures price will tend to be lower than todayâ s spot prices If hedgers hold long positions and spec- ulators holds short positions, the futures price will tend to be higher than todayâ s spot prices If hedgers hold long positions and spec- ulators holds short positions, the futures price will tend to be higher than expected future spot prices Which of the following is NOT a reason why a short position in a stock is closed out? The investor with the short position chooses to close out the position The lender of the shares issues instruc- tions to close out the position The broker is no longer able to borrow shares from other clients The lender of the shares issues instruc- tions to close out the position 33 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu The investor does not maintain margins required on his/her margin account Which of the following describes a known dividend yield on a stock? The size of the dividend payments each year is known Dividends per year as a percentage of todayâ s stock price are known Dividends per year as a percentage of the stock price at the time when divi- dends are paid are known Dividends will yield a certain return to a person buying the stock today Dividends per year as a percentage of the stock price at the time when divi- dends are paid are known Which of the following is NOT true about forward and futures contracts? Forward contracts are more liquid than futures contracts The futures contracts are traded on exchanges while forward contracts are traded in the over-the-counter market In theory forward prices and futures prices are equal when there is no uncer- tainty about future interest rates Taxes and transaction costs can lead to forward and futures prices being different Forward contracts are more liquid than futures contracts What should a trader do when the one-year forward price of an asset is too low? Assume that the asset provides no income. The trader should borrow the price of the asset, buy one unit of the asset and enter into a short forward contract to sell the 34 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu asset in one year. The trader should borrow the price of the asset, buy one unit of the asset and enter into a long forward contract to buy the asset in one year. The trader should short the asset, invest the proceeds of the short sale at the risk-free rate, enter into a short forward contract to sell the asset in one year The trader should short the asset, invest the proceeds of the short sale at the risk-free rate, enter into a long forward contract to buy the asset in one year The trader should short the asset, invest the proceeds of the short sale at the risk-free rate, enter into a long forward contract to buy the asset in one year The spot price of an investment asset that provides no income is $30 and the risk-free rate for all maturities (with con- tinuous compounding) is 10%. What is the three-year forward price? $40.50 $22.22 $33.00 $33.16 $40.50 The spot price of an asset is positively correlated with the market. Which of the following would you expect to be true? The forward price equals the expected future spot price. The forward price is greater than the ex- pected future spot price. The forward price is less than the expect- ed future spot price. The forward price is less than the expect- ed future spot price. 35 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu The forward price is sometimes greater and sometimes less than the expected future spot price. Assume an asset pays no dividends or interest, and also assume that the asset does not yield any non-financial benefits or incur any carrying cost. At initiation, the price of a forward contract on that asset is: lower than the value of the contract. equal to the value of the contract. greater than the value of the contract. greater than the value of the contract. At the initiation of a forward contract on an asset that neither receives benefits nor incurs carrying costs during the term of the contract, the forward price is equal to the: spot price. future value of the spot price. present value of the spot price. future value of the spot price. If the present value of storage costs ex- ceeds the present value of its conve- nience yield, then the commodity's for- ward price is most likely: less than the spot price compounded at the risk-free rate. the same as the spot price compounded at the risk-free rate. higher than the spot price compounded at the risk-free rate. higher than the spot price compounded at the risk-free rate. 36 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu An arbitrage transaction generates a net inflow of funds: throughout the holding period. at the end of the holding period. at the start of the holding period. at the start of the holding period. Arbitrage is a type of transaction under- taken when two assets or portfolios pro- duce identical results but sell for different prices. A trader buys the asset or port- folio with the lower price and sells the asset or portfolio with the higher price, generating a net inflow of funds at the start of the holding period. Because the two assets or portfolios produce identical results, a long position in one and short position in the other means that at the end of the holding period, the payoffs off- set. Therefore, there is no money gained or lost at the end of the holding period, so there is no risk. If the net cost