FINA 4319 Review for Test#2

The prices of 1, 2, 3, and 4-year zero coupon government bonds are 95.42, 90.36, 85.16, and 78.81, respectively. What is the par coupon on a 4-year coupon bond selling at par? (a) 5.02% (b) 5.43% (c) 5.81% (d) 6.06%

(d) 6.06%

Which of the following describes a covered call? A. A long call option on a stock plus a long position in the stock B. A long call option on a stock plus a short put option on the stock C. A short call option on a stock plus a short position in the stock D. A short call option on a stock plus a long position in the stock

A short call option on a stock plus a long position in the stock

What change in cash flows will occur to the fixed rate payer at settlement, in an interest rate swap agreement, when market interest rates rise? A) An increase in cash received B) A decrease in cash received C) No change in cash received D) It cannot be determined based on the information given

A) An increase in cash received In an Interest rate swap, the fixed-rate payer agrees to pay fixed amounts to the counter-party in exchange for the payment of periodic floating amounts. Hence while he pays a fixed rate of interest, he will receive the floating rate. As the interest rates increase, he will receive a higher amount.

Which of the following formulas is used to determine the cheapest to deliver? A) Invoice price - market price B) Market price x accrued interest C) Futures price x accrued interest D) Futures price - invoice price

A) Invoice price - market price The term cheapest to deliver (CTD) refers to the cheapest security that can be delivered in a futures contract to a long position to satisfy the contract specifications. a trader generally takes. A short position—or a short—when he or she sells a financial asset with the intention of buying it back at a lower price later on. Traders generally take short positions when they believe an asset's price will drop in the near future. Futures markets allow traders to take short positions at any time.

All of the positions listed will benefit from a price decline, except: A) Short put B) Long put C) Short call D) Short stock

A) Short put

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

A. A long forward

Which of the following describes a protective put? A. A long put option on a stock plus a long position in the stock B. A long put option on a stock plus a short position in the stock C. A short put option on a stock plus a short call option on the stock D. A short put option on a stock plus a long position in the stock

A. A long put option on a stock plus a long position in the stock

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

A. All calls on a certain stock

Which of the following is NOT true? A. An American put option is always worth less than the present value of the strike price B. A European put option is always worth less than the present value of the strike price C. A European call option is always worth less than the stock price D. An American call option is always worth less than the stock price

A. An American put option is always worth less than the present value of the strike price

When volatility increases with all else remaining the same, which of the following is true? A. Both calls and puts increase in value B. Both calls and puts decrease in value C. Calls increase in value while puts decrease in value D. Puts increase in value while calls decrease in value

A. Both calls and puts increase in value

Which of the following creates a bull spread? A. Buy a low strike price call and sell a high strike price call B. Buy a high strike price call and sell a low strike price call C. Buy a low strike price call and sell a high strike price put D. Buy a low strike price put and sell a high strike price call

A. Buy a low strike price call and sell a high strike price call

How can a straddle be created? A. Buy one call and one put with the same strike price and same expiration date B. Buy one call and one put with different strike prices and same expiration date C. Buy one call and two puts with the same strike price and expiration date D. Buy two calls and one put with the same strike price and expiration date

A. Buy one call and one put with the same strike price and same expiration date

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

A. Interest rates implied by current zero rates for future periods of time 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 periods between one and two years gives the same result as earning the zero rate for two years.

Which of the following is true for American options? A. Put-call parity provides an upper and lower bound for the difference between call and put prices B. Put call parity provides an upper bound but no lower bound for the difference between call and put prices C. Put call parity provides an lower bound but no upper bound for the difference between call and put prices D. There are no put-call parity results

A. Put-call parity provides an upper and lower bound for the difference between call and put prices

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

A. The price must be paid in full

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. The right to buy an asset for a certain price

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

A. The seller of an option

Which of the following best describes the intrinsic value of an option? A. The value it would have if the owner were forced to exercise immediately B. The Black-Scholes-Merton price of the option C. The lower bound for the option's price D. The amount paid for the option

A. The value it would have if the owner were forced to exercise immediately

Prior to the credit crisis that started in 2007 which of the following was the proxy used by derivatives traders for the risk-free rate? A) The Treasury rate B) The LIBOR rate C) The repo rate D) The overnight indexed swap rate

B) The LIBOR rate

Which of the following items will a short bond futures position be most interested in at expiration of the futures contract? A) Cash and carry B) Cheapest to deliver C) Conversion factor D) Implied Repo rate

B) Cheapest to deliver The term cheapest to deliver (CTD) refers to the cheapest security that can be delivered in a futures contract to a long position to satisfy the contract specifications. a trader generally takes. A short position—or a short—when he or she sells a financial asset with the intention of buying it back at a lower price later on. Traders generally take short positions when they believe an asset's price will drop in the near future. Futures markets allow traders to take short positions at any time.

