Chapter 24

29) When a financial institution hedges the interest-rate risk for a specific asset, the hedge is called a ________. A) macro hedge B) micro hedge C) cross hedge D) futures hedge

B) micro hedge

55) A call option gives the seller the ________ to ________ the underlying security. A) right; sell B) obligation; sell C) right; buy D) obligation; buy

B) obligation; sell

20) The number of contracts outstanding in a particular financial future is the ________. A) demand coefficient B) open interest C) index level D) outstanding balance

B) open interest

53) A call option gives the owner the ________ to ________ the underlying security. A) right; sell B) obligation; sell C) right; buy D) obligation; buy

C) right; buy

41) The price specified in an option contract at which the holder can buy or sell the underlying asset is called the ________. A) premium B) call C) strike price D) put

C) strike price

57) If you buy an option to buy Treasury futures at 115, and at expiration the market price is 110, A) the call will be exercised. B) the put will be exercised. C) the call will not be exercised. D) the put will not be exercised.

C) the call will not be exercised.

22) The advantage of forward contracts over futures contracts is that forward contracts A) are standardized. B) have lower default risk. C) are more liquid. D) are none of the above.

D) are none of the above

42) The price specified in an option contract at which the holder can buy or sell the underlying asset is called the ________. A) premium B) strike price C) exercise price D) both B and C of the above.

D) both B and C of the above.

10) By selling short a futures contract of $100,000 at a price of 96, you are agreeing to deliver ________ face value securities for ________. A) $100,000; $104,167 B) $96,000; $100,000 C) $100,000; $96,000 D) $100,000; $100,000

C) $100,000; $96,000

82) The use of financial derivatives by financial institutions to hedge can decrease risk. However, they can also increase risk. Which of the following examples illustrates this? A) Financial derivatives allow financial institutions to increase their leverage. B) Some institutions such huge amounts of derivatives that the amounts exceed capital. C) All of the above are valid examples. D) None of the above are valid examples.

C) All of the above are valid examples.

46) An option that can be exercised only at maturity is called a(n) ________. A) swap B) stock option C) European option D) American option

C) European option

36) Which of the following is a likely reason for a portfolio manager to sell a stock index future short? A) He believes the market will rise. B) He wants to lock in current prices. C) He wants to reduce stock market risk. D) Both B and C are correct.

D) Both B and C are correct.

17) Financial futures are regularly traded on all of the following except the A) Chicago Board of Trade. B) Chicago Mercantile Exchange. C) New York Futures Exchange. D) Chicago Commodity Markets Board.

D) Chicago Commodity Markets Board

79) Intermediaries are active in the swap markets because A) they increase liquidity. B) they reduce default risk. C) they reduce search cost. D) all of the above are true.

D) all of the above are true.

24) Futures markets have grown rapidly because futures contracts A) are standardized. B) have lower default risk. C) are liquid. D) are all of the above.

D) are all of the above.

13) If you buy a long contract on financial futures, you hope interest rates will ________. A) rise B) fall C) not change D) fluctuate

B) fall

14) If you sell a short futures contract, you hope that bond prices will ________. A) rise B) fall C) not change D) fluctuate

B) fall

48) Options on futures contracts are referred to as ________. A) stock options B) futures options C) American options D) individual options

B) futures options

34) If you buy a futures contract on the S&P 500 Index at a price of 450 and the index rises to 500, you will ________. A) lose $12,500 B) gain $12,500 C) lose $50 D) gain $50

B) gain $12,500

4) A contract that requires the investor to buy securities on a future date is called a ________. A) short contract B) long contract C) hedge D) cross

B) long contract

9) By selling short a futures contract of $100,000 at a price of 115, you are agreeing to deliver ________ face value securities for ________. A) $100,000; $115,000 B) $115,000; $110,000 C) $100,000; $100,000 D) $115,000; $115,000

A) $100,000; $115,000

16) Futures contracts are regularly traded on the A) Chicago Board of Trade. B) New York Stock Exchange. C) American Stock Exchange. D) Chicago Board Options Exchange.

A) Chicago Board of Trade.

18) The agency responsible for regulation of the futures exchanges and trading in financial futures is the A) Commodity Futures Trading Commission. B) Securities and Exchange Commission. C) Federal Trade Commission. D) Futures Exchange Commission.

A) Commodity Futures Trading Commission.

49) The agency which regulates stock options is the A) Securities and Exchange Commission. B) Commodities Futures Trading Commission. C) Federal Trade Commission. D) Both A and B are true

A) Securities and Exchange Commission.