of carry of an asset is pos- itive, then the price of a forward contract on that asset is most likely: lower than if the net cost of carry was zero. the same as if the net cost of carry was zero. higher than if the net cost of carry was zero. lower than if the net cost of carry was zero. An asset's forward price is increased by the future value of any costs and de- creased by the future value of any ben- efits. If the net cost of carry (benefits less costs) is positive, the forward price is lower than if the net cost of carry was zero. An arbitrageur will most likely execute a trade when: transaction costs are low. costs of short-selling are high. prices are consistent with the law of one price. transaction costs are low. 37 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu To the holder of a long position, it is more desirable to own a forward contract than a futures contract when interest rates and futures prices are: negatively correlated. uncorrelated. positively correlated. negatively correlated. The price of a forward contract: is the amount paid at initiation. is the amount paid at expiration. fluctuates over the term of the contract. is the amount paid at expiration If you expect a stock market downturn, one potential defensive strategy would be to ________. sell foreign exchange futures buy stock-index options buy stock-index futures sell stock-index futures sell stock-index futures A 1-year gold futures contract is selling for $1,645. Spot gold prices are $1,592 and the 1-year risk-free rate is 3%. The arbitrage profit implied by these prices is ________. $4.39 $5.24 $6.72 $5.24 Parity F0 = S0(1 + rf d)T = $1,592(1 + 0.03 0)1 = $1,639.76 The arbitrage profit is $1,645 1,639.76 = $5.24 An established value below which a trad- er's margin may not fall is called the ________. convergence limit maintenance margin daily limit daily margin maintenance margin 38 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu The overwhelming majority of trading in futures contracts is done via ________. electronic networks open outcry trading pits phone electronic networks An investor who is hedging a corporate bond portfolio using a T-bond futures contract is said to have ________. a spread hedge an arbitrage a cross-hedge an over hedge a cross-hedge A long hedge is a simultaneous ________ position in the spot market and a ________ position in the futures market. long; long short; long long; short short; short short; long The current level of the S&P 500 is 1,250. The dividend yield on the S&P 500 is 3%. The risk-free interest rate is 6%. The futures price quote for a contract on the S&P 500 due to expire 6 months from now should be ________. 1,274.33 1,286.95 1,291.29 1,268.61 1,268.61 F0 = S0(1 + rf d)T = $1,250(1 + 0.06 0.03)0.5 = $1,268.61 You take a long position in a futures con- tract of one maturity and a short position in a contract of a different maturity, both 39 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu on the same commodity. This is called a ________. spread position cross-hedge reversing trade straddle spread position Which one of the following contracts re- quires no cash to change hands when initiated? listed put option forward contract short futures contract listed call option forward contract Margin requirements for futures con- tracts can be met by ________. cash or warehouse receipts for an equiv- alent quantity of the underlying commodity cash or any marketable securities cash or highly marketable securities such as Treasury bills cash only cash or highly marketable securities such as Treasury bills Which one of the following refers to the daily settlement of obligations on future positions? marking to market the open interest the convergence property the triple witching hour marking to market A speculator will often prefer to buy a fu- tures contract rather than the underlying 40 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu asset because: I. Gains in futures contracts can be larger due to leverage. II. Transaction costs in futures are typically lower than those in spot markets. III. Futures markets are often more liquid than the markets of the underlying commodities. I and III only II and III only I and II only I, II, and III I, II, and III A hypothetical futures contract on a non- dividend-paying stock with a current spot price of $100 has a maturity of 1 year. If the T-bill rate is 5%, what should the futures price be? $95.24 $100 $107 $105 $105 F0 = S0(1 + r)T = $100(1.05)1 = $105 At maturity of a futures contract, the spot price and futures price must be approxi- mately the same because of ________. the open interest marking to market the convergence property the triple witching hour the convergence property Which one of the following exploits differ- ences between actual future prices and 41 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu their theoretically correct parity values? index arbitrage marking to market reversing trades settlement transactions index arbitrage The fact that the exchange is the coun- terparty to every futures contract is- sued is important because it eliminates ________ risk. credit interest rate basis market credit An investor who goes long in a futures contract will ________ any increase in value of the underlying asset and will ________ any decrease in value in the underlying asset. pay; pay receive; receive receive; pay pay; receive receive; pay At contract maturity the basis should equal ________. 