Chapter 23 Options, Caps, Floors, and Collars

Giving the purchaser the right to buy the underlying security at a prespecified price is a A. put option. B. call option. C. naked option. D. futures option. E. credit spread call option.

B

The tendency of the variance of a bond's price to decrease as maturity approaches is called A. open interest. B. pull-to-par. C. digital default option. D. futures option. E. credit spread call option.

B

The writer of a bond put option A. receives a premium in return for standing ready to sell the bond at the exercise price. B. receives a premium in return for standing ready to buy bonds at the exercise price. C. pays a premium and has the right to sell the underlying bond at the agreed exercise price. D. pays a premium and has the right to buy the underlying bond at the agreed exercise price E. pays a premium and has the obligation to buy the underlying bond at the agreed exercise price

B

What is the advantage of a futures hedge over an options hedge? A. The futures hedge has lower credit risk exposure. B. The futures hedge reduces volatility in profit gains on both sides. C. The futures hedge is marked to market less frequently. D. The futures hedge offers the least downside risk protection. E. The futures hedge completely offsets losses but only partly offsets gains.

B

What reflects the degree to which the rate on the option's underlying asset moves relative to the spot rate on the asset or liability that is being hedged? A. Credit risk. B. Basis risk. C. Hedge risk. D. Volatility. E. Open interest

B

Which of the following is a good strategy to adopt when interest rates are expected to rise? A. Buying a call option on a bond. B. Writing a call option on a bond. C. Writing a put option on a bond. D. Buying bond futures. E. All of the above.

B

For put options, the delta has a negative sign A. since the value of the put option falls when bond prices rise. B. since the value of the put option rises when bond prices rise. C. since the value of the put option falls when bond prices fall. D. since the change in interest rates is equal to the change in the interest rate on the bond underlying the option contract. E. to adjust for basis risk

A

Giving the purchaser the right to sell the underlying security at a prespecified price is a A. put option. B. call option. C. naked option. D. futures option. E. credit spread call option.

A

Identify a problem associated with using the Black-Scholes model to value bond options. A. It assumes short-term interest rates are constant. B. It assumes that commissions are charged. C. It assumes fluctuating variance of returns on the underlying asset. D. It assumes that the variance of bond prices is constant over time. E. All of the above.

A

KKR issues a $10 million 18-month floating rate note priced at LIBOR plus 400 basis points. What is KKR's interest rate risk exposure and how can it be hedged? A. KKR is exposed to interest rate increases; short hedge by buying put options. B. KKR is exposed to interest rate increases; long hedge by buying call options. C. KKR is exposed to interest rate decreases; long hedge by buying call options. D. KKR is exposed to interest rate decreases; short hedge by buying put options. E. KKR is exposed to interest rate increases; short hedge by buying call options.

A

The outstanding number of put or call contracts is called A. open interest. B. pull-to-par. C. cap. D. floor. E. collar.

A

The writer of a bond call option A. receives a premium and must stand ready to sell the bond at the exercise price. B. receives a premium and must stand ready to buy bonds at the exercise price. C. pays a premium and has the right to sell the underlying bond at the agreed exercise price. D. pays a premium and has the right to buy the underlying bond at the agreed exercise price. E. pays a premium and has the obligation to buy the underlying bond at the agreed exercise price.

A

Purchasing a succession of call options on interest rates is called a A. open interest. B. pull-to-par. C. cap. D. floor. E. collar.

C

Rising interest rates will cause the market value of A. call options on bonds to increase. B. put options on bonds to decrease. C. call options on bonds to decrease. D. bond futures to increase. E. Answers A and B only

C

The buyer of a bond put option A. receives a premium in return for standing ready to sell the bond at the exercise price. B. receives a premium in return for standing ready to buy bonds at the exercise price. C. pays a premium and has the right to sell the underlying bond at the agreed exercise price. D. pays a premium and has the right to buy the underlying bond at the agreed exercise price E. pays a premium and has the obligation to buy the underlying bond at the agreed exercise price

C

Buying a cap is similar to A. writing a call option on interest rates. B. buying a call option on interest rates. C. buying a put option on interest rates. D. buying a floor on interest rates. E. buying a collar on interest rates.

