Derivatives Questions PDF

Consider a stock that will have a value of either 22 or 14 one year from now. If the risk-free rate is 5%, what is the ratio of shares to short call options with an exercise price of 18 for a portfolio that will have the same value at expiration regardless of the stock price at the end of the year?...

Consider a stock that will have a value of either 22 or 14 one year from now. If the risk-free rate is 5%, what is the ratio of shares to short call options with an exercise price of 18 for a portfolio that will have the same value at expiration regardless of the stock price at the end of the year? A. 0.48. B. 0.53. C. 0.50. ANSWER: C One method of valuing a call option with a one-period binomial model involves: A. discounting the average call value at expiration by the risk-free rate. B. using the probabilities of an up-move and a down-move to get the expected value of the payment at expiration. C. finding a combination of the call option and the underlying that will have the same value regardless of the price of the underlying at expiration. ANSWER: C We can use the risk-free rate to value an option with a one-period binomial model because: A. combining put and call options in specific ratio can produce a risk-free future payment. B. combining options with the underlying asset in a specific ratio will produce a risk-free future payment. C. options investors are risk-neutral, on average. ANSWER: B In order to value an option with a one-period binomial model, three things an analyst would need to know are: A. the risk-adjusted discount rate, the volatility of the price of the underlying asset, and option exercise price. B. the probability of an up-move, the option exercise price, and the current asset price. C. the risk-free rate, the volatility of the price of the underlying, and the current asset price. ANSWER: C Consider a European call option and put option that have the same exercise price, and a forward contract to buy the same underlying asset as the two options. An investor buys a risk-free bond that will pay, on the expiration date of the options and the forward contract, the difference between the exercise price and the forward price. According to the put-call-forward parity relationship, this bond can be replicated by: A. writing the call option and buying the put option. B. buying the call option and writing the put option. C. writing the call option and writing the put option. ANSWER: A A synthetic European put option includes a short position in: A. the underlying asset. B. a risk-free bond. C. a European call option. ANSWER: A A fiduciary call is a portfolio that is made up of: A. a call that is synthetically created from other instruments. B. a call option and a bond that pays the exercise price of the call at option expiration. C. a call option and a share of stock. ANSWER: B An investor calculates that the premium of a European put option is less than its value based on put-call parity. In exploiting this arbitrage opportunity, the investor is most likely to: A. sell the underlying short. B. invest the present value of the exercise price at the risk-free rate. C. sell the call option. ANSWER: C Using put-call parity, it can be shown that a synthetic European call can be created by a portfolio that is: A. long the stock, short the put, and short a pure discount bond that pays the exercise price at option expiration. B. long the stock, long the put, and long a pure discount bond that pays the exercise price at option expiration. C. long the stock, long the put, and short a pure discount bond that pays the exercise price at option expiration. ANSWER: C A synthetic European call option includes a short position in: A. the underlying asset. B. a risk-free bond. C. a European put option. ANSWER: B Which of the following portfolios has the same future cash flows as a protective put? A. Short call option, long risk-free bond. B. Long call option, long risk-free bond, short the underlying asset. C. Long call option, long risk-free bond. ANSWER: C Using put-call parity, it can be shown that a synthetic European put can be created by a portfolio that is: A. short the stock, long the call, and long a pure discount bond that pays the exercise price at option expiration. B. short the stock, long the call, and short a pure discount bond that pays the exercise price at option expiration. C. long the stock, short the call, and short a pure discount bond that pays the exercise price at option expiration. ANSWER: A Which of the following instruments is a component of the put-call-forward parity relationship? A. The spot price of the underlying asset. B. The present value of the forward price of the underlying asset. C. The future value of the forward price of the underlying asset. ANSWER: B The relationship