Which of the following is true? A. An American call option on a stock should never be exercised early B. An American call option on a stock should never be exercised early when no dividends are expected C. There is always some chance that an American call option on a stock will be exercised early D. There is always some chance that an American call option on a stock will be exercised early when no dividends are expected

B. An American call option on a stock should never be exercised early when no dividends are expected

What is a description of the trading strategy where an investor sells a 3-month call option and buys a one-year call option, where both options have a strike price of $100 and the underlying stock price is $75? A. Neutral Calendar Spread B. Bullish Calendar Spread C. Bearish Calendar Spread D. None of the above

B. Bullish Calendar Spread

Which of the following can be used to create a long position in a European put option on a stock? A. Buy a call option on the stock and buy the stock B. Buy a call on the stock and short the stock C. Sell a call option on the stock and buy the stock D. Sell a call option on the stock and sell the stock

B. Buy a call on the stock and short the stock

Which of the following creates a bear spread? A. Buy a low strike price call and sell a high strike price call B. Buy a high strike price call and sell a low strike price call C. Buy a low strike price call and sell a high strike price put D. Buy a low strike price put and sell a high strike price call

B. Buy a high strike price call and sell a low strike price call

Which of the following is NOT traded by the CBOE? A. Weeklys B. Monthlys C. Binary options D. DOOM options

B. Monthlys

Which of the following is true when dividends are expected? A. Put-call parity does not hold B. The basic put-call parity formula can be adjusted by subtracting the present value of expected dividends from the stock price C. The basic put-call parity formula can be adjusted by adding the present value of expected dividends to the stock price D. The basic put-call parity formula can be adjusted by subtracting the dividend yield from the interest rate

B. The basic put-call parity formula can be adjusted by subtracting the present value of expected dividends from the stock price

Which of the following is true when dividends are expected? A. Put‐call parity does not hold B. The basic put‐call parity formula can be adjusted by subtracting the present value of expected dividends from the stock price C. The basic put‐call parity formula can be adjusted by adding the present value of expected dividends to the stock price D. The basic put‐call parity formula can be adjusted by subtracting the dividend yield from the interest rate

B. The basic put‐call parity formula can be adjusted by subtracting the present value of expected dividends from the stock price

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

B. The initial margin and maintenance margin are determined by formulas and are equal

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

B. The number of warrants is fixed whereas the number of exchange-traded options in existence depends on trading

When the time to maturity increases with all else remaining the same, which of the following is true? A. European options always increase in value B. The value of European options either stays the same or increases C. There is no effect on European option values D. European options are liable to increase or decrease in value

B. The value of European options either stays the same or increases

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

B. Working from short maturity instruments to longer maturity instruments determining zero rates at each step bootstraping is a way of constructing the zero coupon yield curve from coupon bearing bonds. it involves working from the shortest maturity bond to progressively loner maturity bonds making sure that the calculated zero coupon yield curve is consistent with the market prices of the instruments

You have taken a stock option position and if the stock's price drops you will get a level gain no matter how far prices fall, but you could go bankrupt if the stock's price rises. You have: A. bought a call option. B. bought a put option. C. written a call option. D. written a put option. E. written a straddle.

B. bought a put option

The compound 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 months interest rate D. None of the above

B. unit of measurement for the interest rate The compounding frequency is a unit of measurement . The frequency with which interest is paid may be difference from the compounding frequency used for quoting the rate.