B

Contrast the marking to market characteristics of options versus futures contracts. A. Options are marked to market continuously while futures are marked to market at the close of trading each day. B. Options are marked to market at expiration while futures are marked to market at the close of trading each day. C. Options are marked to market daily while futures are marked to market at the close of trading each day. D. Options are marked to market monthly while futures are marked to market at the close of trading each day. E. There is no difference in the marking to market characteristics.

B

Which of the following holds true for the writer of a bond call option if interest rates decrease? A. Makes profits limited to call premium B. Makes losses limited to call premium C. Potential to make large losses D. Potential to make unlimited profits E. Answers B and D only

C

Which of the following shows the change in the value of a put option for each $1 change in the underlying bond? A. Open interest. B. Volatility. C. Delta. D. Basis. E. Sigma.

C

A contract that results in the delivery of a futures contract when exercised is a A. put option. B. call option. C. naked option. D. futures option. E. credit spread call option.

D

A digital default option A. always pays the par value of a loan if exercised. B. has a payout that is capped at 80 percent of the par value of the loan. C. will cause the FI never to lose more than the premium paid to purchase the option. D. Answers A and C only. E. Answers A and B only.

D

The buyer of a bond call option A. receives a premium in return for standing ready to sell the bond at the exercise price. B. receives a premium in return for standing ready to buy bonds at the exercise price. C. pays a premium and has the right to sell the underlying bond at the agreed exercise price. D. pays a premium and has the right to buy the underlying bond at the agreed exercise price E. pays a premium and has the obligation to buy the underlying bond at the agreed exercise price

D

The combination of being long in the bond and buying a put option on a bond mimics the profit function of A. buying a put option. B. writing a put option. C. writing a call option. D. buying a call option. E. buying a floor.

D

The purchase often of a series of put options with multiple exercise dates results in a A. open interest. B. pull-to-par. C. cap. D. floor. E. collar.

D

The purchaser of an option must pay the writer a A. strike price. B. market price. C. margin. D. premium. E. basis.

D

A contract whose payoff increases as a yield spread increases above some stated exercise spread is a A. put option. B. call option. C. digital default option. D. futures option. E. credit spread call options

E

Buying a cap option agreement A. means buying a (or several) call option on interest rates. B. means buying insurance against excessive decreases in interest rates. C. allows more than one exercise date. D. All of the above are correct. E. Answers A and C only.

E

Credit spread call options are useful because A. its value increases as the risk premium on a specified benchmark bond of the borrower increases above some exercise spread. B. an increase in the value of the call option will tend to offset the decreasing value of an FI's loan and net worth as the credit quality of the borrower decreases. C. they will always cause a loss at least equal to the required premium on the option. D. All of the above. E. Answers A and B only.

E

Using the proceeds from the simultaneous sale of a floor to finance the purchase of a cap is to open a position called a A. open interest. B. pull-to-par. C. cap. D. floor. E. collar.

E

What is the advantage of an options hedge over a futures hedge? A. The options hedge has lower credit risk exposure. B. The options hedge has lower transaction costs. C. The options hedge is marked to market less frequently. D. The options hedge offers the most downside risk protection. E. The options hedge offers the most upside gain potential.

E

Which of the following observations is NOT true? A. Variance of bond prices is nonconstant over time. B. Variance of bond prices rises at first and then falls as the bond approaches maturity. C. As the bond approaches maturity, all price paths must lead to 100 percent of the face value of the bond. D. As the bond approaches maturity, all price paths must lead to the principal paid by the issuer on maturity. E. Variance of a bond's price or return increases as maturity approaches.

E

An FI concerned that the risk on a loan will increase can A. purchase a credit spread call option B. sell a credit spread call option C. sell a credit spread put option. D. purchase a naked option. E. sell a naked option

A

As interest rates increase, the buyer of a bond put option stands to A. make limited gains. B. incur limited losses. C. incur unlimited losses. D. lose the entire premium amount. E. Answers A and D only.

A

As interest rates increase, the writer of a bond call option stands to make A. limited gains. B. limited losses. C. unlimited losses. D. unlimited gains. E. Answers A and B only.

A

An option that does NOT identifiably hedge an underlying asset is a A. put option. B. call option. C. naked option. D. futures option. E. credit spread call option.

C

A contract that pays the par value of a loan in the event of default is a A. put option. B. call option. C. digital default option. D. futures option. E. credit spread call option.

C