Series 66 Chapter 16

Which of the following statements about preemptive rights are TRUE? Preemptive rights give shareholders the right to purchase shares in new stock issues in direct proportion to the number of shares they already own. Preemptive rights allow shareholders to buy as many new shares as they want at any time. Preemptive rights allow shareholders to maintain their proportionate share of ownership in the corporation.

1, 3

The term derivative would apply to which of the following? A) Warrants B) DPPs C) REITs D) UITs

A

Which of the following are characteristics of newly issued warrants? A) Time value, but no intrinsic value B) Time value and intrinsic value C) No intrinsic value and no time value D) Intrinsic value, but no time value

A

Which of the following statements regarding derivative securities is NOT true? A) An option contract's price fluctuates in relationship to the time remaining to expiration as well as with the price movement of the underlying security. B) An owner of a put has the obligation to purchase securities at a designated price (the strike price) before a specified date (the expiration date). C) An option contract is a derivative security because it has no value independent of the value of an underlying security. D) Derivative securities can be sold on listed exchanges or in the over-the-counter market.

B

An investor will likely exercise a put option when the price of the stock is A) above the strike price plus the premium. B) at the strike price. C) below the strike price. D) above the strike price.

C

An investor would exercise a put option when the A) market price of the stock is equal to the strike price. B) current premium is higher than the initial cost. C) market price of the stock is below the strike price. D) market price of the stock is above the strike price.

C

An investor is long stock in a cash account and does not expect the price to change in the immediate future. His best strategy to generate income may be to: A) buy a put. B) sell a put. C) sell a call. D) buy a call.

C Selling a call against a security will generate additional income (the premium). An investor who writes a put receives additional income from the position but must also be willing to increase his position should the put be exercised. An investor who buys a call is speculating that the stock will soon rise dramatically. An investor who buys a put is speculating the stock will soon fall, not stay steady in price.

A farmer entered into a forward contract to sell his produce at $2.25 per bushel. At the expiration date of the contract, the price was $2.00 per bushel. The farmer would receive A) $2.125 per contract B) $2.00 C) $2.25 D) a price negotiated between the buyer and the seller

C The reason the farmer entered into this contract was to hedge against a drop in price. Because the strike price was higher than the market price at expiration, the farmer made a good deal, while the buyer of the contract lost.

When contrasting preemptive rights and warrants, it would be correct to state that, at issuance, A) rights have intrinsic and time value while warrants only have intrinsic value. B) rights have intrinsic value while warrants have intrinsic and time value. C) rights have time value while warrants have intrinsic and time value. D) rights have intrinsic and time value while warrants only have time value.

D

One of your advisory clients indicates that he would like to sell forward contracts in soybeans. It would be wise to warn the client that he will be facing the following risks: Liquidity Creditworthiness of the buyer Lack of assurance that the delivery price will remain stable The location for the delivery may change

1, 2 Because there is no standardization for forward contracts, they are considered to be illiquid. Because there is no entity backing up the contract (as the OCC does with listed options), a seller must always be concerned about the ability of the buyer to pay. Although the market price probably will change, the delivery price is always agreed upon at the time of the contract, as is the method, location, and time of delivery.

Which of the following statements is most accurate when describing equity straddle options? The option buyer is looking for market volatility. The option buyer is looking for market stability. The option seller is looking for market volatility. The option seller is looking for market stability.

1, 4

A European style option differs from an American style option primarily in that it A) can only be exercised on its expiration date B) derives its value from some underlying asset C) is generally offered with a limited number of expiration dates. D) is primarily used for options on foreign securities

A

When contrasting call options, preemptive rights, and warrants, it would be correct to state A) only preemptive rights and warrants are issued by the underlying corporation. B) all of these are issued by the underlying corporation. C) only call options are traded on listed exchanges. D) only call options and warrants have time value.

