2. Which of the following are not characteristics of an interest-rate forward contract?

Transcription

1 Chapter-1: Derivative Self Assessment Questions 1. A forward contract is: a. a contract that involves a long position only. b. a contract that involves a short position only. c. an agreement between a bank and the Fed. d. an agreement by two parties to engage in a financial transaction at a future point in time. 2. Which of the following are not characteristics of an interest-rate forward contract? a. Specification of the place of the transaction. b. Specification of the amount of the debt instrument. c. Specification of the price (interest rate) on the debt instrument. d. Specification of the actual debt instrument. 3. Which of the following is not a problem with an interest-rate forward contract? a. Low interest rates. b. Default risk. c. A lack of liquidity. d. Finding a counterparty 4. The price of a financial futures contract: a. will be the same as the price of the underlying asset to be delivered when the contract is negotiated. b. will be less than the price of the underlying asset to be delivered at the expiration date. c. will be greater than the price of the underlying asset to be delivered at the expiration date. d. will be the same as the price of the underlying asset to be delivered at the expiration date.

2 5. Futures contracts are more successful than interest-rate forward contracts because they: a. are less liquid b. have greater default risk c. are more liquid d. have an interest rate tied to the discount rate. 6. A forward foreign exchange contract: a. is now a violation of IMF policy. b. is based upon the current spot exchange rate. c. exposes the buyer to exchange rate risk. d. allows a buyer to purchase a quantity of foreign exchange to be delivered in the future 7. An option: a. gives the purchaser a right to buy or sell an underlying asset at a strike price. b. that can be exercised at any time is called a European option. c. must be exercised by the owner. d. that can be exercised only at the expiration date is called an American option. 8. A call option: a. is the same as an American option. b. gives the owner a right to sell a financial instrument at the exercise price within a specific period of time. c. gives the owner a right to buy a financial instrument at the exercise price within a specific period of time. d. is the same as a put option. 9. Options are regulated by: a. the SEC and the CFTC.

3 b. the Fed. c. the Fed and the FDIC. d. the FDIC and the Treasury Department. 10. Which of the following does not generate a higher premium on call options? a. A lower strike price. b. A more liquid underlying asset. c. A greater term to maturity. d. A more volatile price for the underlying asset. 11. An American option: a. can be exercised only on its expiration date. b. gives its owner the right to buy a financial instrument at the exercise price. c. gives its owner the right to sell a financial instrument at the exercise price. d. can be exercised at any time up to its expiration date. 12. Compared to the buyer of a futures contract, the buyer of an option contract on the same financial instrument generally will make: a. larger gains or larger losses. b. smaller gains or smaller losses. c. larger gains or smaller losses. d. smaller gains or larger losses. 13. Which of the following is not an advantage of using interest rate swaps to eliminate interest-rate risk? a. Financial institutions can engage in the types of lending for which they have informational advantages. b. They avoid the transaction costs of shifting funds between rate-sensitive and fixed-rate assets. c. They can be written to cover time horizons of several years. d. They entail no default risk.

4 14. Hedging a. Is the process of reducing risk by engaging in a financial transaction that offsets a position already taken. b. Is the process of trading financial derivatives. c. Is the process of diversifying risk. d. Is the process of reducing risk by buying risk-free government bonds. 15. The payoffs for financial derivatives are linked to a. securities that will be issued in the future. b. the volatility of interest rates c. previously issued securities d. none of the above 16. Financial derivatives include a. stocks b. bonds c. futures d. none of the above 17. Financial derivatives include a. stocks b. bonds c. forward contracts d. both (a) and (b) are true 18 Which of the following is not a financial derivative? a. Stock b. Futures c. Options d. Forward contracts

5 19. Derivatives are products whose value is derived from one or more basic variables called underlying assets or base. 20. Financial derivatives provide a powerful tool for limiting risks that individuals and organizations face in the ordinary conduct of their businesses. Answers for Self Assessment Questions 1. (d) 2.(a) 3.(a) 4.(d) 5.(c) 6. (d) 7.(a) 8.(c) 9.(a) 10.(b) 11. (d) 12.(b) 13.(d) 14.(a) 15.(c) 16. (c) 17. (c) 18. (a) 19. (a) 20. (a)

6 Chapter-2: Structure of Options Market Self Assessment Questions 1. Call options are most profitable for the buyer when the underlying instrument moves up, making the price of the underlying instrument closer to, or above, and the strike price. 2. Standardized futures contracts exist for all of the following underlying assets except: a. stock indexes b. common stocks c. gold d. Treasury bonds 3. Which of the following is false? a. Futures contracts allow fewer delivery options than forward contracts. b. Futures contracts trade on a financial exchange. c. Futures contracts are more liquid than forward contracts. d. Futures contracts are marked to market. 4. Which one of the following actions will offset a long position in a futures contract that expires in June? a. Sell any futures contract, regardless of its expiration date. b. Sell a futures contract that expires in June. c. Buy any futures contract, regardless of its expiration date. d. Buy a futures contract that expires in June. 5. The OTC deals are the consequence of discussion and negotiation between two counterparties, without the interference and/or regulation of a market-exchange.