referred to as put-call-forward parity states that at time = 0, if there is no arbitrage opportunity, the value of a call at X on an asset that has no holding costs or benefits plus the present value of X is equal to: A. the value of a put option at X plus the present value of the forward contract price. B. the forward contract price plus the value of a put option at X. C. the asset price minus the value of a put option at X. ANSWER: A The value of a put option at expiration is most likely to be increased by: A. a lower risk-free interest rate. B. higher volatility of the underlying asset price. C. a higher exercise price. ANSWER: C A call option that is in the money: A. has an exercise price less than the market price of the asset. B. has an exercise price greater than the market price of the asset. C. has a value greater than its purchase price. ANSWER: A At expiration, exercise value is equal to time value for: A. an out-of-the-money call or an out-of-the-money put. B. an out-of-the-money call or an in-the-money put. C. an in-the-money call or an out-of-the-money put. ANSWER: A Which of the following statements about long positions in put and call options is most accurate? Profits from a long call: A. and a long put are positively correlated with the stock price. B. are negatively correlated with the stock price and the profits from a long put are positively correlated with the stock price. C. are positively correlated with the stock price and the profits from a long put are negatively correlated with the stock price. ANSWER: C Which of the following will increase the value of a call option? A. An increase in the exercise price. B. A dividend on the underlying asset. C. An increase in volatility. ANSWER: C An option's intrinsic value is equal to the amount the option is: A. in the money, and the time value is the market value minus the intrinsic value. B. in the money, and the time value is the intrinsic value minus the market value. C. out of the money, and the time value is the market value minus the intrinsic value. ANSWER: A An increase in the riskless rate of interest, other things equal, will: A. decrease call option values and decrease put option values. B. decrease call option values and increase put option values. C. increase call option values and decrease put option values. ANSWER: C Compared to an otherwise identical European put option, one that has a longer time to expiration: A. must be worth more than the put that is nearer to expiration. B. must be worth at least as much as the put that is nearer to expiration. C. may be worth less than the put that is nearer to expiration. ANSWER: C Which of the following statements about moneyness is most accurate? When the stock price is: A. below the strike price, a call option is in-the-money. B. above the strike price, a put option is in-the-money. C. above the strike price, a put option is out-of-the-money. ANSWER: C The time value of a European call option with 30 days to expiration will most likely be: A. less than the current option premium if the option is currently in-the-money. B. greater than the current option premium if the option is currently out-of-the money. C. equal to the intrinsic value if the exercise price is greater than the current spot price. ANSWER: A For a European style put option: A. time value is equal to its market price minus its exercise value. B. intrinsic value is equal to its market price plus its exercise value. C. exercise value is equal to the underlying stock price minus its exercise price. ANSWER: A The time value of an option is most accurately described as: A. the amount by which the intrinsic value exceeds the option premium. B. increasing as the option approaches its expiration date. C. equal to the entire premium for an out-of-the-money option. ANSWER: C Other things equal, a short put position would become more valuable as a result of an increase in: A. the time to expiration. B. the price of the underlying asset. C. the volatility of the price of the underlying asset. ANSWER: B Dividends or interest paid by the asset underlying a call option: A. decrease the value of the option. B. increase the value of the option. C. have no effect on the value of the option. ANSWER: A An investor has bought a European put option and written a European call option. Other things equal, a decrease in the risk-free rate will increase the value of: A. only one of these option positions. B. both of these option positions. C. neither of these option positions. ANSWER: B A decrease in the riskless rate of interest, other things equal, will: A. decrease call option values and decrease put option values. B. increase call option values and decrease put option values. C. decrease call option values and increase put option values. ANSWER: C An investor will exercise