1 1 the risk-free interest rate 0 0 Investors who take short positions in fu- tures contract agree to ________ de- livery of the commodity on the delivery date, and those who take long positions agree to ________ delivery of the com- modity. make; take 42 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu make; take make; make take; take take; make On January 1, you sold one April S&P 500 Index futures contract at a futures price of 1,300. If the April futures price is 1,250 on February 1, your profit would be ________ if you close your position. (The contract multiplier is 250.) $12,500 $15,000 $12,500 $15,000 $12,500 Violation of the spot-futures parity rela- tionship results in ________. fines and other penalties imposed by the SEC suspension of delivery privileges arbitrage opportunities for investors who spot them suspension of trading arbitrage opportunities for investors who spot them Which of the following provides the profit to a long position at contract maturity? zero basis original futures price Spot price at matu- rity spot price at maturity Original futures price spot price at maturity Original futures price Single stock futures, as opposed to stock index futures, are ________. not yet being offered by any exchanges scheduled to begin trading in 2015 on 43 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu several exchanges currently trading on OneChicago, a joint venture of several exchanges offered overseas but not in the United States currently trading on OneChicago, a joint venture of several exchanges You believe that the spread between the September T-bond contract and the June T-bond futures contract is too large and will soon correct. This market exhibits positive cost of carry for all contracts. To take advantage of this, you should ________. buy the September contract and buy the June contract sell the September contract and buy the June contract buy the September contract and sell the June contract sell the September contract and sell the June contract sell the September contract and buy the June contract The open interest on silver futures at a particular time is the number of ________. silver futures contracts traded during the day silver futures contracts traded the previ- ous day long and short silver futures positions counted separately on a particular trad- ing day all outstanding silver futures contracts all outstanding silver futures contracts In the futures market the short position's loss is ________ the long position's gain. less than sometimes less than and sometimes greater than equal to 44 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu equal to greater than At year-end, taxes on a futures position ________. must be paid regardless of whether the position has been closed out or not must be paid if the position has been closed out need not be paid if the position supports a hedge must be paid if the position has not been closed out must be paid regardless of whether the position has been closed out or not A hypothetical futures contract on a non- dividend-paying stock with a current spot price of $100 has a maturity of 4 years. If the T-bill rate is 7%, what should the futures price be? $131.08 $107 $76.29 $93.46 $131.08 F0 = S0(1 + r)4 = $100(1.07)4 = $131.08 The ________ contract dominates trad- ing in stock-index futures. Nasdaq 100 DJIA Russell 2000 S&P 500 S&P 500 A futures contract ________. is a contract to be signed in the future by the buyer and the seller of a commodity is an agreement to buy or sell a specified amount of an asset at whatever the spot price happens to be on the expiration 45 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu date of the contract gives the buyer the right, but not the obligation, to buy an asset some time in the future is an agreement to buy or sell a specified amount of an asset at a predetermined price on the expiration date of the con- tract is an agreement to buy or sell a specified amount of an asset at a predetermined price on the expiration date of the con- tract An investor who goes short in a futures contract will ________ any increase in value of the underlying asset and will ________ any decrease in value in the underlying asset. pay; receive pay; pay receive; receive receive; pay pay; receive A person with a long position in a com- modity futures contract wants the price of the commodity to ________. remain unchanged decrease substantially increase substantially increase or decrease substantially increase substantially A 1-year gold futures contract is selling for $1,645. Spot gold prices are $1,592 and the 1-year risk-free rate is 3%.Based on the above data, which of the following set of transactions will yield positive risk- less arbitrage profits? Buy gold spot with borrowed money, and buy the futures contract. Buy gold in the spot with borrowed mon- Buy gold in the spot with borrowed mon- ey, and sell the futures contract. Actual F0 = $1,645, but according to spot-futures parity it should be $1,639.76, so the futures contract is 46 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu ey, and sell the futures contract. Buy the futures contract, and buy the gold spot using borrowed money. Buy the futures contract, and sell the gold spot and invest the money earned. overpriced. Sell futures today, and buy gold spot with borrowed money. An investor establishes