7 6. Which of the following does the most to reduce default risk for futures contracts? a. Flexible delivery arrangements. b. Marking to market. c. High liquidity. d. Credit checks for both buyers and sellers. 7. Which of the following is most similar to a stock broker? a. Futures commission merchant. b. Pit trader. c. Floor broker. d. Local. 8. Using futures contracts to transfer price risk is called: a. diversifying b. arbitrage c. speculating d. hedging 9. Which of the following is best described as selling a synthetic asset and simultaneously buying the actual asset? a. Hedging. b. Arbitrage. c. Speculating. d. Diversifying. 10. Which of the following causes the futures price of an asset to increase, everything else held constant? a. Higher expected spot price for the underlying asset. b. Lower risk-free rate of interest. c. Higher costs of carrying the underlying asset.

8 d. Higher income received while carrying the underlying asset. 11. Which of the following has the right to sell an asset at a predetermined price? a. A put buyer. b. A put writer. c. A call writer. d. A call buyer. 12. Which of the following is potentially obligated to sell an asset at a predetermined price? a. A put buyer. b. A put writer. c. A call writer. d. A call buyer. 13. Which of the following is not a characteristic of option contracts that trade on the Chicago Board Options Exchange? a. The contracts are standardized. b. It is easy to transfer the contracts between investors. c. Option holders must take physical delivery of the underlying asset. d. Option writers are required to put up collateral. 14. Which of the following actions will not close a long position in a call option? a. Buying a put with the same strike price, expiration, and underlying asset. b. Allowing the call to expire. c. Exercising the call. d. Selling a call with the same strike price, expiration, and underlying asset. 15. Which of the following strategies will be profitable if the price of the underlying asset is expected to decrease? (There may be more than one correct response.) a. Selling a put.

9 b. Buying a put. c. Buying a call. d. Selling a call. 16. Which of the following investment strategies has unlimited profit potential? a. Writing a call. b. Bull spread. c. Protective put. d. Covered call. 17. An option indenture is an agreement between two parties to buy/sell an asset at a fixed price and fixed date in the future. 18. The exchange where nearly everyone of the business and selling of options contracts take place is called the options marketplace. 19. A call option, over and over again simply labeled a call, is a financial agreement between two parties, the buyer and the seller of this type of option. 20. Non Qualified Stock Options (NSO) is not the simplest type of stock options where the employee is required to pay ordinary income tax on the profit.

10 Answers for Self Assessment Questions 1. (a) 2.(b) 3.(a) 4.(b) 5.(a) 6. (b) 7.(a) 8.(d) 9.(b) 10.(c) 11. (a) 12.(c) 13.(c) 14.(a) 15.(b) 16. (c) 17. (a) 18. (a) 19. (a) 20. (a)

11 Chapter-3: Principles of Options Pricing Self Assessment Questions 1. The maximum value of a call or put option could be any value between zero and the difference between the underlying price and exercise price. 2. Which of the following is/are call options? a. The abandonment option on an investment project b. Stand-by underwriting c. A and B d. The company's option to redeem its bonds at a premium before maturity 3. Which of the following investors would be happy to see the stock price rise sharply? a. An investor who owns a call option b. An investor who owns a put option c. An investor who owns the stock and has sold a call option d. An investor who has sold a call option 4. Suppose an investor sells a put option. What will happen if the stock price on the exercise date exceeds the exercise price? a. The seller will need to deliver stock to the owner of the option b. The seller will be obliged to buy stock from the owner of the option c. The owner will not exercise his option d. None of the above 5. Suppose an investor buys one share of stock and a put option on the stock. What will be the value of the investment on the final exercise date if the stock price is below the exercise price?

