Derivatives

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) $12. B) $0. C) $35.

A) $12.

An analyst determines that a portfolio with a 35% weight in Investment P and a 65% weight in Investment Q will have a standard deviation of returns equal to zero. Investment P has an expected return of 8%. Investment Q has a standard deviation of returns of 7.1% and a covariance with the market of 0.0029. The risk-free rate is 5% and the market risk premium is 7%. If no arbitrage opportunities are available, the expected rate of return on the combined portfolio is closest to: A) 5%. B) 6%. C) 7%

A) 5%.

Which of the following definitions involving derivatives is least accurate? A) A call option gives the owner the right to sell the underlying good at a specific price for a specified time period. B) An option writer is the seller of an option. C) An arbitrage opportunity is the chance to make a riskless pro

A) A call option gives the owner the right to sell the underlying good at a specific price for a specified time period.

Which of the following is NOT an over-the-counter (OTC) derivative? A) A futures contract. B) A forward contract. C) A bond option.

A) A futures contract.

Which of the following represents a long position in an option? A) Buying a put option. B) Writing a call option. C) Writing a put option.

A) Buying a put option.

Which of the following is most accurate regarding derivatives? A) Derivative values are based on the value of another security, index, or rate. B) Derivatives have no default risk. C) Exchange-traded derivatives are created and traded by dealers in a market with no central location.

A) Derivative values are based on the value of another security, index, or rate.

Which of the following statements regarding plain-vanilla interest rate swaps is least accurate? A) In a swap contract, the counterparties usually swap the notional principal. B) The settlement dates are when the interest payments are to be made. C) The time frame covered by the swap is called the tenor of the swap.

A) In a swap contract, the counterparties usually swap the notional principal.

Which of the following relationships between arbitrage and market efficiency is least accurate? A) Market efficiency refers to the low cost of trading derivatives because of the lower expense to traders. B) Investors acting on arbitrage opportunities help keep markets efficient. C) The concept of rationally priced financial instruments preventing arbitrage opportunities is the basis behind the no-arbitrage principle.

A) Market efficiency refers to the low cost of trading derivatives because of the lower expense to traders.

Which of the following statements about options is most accurate? A) The holder of a put option has the right to sell to the writer of the option. B) 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. 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 put option has the right to sell to the writer of the option.

Which of the following is least likely one of the conditions that must be met for a trade to be considered an arbitrage? A) There are no commissions. B) There is no initial investment. C) There is no risk.

A) There are no commissions.

If the margin balance in a futures account with a long position goes below the maintenance margin amount: A) a deposit is required to return the account margin to the initial margin level. B) a deposit is required which will bring the account to the maintenance margin level. C) a margin deposit equal to the maintenance margin is required within two business days.

A) a deposit is required to return the account margin to the initial margin level.

A similarity of margin accounts for both equities and futures is that for both: A) additional payment is required if margin falls below the maintenance margin. B) interest is charged on the margin loan balance. C) the value of the security is the collateral for the loan.

A) additional payment is required if margin falls below the maintenance margin.

The underlying instrument in a forward rate agreement is: A) an interest rate. B) an asset. C) a fixed-income security.

A) an interest rate.

Over-the- counter derivatives: A) are customized contracts. B) have good liquidity in the over-the-counter (OTC) market. C) are backed by the OTC Clearinghouse.

A) are customized contracts.

Which of the following statements regarding call options is most accurate? The: A) breakeven point for the buyer is the strike price plus the option premium. B) call holder will exercise (at expiration) whenever the strike price exceeds the stock price. C) breakeven point for the seller is the strike price minus the option premium.

A) breakeven point for the buyer is the strike price plus the option premium.

The clearinghouse, in U.S. futures markets is least likely to: A) choose which assets will have futures contracts. B) act as a counterparty in futures contracts. C) guarantee performance of futures contract obligations.

A) choose which assets will have futures contracts.

A financial instrument that has payoffs based on the price of an underlying physical or financial asset is a(n): A) derivative security. B) option. C) future.

A) derivative security.

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.

A) equal to its intrinsic value.

A standardized and exchange-traded agreement to buy or sell a particular asset on a specific date is best described as a: A) futures contract. B) swap. C) forward contract.