A

An investor who is long a put option for 100 shares of ABC common stock A) has the right to sell 100 shares at the higher of the exercise or market price B) has the right to buy 100 shares at the lower of the exercise or market price C) has the right to buy 100 shares at the stated exercise price D) has the right to sell 100 shares at the stated exercise price

D

An investor wishes to be able to obtain the right, but not the obligation, to purchase 100 shares of KAPCO common stock at $50 per share for the next 6 months. KAPCO is currently selling for $52 per share. This investor's wishes could be met by A) the sale of a put option B) the purchase of a pre-emptive right C) the purchase of a forward contract D) the purchase of a call option

D

In May, an investor purchased a futures contract to purchase 5,000 bushels of wheat at $4.30 per bushel for December delivery. On settlement date, the spot price of wheat is $4.20 per bushel. For the investor, this A) represents a loss of $50 B) contract should be left to expire C) represents a successful hedge D) represents a loss of $500

D

Which of the following statements regarding warrants is TRUE? A) Warrants give the holder a perpetual interest in the issuer's stock. B) Warrants are safer than corporate bonds. C) Warrants' terms are generally shorter than rights' terms. D) Warrants are often issued with other securities to make the offering more attractive.

D

One of your clients purchases a European-style put option on a stock. The premium is $3 and the exercise price is $35. If the price of the underlying asset is $40 on the exercise date, the client has A) lost $300. B) made $200. C) lost $200. D) made $500.

A

Which one of the following option positions would generally command the greatest time value? A) Straddles B) Puts C) Calls D) LEAPS

D

Which type of contract obligates both parties to act? Forward contract Futures contract Option contract Warrant

1, 2 It is only in the case of forward and futures contracts that both parties are obligated to fulfill the terms of the contract. Only the seller of an option contract is obligated, and in the case of a warrant, it is the issuer of the warrant who is obligated to deliver the underlying shares if the owner exercises.

Bail Bonds, Inc., might issue warrants in connection with a bond issue for which of the following reasons? As an inducement to make the bonds more marketable To lower their interest cost on the issue To increase the marketability of their common stock To increase the number of common shares outstanding

1, 2 Warrants permit the purchase of common stock of the issuer at a fixed price. A bond with warrants attached has more value than a straight bond and is more attractive (marketable) to investors. Attaching warrants to a bond issue usually permits the bonds to be issued with a lower interest rate.

One way in which futures contracts differ from options contracts is that A) both parties are obligated on futures contracts where only the seller is obligated on an options contract B) both parties are obligated on futures contracts where only the buyer is obligated on an options contract C) only the seller is obligated on a futures contract where both parties are obligated on options contracts D) only the buyer is obligated on a futures contract where only the seller is obligated on an options contract

A

The term "derivative" would NOT apply to which of the following? A) REITs B) Forwards C) Futures D) Warrants

A

The writer of a call option A) receives the premium. B) has the right to sell the underlying asset. C) pays the premium. D) is obligated to buy the underlying asset.

A

A member of the investment banking department of ABC Securities is explaining some of the advantages and disadvantages of rights and warrants to the board of directors of XYZ Corporation. Which of the following statements could he make? The exercise prices of stock rights are usually below the current market price of the underlying security at time of issue. The exercise prices of warrants are usually above the current market price of the underlying security at time of issue. Both rights and warrants may trade in the secondary market and may have prices that include a speculative (time) value. Warrants are often issued attached to a bond issue to reduce the interest costs to the issuer.

1, 2, 3, 4

A client calls to say he has just read about a European option and doesn't know what it is. You would explain that it is a derivative because A) the currency used is generally something other than the U.S. dollar B) it can only be exercised on the expiration date C) its value is based on some underlying asset D) intrinsic value does not affect the premium

C Although the unique characteristic of a European option is that it can only be exercised on its expiration date, that doesn't answer this question. It is a derivative like any other option because its value is based on the underlying asset.