12 a. The value of two shares of stock b. The value of one share of stock plus the exercise price c. The exercise price d. The value of one share of stock minus the exercise price 6. A put option gives the owner the right a. And the obligation to buy an asset at a given price b. And the obligation to sell an asset at a given price c. But not the obligation to buy an asset at a given price d. But not the obligation to sell an asset at a given price 7. The buyer of a call option has the choice to exercise, but the writer of the call option has: a. The choice to offset with a put option b. The obligation to deliver the shares at exercise c. The choice to deliver shares or take a cash payoff d. The choice of exercising the call or not 8. A lower price level has the opposite effect, inducing a decrease in the interest rate which triggers an increase in borrowing used for consumption expenditures and investment expenditures. 9. Suppose an investor buys one share of stock and a put option on the stock and simultaneously sells a call option on the stock with the same exercise price. What will be the value of his investment on the final exercise date? a. Above the exercise price if the stock price rises and below the exercise price if it falls b. Equal to the exercise price regardless of the stock price c. Equal to zero regardless of the stock price d. Below the exercise price if the stock price rises and above if it falls

13 10. A call option that can be exercised only on one particular day is called a. A European call b. An American call c. A short call d. None of the above 11. The higher the exercise price: a. The higher the call price b. The lower the call price c. Has no effect on call price d. The higher the stock price 12. Which of the following features increase(s) the value of a call option? a. A high interest rate b. A long time to maturity c. A highly variable stock price d. All of the above 13. If the volatility of the underlying asset decreases, then the: a. Value of the put option will increase, but the value of the call option will decrease b. Value of the put option will decrease, but the value of the call option will increase c. Value of both the put and call option will increase d. Value of both the put and call option will decrease 14. Most investment expenditures by the business sector and a fair amount of consumption expenditures by the household sector (especially for durable goods) are made with borrowed funds.

14 15. Which of the following statements is true? a. For both calls and puts an increase in the exercise price will cause an increase in the option price b. For both calls and puts an increase in the time to maturity will cause an increase in the option price c. For calls, but not for puts, an increase in the time to maturity will cause an increase in the option price d. For puts, but not for calls, an increase in the time to maturity will cause an increase in the option price 16. The maximum loss is therefore unlimited to the upside, which is why selling naked or unprotected call options comes with such a high risk. 17. The price of an option increases with an increase in all of the following except: a. Stock Price b. Interest Rate c. Time to expiration d. Exercise Price 18. A common stock is a.. option written on firm's assets a. call b. put c. Both a and b 19. Early exercise is not never optimal for American call options on non-dividendpaying stock.

15 20. Remember that the maximum value of a call option is the greater of zero or, its underlying price minus the exercise price. Answers for Self Assessment Questions 1. (a) 2.(d) 3.(a) 4.(c) 5.(c) 6. (d) 7.(b) 8.(a) 9.(b) 10.(a) 11. (b) 12.(d) 13.(d) 14.(b) 15.(b) 16. (a) 17. (d) 18. (a) 19. (b) 20. (a)

16 Chapter-4: Principles of Put Option Pricing Self Assessment Questions 1. If a call option is far 'out of the money' the value of the option will be: a. Equal to the value of a put option with the same exercise price b. Less than the value of a put option with the same exercise price c. Greater than the value of a put option with the same exercise price d. Zero 2. The difference between the value of a call option and a put option with the same exercise price is due primarily to: a. The volatility of the price of the underlying stock b. The use of continuous as opposed to discrete discounting c. The differential between the current stock price and the exercise price in present value terms d. The greater liquidity of call options 3. Which of the following statements is false? a. European options are traded in Europe as well as in America b. The intrinsic value reflects the option's potential appreciation c. Out-of-the-money for a call means that the stock price is less than the exercising price d. Option prices almost always exceed intrinsic values 4. A/An.. gives the buyer the right, but not the obligation, to exercise the option at any time before the expiration or maturity date: a. Complex Option b. European Option c. American Option d. At-The-Money Option

17 5. Which of the following is not an interest rate derivative used for interest rate management? a. Floor b. Swap c. Cap d. All of the above are interest rate derivatives 6. An agreement which guarantees an investor a minimum return on a principal amount is called a: a. Cap b. Floor c. Stock option 7. An option provides the holder with the right to buy or sell a specified quantity of an underlying asset at a fixed price (called a strike price or an exercise price) at or before the expiration date of the option. 8. An American option is more valuable than a European option on the same dividendpaying stock with the same terms because the: a. European options do not conform to the Black and Scholes model and are often mispriced b. European option contract is not adjusted for stock splits and stock dividends c. American options are traded on US exchanges, which offer much more volume and liquidity d. American option can be exercised from date of purchase until expiration, but the European option can be exercised only at expiration

18 9. Which one of the following transactions would be considered a protective strategy? a. Sell a call against a stock you sold short b. Sell a naked put c. Buy a call on a stock you own d. Buy a put on a stock you own 10. The tendency to believe that exercising an option because the stock can go up no further ignores the fact that an option can generally be sold. 11. Put Call Parity is not an option pricing concept that requires the extrinsic values of call and put options to be in equilibrium so as to prevent arbitrage. 12. The intrinsic value of an option is the difference between the actual price of the underlying security and the.. of the option. a. cost price b. strike price c. both a and b gives the buyer of the option the right to buy the underlying asset at a fixed price (strike price or K) at any time prior to the expiration date of the option. a. A put option b. A call option c. A value option