a long position in a futures contract now (time 0) and holds the position until maturity (time T). The sum of all daily settlements will be ________. F0 S0 FT S0 FT F0 F0 FT FT F0 On May 21, 2012, you could have pur- chased a futures contract from Intrade for a price of $5.70 that would pay you $10 if Barack Obama won the 2012 presidential election. This tells you ________. that the market believed Obama's chances of winning were about 43% that the market believed that Obama had a 57% chance of winning that the market believed that Obama would not win the election nothing about the market's belief con- cerning the odds of Obama winning that the market believed that Obama had a 57% chance of winning Forward contracts ________ traded on an organized exchange, and futures con- tracts ________ traded on an organized exchange. are not; are 47 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu are not; are are; are not are; are are not; are not ________ are likely to close their po- sitions before the expiration date, while ________ are likely to make or take de- livery. Speculators; hedgers Investors; regulators Hedgers; speculators Regulators; investors Speculators; hedgers The price of a corn futures contract is $2.65 per bushel when the contract is issued, and the commodity spot price is $2.55. When the contract expires, the two prices are identical. What principle is represented by this price behavior? convergence volatility basis margin convergence If the risk-free rate is greater than the dividend yield, then we know that ________. arbitrage profits are possible FT > ST F0 < S0 the futures price will be higher as con- tract maturity increases the futures price will be higher as con- tract maturity increases A wheat farmer should ________ in or- der to reduce his exposure to risk asso- ciated with fluctuations in wheat prices. sell wheat futures if the basis is currently 48 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu positive and buy wheat futures if the ba- sis is currently negative sell wheat futures buy a contract for delivery of wheat now and sell a contract for delivery of wheat at harvest time buy wheat futures sell wheat futures The spot price for gold is $1,550 per ounce. The dividend yield on the S&P 500 is 2.5%. The risk-free interest rate is 3.5%. The futures price for gold for a 6-month contract on gold should be ________. $1,557.73 $1,554.04 $1,569.08 $1,504.99 $1,557.73 F0 = S0(1 + rf - d)T = $1,550(1 + 0.035 - 0.025)0.5 = $1,557.73 Futures markets are regulated by the ________. CFTC SEC CFA Institute CIA CFTC The S&P 500 Index futures contract is an example of a(n) ________ delivery contract. The pork bellies contract is an example of a(n) ________ delivery con- tract. cash; actual actual; cash cash; cash actual; actual cash; actual Synthetic stock positions are common- ly used by ________ because of their ________. 49 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu money market funds; limited exposure banks; lower risk wealthy investors; tax treatment market timers; lower transaction cost market timers; lower transaction cost Which one of the following is a true state- ment? The maintenance margin is the amount of money you post with your broker when you buy or sell a futures contract. All futures contracts require the same margin deposit. The maintenance margin is the value of the margin account below which the holder of a futures contract receives a margin call. A margin deposit can be met only by cash. The maintenance margin is the value of the margin account below which the holder of a futures contract receives a margin call. Approximately ________ of futures con- tracts result in actual delivery. less than 60% to 80% less than 1% to 3% 0% less than 5% to 15% less than 1% to 3% A hog farmer decides to sell hog futures. This is an example of ________ to limit risk. speculating spreading short hedging cross-hedging short hedging 50 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu Initial margin is usually set in the region of ________ of the total value of a fu- tures contract. 20%-30% 10%-20% 15%-25% 5%-15% 5%-15% A short hedge is a simultaneous ________ position in the spot market and a ________ position in the futures market. long; short short; long long; long short; short long; short A farmer sells futures contracts at a price of $2.75 per bushel. The spot price of corn is $2.55 at contract expiration. The farmer harvested 12,500 bushels of corn and sold futures contracts on 10,000 bushels of corn.What are the farmer's proceeds from the sale of corn? $35,950 $31,875 $27,500 $33,875 $33,875 Net proceeds = (2.75 × 10,000) + (2.55 × 2,500) = 33,875 A company that mines bauxite, an alu- minum ore, decides to short aluminum futures. This is an example of ________ to limit its risk. cross-hedging long hedging spreading speculating cross-hedging 51 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu The CME weather futures contract is an example of ________. a financial future an agricultural contract a cash-settled contract a commodity future a cash-settled contract Futures contracts have many advan- tages over forward contracts except that ________. futures contracts are tailored to the spe- cific needs of the investor counterparty credit risk is not a concern on futures futures trading preserves the anonymity of the participants futures positions are easier to trade futures