Mark's company, which is located in Oregon, makes unfinished wood furniture. His company sells this furniture directly to the public from a large warehouse. Theresa's company, which is located in southern Georgia, grows cotton for t-shirts manufacturers. Which of the following statements correctly identifies hedging strategies for Mark and Theresa? Mark should buy lumber futures. Theresa should sell cotton futures. Mark should sell lumber futures. Theresa should buy cotton futures.

1, 2 Mark is "short" lumber because he needs lumber to produce his products. A hedge position for Mark would be to go long lumber futures, that is, to purchase lumber futures. Theresa is "long" cotton because she owns cotton for manufacturing purposes. A hedge position for Theresa is to go short, that is, to sell cotton futures.

An investor would write a call option to A) obtain income B) seek long-term capital gain C) protect the premium D) fix the purchase price to add stock to his portfolio

A

For which of the following is there no active secondary market? A) Forward contracts B) Options C) Futures contracts D) ETFs

A

Which of the following definitions involving derivatives is inaccurate? A) A call option gives the owner the right to sell the underlying asset at a specific price for a specified time period. B) A long straddle consists of a long call and a long put on the same underlying stock with the same strike price and the same expiration date. C) An option writer is the seller of an option. D) The seller of a put option has a neutral outlook.

A

Which of the following is NOT considered a derivative? A) Unit investment trust B) Futures contract C) Call option D) Warrant

A

If a call option with an exercise price of $50 is purchased for $300, the maximum amount the investor can lose is A) $300 B) $4,700 C) $5,000 D) unlimited

A

Nonsecurities derivatives would include forward contracts futures contracts hedge funds REITs

1, 2

Which of the following financial instruments is NOT a derivative? A) A share of stock B) LEAPS C) A call option D) A put option

D

All of the following are characteristics of a rights offering EXCEPT A) the subscription price is below the current market value B) it is issued to current stockholders C) the subscription period is up to 2 years D) the rights are marketable

C

In contrast with a typical forwards contract, futures contracts have: A) standardized terms. B) greater counterparty risk. C) nonstandard terms. D) less liquidity.

A Futures are contracts that trade on exchanges and have standardized terms, in contrast with forwards contracts, which are customized instruments. A futures clearinghouse reduces counterparty risk by guaranteeing the performance of buyers and sellers. Because futures contracts trade on organized exchanges and have standardized terms, they are more liquid than forwards contracts.

With respect to the specific commodity that is the subject of the contract, all of the following are standardized parts to an exchange-traded futures contract except A) the market price. B) the quality. C) the time for delivery. D) the quantity.

A It is the delivery price which is standardized, not the market price (that is continuously fluctuating). Exchange-traded futures contracts offer standardized quantities and qualities (grade of the commodity) as well as a standardized time for delivery.

A commodities speculator purchases a 1,000 bushel wheat futures contract at 50 cents per bushel. At expiration, the settlement price is 45 cents per bushel. This individual A) has a $50 gain B) has a $50 loss C) ​effectively hedged the long wheat position D) must make delivery of the wheat

B

Purchasers of options can have a number of different objectives. One of your clients who is a soft drink fan already has a long position in KO. What would be a possible reason for this client to go long a KO call option? A) To complete the other side of a spread B) To fix the cost of acquiring additional stock to the portfolio C) This would generate additional income D) Owning a long call on stock you already own offers a hedge against a market decline

B Those who are bullish on a stock, but don't have sufficient funds at this time to purchase the stock, can "lock-in" their future cost by going long a call. Income is generated only through selling options. Because a long call is on the same side of the market as long stock, there is no hedge. A spread involves a long and short option.

An investor owns five DEF call options with a strike price of $40. The options are European style. If the holder exercises, the cost will be A) zero because European options are exercisable only at expiration. B) $4,000. C) $20,000. D) $2,000.

C

An investor purchases two PMJ Dec 16 calls at $.85. If the commission charge is $8, the total cost is A) $328. B) $93. C) $178. D) $188.