19 14. The.. knows this loss will be incurred as soon as the stock goes exdividend. a. Put holder b. Value holder c. call holder 15. The intrinsic value of an option is the difference between the actual price of the underlying security and the strike price of the option. 16. Put Call Parity is an option pricing concept that requires the extrinsic. and put options to be in equilibrium so as to prevent arbitrage. a. values of put b. values of operation c. values of call 17. Support for this pricing relationship is based upon the argument that arbitrage opportunities would materialize if there is a divergence between the value of. a. Calls b. puts c. Both a and b 18. The more dividends paid, the lower the stock price is driven and the more valuable it is to hold on to the put.

20 19. The price of an option has two components a. the intrinsic value b. the time value c. the value time d. Both a and b 20. The tendency to believe that exercising an option because the stock can go up no further ignores the fact that an option can generally be sold. Answers for Self Assessment Questions 1. (b) 2.(c) 3.(b) 4.(c) 5.(d) 6. (b) 7.(b) 8.(d) 9.(d) 10.(a) 11. (b) 12.(b) 13.(b) 14.(c) 15.(a) 16. (c) 17. (c) 18. (a) 19. (d) 20. (a)

21 Chapter-5: Basic Option Pricing Models Self Assessment Questions 1. Valuations are needed for many reasons such as investment analysis, capital budgeting, merger and acquisition transactions, financial reporting, taxable events to determine the proper tax liability, and in litigation. 2. The primary drivers of the price of an option: current stock price a. intrinsic value b. time to expiration or time value c. volatility d. All of these 3. The movement of the price of the stock up or down has a direct although not equal - effect on the.. a. Financial of the option b. Puts of the option c. price of the option 4. Call Option Intrinsic Value = Underlying Stock s Current Price a. Call Strike Price b. Put Strike Price c. Put Option Intrinsic Value 5. The time value of options is the amount by which the price of any option exceeds the intrinsic value. 6. Which of the following is consistent with a chase strategy?

22 a. vary production levels to meet demand requirements b. vary work force to meet demand requirements c. vary production levels and workforce to meet demand requirements d. all of these 7. Which of the following is not an advantage of level scheduling? a. stable employment b. more employee commitment c. matching production exactly with sales d. lower turnover 8. Which of the following actions is consistent with use of level strategy? a. use of inventory to meet demand requirements b. vary the amount of subcontracting to meet demand requirements c. vary production levels to meet demand requirements d. vary production levels workforce to meet demand requirements 9. "An optimal plan for minimizing the cost of allocating capacity to meet demand over several planning periods" best describes a. the linear decision rule b. simulation c. the management coefficients model d. the transportation method 10. Which of the following aggregate planning models is based primarily upon a manager's past experience? a. the linear decision rule b. simulation c. the management coefficients model d. the transportation method 11. Time Value =. Intrinsic Value a. Put Strike Price b. Put Option Intrinsic Value c. Option Price

23 12. Time value is often referred to as extrinsic value. 13. The number of units of the stock required per option is known as the (Delta) of the stock and taking these positions to create a risk-free investment is known as Delta Hedging. b. false 14. Time value is basically the risk premium that the option seller requires to provide the option buyer the right to up to the date the option expires. a. buy the stock b. sell the stock c. Both a and b 15. An option s time value is also highly dependent on the volatility in that the market expects the stock will display up to expiration. 16. Parity is a word that means equivalence, and it is used in option trading to express a certain balance among elements. 17. A stock investor who is interested in using options to capture a potential move in a stock must understand how options are priced. a. Time Value

24 b. Intrinsic Value c. The Bottom Line 18. Knowing the current and expected volatility that is in the price of an option is essential for any investor that wants to take advantage of the movement of a stock s price. 19. The option purchaser has no obligation to exercise the option and trade, but the option writer the person who sells the option must trade if the option is exercised and assigned to him. 20. Compound options can take any of four forms a. a call on a call and a put on a put b. a call on a put and a put on a call c. Both a and b Answers for Self Assessment Questions 1. (a) 2.(d) 3.(c) 4.(a) 5.(a) 6. (d) 7.(c) 8.(a) 9.(d) 10.(c) 11. (c) 12.(a) 13.(a) 14.(c) 15.(a) 16. (b) 17. (c) 18. (a) 19. (a) 20. (c)

25 Chapter-6: Pricing Model Self Assessment Questions 1. The Black-Scholes Option Pricing Model is an approach used for calculating the value of a stock option. 2. In the context of the Capital Asset Pricing Model the relevant measure of risk is: a. unique risk. b. beta. c. standard deviation of returns. d. variance of returns. 3. Which statement is not true regarding the market portfolio? a. It includes all publicly traded financial assets. b. It lies on the efficient frontier. c. All securities in the market portfolio are held in proportion to their market values. d. It is the tangency point between the capital market line and the indifference curve. 4. The Black-Scholes model assumes that markets are perfectly liquid and it is possible to purchase or sell any amount of stock or options or their fractions at any given time. 5. The binomial model breaks down the time to expiration into potentially a very large number of time intervals.