a European put option on a stock at its expiration date if the stock price is: A. equal to the exercise price. B. less than the exercise price. C. greater than the exercise price. ANSWER: B A call option's intrinsic value: A. decreases as the stock price increases above the strike price, while a put option’s intrinsic value increases as the stock price decreases below the strike price. B. increases as the stock price increases above the strike price, while a put option’s intrinsic value decreases as the stock price decreases below the strike price. C. increases as the stock price increases above the strike price, while a put option’s intrinsic value increases as the stock price decreases below the strike price. ANSWER: C An investor holds two options on the same underlying stock, a call option with an exercise price of 25 and a put option with an exercise price of 30. If the market price of the stock is 27: A. neither option is in the money. B. only one of the options is in the money. C. both options are in the money. ANSWER: C Which of the following is typically equal to zero at the initiation of an interest rate swap contract? C. Neither its value nor its price. A. Its value. B. Its price. ANSWER: A An investor could best replicate the position of the floating rate payer in a swap by: B. borrowing at a floating rate and entering a series of zero-value FRAs. A. borrowing at a floating rate and buying a fixed-rate bond. C. borrowing at a fixed rate and entering a series of zero-value FRAs. ANSWER: A The price of a fixed-for-floating interest rate swap contract: B. is established at contract initiation. A. may vary over the life of the contract. C. is directly related to changes in the floating rate. ANSWER: B For a series of forward contracts to replicate a swap contract, the forward contracts must have: A. values at swap initiation that sum to zero. C. values at swap initiation that are equal to zero. B. values at swap expiration that sum to zero. ANSWER: A Long futures contracts may be preferred to equivalent forward contracts without central clearing when interest rates are: A. uncorrelated with the price of the underlying. B. negatively correlated with the price of the underlying. C. positively correlated with the price of the underlying. ANSWER: C Compared to an interest rate futures contract, an otherwise equivalent forward rate agreement will: B. exhibit greater convexity. A. have greater payments for a given decrease in interest rates. C. have greater volatility. ANSWER: B Long forward contracts without central clearing may be preferred to equivalent futures contracts when interest rates are: A. positively correlated with the price of the underlying. B. negatively correlated with the price of the underlying. C. uncorrelated with the price of the underlying. ANSWER: B Bea Moran wants to establish a long derivatives position in a commodity she will need to acquire in six months. Moran observes that the six-month forward price is 45.20 and the six-month futures price is 45.10. This difference most likely suggests that for this commodity: A. long investors should prefer futures contracts to forward contracts. C. there is an arbitrage opportunity among forward, futures, and spot prices. B. futures prices are negatively correlated with interest rates. ANSWER: B For a futures contract, the adjustment for the change in settlement price from one day to the next will result in: A. changes in both the contract price and contract value. B. a change in contract price but no change in contract value. C. no change in contract price but a change in contract value. ANSWER: B If the price of a forward contract is greater than the price of an identical futures contract, the most likely explanation is that: B. the forward contract is more liquid than the futures contract. A. the futures contract requires daily settlement and the forward contract does not. C. the futures contract is more difficult to exit than the forward contract. ANSWER: A For an underlying asset that has no holding costs or benefits, the value of a forward contract to the long during the life of the contract is the: C. present value of the difference between the spot price and the forward price. A. spot price minus the present value of the forward price. B. difference between the spot price and the forward price. ANSWER: A At time t, prior to its settlement date at time T, the value Vt of a long forward with a price of F will be related to the spot price, S, of an asset that has a zero net cost of carry by: C. Vt = (St − F0(T))(1 + Rf)^(–(T – t)). A. Vt = St − F0(T)(1 + Rf)^(–(T – t)). B. Vt = F0(T) − St(1 + Rf)^(–(T – t)). ANSWER: A The value of a forward or futures contract is: A. specified in the contract. B. typically zero at initiation. C. equal to the spot price at