C

An investor who is long XYZ stock would consider going long an XYZ call to A) hedge the long position B) protect against a decrease in the market price of XYZ stock C) protect against an increase in the market price of XYZ stock D) obtain income from the premium

C

Which of the following strategies would be considered most risky in a bull market? A) Buying a put B) Writing naked puts C) Writing naked calls D) Buying calls

C

News reports indicate that the wheat crop scheduled to be harvested in 3 months will be much larger than normal. To hedge, a wheat farmer would most likely A) take a long position in wheat futures. B) grow corn instead. C) take a short position in wheat futures. D) sell wheat stocks short.

C A bumper crop means lower prices for the producers (farmers). The appropriate protection is a short hedge - selling wheat futures. Think of it this way - if you thought a stock's price was going to decline, you would sell that stock short. Here, believing that wheat prices will decline, you take a short position in that commodity futures contract. There is no such thing as wheat stock and the wheat has already been planted; it is too late to switch crops.

A speculator, believing that a drought in the Midwest will lead to a weak corn crop, would probably A) take a long position in corn forwards B) take a short position in corn futures C) take a long position in corn futures D) take a long position in orange juice futures

C A weak corn crop means a shortage in the supply. That will lead to an increase in prices. When one is speculating that prices will go up, the best position is a long one. So, why not the long forwards? Those who purchase forwards contracts anticipate accepting delivery of the asset. This individual is merely speculating and has no interest in taking physical possession of the commodity and paying for transportation, silage, and insurance until the commodity is sold. If the person in the question had been a user of corn (a cereal maker, for example), then the forward contract would have been a better choice.

An investor goes short 5 soybean futures contracts on the Chicago Mercantile Exchange (CME). When the contract expires, A) only the exchange is obligated to perform B) only the buyer is obligated to perform C) only the seller is obligated to perform D) both the buyer and the seller are obligated to perform

D

An investor purchased a Mosaks, Inc. put option with a strike price of $105. If Mosaks' stock price is $115 at expiration, the value of the put option is A) -$10. B) $10. C) $105. D) $0.

D

Covered call writing is a strategy where an investor A) buys a call on a security he has sold short B) sells a call on an index that contains some of the securities that he has in his portfolio C) buys two calls on the same security he owns to leverage the position D) sells a call on a security he owns to reduce the volatility of the stock's returns and to generate income with the premium

D A covered call is simply defined as an investor owning 100 shares of the underlying stock for each option written (sold). The premium received is not only a source of income, but also serves to provide downside protection to the extent of the amount received.

All of the following statements regarding futures contracts are correct except A) purchasing a contract for future delivery is considered taking a long position. B) futures contracts can be written on financial assets or commodities. C) a short position will increase in value if the underlying commodity or asset declines in value. D) completing a futures contract requires the delivery of the commodity.

D In almost all cases, the holder of the futures contract will purchase an offsetting contract canceling the original position or sell the contract prior to expiration. In isolated cases, delivery of the commodity may be made, but is not required. Futures contracts can be written on financial assets such as currencies and stock indexes as well as on commodities such as agricultural products or precious metals. As with anyone taking a short position, the value goes up when the price of the underlying asset declines. And, just as purchasing a stock or bond, a long position represents one of ownership.

Nonsecurities derivatives include futures and forwards. Among the differences between futures and forwards is that futures contracts A) are not regulated by the CFTC while forwards are. B) are preferred to forwards by producers. C) are nonstandardized while forwards are. D) are rarely exercised while forwards generally are.

D In the vast majority of the cases, futures contracts are closed out prior to expiration. That is one reason they are more popular with speculators than forwards. Because forwards are generally delivered, they are the preferred tool by producers and it is futures which are standardized and CFTC regulates, not forwards.

The RIF Corporation would not be able to issue A) RIF common stock. B) RIF rights. C) RIF warrants. D) RIF call options.

D Options contracts are not issued by the underlying asset. Technically, listed options (the only type that will be on the exam), are issued by the Options Clearing Corporation (OCC). A corporation issues common stock and can issue rights (preemptive rights) and/or warrants.