26 6. A dividend-paying stock can reasonably be expected to follow the stochastic process developed except when the stock goes ex-dividend. 7. In a well diversified portfolio: a. market risk is negligible. b. unsystematic risk is negligible. c. systematic risk is negligible. d. none of these 8. The opportunity line is the: a. set of investment opportunities made available by mixing a risky asset and a risk-free asset. b. set of all portfolios with the same expected rate of return but different standard deviations. c. set of portfolios among which the investor is indifferent. d. set of investment opportunities made available by mixing two risky assets. 9. Consider a graph with standard deviation on the horizontal axis and expected return on the vertical axis. The line that connects the risk-free rate and the optimal risky portfolio is called: a. the security market line. b. the capital market line. c. the indifference curve. d. the characteristic line. 10. Market risk is also called: a. nondiversifiable risk and systematic risk. b. systematic risk and diversifiable risk. c. unique risk and nondiversifiable risk. d. systematic risk and unique risk.

27 11. If an asset s expected return plots above the security market line, the asset is: a. overpriced. b. both the first and third answers. c. under priced. d. fairly priced (if it has an unusually large amount of unique risk). 12. The market risk premium is the slope of: a. the efficient frontier. b. the capital market line. c. the characteristic line. d. the security market line. 13. European options can be analyzed by assuming that the stock price is the sum of two components: a riskless component that corresponds to the known dividends during the life of the option and a risky component. 14. Dividends are paid at various times while the stock is held by the.., and hence are measured in terms of a continuous dividend yield. a. customer b. investor c. vendor 15. Perishable goods markets require highly flexible production and distribution systems so that. can be closely matched and waste production minimized. a. supply b. demand c. Both a and b

28 16. The higher the level of interest rates, the higher the expected return required on any given stock. 17. The expected growth rate in the.. changes and the discount rate that must be used for any payoffs from the derivative changes. a. Market price b. stock price c. business price 18. Establishes a., but provides for adjustment based on specified contingencies, such as an economic price adjustment. a. fixed contract price b. variable contract price c. contract price 19. The Black-Scholes model, often also called using it is full name Black-Scholes Option Pricing Model, is an approach for calculating the value of a stock option, let it be a call option or a put option. 20. The Black-Scholes model is basically a formula that is used to calculate. a. Put option b. Call option c. option values

29 Answers for Self Assessment Questions 1. (a) 2.(b) 3.(d) 4.(a) 5.(a) 6. (a) 7.(b) 8.(a) 9.(b) 10.(a) 11. (c) 12.(d) 13.(a) 14.(b) 15.(c 16. (a) 17. (b) 18. (a) 19. (a) 20. (c)

30 Chapter-7: Basic Option Strategies Self Assessment Questions 1. Basic options strategies are single direction strategies that are implemented using combinations of. a. underlying stock b. single call contracts c. single put contracts d. All of these 2. A long call is one of the most simple. a. Put option b. Call option c. options strategies 3. A short covered call is an options strategy that involves both stock and an options contract. 4. A long covered put is an options strategy that is used insurance for an already... a. Interring trade b. existing trade c. Both a and b 5. A bull call spread is an independent trade that uses a combination of two calls, but is still a. a. single direction strategy

31 b. two direction strategy c. more direction strategy 6. Profit = Increase in net assets +. extra capital introduced. a. Drawings b. increase in capital c. liabilities 7. Which one of the following could not be used to describe a summary of a company's assets, liabilities and capital at a specific date? a. Profit and loss account b. Balance sheet c. Position statement d. Statement of financial position 8. The market value of a company whose shares are listed on a stock market can be found by: a. looking at the company's latest balance sheet totals. b. looking at the company's profit and loss account balance. c. looking at the company's share price and multiplying it by the number of shares issued by the company at that date. d. looking at the company's share price and multiplying it by the maximum number of shares the company is allowed to issue. 9. Which one of the following could be described as an 'off balance sheet asset'? a. Purchased goodwill b. Internally generated goodwill c. An asset being bought on hire-purchase d. Leasehold land