33) Who would be most likely to buy a long stock index future? A) a mutual fund manager who believes the market will rise B) a mutual fund manager who believes the market will fall C) a mutual fund manager who believes the market will be stable D) none of the above would be likely to purchase a futures contract

A) a mutual fund manager who believes the market will rise

69) If a bank manager wants to protect the bank against losses that would be incurred on its portfolio of Treasury securities should interest rates rise, he could ________ options on financial futures. A) buy put B) buy call C) sell put D) sell call

A) buy put

51) An option that gives the owner the right to buy a financial instrument at the exercise price within a specified period of time is a(n) ________. A) call option B) put option C) American option D) European option

A) call option

61) The main advantage of using options on futures contracts rather than the futures contracts themselves is that interest-rate risk is A) controlled while preserving the possibility of gains. B) controlled while removing the possibility of losses. C) not controlled but the possibility of gains is preserved. D) not controlled but the possibility of gains is lost.

A) controlled while preserving the possibility of gains.

65) All other things held constant, premiums on call options will increase when the A) exercise price falls. B) volatility of the underlying asset falls. C) term to maturity decreases. D) futures price increases.

A) exercise price falls.

67) An increase in the volatility of the underlying asset, all other things held constant, will ________ the option premium. A) increase B) decrease C) not affect D) Not enough information is given.

A) increase

72) A swap that involves the exchange of one set of interest payments for another set of interest payments is called a(n) ________. A) interest-rate swap B) currency swap C) swaption D) notional swap

A) interest-rate swap

35) If you sell a futures contract on the S&P 500 Index at a price of 450 and the index rises to 500, you will ________. A) lose $12,500 B) gain $12,500 C) lose $50 D) gain $50

A) lose $12,500

30) When a financial institution is hedging interest-rate risk on its overall portfolio, the hedge is a ________. A) macro hedge B) micro hedge C) cross hedge D) futures hedge

A) macro hedge

44) The seller of an option has the ________ to buy or sell the underlying asset, while the purchaser of an option has the ________ to buy or sell the asset. A) obligation; right B) right; obligation C) obligation; obligation D) right; right

A) obligation; right

40) Options are contracts that give the purchasers the A) opportunity to buy or sell an underlying asset. B) the obligation to buy or sell an underlying asset. C) the right to hold an underlying asset. D) the right to switch payment streams.

A) opportunity to buy or sell an underlying asset.

74) If Second National Bank has more rate-sensitive liabilities than rate-sensitive assets, it can reduce interest-rate risk with a swap which requires Second National to A) pay a fixed rate while receiving a floating rate. B) receive a fixed rate while paying a floating rate. C) both receive and pay a fixed rate. D) both receive and pay a floating rate.

A) pay a fixed rate while receiving a floating rate.

75) If a bank has a gap of -$10 million, it can reduce its interest-rate risk by A) paying a fixed rate on $10 million and receiving a floating rate on $10 million. B) paying a floating rate on $10 million and receiving a fixed rate on $10 million. C) selling $20 million fixed-rate assets. D) buying $20 million fixed-rate assets.

A) paying a fixed rate on $10 million and receiving a floating rate on $10 million.

63) The main disadvantage of futures contracts as compared to options on futures contracts is that futures A) remove the possibility of gains. B) increase the transactions cost. C) are not as effective a hedge. D) do not remove the possibility of losses.

A) remove the possibility of gains.

54) A put option gives the owner the ________ to ________ the underlying security. A) right; sell B) obligation; sell C) right; buy D) obligation; buy

A) right; sell

12) If you sell a short contract on financial futures, you hope interest rates will ________. A) rise B) fall C) not change D) fluctuate

A) rise

38) If a firm is due to be paid in euros in two months, to hedge against exchange rate risk the firm should A) sell foreign exchange futures short. B) buy foreign exchange futures long. C) stay out of the exchange futures market. D) do none of the above.

A) sell foreign exchange futures short.

7) A short contract requires that the investor A) sell securities in the future. B) buy securities in the future. C) hedge in the future. D) close out his position in the future.\

A) sell securities in the future.

37) If a portfolio manager believes stock prices will fall and knows that a block of funds will be received in the future, then he should A) sell stock index futures short. B) buy stock index futures long. C) stay out of the futures market. D) borrow and buy securities now.

A) sell stock index futures short.