contracts are tailored to the spe- cific needs of the investor The daily settlement of obligations on futures positions is called ________. the initial margin requirement marking to market a margin call a variation margin check marking to market When dividend-paying assets are in- volved, the spot-futures parity relation- ship can be stated as ________. F1 = S0(1 + rf) F0 = S0(1 + rf)T F0 = S0(1 + rf d)T F0 = S0(1 + rf + d)T F0 = S0(1 + rf d)T The only money exchanged by both the long and short at the creation of a futures contract is called the ________. spot price futures price Margin 52 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu collateral Margin Which of the following provides the profit to a short position at contract maturity? original futures price Spot price at matu- rity basis zero spot price at maturity Original futures price original futures price Spot price at matu- rity The advantage that standardization of futures contracts brings is that ________ is improved because ________. trading cost; trading volume is reduced credit risk; all traders understand the risk of the contracts liquidity; all traders must trade a small set of identical contracts pricing; convergence is more likely to take place with fewer contracts liquidity; all traders must trade a small set of identical contracts From the perspective of determining profit and loss, the long futures position most closely resembles a levered invest- ment in a ________. long call short call short stock position long stock position long stock position You are currently long in a futures con- tract. You instruct a broker to enter the short side of a futures contract to close your position. This is called ________. marking to market a reversing trade a reversing trade 53 / 54
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Derivatives Midterm Prep Study online at https://quizlet.com/_dumemu a speculation a cross-hedge Margin must be posted by ________. buyers of futures contracts only speculators only both buyers and sellers of futures con- tracts sellers of futures contracts only both buyers and sellers of futures con- tracts If an asset price declines, the investor with a ________ is exposed to the largest potential loss. long put option long futures contract long call option short futures contract long futures contract A farmer sells futures contracts at a price of $2.75 per bushel. The spot price of corn is $2.55 at contract expiration. The farmer harvested 12,500 bushels of corn and sold futures contracts on 10,000 bushels of corn.Ignoring the transaction costs, how much did the farmer improve his cash flow by hedging sales with the futures contracts? $33,875 $31,875 $0 $2,000 $2,000 Gain = (2.75 2.55)10,000 = 2,000 54 / 54
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A builder is offering $131,554 loans for his properties at 9 percent for 25 years. Monthly payments are based on current market rates of 9.5 percent and are to be fully amortized over 25 years. The property would normally sell for $140,000 without any special financing. Required: a. At what price should the builder sell the properties to earn, in effect, the market rate of interest on the loan? Assume that the buyer would have the loan for the entire term of 25 years. b. At what price should the builder sell the properties to earn, in effect, the market rate of interest on the loan if the property is resold after 10 years and the loan repaid? Complete this question by entering your answers in the tabs below. Required A Required B At what price should the builder sell the properties to earn, in effect, the market rate of interest on the loan? Assume that the buyer would have the loan for the entire term of 25 years. (Do not round intermediate calculations. Round your final answer to the…
Sh16 Please help me.  Solution Thankyou
march eacg Letter to the correct  number answer  to the left: 1.       Interest 2.       Monetary asset 3.       Compound interest 4.       Simple interest 5.       Annuity 6.       Present value of a single amount 7.       Annuity due 8.       Future value of a single amount 9.       Ordinary annuity 10.   Effective rate or yield 11.   Nonmonetary asset 12.   Time value of money 13.   Monetary liability     1.       ______ 2.       ______ 3.       ______ 4.       ______ 5.       ______ 6.       ______ 7.       ______ 8.       ______ 9.       ______ 10.   ______ 11.   ______ 12.   ______ 13.   ______ a.       First cash flow occurs one period after agreement begins b.       The rate at which money will actually grow during a year c.       First cash flow occurs on the first day of the agreement d.       The amount of money that a dollar will grow to e.       Amount of money paid/received in excess of amount borrowed/lent f.        Obligation to pay a sum of cash, the amount of which…
Check Progress QUESTION FINANCING AND SETTLEMENT » FINANCING LEGISLATION 32 c When a buyer goes in to apply for a loan on a new first mortgage, what must the lender give to the buyer? Glossary Terms Mortgage, ANSWERS EXPLANATION A > The broker's commission amount B > An estimate of the buyer's closing costs C> An estimate of the seller's closing costs D> A three day right of rescission document on the buyer's loan CONN ESTW ITL CI SCEPTR