32 10. The International Accounting Standard on Intangible Assets presumes that the useful life of goodwill does not exceed which of the following time periods? a. 5 years b. 15 years c. 10 years d. 20 years 11. Net current assets are a measure of how solvent or liquid a business is. Many businesses need to have working capital. 12. Which one of the following tangible fixed assets would not normally be depreciated? a. Buildings that have been revalued to a lower value than their original cost b. Buildings that have been revalued to a higher value than their original cost c. Leasehold land d. Freehold land 13. Buy-to-Open is the transaction the options buyers make to enter a long position on an option. 14. An asset leased under a finance lease would be shown in the lessee's financial summaries in which of the following ways? a. The only entry would be to show the cost of the asset as a fixed asset on the balance sheet. b. The entries would be to show the cost of the asset as a fixed asset, and any amounts due to the lessor as liabilities on the balance sheet. There would be no entries in the profit and loss account.

33 c. The entries would be to show the cost of the asset as a fixed asset, and any amounts due to the lessor as liabilities on the balance sheet. The finance charge for the year would be shown on the profit and loss account. d. As it is leased, there would be no entries in the lessee's financial summaries. 15. Separate items of stock are valued at: a. the lower of cost and net realizable value.the lower of cost and realizable value. b. the lower of cost and realizable value. c. the lower of cost and replacement value. d. the higher of cost and net realizable value. 16. Which of the following would not be considered a component of 'cost' of stock? a. Sales force salaries b. Transport costs c. Import duties d. Purchase price 17. If physical stock cannot be matched with invoiced prices, a theoretical stock valuation method such as FIFO is often used. What does FIFO mean? a. Finished stock In Finished stock Out b. First In First Out c. Final Input Final Output d. Fabrications Inward Fabrications Outward 18. Holding period return/yield is calculated as the sum of all income and capital growth divided by the value at the beginning of the period being measured.

34 19. Fixed assets consist of those items that are kept within the business to create wealth over a period of time e.g. machinery, equipment, vehicles, computers, etc. 20. An opening transaction would involve the purchase of a security when initiating a long position and the sale of a security when initiating a short sale or short position. Answers for Self Assessment Questions 1. (d) 2.(c) 3.(a) 4.(b) 5.(a) 6. (a) 7.(a) 8.(c) 9.(b) 10.(d) 11. (a) 12.(d) 13.(a) 14.(c) 15.(a) 16. (a) 17. (b) 18. (a) 19. (a) 20. (c)

35 Chapter-8: Forward and Futures Self Assessment Questions 1. As trading in forwards is closely integrated with cash market transactions, direct trading in forward contracts is restricted to the significant spot market participants, effectively the largest banks and financial institutions. 2. Which of the following statements about futures contracts is wrong? a. A futures contract is a marketable forward contract b. Futures contracts can be used to fix the future selling price regardless of future changes in spot market prices c. The basis in futures is similar to a basis point in banks d. Both c and d 3. The basis is defined as: a. forward price minus spot price b. futures price minus spot price c. spot price minus forward price d. spot price minus futures price 4. The basis must equal at the delivery date for the futures contract. a. a positive value b. a negative value c. the fixed futures price d. zero 5. To minimize default risk, futures exchanges require all contracts to be: a. mark to market b. settled in cash c. delivered on time

36 d. Both b and c 6. The financial institution that guarantees both sides of a future trade is called the: a. futures commission merchant b. clearinghouse c. futures exchange d. local 7. A managed fund is exactly that - an investment fund that is managed professionally by an expert fund manager who invests in a variety of investments. 8. Financial Futures refer to a futures contract in a foreign exchange or financial instruments like Treasury bill, commercial paper, stock market index or interest rate. 9. Which of the following statements about margin requirements is wrong? a. The maintenance margin is always smaller than the initial margin b. To buy a futures contract, you must satisfy the initial margin requirement c. Futures margins are usually significantly lower than margins for stocks d. The maintenance margin is only required for sellers of futures contracts 10. A futures contract is: a. an agreement to buy or sell a specified quantity of a particular asset during a given period at the spot price b. a marketable obligation to buy or sell a specified quantity of a particular asset during a given period for a given price c. an option to buy or sell a specified quantity of a particular asset during a given period for a given price d. a marketable obligation to buy or sell a specified quantity of a particular

37 asset during a given period at a price to be determined in the future 11. If a farmer buys a corn option on futures: a. the farmer has the right to deliver the corn, and will do so only if the price is favorable b. the farmer must accept delivery of the corn at a fixed price c. the farmer must deliver the corn at the market price d. the farmer must deliver the corn at a fixed price 12. Futures markets and forward markets trade contracts that determine a current price for a commodity transaction designated to take place at a later date. 13. A high-quality investment in another country may prove worthless because of a weak domestic currency. 14. A unit trust works by pooling money from a number of investors and then using this money to buy a variety of.. a. Production b. Material c. Investments 15. Insurance Bond is the expression used to describe the range of investment-linked policies offered by several life insurance companies.