5) A contract that requires the investor to sell securities on a future date is called a ________. A) short contract B) long contract C) hedge D) micro hedge

A) short contract

31) The risk that occurs because stock prices fluctuate is called ________. A) stock market risk B) reinvestment risk C) interest-rate risk D) default risk

A) stock market risk

47) Options on individual stocks are referred to as ________. A) stock options B) futures options C) American options D) individual options

A) stock options

3) Which of the following is not a financial derivative? A) stocks B) futures C) options D) forward contracts

A) stocks

59) If you buy an option to buy Treasury futures at 110, and at expiration the market price is 115, A) the call will be exercised. B) the put will be exercised. C) the call will not be exercised. D) the put will not be exercised.

A) the call will be exercised.

80) A valid concern about financial derivatives is that A) they allow financial institutions to increase their leverage. B) they are too sophisticated because they are so complicated. C) the notional amounts can greatly exceed a financial institution's capital. D) all of the above are valid concerns. E) none of the above are valid concerns.

A) they allow financial institutions to increase their leverage.

11) By buying a long $100,000 futures contract for 115, you agree to pay ________ for ________ face value securities. A) $100,000; $115,000 B) $115,000; $100,000 C) $86,956; $100,000 D) $86,956; $115,000

B) $115,000; $100,000

50) The agency which regulates futures options is the A) Securities and Exchange Commission. B) Commodities Futures Trading Commission. C) Federal Trade Commission. D) Both A and B are true.

B) Commodities Futures Trading Commission.

32) The most widely traded stock index future is on the A) Dow Jones 1000 index. B) S&P 500 index. C) NASDAQ index. D) Dow Jones 30 index.

B) S&P 500 index.

8) Which is not a problem of forward contracts? A) a lack of liquidity B) a lack of flexibility C) the difficulty of finding a counterparty D) default risk

B) a lack of flexibility

76) One advantage of using swaps to eliminate interest-rate risk is that swaps A) are less costly than futures. B) are less costly than rearranging balance sheets. C) are more liquid than futures. D) have better accounting treatment than options.

B) are less costly than rearranging balance sheets

6) A long contract requires that the investor A) sell securities in the future. B) buy securities in the future. C) hedge in the future. D) close out his position in the future.

B) buy securities in the future.

39) If a firm must pay for goods it has ordered with foreign currency, it can hedge its foreign exchange rate risk by A) selling foreign exchange futures short. B) buying foreign exchange futures long. C) staying out of the exchange futures market. D) doing none of the above.

B) buying foreign exchange futures long.

71) A swap that involves the exchange of a set of payments in one currency for a set of payments in another currency is a(n) ________. A) interest-rate swap B) currency swap C) swaption D) notional swap

B) currency swap

68) An increase in the exercise price, all other things held constant, will ________ the premium on call options. A) increase B) decrease C) not affect D) Not enough information is given.

B) decrease

52) An option that gives the owner the right to sell a financial instrument at the exercise price within a specified period of time is a(n) ________. A) call option B) put option C) American option D) European option

B) put option

73) If Second National Bank has more rate-sensitive assets than rate-sensitive liabilities, it can reduce interest-rate risk with a swap which requires Second National to A) pay a fixed rate while receiving a floating rate. B) receive a fixed rate while paying a floating rate. C) both receive and pay a fixed rate. D) both receive and pay a floating rate.

B) receive a fixed rate while paying a floating rate.

43) The seller of an option has the A) right to buy or sell the underlying asset. B) the obligation to buy or sell the underlying asset. C) ability to reduce transaction risk. D) right to exchange one payment stream for another.

B) the obligation to buy or sell the underlying asset.

58) If you buy an option to sell Treasury futures at 115, and at expiration the market price is 110, A) the call will be exercised. B) the put will be exercised. C) the call will not be exercised. D) the put will not be exercised.

B) the put will be exercised.

62) The main reason to buy an option on a futures contract rather than the futures contract itself is A) to reduce transaction cost. B) to preserve the possibility for gains. C) to limit losses. D) to remove the possibility for gains.

B) to preserve the possibility for gains.

66) All other things held constant, premiums on both put and call options will increase when the A) exercise price increases. B) volatility of the underlying asset increases. C) term to maturity decreases. D) futures price increases.

B) volatility of the underlying asset increases.

15) The elimination of riskless profit opportunities in the futures market is referred to as ________. A) speculation B) hedging C) arbitrage D) open interest E) mark to market

C) arbitrage

23) The advantage of forward contracts over futures contracts is that forward contracts A) are standardized. B) have lower default risk. C) are more flexible. D) both A and B are true.

