Investments Chapter 11 Review Questions

The expiration date of a derivatives contract is the date when the: contract expires. option premium is paid. contract must be settled.

contract expires.

A call option contract on shares of Company A has an exercise price of €50. The option is in the money when the share price of Company A is: A) €45. B) €50. C) €55.

C) €55

For an exporter exposed to currency risk, the use of currency derivatives will most likely: reduce currency risk. increase currency risk. leave currency risk unchanged.

reduce currency risk.

Which of the following options would be described as being in the money? A) A put option in which the underlying's price is lower than the exercise price. B) A call option in which the underlying's price is lower than the exercise price. C) A put option in which the underlying's price is higher than the exercise price

A) A put option in which the underlying's price is lower than the exercise price.

Which of the following parties to an option contract on a company's shares is obligated to buy shares at the option strike price if the option is exercised? A) Put seller B) Put buyer C) Call seller

A) Put seller

The value of a derivatives contract is most likely to be directly affected by the: A) price of the underlying. B) supply of the underlying. C) demand for the underlying

A) price of the underlying

Counterparty risk is most likely lowest for: A) swap contracts. B) futures contracts. C) forward contracts.

B) futures contracts.

Swap contracts: A) are mostly traded on exchanges. B) have an initial net value of zero. C) are not susceptible to counterparty risk.

B) have an initial net value of zero.

Forward contracts and futures contracts, with otherwise identical terms, are similar with respect to: A) counterparty risk. B) payoffs at maturity. C) customisation of contracts

B) payoffs at maturity.

A farmer will harvest his corn crop in six months but wants to lock in a price today. The farmer will most likely: A) buy a corn futures contract. B) sell a corn futures contract. C) buy a corn forward contract.

B) sell a corn futures contract.

Which of the following parties to an option contract on a company's shares has the right to buy shares at the exercise price? A) Put seller B) Call seller C) Call buyer

C) Call buyer

Relative to a futures contract, an advantage of a forward contract is: A) greater liquidity. B) lower counterparty risk. C) the ability to customise the contract

C) the ability to customise the contract

A put option on shares of Company B has an exercise price of £40. The option is out of the money when the share price of Company B is: A) £35. B) £40. C) £45

C) £45

Derivatives contracts are constructed such that the underlying may be based on: only an outcome. only a tangible asset. a tangible asset or an outcome.

a tangible asset or an outcome.

A benefit of futures contracts is that they offer investors the advantage of: customising contract terms. access to high-risk investors. no initial margin requirement.

access to high-risk investors

The seller of a credit default swap (CDS): receives protection from the buyer in the event of a default. agrees to protect the buyer from losses in the event of a default. exchanges principal with the counterparty when the swap is initiated.

agrees to protect the buyer from losses in the event of a default.

A derivatives contract must be based on an underlying that is a tangible: asset. outcome. asset or outcome.

asset or outcome.

For futures contracts, marking to market most likely reduces counterparty risk through the process of: cash settlement of profits and losses at the end of each day. increasing initial margins for underlying assets with higher price volatility. increasing maintenance margins for underlying assets with higher price volatility.

cash settlement of profits and losses at the end of each day.

A contract in which one party directly enters into a customised agreement with a party to take delivery of a quantity of corn, at a specified price, at some future date, is called a: spot contract. futures contract. forward contract.

forward contract.

A key distinction between forward contracts and futures contracts is that forward contracts: are only settled with cash. have lower transactions costs. have no cash flows except at maturity.

have no cash flows except at maturity.

A primary difference between a futures contract on an asset and an option contract on the same asset is that the futures contract: represents the right to trade the asset. is marked to market at the end of each trading day. cannot be easily cancelled or closed out at any time before expiration.

is marked to market at the end of each trading day.

Compared with a forward contract, in the case of a futures contract: counterparty risk is higher. it is easier to exit a position before maturity. only the buyer has an obligation to fulfil the contract.

it is easier to exit a position before maturity.

Compared with investing directly in an asset, derivatives allow an investor a way to gain exposure to the asset by committing: less capital and incurring lower transaction costs. more capital and incurring higher transaction costs. less capital and incurring higher transactions costs.

less capital and incurring lower transaction costs

Consider a put option whereby the market price of the underlying stock is greater than the exercise price. At maturity, the profit for the holder of the put option is most likely: equal to zero. less than zero. greater than zero.

less than zero.

The value of a call option, relative to other comparable call options, will be higher if the time to maturity and price volatility of the underlying asset, respectively, are: longer; higher shorter; lower shorter; higher

longer; higher

Depending on the terms specified in the contract, settlement in a derivatives contract can be carried out by: settling with cash only. physical delivery of the underlying asset only. physical delivery of the underlying asset or cash settlement.

physical delivery of the underlying asset or cash settlement.

For option contracts, buyers and sellers (writers) of the option, respectively, have the: obligation to trade underlying asset; right to trade underlying asset right to trade underlying asset; obligation to trade underlying asset obligation to trade underlying asset; obligation to trade underlying asset

right to trade underlying asset; obligation to trade underlying asset

An investor in an option on a stock who must purchase the stock when the option is exercised is: buying a put option. selling a put option. selling a call option.

selling a put option.

Forwards and futures are similar in that for both types of contracts: terms are customised. buyers and sellers are obliged to fulfil the contract. positions can be closed by entering an opposite position.

terms are customised.

The value of a derivatives contract is most likely determined by: the exchange the contract trades on. the performance of an underlying asset. negotiation between the parties involved in the derivatives trade.

the performance of an underlying asset.

In contrast to forward contracts, futures contracts: trade on organised exchanges. have negotiable expiration dates. have contract sizes tailored to investor needs.

trade on organised exchanges

In a contractual agreement to purchase or sell an asset in the future, in which the value of the contract is tied to the performance of the asset, that asset may be described as the: hedge. derivative. underlying.

underlying

In contrast to forward contracts, option contracts are: bilateral contracts. unilateral contracts. multilateral contracts.

unilateral contracts.