A) futures contract.

If futures prices are positively correlated with interest rates, futures prices will be: A) greater than forward prices. B) unaffected relative to forward prices. C) less than forward prices.

A) greater than forward prices.

Which of the following statements about futures and the clearinghouse is least accurate? The clearinghouse: A) has defaulted on one half of one percent of futures trades. B) requires the daily settlement of all margin accounts. C) guarantees that traders in the futures market will honor their obligations.

A) has defaulted on one half of one percent of futures trades.

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: A) in-the-money by $7.50. B) in-the-money by $10.00. C) out-of-the-money by $2.50.

A) in-the-money by $7.50.

MBT Corporation recently announced a 15% increase in earnings per share (EPS) over the previous period. The consensus expectation of financial analysts had been an increase in EPS of 10%. After the earnings announcement the value of MBT common stock increased each day for the next five trading days, as analysts and investors gradually reacted to the better than expected news. This gradual change in the value of the stock is an example of: A) inefficient markets. B) efficient markets. C) speculation.

A) inefficient markets.

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) initial margin. B) maintenance margin. C) daily margin.

A) initial margin.

The process of arbitrage does all of the following EXCEPT: A) insure that risk-adjusted expected returns are equal. B) promote pricing efficiency. C) produce riskless profits.

A) insure that risk-adjusted expected returns are equal.

One of the principal characteristics of swaps is that swaps: A) may be likened to a series of forward contracts. B) are standardized derivative instruments. C) are highly regulated over-the-counter agreements.

A) may be likened to a series of forward contracts.

Financial derivatives contribute to market completeness by allowing traders to do all of the following EXCEPT: A) narrow the amount of trading opportunities to a more manageable range. B) engage in high risk speculation. C) increase market efficiency through the use of arbitrage.

A) narrow the amount of trading opportunities to a more manageable range.

On the expiration date of a European put option, if the spot price of the underlying asset is less than the exercise price, the value of the option is: A) positive. B) zero. C) negative.

A) positive.

Any rational quoted price for a financial instrument should: A) provide no opportunity for arbitrage. B) provide an opportunity for investors to make a profit. C) be low enough for most investors to afford.

A) provide no opportunity for arbitrage.

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) put option. B) call option. C) swap.

A) put option.

Which of the following is a difference between futures and forward contracts? Futures contracts are: A) standardized. B) larger than forward contracts. C) over-the-counter instruments.

A) standardized.

Other things equal, the no-arbitrage forward price of an asset will be higher if the asset has: A) storage costs. B) convenience yield. C) dividend payments.

A) storage costs.

Derivatives valuation is based on risk-neutral pricing because: A) the risk of a derivative is based entirely on the risk of its underlying asset. B) this method provides an intrinsic value to which investors apply a risk premium. C) risk tolerances of long and short investors are assumed to offset.

A) the risk of a derivative is based entirely on the risk of its underlying asset.

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. B) values at swap initiation that are equal to zero. C) values at swap expiration that sum to zero.

A) values at swap initiation that sum to zero.

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) writing the call option and writing the put option. C) buying the call option and writing the put option.

A) writing the call option and buying the put option.

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 closest to: A) −$4.50. B) −$5.00. C) $4.50.

A) −$4.50.

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) $10. B) $0. C) $105

B) $0.

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.

B) $26.

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. B) $3.80. C) $16.20.

B) $3.80.

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) $41. B) $9. C) $0.

B) $9.

The spot price of an asset is 62 and the risk-free rate is 2.5%. If the net cost of carry for the asset over the next six months is −3 in present value terms, the no-arbitrage 6-month forward price is closest to: A) 66.6 B) 65.8 C) 59.7

B) 65.8

Bidco Corporation common stock has a market value of $30.00. Which statement about put and call options available on Bidco common is most accurate? A) A call with a strike price of $25.00 is at-the-money. B) A put with a strike price of $35.00 is in-the-money. C) A put with a strike price of $20.00 has intrinsic value.

B) A put with a strike price of $35.00 is in-the-money.

Which of the following will increase the value of a call option? A) An increase in the exercise price. B) An increase in volatility. C) A dividend on the underlying asset.