A Forward Rate Agreement contains an agreed interest rate of 3.1% on a 6-month loan. If settled at the time of borrowing, what amount would the borrower pay or receive on a $500,000 loan if the prevailing 6-month interest rate is 2.9%? a) $1000 payment b) $1000 receipt c) $972 payment d) $972 receipt

C 972 receipt FRA agreed rate = 3.1% (6 months rate) It means that, borrower is agreeing to pay 3.1% for the loan he will take in future. At the time of borrowing, rate = 2.9% So borrower is in loss since he has to pay more interest than the market rate Principal amount = 500,000 So borrower needs to pay at the end of the loan = 500,000 * (3.1 - 2.9 ) / 100 = 1000 But this amount the borrower has to pay after the loan period is over. But we need to calculate the amount at the time of borrowing or when FRA expires So we need to find present value ( 6 months present value ) of 1000 at market rate So = 1000 / ( 1.029) = 971.8 = 972 payment

What is the number of different option series used in creating a butterfly spread? A. 1 B. 2 C. 3 D. 4

C. 3 Three different options all with the same maturity are involved in creating a butterfly spread. The strike prices are usually equally spaced. The creator buys the low strike option, buys the high strike option, and sells two of the intermediate strike option

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

C. A position where an option has been purchased

How can a strip trading strategy be created? A. Buy one call and one put with the same strike price and same expiration date B. Buy one call and one put with different strike prices and same expiration date C. Buy one call and two puts with the same strike price and expiration date D. Buy two calls and one put with the same strike price and expiration date

C. Buy one call and two puts with the same strike price and expiration date

When interest rates increase with all else remaining the same, which of the following is true? A. Both calls and puts increase in value B. Both calls and puts decrease in value C. Calls increase in value while puts decrease in value D. Puts increase in value while calls decrease in value

C. Calls increase in value while puts decrease in value

When the stock price increases with all else remaining the same, which of the following is true? A. Both calls and puts increase in value B. Both calls and puts decrease in value C. Calls increase in value while puts decrease in value D. Puts increase in value while calls decrease in value

C. Calls increase in value while puts decrease in value

Which of the following describes a PUT 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

C. The right to sell an asset for a certain price

Which of the following describes a situation where an American put option on a stock becomes more likely to be exercised early? A. Expected dividends increase B. Interest rates decrease C. The stock price volatility decreases D. All of the above

C. The stock price volatility decreases

At what interest rate does a government borrow in its own currency? a. Treasury rate b. LIBOR c. LIBID d. repo rate

a. Treasury rate

Which of the following is correct? A. A calendar spread can be created by buying a call and selling a put when the strike prices are the same and the times to maturity are different B. A calendar spread can be created by buying a put and selling a call when the strike prices are the same and the times to maturity are different C. A calendar spread can be created by buying a call and selling a call when the strike prices are different and the times to maturity are different D. A calendar spread can be created by buying a call and selling a call when the strike prices are the same and the times to maturity are different

D. A calendar spread can be created by buying a call and selling a call when the strike prices are the same and the times to maturity are different

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

D. A position where an option has been sold

Which of the following is true of a box spread? A. It is a package consisting of a bull spread and a bear spread B. It involves two call options and two put options C. It has a known value at maturity D. All of the above

D. All of the above

Which of the following describes an interest rate swap? A. A way of converting a liability from fixed to floating B. A portfolio of forward rate agreements C. An agreement to exchange interest at a fixed rate for interest at a floating rate D. All of the above

D. All of the above An interest rate swap is a forward contract in which one stream of future interest payments is exchanged for another based on a specified principal amount. Interest rate swaps usually involve the exchange of a fixed interest rate for a floating rate, or vice versa, to reduce or increase exposure to fluctuations in interest rates or to obtain a marginally lower interest rate than would have been possible without the swap.

How can a strap trading strategy be created? A. Buy one call and one put with the same strike price and same expiration date B. Buy one call and one put with different strike prices and same expiration date C. Buy one call and two puts with the same strike price and expiration date D. Buy two calls and one put with the same strike price and expiration date

D. Buy two calls and one put with the same strike price and expiration date

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

D. None of the above

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

D. None of the above

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

D. One of the options must be either in the money or at the money

When dividends increases with all else remaining the same, which of the following is true? A. Both calls and puts increase in value B. Both calls and puts decrease in value C. Calls increase in value while puts decrease in value D. Puts increase in value while calls decrease in value

D. Puts increase in value while calls decrease in value

When the strike price increases with all else remaining the same, which of the following is true? A. Both calls and puts increase in value B. Both calls and puts decrease in value C. Calls increase in value while puts decrease in value D. Puts increase in value while calls decrease in value