C) are more flexible.

2) Financial derivatives include ________. A) stocks B) bonds C) forward contracts D) both A and B

C) forward contracts

1) Financial derivatives include ________. A) stocks B) bonds C) futures D) none of the above

C) futures

81) The biggest danger of financial derivatives occurs A) when notional amounts exceed a bank's capital. B) when financial market prices and rates are highly volatile. C) in the trading activities of financial institutions. D) in the large amount of credit exposure.

C) in the trading activities of financial institutions.

78) As compared to a default on the notional principle, a default on a swap A) is more costly. B) is about as costly. C) is less costly. D) may cost more or less than default on the notional principle.

C) is less costly.

21) The futures markets have grown rapidly in recent years because A) interest rate volatility has increased. B) financial managers are more risk averse. C) of both A and B. D) of neither A nor B.

C) of both A and B.

64) All other things held constant, premiums on put options will increase when the A) exercise price increases. B) volatility of the underlying asset falls. C) term to maturity increases. D) A and C are both true.

D) A and C are both true.

45) An option that can be exercised at any time up to maturity is called a(n) ________. A) swap B) stock option C) European option D) American option

D) American option

28) Which of the following features of Treasury bond futures contracts were not designed to increase liquidity? A) standardized contracts B) traded up until maturity C) not tied to one specific type of bond D) can be closed with offsetting trade

D) can be closed with offsetting trade

19) The purpose of the Commodity Futures Trading Commission is to do all of the following except A) oversee futures trading. B) see that prices are not manipulated. C) approve proposed futures contracts. D) establish minimum prices for futures contracts.

D) establish minimum prices for futures contracts.

27) Which of the following features of Treasury bond futures contracts were not designed to increase liquidity? A) standardized contracts B) traded up until maturity C) not tied to one specific type of bond D) marked to market daily

D) marked to market daily

26) Futures differ from forwards because they are A) used to hedge portfolios. B) used to hedge individual securities. C) used in both financial and foreign exchange markets. D) marked to market daily.

D) marked to market daily.

56) A put option gives the seller the ________ to ________ the underlying security. A) right; sell B) obligation; sell C) right; buy D) obligation; buy

D) obligation; buy

25) Futures differ from forwards because they are A) used to hedge portfolios. B) used to hedge individual securities. C) used in both financial and foreign exchange markets. D) standardized contracts.

D) standardized contracts.

70) A financial contract that obligates one party to exchange a set of payments it owns for another set of payments owned by another party is called a ________. A) cross hedge B) cross call option C) cross put option D) swap

D) swap

60) If you buy an option to sell Treasury futures at 110, and at expiration the market price is 115, A) the call will be exercised. B) the put will be exercised. C) the call will not be exercised. D) the put will not be exercised.

D) the put will not be exercised.

77) The disadvantage of swaps is that A) they lack liquidity. B) it is difficult to arrange for a counterparty. C) they suffer from default risk. D) they are all of the above.

D) they are all of the above.

11) An option that gives the holder the right to buy an asset in the future is a put

FALSE

14) Using options to control interest-rate risk reduces the chance of a loss but increases the chance of a gain.

FALSE

16) Interest-rate swaps involve the exchange of a set of payments in one currency for a set of payments in another.

FALSE

3) A long contract obligates the holder to sell securities in the future.

FALSE

5) One problem with a futures contract is finding a counterparty.

FALSE

6) Futures contracts are subject to default risk.

FALSE

8) Open interest allows investors to change the interest rate on futures contracts.

FALSE

9) To reduce the interest-rate risk of holding a portfolio of bonds, Treasury bond futures contracts should be bought.

FALSE

1) A forward contract is more flexible than a futures contract.

TRUE

10) To reduce foreign exchange risk from selling goods to a foreign country, futures contracts should be sold.

TRUE

12) Option premiums increase as the term to maturity increases.

TRUE

13) Option premiums fall as the volatility of the underlying asset falls.

TRUE

15) One advantage of using options to hedge is that the accounting transaction will never require the firm to show large unrecognized losses.

TRUE

17) Currency swaps involve the exchange of a set of payments on one currency for a set of payments in another.

TRUE

18) If Friendly Finance Company has more rate-sensitive assets than rate-sensitive liabilities, it may reduce risk with a swap.

TRUE

2) Futures contracts are standardized.

TRUE

4) A short contract obligates the holder to sell securities in the future.

TRUE

7) Futures trading is regulated by the Commodity Futures Trading Commission.

TRUE