A manufacturer of soybean oil is concerned that the price of soybeans will increase over the next 6 months. The best strategy to employ would probably be A) a trimmed hedge. B) a short hedge. C) a neutral hedge. D) a long hedge.

D The concern is that the price will go up. Just as with options, when we are concerned that the price of something will go up, we go long that item. With options, it would be a long call; with futures it is simply hedging by going long (buying) the soybean futures. The soybean farmer who would be concerned about a decline in the price would go short soybean futures.

George owns XYZ stock. Based on recent analyst projections and George's own research, he believes XYZ's price will remain flat over the next few months. Accordingly, which strategy would George most likely employ? A) Buy a call option B) Sell a put option C) Buy a warrant D) Sell a call option

D When the price is expected to stay flat, selling an option is a way to profit with little risk of the option being exercised. Why sell the call instead of the put? Because George owns the XYZ stock, this is a covered call and entails no downside risk. Selling the put would expose George to potentially significant loss if the price of XYZ should suffer a large decline.

You have a client who is bullish on XYZ stock and currently owns 100 shares that last traded at $50. He has a CD coming due in March, 6 months from now, and is afraid that by the time those funds are available, XYZ will have shot up in price. How can he ensure that he'll be able to pick up the stock at today's price 6 months from now and not miss out on that market appreciation? A) Buy an XYZ March 50 call option B) Buy XYZ stock rights C) Sell an XYZ March 50 put option D) Buy an XYZ March 50 put option

A

Included in the definition of derivative would be all of the following EXCEPT A) leveraged ETFs B) futures C) rights D) options

A ETFs, whether leveraged or not, are investment companies and are not included in the definition of derivative.

Which of the following is a multi-option strategy? A) Long call B) Straddle C) Short call D) Protective put

B

Specified in an exchange-traded futures contract would be the quantity of the underlying asset the quality of the underlying asset the time of delivery of the underlying asset the location of delivery of the underlying asset

1, 2, 3, 4

A financial instrument whose value depends upon the value of another asset is known as A) an investment contract. B) a derivative. C) a commodity. D) a security.

B

All of the following pay dividends EXCEPT A) common stock B) warrants C) preferred stock D) convertible preferred stock

B

All of the following positions expose a customer to unlimited risk EXCEPT A) Short 200 shares of XYZ B) Short 2 XYZ uncovered puts C) Short 200 shares of XYZ and short 2 XYZ puts D) Short 2 XYZ uncovered calls

B

An investor has been following the price movements of ABC common stock and believes that the stock is positioned for a significant upward move in the very near term. If the investor's goal is capital gains, which of the following would be the most appropriate position for this investor to take? A) Sell ABC put options B) Buy ABC call options C) Buy ABC put options D) Sell ABC call options

B

An option that may be exercised before its expiration date is said to be A) Premature style B) American style C) European style D) Flexible style

B

One of the differences between call options, rights, and warrants is that A) rights generally have the longest "life" of these 3. B) a corporation can't issue call options on its own stock. C) warrants generally have a strike price below the current market value of the underlying stock. D) holders of call options stand to profit if the market price of the underlying stock increases.

B

The long party to a put option contract has A) the obligation to sell the underlying asset. B) the right to sell the underlying asset. C) the obligation to buy the underlying asset. D) the right to buy the underlying asset.

B

Traders in stock index options are exposed to A) call risk B) systematic risk C) redemption risk D) credit risk

B

Which of the following investments would NOT be considered an exchange-traded derivative? A) Futures B) Forwards C) Options D) Warrants

B Forwards are never traded on an exchange; the other 3 choices can be traded OTC or on an exchange.

Mr. Brown has received preemptive rights from one of the stocks held in his portfolio. Which of the following is NOT an alternative regarding these stock rights? A) Exercising B) Selling at the market C) Redeeming them from the issuer for cash D) Giving the rights to his son

C