38 16. Managed funds provide private investors with access to markets and strategies that rely on. a. economies of seal b. economies of scale c. economies of business 17.. provide the personal investor with the opportunity to invest their money across the world, depending on what is requested by the investor. a. Managed funds b. Business funds c. Management funds 18. A hedge fund is a fund that can take both long and short positions, use arbitrage,. undervalued securities, trade options or bonds, and invest in almost any opportunity in any market where it foresees impressive gains at reduced risk. a. buy b. sell c. Both a and b 19.. strategies vary enormously many hedges against downturns in the markets especially important today with volatility and anticipation of corrections in overheated stock markets. a. Business funds b. Management funds c. Hedge fund 20. Hedge funds utilize a variety of financial instruments to reduce risk, enhance returns and minimize the correlation with equity and bond markets.

39 Answers for Self Assessment Questions 1. (a) 2.(c) 3.(d) 4.(d) 5.(a) 6. (b) 7.(a) 8.(a) 9.(d) 10.(b) 11. (a) 12.(a) 13.(a) 14.(c) 15.(a) 16. (b) 17. (a) 18. (c) 19. (c) 20. (a)

40 Chapter-9: Forward and Futures Hedging Concepts Self Assessment Questions 1. Non-delivery forwards (NDF) are settled at maturity and no delivery of primary assets is assumed. 2. The profit or loss from a forward contract depends on the difference between the of the asset on the day the forward contract matures. a. forward price b. spot price c. Both a and b 3. Insurance companies have some advantages in bearing risk; these include: a. Superior ability to estimate the probability of loss. b. Extensive experience and knowledge about how to reduce the risk of a loss. c. The ability to pool risks and thereby gain from diversification. d. All of these 4. A derivative is a financial instrument whose value is determined by: a. A regulatory body such as the FTC b. An underlying asset c. Hedging a risk d. Speculation 5. Derivatives can be used either to hedge or to speculate. These actions: a. Increase risk in both cases b. Decrease risk in both cases c. Spread or minimize risk in both cases

41 d. Offset risk by hedging and increase risk by speculating 6. What questions does a risk manager need to answer? a. What are the major risks the company is facing? b. Is the company being paid for taking these risks? c. How should risks be controlled? d. All of these 7. A forward contract is described by: a. Agreeing today to buy a product at a later date at a price to be set in the future. b. Agreeing today to buy a product today at its current price. c. Agreeing today to buy a product at a later date at a price set today. d. Agreeing today to buy a product if and only if its price rises above the exercise price today at its current price. 8. Hedging risks can make sense if it: a. Reduces the chances of financial distress b. Motivates operations managers c. Allows managers to concentrate on controllable business aspects d. All of these 9. Currency risk is part of the financial and operational risks associated with the possibility of adverse movement in the exchange rate of a particular currency relative to another. 10. A chocolate company which uses the futures market to lock in the price of cocoa to protect a profit, is an example of: a. A long hedge

42 b. A short hedge c. Purchasing futures to guard against a potential loss d. Both a and c 11. Which of the following is a riskier position? a. Owning corn and shorting corn contracts b. Making cereal and longing corn contracts c. Longing and shorting corn contracts d. Owning corn only 12. The forward contract is unstandardized instruments with economic function nearly the same as the futures contract. 13. With hedging, you can create a risk-free net position if: a. The assets are positively correlated b. The assets are perfectly correlated c. The assets are negatively correlated d. It is impossible to have a risk-free net position 14. It is worth noting that if the hypothetical portfolio of stocks remains fixed, the weights assigned to individual stocks in the portfolio do not remain fixed. 15. If two assets have the same duration, their prices will be equally affected by any change in: a. Standard Deviation b. Interest Rates c. Beta d. Covariance

43 16. Delta measures the number of units of one assts that is needed to offset changes in value of the other asset. This is also known as a: a. Short hedge b. Long hedge c. Hedge Ratio d. Speculation Ratio 17. Options are derivatives, whose price is derived from the value of a particular underlying security, currency or commodity. 18. A hedge using index futures removes the risk arising from market moves and leaves the hedger exposed only to the performance of the portfolio relative to the market. 19. Currency options are not derivative instruments, which give buyer of the option the right but not the obligation to execute a specified transaction in the underlying currency pair. 20. Hedging stock is an important tool for diversifying risk by pairing the stock owned (the long position) with an appropriate short position.

