Unit 16 Derivatives (5)
A farmer who produces soybeans believes that this year's crop will be the biggest ever. The farmer would most likely hedge this risk by A) going short soybean futures B) going short soybean forwards C) going long soybean futures D) going long soybean forwards
B. A big crop means more supply and lower prices when the crop is harvested. Hedging involves taking an opposite position (benefiting if prices fall). If the farmer is correct, selling short at today's price will enable delivery in the future at that higher price. Because this is a producer who will have product to deliver, forwards are likely to be more appropriate than futures. U16LO4
The term derivative would apply to which of the following? A) UITs B) Warrants C) DPPs D) REITs
B. A derivative has its value based upon some underlying asset. The value of a warrant is based on the value of the security into which it is exchangeable. U16LO3
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) Derivative securities can be sold on listed exchanges or in the over-the-counter market. D) An option contract is a derivative security because it has no value independent of the value of an underlying security.
B. An owner of a put has the right, not the obligation, to sell, not purchase, a security at a designated price (the strike price) before a specified date (the expiration date). Although this exam deals exclusively with listed equity options, there are options traded in the OTC market. Two of the factors affecting the market price of an option (its premium) are the length of time until expiration (the longer the time, the greater the time value) and whether or not the option has intrinsic value (the difference between the stock price and the market price). U16LO3
The term "derivative" would NOT apply to which of the following? A) Warrants B) REITs C) Forwards D) Futures
B. REITs are not based on the value of something other than their own assets. Warrants (and rights) derive their value from the underlying security. Futures and forwards are contracts whose value is based on some underlying asset. U16LO1
An investor who is long a put option for 100 shares of ABC common stock A) has the right to buy 100 shares at the lower of the exercise or market price B) has the right to sell 100 shares at the higher 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. One who is long a put is an owner of the option. Owning a put option gives the holder the right to sell the underlying asset (in this case 100 shares of ABC stock) at the stated exercise (or strike) price. This would be advantageous if the strike price is above the current market price. U16LO2