Question 1 Seroja Berhad (Seroja) wishes to evaluate the following two alternatives available to acquire a machine: Lease Alternative Seroja can lease the machine under a 5-year lease requiring lease payment of RM5,000 at the beginning of each year. All maintenance costs will be borne by the lessor and the insurance and other costs will be borne by the lessee. "Borrowing to Buy" Alternative The machine costs RM20,000 and will have a 5-year life. The purchase will be financed by a 5- year, 15% interest. Seroja will pay RM1,000 per year for a service contract that covers insurance and other costs. Seroja Berhad plans to keep the machine and use it beyond its 5-year life. The machine will be depreciated as given below: Year Depreciation RM 1 5,000 2 4,000 3 3,000 4 2,000 5 1,000 Given that the corporate tax rate is 30%. From the above information you are required to answer the following questions. a. Give explanation to Seroja on ONE (1) benefit of leasing. b. Prepare the Cash Flows…
6. Entity X sells a building to Entity Y and simultaneously leases Sale and leaseback 6. Entity X sells a building to Entity Y and simultaneously it back. Relevant information follows: P2,000,00 Cash selling price of building Fair,value of building Carrying amount of building Annual rent payable at the end of each year 1,800,00 1,000,00 120,000 18 years Lease term 4.5% Implicit interest rate (readily determinable to Entity X) The terms and conditions of the transaction are such that the transfer of the building qualifies as a sale under PFRS 15. Requirements: Prepare the journal entries in the books of Entity X (seller-lessee) and Entity Y (buyer-lessor) on lease commencement. (Adapted - IFRS 16. IE11)
Please answer fast what is correct option with explanation please without plagiarism
$100,000 × 4.79079** = $479,079 Lease Payments Right-of-Use Asset - Present value of an annuity due of $1: n = 6,i = 10% How to use financial calculator to find the right of use asset? C $100,000 x 4.79079* = Lease Payments $479,079 Right-of-Use Asset *Present value of an annuity due of $1: n=6, i=10%
Use the information below to answer questions 3, 4, 5 and 6.                                                   2020        2021                                                       Sales$5,300 $5,900 Depreciation750850COGS24002900Interest180196Cash200500Accts Receivables200400Notes Payable800550Long-term debt15001950Net fixed assets30003500Accounts Payable250400Inventory700900Dividend payout30%30%Tax rate35%30%                                      What is the ROE for 2021?
$100,000 × 4.79079** = $ 479,079 Lease Payments Right - of Use Asset - Present value of an annuity due of $1: 6,i=10% How to use financial calculator to find the right of use asset? $100,000 x 4.79079* = Lease Payments $479,079 Right-of-Use Asset Present value of an annuity due of $1:n-6/-10%
Sh7 Please help me.  Thankyou.
On January 1, 2018, SARS Co. grants 100 cash share appreciation rights to each of its 500 employees, on condition that the employees remains employed in the company for the next three years. During 2018, 30 employees leave. The entity estimates that a further 60 will leave during 2019 and 2020. During 2019, 20 employees leave and the entity estimates that a further 27 will leave during 2020. During 202, 18 employees leave. At the end of 2020, 100 employees exercise their share appreciation rights, another 150 employees exercise their share appreciation rights at the end of 2021 and the remaining employees exercise their share appreciation rights at the end of 2022. The entity estimates the fair value of the share appreciation rights at the end of each year in which a liability exists as shown below. At the end of 2020, all share appreciation rights held by the remaining employees vest. The intrinsic values of the share appreciation rights at the date exercise (which equal to the cash…
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Match the words with the term.   Question 13 options: 12345 mortgage 12345 trade receivables 12345 equipment 12345 working capital 12345 inventory   1. factoring 2. warehouse financing 3. line of credit 4. term loan 5. building
Match the words with the term.   Question 4 options:   one who pays to use an asset   agreed commitment   purchase   cancelable upon notice   one who lends an asset   1. lessee 2. sale and leaseback 3. financial lease 4. operating lease 5. lessor
please get the correct answer for the lease alternative, thanks
Example 1 and 2 answers please
Question 4 On January 1, 2019, the Okanagan Flight Institute, which reports its financial results in accordance with ASPE, entered into a contract to lease a flight simulator, details of which follow: Lease term Economic life of equipment Lease payment Fair value of asset Implicit rate in the lease (not known by lessee) Incremental borrowing rate Option to purchase Guaranteed residual value Year end is December 31 Expected payout under guarantee 5 years 7 years $7,800, first due January 1, 2019 $40,000 6% 7% No $5,000 $0 Required: a) Evaluate this term from the perspective of Okanagan Flight Institute using the four primaryASPE criteria. Should it classify the lease as a finance lease or an operating lease? b) Using Excel, prepare an asset depreciation schedule that covers the useful life of the equipment using straight-line depreciation. c) Prepare a lease liability amortization schedule for the life of the lease using Excel. d) Prepare all journal entries for Okanagan Flight…
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