D. Puts increase in value while calls decrease in value

Which of the following is the put-call parity result for a non-dividend-paying stock? A. The European put price plus the European call price must equal the stock price plus the present value of the strike price B. The European put price plus the present value of the strike price must equal the European call price plus the stock price C. The European put price plus the stock price must equal the European call price plus the strike price D. The European put price plus the stock price must equal the European call price plus the present value of the strike price

D. The European put price plus the stock price must equal the European call price plus the present value of the strike price

Since the credit crisis that started in 2007 which of the following have derivatives traders used as the risk-free rate A. The Treasury rate B. The LIBOR rate C. The repo rate D. The overnight indexed swap rate

D. The overnight indexed swap rate

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%

a. 11.83% The equivalent rate per quarter is 1.06^0.5-1= 2.956%. The annualized rate with quarterly compounding is four times this or 11.83%

The prices of 1, 2, 3, and 4-year zero coupon government bonds are 95.42, 90.36, 85.16, and 78.81, respectively. What is the continuously compounded 3-year zero yield? a. 5.35% b. 5.85% c. 6.12% d. 6.40%

a. 5.35% =1/3 x ln(85.16/100)= 5.3545

Which of the following is true for an interest rate swap? a. A swap is usually worth close to zero when it is first negotiated b. Each forward rate agreement underlying a swap is worth close to zero when the swap is first entered into c. Comparative advantage is a valid reason for entering into the swap d. None of the above

a. A swap is usually worth close to zero when it is first negotiated

A company enters into an interest rate swap where it is paying fixed and receiving LIBOR. When interest rates increase, which of the following is true? a. The value of the swap to the company increases b. The value of the swap to the company decreases c. The value of the swap can either increase or decrease d. The value of the swap does not change providing the swap rate remains the same

a. The value of the swap to the company increases

The zero curve is upward 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 Z

a. X is less than Y which is less than Z 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.

How can a strangle trading strategy be created? a. Buy one call and one put with the same strike price and same expiration date b. Buy one call and one put with different strike prices and same expiration date c. Buy one call and two puts with the same strike price and expiration date d. Buy two calls and one put with the same strike price and expiration date

b. Buy one call and one put with different strike prices and same expiration date

The change in a bond price for a unit change in the prevailing yield is calculated as $198.54. What is the price value of a basis point on this bond? a. $0.019854 b. $0.19854 c. $1.9854 d. $19.584

c. $1.9854 Price value of a basis point or PVBP is given as Change in Bond Price/Change in 1 bps yield=(Change in Bond Price/Change in 1% yield)/100=198.54/100=1.9854

The price of a 3-year zero coupon government bond is 85.16. The price of a similar 4-year bond is 79.81. What is the yield to maturity (effective annual yield) on the 4-year bond? a. 4.6% b. 5.5% c. 5.8% d. 6.7%

c. 5.8% Par Value= 100 Price= 79.81 YTM= (100/79.81)^(1/4)-1= 5.8%

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

c. Exchange-traded stock options with longer lives than regular exchange-traded stock options

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 trasure 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.

c. It is a rate used when borrowing and lending takes place between banks LIBOR is a rate used for interbank transactions

Given the choice between 5- year and 1- year instruments most people would choose 5- year instruments when borrowing and 1 year instruments when lending. Which of the following is a theory consistent with this observation? a. expectations theory b. market segmentation theory c. liquidity preference theory d. maturity preference theory

c. liquidity preference theory

A repo rate is a. an uncollatrealized rate b. a rate where the credit risk is relatively high c. the rate implicit in a transaction where securities are sold and bought back at a higher price d. none of the above

c. the rate implicit in a transaction where securities are sold and bought back at a higher price 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

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%

d. 7.5% the forward rate for the third year is (3 x 0.065 -2 x 0.06)/(3-2) = 0.075 or 7.5%

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

d. All calls with a particular time to maturity and strike price on a certain stock

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

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 the less pronounced way

Under liquidity preference theory, which of the following is always true. a. a 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 rate

d. forward rates are higher than expected future spot rate liquidity preference theory argues that individuals like thier borrowings to have a long maturity and their deposits to have a short maturity. to induce people to lend for a long periods forward rates are raised relative to what expected future short rates would predict.