B) An increase in volatility.

Which of the following statements about arbitrage is NOT correct A) No investment is required when engaging in arbitrage. B) Arbitrage can cause markets to be less efficient. C) If an arbitrage opportunity exists, making a profit without risk is possible.

B) Arbitrage can cause markets to be less efficient.

Which of the following is most likely an exchange-traded derivative? A) Currency forward contract. B) Equity index futures contract. C) Bond option.

B) Equity index futures contract.

Sally Ferguson, CFA, is a hedge fund manager. Ferguson utilizes both futures and forward contracts in the fund she manages. Ferguson makes the following statements about futures and forward contracts: Statement 1: A futures contract is an exchange traded instrument with standardized features. Statement 2: Forward contracts are marked to market on a daily basis to reduce credit risk to both counterparties. Are Ferguson's statements accurate? A) Neither of these statements is accurate. B) Only one of these statements is accurate. C) Both of these statements are accurate.

B) Only one of these statements is accurate.

Which of the following statements about futures is least accurate? A) The futures exchange specifies the minimum price fluctuation of a futures contract. B) The exchange-mandated uniformity of futures contracts reduces their liquidity. C) Futures contracts have a maximum daily allowable price limit.

B) The exchange-mandated uniformity of futures contracts reduces their liquidity.

Which of the following is the best interpretation of the no-arbitrage principle? A) There is no way you can find an opportunity to make a profit. B) There is no free money. C) The information

B) There is no free money.

A synthetic European call option includes a short position in: A) a European put option. B) a risk-free bond. C) the underlying asset.

B) a risk-free bond.

The process that ensures that two securities positions with identical future payoffs, regardless of future events, will have the same price is called: A) exchange parity. B) arbitrage. C) the law of one price.

B) arbitrage.

Which of the following statements regarding exchange-traded derivatives is NOT correct? Exchange-traded derivatives: A) are standardized contracts. B) are illiquid. C) often trade in a physical location.

B) are illiquid.

Regarding buyers and sellers of put and call options, which of the following statements concerning the resulting option position is most accurate? The buyer of a: A) call option is taking a long position and the buyer of a put option is taking a short position. B) call option is taking a long position while the seller of a put is taking a short position. C) put option is taking a short position and the seller of a call option is taking a short position.

B) call option is taking a long position while the seller of a put is taking a short position.

Derivatives are often criticized by investors with limited knowledge of complex financial securities. A common criticism of derivatives is that they: A) increase investor transactions costs. B) can be likened to gambling. C) shift risk among market participants

B) can be likened to gambling.

A forward rate agreement (FRA): A) is settled by making a loan at the contract rate. B) can be used to hedge the interest rate exposure of a floating-rate loan. C) is risk-free when based on the Treasury bill rate.

B) can be used to hedge the interest rate exposure of a floating-rate loan.

Dividends or interest paid by the asset underlying a call option: A) increase the value of the option. B) decrease the value of the option. C) have no effect on the value of the option.

B) decrease the value of the option.

A forward contract that must be settled by a sale of an asset by one party to the other party is termed a: A) physicals-only contract. B) deliverable forward contract. C) take-and-pay contract.

B) deliverable forward contract.

All of the following are benefits of derivatives markets EXCEPT: A) transactions costs are usually smaller in derivatives markets, than for similar trades in the underlying asset. B) derivatives markets help keep interest rates down. C) derivatives allow the shifting of risk to those who can most efficiently bear it.

B) derivatives markets help keep interest rates down.

Some forward contracts are termed cash settlement contracts. This means: A) at settlement, the long purchases the asset from the short for cash. B) either the long or the short in the forward contract will make a cash payment at contract expiration and the asset is not delivered. C) at contract expiration, the long can buy the asset from the short or pay the difference between the market price of the asset and the contract price.

B) either the long or the short in the forward contract will make a cash payment at contract expiration and the asset is not delivered.

A legally binding promise to buy 140 oz. of gold two months from now at a price agreed upon today is most likely a: A) hedge. B) forward commitment. C) futures contract.

B) forward commitment.

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. B) futures prices are negatively correlated with interest rates. C) there is an arbitrage opportunity among forward, futures, and spot prices.