44 Answers for Self Assessment Questions 1. (a) 2.(c) 3.(d) 4.(b) 5.(d) 6. (d) 7.(c) 8.(d) 9.(a) 10.(d) 11. (d) 12.(a) 13.(c) 14.(a) 15.(b) 16. (c) 17. (a) 18. (a) 19. (b) 20. (a)

45 Chapter-10: Swaps Self Assessment Questions 1. Hedgers who are short in an asset can establish the maximum price they will have to pay for that asset by: a. buying a put option on the asset b. buying a call option on the asset c. writing a call option on the asset d. either the first or fourth answer 2. Options have an advantage over futures because: a. they provide a hedge without removing the opportunity to make a profit b. they are likely to be cheaper because all one is buying is the right to do something c. they provide a more certain hedge d. they are less likely to require delivery of the underlying asset 3.A traders are likely to prefer an options contract to a futures contract on an asset if: a. he is uncertain but thinks it more likely that the price of the asset will fall than rise b. he thinks the price of the asset will certainly rise c. he is uncertain but thinks it more likely that the price of the asset will rise than fall d. he thinks the price of the asset in the underlying market will certainly fall 4. Equity swaps enjoyed a brief and intense popularity in the United States as a way for high-tax bracket investors to achieve diversification, by exchanging the return on a single stock or an undiversified stock basket for the return on a broad stock market index.

46 5. The time value of an option is greater the longer the period the option has to run. 6. A strangle is a mixed options strategy consisting of: a. a call and a put for the same expiry date but at different strike prices b. two puts and one call with the same expiry date c. two calls and one put with the same expiry dates d. a call and a put at the same strike price and expiry date 7. An option whose intrinsic value is calculated by comparing the strike price with the average spot price over the period of the option is: a. a warrant b. an Asian option c. a barrier option d. an American option 8. Equity swaps can be customized to any specific stock, portfolio, or index and are an excellent means of investing in markets that would otherwise not be very accessible. 9. Which two of the following exist? a. options on swaps b. options on options c. options on futures d. swaps of options 10. Which of the following is not a reason for international investment? a. To provide an expected risk-adjusted return in excess of that required. b. To gain access to important raw materials. c. To produce products and/or services more efficiently than possible domestically.

47 d. International investments have less political risk than domestic investments. 11. The. refers to the orderly relationship between spot and forward currency exchange rates and the rates of interest between countries. a. one-price rule b. interest-rate parity c. purchasing-power parity d. exchange-power parity 12. The.. is especially well suited to offer hedging protection against transactions risk exposure. a. forward market b. spot market c. transactions market d. inflation-rate market 13. An accounting loss or gain that arises from translating the assets and liabilities of a foreign subsidiary (non-dollar denominated) into the parent company's currency is accounted for as a translation adjustment... a. in the owners' equity section b. on the income statement c. in both the balance sheet and income statement d. on internal accounting records only and does not materially impact accounting income 14. A multinational company that is faced with mild interference up to complete confiscation of all assets is encountering. a. translation risk exposure b. transactions risk exposure c. political risk exposure d. a very bad day

48 15. Suppose that some time after the initiation of the contracts, the contract with Microsoft has a positive value to the financial institution, whereas the contract with Intel has a negative value. 16. A written statement by the exporter ordering the importer to pay a specific amount of money upon presentation to drawee to whom it is addressed is known as a. a. bill of lading b. sight draft c. time draft d. letter of credit 17. A trade agreement in which a domestic firm accepts whiskey for full payment on a sale of computer equipment is an example of. a. export factoring b. forfaiting c. a scene from the classic movie "Animal House" d. countertrade 18. AusAmer is an exporter who has sold outright their accounts receivable to another institution. This is an example of. a. export factoring b. forfaiting c. striding d. countertrade 19. Which of the following is not an example of an international trade draft? a. Time draft. b. Sight draft. c. Both the first and second answers are correct.

49 d. None of the answers given are correct. 20. Suppose that the Euro is selling at a forward discount in the forward-exchange market. This implies that most likely... a. the Euro has low exchange-rate risk b. the Euro is gaining strength in relation to the dollar c. interest rates are higher in Euroland (i.e., the Euro area) than in the United States d. interest rates are declining in Europe Answers for Self Assessment Questions 1. (d) 2.(a) 3.(c) 4.(a) 5.(a) 6. (a) 7.(b) 8.(a) 9.(c) 10.(d) 11. (b) 12.(a) 13.(a) 14.(c) 15.(a) 16. (b) 17. (d) 18. (a) 19. (c) 20. (c)