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Chap 1 Chap 12 Qa

This document contains questions and answers related to options, futures, and other derivatives. It includes 13 multiple choice questions that test understanding of key concepts such as the differences between calls and puts, forwards and futures, American and European options, and calculating profits and losses from options positions. The answers provided explain in detail the reasoning behind the correct multiple choice response for each question.

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0% found this document useful (0 votes)

54 views53 pages

Chap 1 Chap 12 Qa

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Chap 1- Chap 12 Q&A

Option, Futures and Other Derivatives (Đại học Kinh tế Quốc dân)

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Chap 1
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.
=> 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. 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.
=> 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.

3. 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
=> When the stock price is $35, the two call options provide a payoff of
2×(35−30) or $10. The put option provides no payoff. The total cost of the
options is 2×3+ 4 or $10. The stock price in A, $35, is therefore the breakeven
stock price above which the position is profitable because it is the price for
which the cost of the options equals the payoff.
3 & 4 are stated in the question

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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
=> 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.

5. 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.
=> The OTC market is about $600 trillion whereas the exchange-traded market
is about $60 trillion.

6. 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
=> 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. 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
=> A long forward contract is an agreement to buy the asset at a predetermined
price. The contractbecomes 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. An investor sells a futures contract an asset when the futures price is $1,500.
Each contract is on100 units of the asset. The contract is closed out when the
futures price is $1,540. Which of thefollowing 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
=> An investor who buys (has a long position) has a gain when a futures price
increases. An investorwho sells (has a short position) has a loss when a futures
price increases.

9. 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)
=> 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.

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10. 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
=> 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 D are correct

8. AAn 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. 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)
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. 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

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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.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
=> 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.

12.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
=> 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.

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13. 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
=> 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.

14. 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 $1,000
=> 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. 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
=> 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.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
=> 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.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
=> 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. A short forward contract on an asset plus a long position in a European call
option on the assetwith a strike price equal to the forward price is equivalent to
A. A short position in a call option
B. A short position in a put option
C. A long position in a put option
D. None of the above
=> 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.

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19. A trader has a portfolio worth $5 million that mirrors the performance of a
stock index. Thestock index is currently 1,250. Futures contracts trade on the
index with one contract being on250 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
=> 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. 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
=>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\

Chap 2
1. 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.
=> Futures contracts trade only on exchanges. Forward contracts trade only in
the over-the-counter market.

2. 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.
=> Forward contracts often last longer than futures contracts. B, C, and D are
true

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3. 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
=> 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.

4. 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
=> 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 futures price is currently 70 cents.
When the price rises above 72 cents there will be a margin call.

5. 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
=> Amounts in the margin account in excess of the initial margin can be
withdrawn. Each $ increase in the futures price leads to a gain of $1000. When

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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.

6. 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
=> The open interest goes down by one. There is one less long position and one
less short position.

7. 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
=> 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.

8. 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
=> 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
$2,000 to $1,800.

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9. 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
=> Hedge accounting is used. The whole of the gain or loss on the futures is
therefore recognized in2013. None is recognized in 2012. In this case the gain is
$4 per unit or $4,000 in total.

10. 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
=> 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.

11. The frequency with which futures margin accounts are adjusted for gains
and losses is
A. Daily
B. Weekly
C. Monthly
D. Quarterly
=> In futures contracts margin accounts are adjusted for gains or losses daily.

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12. 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
=> 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.

13. 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
=> The CFTC has primary responsibility for regulating futures markets

14. 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
=> The contracts which are close to maturity tend to have the highest open
interest. However, during the maturity month itself the open interest declines.

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
=> Clearing houses are always used by exchanges trading futures. Increasingly,
OTC products are cleared through CCPs, which are a type of clearing house.

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16. 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 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.

17. With bilateral clearing, the number of agreements between four dealers, who
trade with each other, is
A. 12
B. 1
C. 6
D. 2
=> Suppose the dealers are W, X, Y , and Z. The agreements are between W and
X, W and Y, W andZ, X and Y, X and Z, and Y and Z. There are therefore a total
of 6 agreements.

18. 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
=> CCPs do for the OTC market what exchange clearing houses do for the
exchange-traded market. The correct answer is therefore D. CCPs must be used
for most standard OTC derivatives transactions, but not for all derivatives
transactions.

19. Which of the following are cash settled

A. All futures contracts
B. All option contracts
C. Futures on commodities
D. Futures on stock indices
=> Futures on stock indices are usually cash settled. The rest are usually settled
by delivery of theunderlying assets

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20. 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
=> In a limit order a trader specifies the worst price (from the trader’s
perspective) at which thetrade can be carried out.

Chap 3
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 positin worsens
C. The hedger’s position sometimes worsens and sometimes improves
D. The hedger’s position stays the same.
=> 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
=> 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.

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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
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
=> The user of the comodity takes a long futures position. The gain of the
futures is 63.5 - 59 or $4.5. The effective paid realized is therefore 64 - 4.5 or
$59.5. 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 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
=> 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).
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
=> The optimal hedge ratio is 0.9×(2/3) or 0.6.

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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
=> 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 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
=> 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).
=> The optimal hedge ratio reflects the ratio of movements in the spot price to
movements in the futures price.