expiration. ANSWER: B The most likely use of a forward rate agreement is to: A. lock in an interest rate for future borrowing or lending. B. exchange a floating-rate obligation for a fixed-rate obligation. C. obtain the right, but not the obligation, to borrow at a certain interest rate. ANSWER: A For an underlying asset that has no holding costs or benefits, the no-arbitrage forward price at initiation of a forward contract is: A. zero. B. the future value of the spot price. C. equal to the spot price. ANSWER: B It is possible to profit from arbitrage when there are no costs or benefits to holding the underlying asset and the forward contract price is: B. less than the future value of the spot price. A. equal to the future value of the spot price. C. greater than the present value of the spot price. ANSWER: B Other things equal, an increase in storage costs of the underlying asset will: A. decrease the no-arbitrage forward price. B. Not affect the no-arbitrage forward price. C. increase the no-arbitrage forward price. ANSWER: C Costs of holding the underlying that are greater than benefits from holding the underlying will: A. increase the no-arbitrage forward price. C. have no effect on the no-arbitrage forward price. B. decrease the no-arbitrage forward price. ANSWER: A Which of the following is most likely to increase the no-arbitrage forward price of an asset? A. Lower convenience yield for a commodity. C. Higher dividends from a stock. B. Lower storage costs for a commodity. ANSWER: A The calculation of derivatives values is based on an assumption that: B. arbitrage opportunities are exploited rapidly. C. investors are risk neutral. A. arbitrage opportunities do not arise in real markets. ANSWER: B A net benefit from holding the underlying asset of a forward contract will: B. decrease the no-arbitrage forward price at initiation. C. decrease the value of the forward contract at expiration. A. increase the value of the forward contract during its life. ANSWER: B Other things equal, the no-arbitrage forward price of an asset will be higher if the asset has: A. storage costs. B. dividend payments. C. convenience yield. ANSWER: A A corporation that employs hedge accounting and uses derivatives to reduce the volatility of the value of its inventory is most likely using a: A. cash flow hedge. B. fair value hedge. C. net investment hedge. ANSWER: B A corporation that employs hedge accounting and uses an interest rate swap to offset changes in the value of fixed rate bond liability is said to be employing a: A. cash flow hedge. B. net investment hedge. C. fair value hedge. ANSWER: C Hedge accounting with a net investment hedge most likely refers to a company that is using derivatives to reduce the volatility of: A. the value of a foreign subsidiary. B. a balance sheet liability. C. its net working capital. ANSWER: A A call option has an exercise price of \\$120, and the stock price is \\$105 at expiration. The expiration day value of the call option is: A. $0. B. $15. C. $105. ANSWER: A Which of the following statements regarding a forward commitment is least accurate? A forward commitment: B. can involve a stock index. C. is not legally binding. A. is a contractual promise. ANSWER: C A put option has an exercise price of \\$80, and the stock price is \\$75 at expiration. The expiration day value of the put option is: A. $5. B. $0. C. $80. ANSWER: A Which of the following statements regarding call options is most accurate? The: A. breakeven point for the buyer is the exercise price plus the option premium. B. breakeven point for the seller is the exercise price minus the option premium. C. call holder will exercise (at expiration) if the exercise price exceeds the stock price. ANSWER: A A financial instrument with a payoff that depends on a specified event occurring is most accurately described as: A. a contingent claim. B. an option. C. a default swap. ANSWER: A At expiration, the value of a call option is the greater of zero or the: A. underlying asset price minus the exercise value. B. underlying asset price minus the exercise price. C. exercise price minus the exercise value. ANSWER: B An investor buys a call option that has an option premium of \\$5 and an exercise price of \\$22.50. The current market price of the stock is \\$25.75. At expiration, the value of the stock is \\$23.00. The net profit/loss of the call position is closest to: A. −$4.50. B. $4.50. C. −$5.00. ANSWER: A Basil, Inc., common stock has a market value of \\$47.50. A put available on Basil stock has a strike price of \\$55.00 and is selling for an option premium of \\$10.00. The put is: B. in-the-money by $7.50. C. in-the-money by $10.00. A. out-of-the-money by $2.50. ANSWER: B Jimmy Casteel pays a premium of \\$1.60 to buy a put option with an exercise price of \\$145. If the stock price at expiration is \\$128, Casteel's profit or loss from the options position is: A. $1.60. B. $18.40. C. $15.40. ANSWER: C Ed Verdi has a long position in a European put option on a stock. At expiration, the stock price is greater than the exercise price. The value of the put option to Verdi on its expiration date is: B. negative. C. positive. A. zero. ANSWER: A Al Steadman receives a premium of \\$3.80 for writing a put option with an exercise price of \\$64. If the stock price at expiration is \\$84, Steadman's profit or loss from the options position is: A. $23.80. C. $16.20. B. $3.80. ANSWER: B A put option has an exercise price of \\$65, and the stock price is \\$39 at expiration. The expiration day value of the put option is: A. $0. B. $26. C. $65. ANSWER: B A European call option on a stock has an exercise price of 42. On the expiration date, the stock price is 40. The value of the option at expiration is: A. positive. B. negative. C. zero. ANSWER: C At expiration, the value of a European call option is: A. equal to its intrinsic value. B. equal to the asset price minus the present value of the exercise price. C. less than that of an otherwise identical American call option. ANSWER: A Consider a call option with an exercise price of \\$32. If the stock price at expiration is \\$41, the value of the call option is: A. $0. B. $9. C. $41. ANSWER: B On the expiration date of a put option, if the spot price of the underlying asset is less than the exercise price, the value of the option is: A. negative. C. zero. B. positive. ANSWER: B Mosaks, Inc., has a put option with an exercise price of \\$105. If Mosaks stock price is \\$115 at expiration, the value of the put option is: A. $0. B. $10. C. $105. ANSWER: A A call option has a strike price of \\$35 and the stock price is \\$47 at expiration. What is the expiration day value of the call option? A. $35. B. $12. C. $0. ANSWER: B A futures investor receives a margin call. If the investor wishes to maintain her futures position, she must make a deposit that restores her account to the: A. maintenance margin. B. daily margin. C. initial margin. ANSWER: C Credit default swaps are least accurately characterized as: A. forward commitments. B. insurance. C. contingent claims. ANSWER: A In a credit default swap (CDS), the buyer of credit protection: A. makes a series of payments to a credit protection seller. B. exchanges the return on a bond for a fixed or floating rate return. C. issues a security that is paid using the cash flows from an underlying bond. ANSWER: A If the margin balance in a futures account with a long position goes below the maintenance margin amount: C. a deposit is required which will bring the account to the maintenance margin level. A. a deposit is required to return the account margin to the initial margin level. B. a margin deposit equal to the maintenance margin is required within two business days. ANSWER: A The settlement price for a futures contract is: B. the price of the last trade of a futures contract at the end of the trading day. A. an average of the trade prices over a period at the end of a trading session. C. the price of the asset in the future for all trades made in the same day. ANSWER: A An agreement that gives the holder the right, but not the obligation, to sell an asset at a specified price on a specific future date is a: A. call option. B. swap. C. put option. ANSWER: C Which of the following statements about options is most accurate? B. The holder of a put option has the right to sell to the writer of the option. C. The writer of a put option has the obligation to sell the asset to the holder of the put option. A. The holder of a call option has the obligation to sell to the option writer if the stock’s price rises above the strike price. ANSWER: B Which of the following statements regarding exchange-traded derivatives is least accurate? Exchange-traded derivatives: B. are illiquid. C. are backed by a central clearinghouse. A. often trade in a physical location. ANSWER: B For exchange-traded derivatives, the role of the central clearinghouse is to: A. guarantee that all obligations by traders will be honored. B. maintain private insurance that can be used to provide funds if a trader defaults. C. stabilize the market price fluctuations of the underlying commodity. ANSWER: A In futures markets, the primary role of the clearinghouse is to: A. prevent arbitrage and enforce federal regulations. B. reduce transaction costs by making contract prices public. C. act as guarantor to both sides of a futures trade. ANSWER: C A derivative is defined as a security that has a value: A. based on another security, commodity, or index. B. established outside an organized exchange. C. stated in a contract between two counterparties. ANSWER: A