B) futures prices are negatively correlated with interest rates.

In the trading of futures contracts, the role of the clearinghouse is to: A) maintain private insurance that can be used to provide funds if a trader defaults. B) guarantee that all obligations by traders, as set forth in the contract, will be honored. C) stabilize the market price

B) guarantee that all obligations by traders, as set forth in the contract, will be honored.

The price of a fixed-for-floating interest rate swap contract: A) may vary over the life of the contract. B) is established at contract initiation. C) is directly related to changes in the floating rate.

B) is established at contract initiation.

Which of the following statements regarding a forward commitment is NOT correct? A forward commitment: A) is a contractual promise. B) is not legally binding. C) can involve a stock index.

B) is not legally binding.

A European option can be exercised by: A) either party, at contract expiration. B) its owner, only at the expiration of the contract. C) its owner, anytime during the term of the contract

B) its owner, only at the expiration of the contract

The party to a forward contract that is obligated to purchase the asset is called the: A) receiver. B) long. C) short.

B) long.

In a credit default swap (CDS), the buyer of credit protection: A) exchanges the return on a bond for a fixed or floating rate return. B) makes a series of payments to a credit protection seller. C) issues a security that is paid using the cash

B) makes a series of payments to a credit protection seller.

In a plain vanilla interest rate swap: A) payments equal to the notional principal amount are exchanged at the initiation of the swap. B) one party pays a floating rate and the other pays a fixed rate, both based on the notional amount. C) each party pays a fixed rate of interest on a notional amount.

B) one party pays a floating rate and the other pays a fixed rate, both based on the notional amount.

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 short a pure discount bond that pays the exercise price at option expiration. B) short the stock, long the call, and long 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.

B) short the stock, long the call, and long a pure discount bond that pays the exercise price at option expiration.

The payoff of a call option on a stock at expiration is equal to: A) the minimum of zero and the stock price minus the exercise price. B) the maximum of zero and the stock price minus the exercise price. C) the maximum of zero and the exercise price minus the stock price.

B) the maximum of zero and the stock price minus the exercise price.

When calculating the payoff for a stock option, if the stock price is greater than the strike price at expiration: A) the payoff to a put option is equal to the strike price. B) the payoff to a call option is the difference between the stock price and the strike price. C) a call option expires worthless.

B) the payoff to a call option is the difference between the stock price and the strike price.

Compared to an American call option on a stock that does not pay a dividend, an otherwise identical European call option will have: A) a lower value. B) the same value. C) a higher value.

B) the same value.

The intrinsic value of an option is equal to: A) its speculative value. B) zero or the amount that it is in the money. C) the amount that it is in or out of the money.

B) zero or the amount that it is in the money.

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) $105. B) $15. C) $0.

C) $0.

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.

C) $15.40.

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) $80. B) $0. C) $5.

C) $5.

Which of the following statements about forward contracts is least accurate? A) The long promises to purchase the asset. B) Both parties to a forward contract have potential default risk. C) A forward contract can be exercised at any time.

C) A forward contract can be exercised at any time.

Which of the following is an example of an arbitrage opportunity? A) A put option on a share of stock has the same price as a call option on an identical share. B) A stock with the same price as another has a higher rate of return. C) A portfolio of two securities that will produce a certain return that is greater than the risk-free rate of interest.

C) A portfolio of two securities that will produce a certain return that is greater than the risk-free rate of interest.

Which of the following statements about arbitrage opportunities is most accurate? A) Engaging in arbitrage requires a large amount of capital. B) The market prices of two assets or portfolios that have the same future payoffs cannot differ for protracted periods. C) Arbitrage is referred to as the law of one price.

C) Arbitrage is referred to as the law of one price.

Which of the following statements regarding futures and forward contracts is least accurate? A) Futures contracts are highly standardized. B) Forwards require no cash transactions until the delivery date, while futures require a margin deposit when the position is opened. C) Both forward contracts and futures contracts trade on organized exchanges.

C) Both forward contracts and futures contracts trade on organized exchanges.

Which of the following is a common criticism of derivatives? A) Fees for derivatives transactions are relatively high. B) Derivatives are too illiquid. C) Derivatives are likened to gambling.