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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 hedging
D. None of the above
=> Tailing the hedge is a calculation appropriate when futures are used for
hedging. It corrects for daily settlement
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 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
=> 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 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
=> 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 described “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
=> 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

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maturity futures contracts and so on. The result is the creation of a long term
hedge from short-term futures contracts.

13. 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
=> 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.)

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
=> 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.

15. 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 => A, B, and C all describe beta but beta has nothing to do with
the correlation between futures and spot prices for a commodity

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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
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
=> 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.

17. 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
=> 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.

18. 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 whether it
shareholders want exposure to the price of gold
D. Gold producers can hedge by buying gold in the forward market
=> 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.

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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 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
=> 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.

20. 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
C. $102
D. $106
=> On the 80% (hedged) part of the commodity purchase the price paid will be
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.

Chap 4
1. 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

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D. None of the above

=> 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.

2. 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%
=> The equivalent rate with continuous compounding is ln(1.06) = 0.0583 or
5.83%.

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%
C. 4.97%
D. 4.94%
=> The equivalent rate with semiannual compounding is 2×(e0.05/2−1) =
0.0506 or 5.06%.

4. 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%

5. 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%
=> 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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6. 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%

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
semiannually.
A. $9.12
B. $9. 02
C. $8.88
D. $8.63
=> The value of the FRA is the value of receiving an extra
0.5×(0.08−0.06)×1000 = $10 in 2.5 years. This is 10/(1.03 5 ) = $8.63.

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 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.
=> 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.

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9. The zero curve is upward sloping. Define X as the 1-year par yield, Y as the
1-year zero rate and Zas 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
=> 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.

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
=> 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.

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?
A. Increase of $2,500
B. Decrease of $2,500
C. Increase of $25,000
D. Decrease of $25,000
=> 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.

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

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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
corresponding 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.

=> LIBOR is a rate used for interbank transactions.

14. 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
=> 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.

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
=> Maturity preference theory is not a theory of the term structure. The other
three are.

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 transaction where securities are sold and bought back
later at a higher price
D.None of the above

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=> 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.

17. 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
=> 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.

18. 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
=> The forward rate accentuates trends in the zero curve. The par yield shows
the same trends but in a less pronounced way.

19. Which of the following is true?

A. When interest rates in the economy increase, all bond prices 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
=> 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.

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20. 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%
=> 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.

Chap 5
1. Which of the following is a consumption asset?
A. The S&P 500 index
B. The Canadian dollar
C. Copper
D. IBM stock
=> A, B, and D are investment assets (held by at least some investors purely for
investment 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
=> 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.

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3. 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
=> The 3-year forward price is the spot price grossed up for 3 years at the
riskfree rate. It is 30e 0.1×3 =$40.50.

4. 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
=>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)e 0.1×3 = $35.84.

5. 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
=> The six-month forward rate is 0.7000e−(0.05−0.07)×0.5=0.6930.

6. 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.

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=> 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.

7. 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
=> 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. 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 expected future spot price.
D. The forward price is sometimes greater and sometimes less than the expected
future spot price.
=> 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.

9. 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
=>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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10.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
=> 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.

11.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
=> 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.

12.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
=> 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

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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, 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
=> 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 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
=> 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 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
=> 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.

16. As inventories of a commodity decline, which of the following is true?

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=> When inventories decline, the convenience 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
dividends are paid are known
D. Dividends will yield a certain return to a person buying the stock today
=> The dividend yield is the dividend per year as a percent of the stock price at
the time when the dividend is paid.

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
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
=> 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.

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
=> 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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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
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
=>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.

Chap 10
1. 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
 A call option is the right, but not the obligation to buy.

2. Which of the following is true?

A. A long call is the same as a short put

B. A short call is the same as a long put
C. A call on a stock plus a stock is the same as a put
D. None of the above

 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.

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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

 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.

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

=> The stock dividend is equivalent to a 5 for 4 stock split. The number of
shares goes up by 25% and the strike price is reduced to 4/5 of its previous
value.

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

 Cash dividends unless they are unusually large have no effect on the
terms of an option.

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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
 A short position is a position where the option has been sold (the opposite
to a long position).

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
 A warrant is a fixed number of options issued by a company. They often
trade on an exchange after they have been issued.

8. 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

=> LEAPS are long-term equity anticipation securities. They are exchange-
traded options with relatively long maturities.

9. 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

=> An option class is all calls on a certain stock or all puts on a certain stock.

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10. Which of the following is an example of an option series?

A. All calls on a certain stock

=> 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.

11. 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

=> 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.

12. 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

=> 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.

13. Which of the following is NOT traded by the CBOE?

A. Weeklys
B. Monthlys
C. Binary options
D. DOOM options

=>Monthlys are not a CBOE product. The others are.

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14. 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

=> Only options lasting more than 9 months can be bought on margin.

15. 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

=>Margin accounts for options must be brought up to the initial/maintenance

margin level every day.

16. 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

=> 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.

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17. 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

=> From adding up the two payoffs we see that A is true:

max(ST−K,0)−max(K−ST,0)= ST−K

18. 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

=> The payoff must be more than the $10 paid for the option. The stock price
must therefore be below $50.

19. 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

=> 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.

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20. 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

=> 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.

Chap 11
1. When the stock price increases with all else remaining the same, which of
the following is true?