M.Com IV Semester: Financial Derivatives and Risk Management
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Questions and Answers

The payoffs for financial derivatives are linked to

  • The volatility of interest rates
  • Government regulations specifying allowable rates of return
  • Previously issued securities (correct)
  • Securities that will be issued in the future

    • Financial Derivatives include

  • Stocks
  • None of these (correct)
  • Bonds
  • Futures

    • By hedging Portfolio a bank manager

  • Increases the probability of gains
  • Increases exchange rate risk
  • Increases reinvestment risk
  • Reduces interest rate risk (correct)

    • The markets in which derivatives are traded is known as

    <p>Derivative market</p> Signup and view all the answers

    The contract where buyer and seller agrees to exchange asset on future date without the involvement of an exchange

    <p>Forwards</p> Signup and view all the answers

    The contract which gives the buyer the right but not obligation

    <p>Options</p> Signup and view all the answers

    The buyer in the derivative contract is also known as

    <p>Long in the contract</p> Signup and view all the answers

    ETD stands for

    <p>Exchange traded derivatives</p> Signup and view all the answers

    Market players who take benefits from difference in market prices are called

    <p>Arbitrageurs</p> Signup and view all the answers

    Short in derivative contract implies

    <p>Seller</p> Signup and view all the answers

    Which of the following is potentially obligated to sell an asset at a predetermined price

    <p>Put writer</p> Signup and view all the answers

    Which of the following contract is non-standardized and suffers illiquidity most

    <p>Forwards</p> Signup and view all the answers

    The initial amount paid by option buyer at the time of entering the contract

    <p>Option premium</p> Signup and view all the answers

    When the maturity matches but the size of the futures does not match, the hedge can be

    <p>Cross hedge</p> Signup and view all the answers

    What is the total number of futures/option contracts outstanding at the close of the previous day’s trading?

    <p>Open interest</p> Signup and view all the answers

    Which of the following is a non-variance based model for computation of VaR?

    <p>All of the above</p> Signup and view all the answers

    Who takes the short position in an option contract?

    <p>Option writer</p> Signup and view all the answers

    Which of the following is not used in future pricing?

    <p>CAPM</p> Signup and view all the answers

    Which type of option contract would lead to zero cash flow if exercised immediately?

    <p>At the money option</p> Signup and view all the answers

    Which type of option contract would lead to positive cash flow if exercised immediately?

    <p>In the money option</p> Signup and view all the answers

    The absence of arbitrage between the value of European call and put options with same strike price and expiry date on the same underlying asset is shown by

    <p>Put-call parity pricing relationship</p> Signup and view all the answers

    What is a swap that takes into consideration daily variation of market rates within a specific range?

    <p>Corridor swap</p> Signup and view all the answers

    What is a swap that pays a certain fixed amount if the rate is above or below a certain level?

    <p>Digital swap</p> Signup and view all the answers

    Study Notes

    Financial Derivatives and Risk Management

    Financial Derivatives

    • Payoffs are linked to underlying assets or securities, such as interest rates, currencies, or commodities.
    • Include futures, options, forwards, and swaps.

    Futures

    • Traded on exchanges, such as NCDEX, NMCE, and MCX.
    • Mark-to-market settlement system used.
    • Open interest refers to the total number of outstanding contracts.

    Options

    • Give the buyer the right, but not the obligation, to buy or sell an underlying asset.
    • Types: call, put, American, European, and Bermudan options.
    • OPTION STRATEGIES:
      • Selling one put option at a low strike price and buying a put option at a high strike price is a put bear spread.
      • A calendar spread is formed by using options on the same asset with the same strike price but different expiration dates.

    Forwards

    • Customized contracts between two parties.
    • Not traded on exchanges.
    • Settlement occurs on the expiration date.

    Swaps

    • Agreement to exchange cash flows between two parties.
    • Types: currency swaps, interest rate swaps, and commodity swaps.
    • SWAP FEATURES:
      • Callable swap: seller has the chance to terminate the swap at any time before maturity.
      • Putable swap: buyer has the chance to terminate the swap at any time before maturity.

    Risk Management

    • Hedging: reduces risk by taking a position in a futures or options contract to offset potential losses or gains in an underlying asset.
    • Types of risk: market risk, liquidity risk, credit risk, and operational risk.
    • Value-at-Risk (VaR): estimates the potential loss of a portfolio over a specific time horizon with a given probability.

    Option Pricing Models

    • Binomial Option Pricing Model: developed by John Cox, Stephen Ross, and Mark Rubinstein.
    • Black-Scholes Model: used to estimate the value of options.

    Swap Agreements

    • Notional principle: the underlying amount in a swap contract.
    • LIBOR: London Interbank Offered Rate, used as a reference rate in swap agreements.

    Hedging and Speculation

    • Hedgers: reduce risk by taking a position in a futures or options contract to offset potential losses or gains in an underlying asset.
    • Speculators: take positions in futures or options contracts in anticipation of profit from price movements.
    • Arbitrageurs: take advantage of price differences between two markets to earn a risk-free profit.### Types of Swaps
    • An accreting swap is a type of swap where one stream of future interest payments is exchanged for another based on a specified principal amount.
    • Interest rate swaps are a type of swap where one party exchanges a series of fixed-rate interest payments for a series of floating-rate interest payments.

    Futures vs. Forwards

    • Futures differ from forwards because they are marked to market daily.
    • Futures are used to hedge portfolios, individual securities, and in both financial and foreign exchange markets.

    Standardized Futures Contracts

    • Standardized futures contracts exist for stock indexes, gold, and Treasury bonds.
    • Common stocks are an exception, where standardized futures contracts do not exist.

    Roles in Futures Markets

    • A pit trader is a type of trader who executes trades on the floor of an exchange.
    • A local is a trader who trades for their own account.
    • A floor broker is a trader who executes trades for others.
    • A futures commission merchant is similar to a stock broker, as they act as an intermediary between buyers and sellers.

    Risk Management

    • Using futures contracts to transfer price risk is called hedging.
    • Hedging involves reducing or eliminating risk by taking a position in a futures contract that is opposite to a current position.

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    Financial Derivatives and Risk Management PDF

    Description

    Test your knowledge of financial derivatives and risk management with this multiple-choice question bank designed for M.Com IV semester students.

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