C) Derivatives are likened to gambling.

Which of the following regarding a plain vanilla interest rate swap is most accurate? A) The notional principal is swapped. B) The notional principal is returned at the end of the swap. C) Only the net interest payments are made.

C) Only the net interest payments are made.

What is the primary difference between an American and a European option? A) The European option can only be traded on overseas markets. B) American and European options are never written on the same underlying asset. C) The American option can be exercised at anytime on or before its expiration date.

C) The American option can be exercised at anytime on or before its expiration date.

The settlement price for a futures contract is: A) the price of the asset in the future for all trades made in the same day. B) the price of the last trade of a futures contract at the end of the trading day. C) an average of the trade prices during the 'closing period'.

C) an average of the trade prices during the 'closing period'.

Which of the following statements about long positions in put and call options is most accurate? Profits from a long call: A) are negatively correlated with the stock price and the profits from a long put are positively correlated with stock price. B) and 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.

C) are positively correlated with the stock price and the profits from a long put are negatively correlated with the stock price.

As a forward contract approaches its expiration date, its value: A) approaches zero. B) increases to the forward contract price. C) depends on the price of the underlying asset.

C) depends on the price of the underlying asset.

The price of a pay-fixed receive-floating interest rate swap is: A) zero when floating rates and fixed rates are equal. B) negative when floating rates are highly volatile. C) determined by expected future short-term rates.

C) determined by expected future short-term rates.

When interest rates and futures prices for an asset are uncorrelated and forwards are less liquid than futures, it is most likely that the price of a forward contract is: A) greater than the price of a futures contract. B) less than the price of a futures contract. C) equal to the price of a futures contract.

C) equal to the price of a futures contract.

An American option is: A) an option on a U.S. stock or bond. B) exercised only at expiration. C) exercisable at any time up to its expiration date.

C) exercisable at any time up to its expiration date.

Credit derivatives are least accurately characterized as: A) contingent claims. B) insurance. C) forward commitments.

C) forward commitments.

A derivative security: A) has no default risk. B) has a value based on stock prices. C) has a value based on another security or index.

C) has a value based on another security or index.

Typically, forward commitments are made with respect to all the following EXCEPT: A) equities. B) bonds. C) inflation.

C) inflation.

The short in a forward contract: A) has the right to deliver the asset upon expiration of the contract. B) is obligated to deliver the asset anytime prior to expiration of the contract. C) is obligated to deliver the asset upon expiration of the contract

C) is obligated to deliver the asset upon expiration of the contract

A derivative security: A) has a value dependent on the shape of the yield curve. B) is like a callable bond. C) is one that is based on the value of another security.

C) is one that is based on the value of another security.

Default risk in a forward contract: A) only applies to the short, who must make the cash payment at settlement. B) only applies to the long, and is the probability that the short can not acquire the asset for delivery. C) is the risk to either party that the other party will not fulfill their contractual obligation.

C) is the risk to either party that the other party will not fulfill their contractual obligation.

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.

C) long the stock, long the put, and short a pure discount bond that pays the exercise price at option expiration.

Which of the following is least likely a characteristic of futures contracts? Futures contracts: A) are backed by the clearinghouse. B) are traded in an active secondary market. C) require weekly settlement of gains and losses.

C) require weekly settlement of gains and losses.

One reason that criticism has been leveled at derivatives and derivatives markets is that: A) derivatives expire. B) derivatives have too much default risk. C) they are complex instruments and sometimes hard to understand.

C) they are complex instruments and sometimes hard to understand

At expiration, the value of a call option is the greater of zero or the: A) underlying asset price minus the exercise value. B) exercise price minus the exercise value. C) underlying asset price minus the exercise price.

C) underlying asset price minus the exercise price.

Standardized futures contracts are an aid to increased market liquidity because: A) standardization of the futures contract stabilizes the market price of the underlying commodity. B) standardization results in less trading activity. C) uniformity of the contract terms broadens the market for the futures by appealing to a greater number of traders.

C) uniformity of the contract terms broadens the market for the futures by appealing to a greater number of traders.

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) negative. B) positive. C) zero.

C) zero.