Mock Final Exam: 2 Parts: Multiple choice Short answer questions PART I

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Mock Final Exam:

2 Parts:

• Multiple choice

• Short answer questions

PART I

Introduction

1. Investors who do not consider risk in their decisions are said to be a. speculating

b. short selling c. risk neutral d. traders

e. none of the above

2. In which one of the following types of contract between a seller and a buyer does the seller agree to sell a specified asset to the buyer today and then buy it back at a specified time in the future at an agreed future price.

a. repurchase agreement b. short selling

c. swap d. call

Structure of Options Markets

3. The option price is also referred to as the a. strike

b. spread c. premium d. fee

4. The option price is also referred to as the a. strike

b. spread c. premium d. fee

The structure of Forward and Futures Markets

5. Variation margin is which of the following?

a. the difference in margin between hedger and speculator b. margin differences according to trading style

c. margin deposited as a result of marking-to-market d. margin set by the variability of a futures price e. none of the above

6. Variation margin is which of the following?

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c. margin deposited as a result of marking-to-market d. margin set by the variability of a futures price e. none of the above

Futures Hedging strategies

7. Determine the optimal hedge ratio for Treasury bonds worth $1,000,000 with a modified duration of 12.45 if the futures contract has a price of $90,000 and a modified duration of 8.5 years.

a. 16.27 b. 15.93 c. 7.42 d. 11.11

8. You hold a bond portfolio worth $10 million and a modified duration of 8.5. What futures transaction would you do to raise the duration to 10 if the futures price is $93,000 and its implied modified duration is 9.25? Round up to the nearest whole contract.

a. buy 109 contracts b. buy 17 contracts c. buy 669 contracts d. sell 100 contracts e. sell 669 contracts

Option Strategies (Basic)

9. Identify the correct statement related to the choice of exercise price for buying a call.

a. the higher the exercise price the higher the call premium

b. the lower the exercise price the more likely the call option will expire out-of-the-money

c. A higher strike price results in smaller gains on the upside but smaller losses on the downside

d. the higher the exercise price the more dividends contribute to the overall profit

e. none of the above are correct statements related to the choice of exercise price for buying a call

10. Consider the following statement related to writing a naked call option. For a given stock price, the ____________ the position is held, the more time value it loses and the ___________ the profit. Identify the correct words for these two blanks.

a. longer, lower b. longer, higher c. shorter, lower d. shorter, higher e. longer, flatter

11. Consider the following statement related to buying a put option. For a given stock price, the ____________ the position is held, the more time value it loses and the ___________ the profit; however, an exception can occur when the stock price is ___________. Identify the correct words for these two blanks.

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c. shorter, lower, low d. shorter, higher, high e. longer, flatter, low

12. A synthetic long call position can be created with which of the following sets of transactions.

a. borrow the present value of the strike price, sell stock, sell put b. lend the present value of the strike price, sell stock, buy put c. sell put, buy stock, lend the present value of the strike price d. buy stock, buy put, borrow the present value of the strike price e. none of the above creates a synthetic long call position

13. A synthetic short put position can be created with which of the following sets of transactions.

a. borrow the present value of the strike price, sell stock, sell call b. lend the present value of the strike price, sell stock, buy call c. sell call, buy stock, lend the present value of the strike price d. buy stock, buy call, borrow the present value of the strike price e. none of the above creates a synthetic long call position

Option Strategies (Advanced)

14. The purchase of one option and the sale of another is known as a. box

b. bear strategy c. bull strategy d. collar e. spread

15. The option strategy where the holder of a long position in a stock buys a put with an exercise price lower than the current stock price and sells a call with an exercise price higher than the current stock price is known as

a. box

b. bear strategy c. bull strategy d. collar e. spread

16. The profit from a put bear spread strategy when both options are out of the money is

a. –X1 + ST + P1 + X2 – ST – P2 b. –X1 + ST + P1 – P2

c. X1 – ST – P1 – X2 + ST + P2 d. P1 + X2 – ST – P2

e. P1 – P2

17. Like the butterfly spread, the calendar spread is one in which the underlying instrument’s ___________ is the major factor in its performance.” The best word for the blank is which of the following?

a. volatility

b. expected rate of return c. beta

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18. Which of the following statements best describes the nature of option time value decay?

a. time value decays more rapidly as the stock price approaches being at-the-money

b. time value decays more rapidly as expiration approaches c. time value decays more rapidly for put option than call options d. time value decay does not occur for collar option strategies

e. time value decay is detrimental for a trader who is short call options

Principles of Pricing Forwards and Futures Pricing

19. The value of a long position in a forward contract at expiration is a. the spot price plus the original forward price

b. the spot price minus the original forward price c. the original forward price discounted to expiration

d. the spot price minus the original forward price discounted to expiration e. none of the above

20. The value of a futures contract immediately after being marked to market is a. numerically equal to the daily settlement amount

b. the spot price plus the original forward price

c. equal to the amount by which the price changed since the contract was opened

d. simply zero e. none of the above

21. Under uncertainty and risk aversion, today’s spot price equals

a. the expected future spot price, minus the storage costs, minus the interest forgone, minus the risk premium

b. the expected future spot price, minus the storage costs, minus the interest forgone, plus the risk premium

c. the expected future spot price, minus the storage costs, minus the risk premium

d. the future spot price minus the cost of storage e. none of the above

22. The additional return earned by holding a commodity that is in short supply or a nonpecuniary gain from an asset is referred to as

a. the negative cost of carry b. the convenience yield c. cash-flow free gains d. gains on the underlying e. none of the above

23. Put-call-futures parity is the relationship between the prices of puts, calls, and futures on an asset. Assuming a constant risk-free rate and European options, which of the following correctly expresses the relationship of put-call-futures parity?

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Principles of Option Pricing

a. Pe(S0,T) = Ce(S0,T) + (X – f0(T))(1 + r)-T b. Pe(S0,T,X) = Ce(S0,T) – (X – f0(T))(1 + r)-T c. Pe(S0,T,X) = Ce(S0,T,X) + (X – f0(T))(1 + r)-T d. Pe(S0,T,X) = Ce(S0,T,X)(X – f0(T))(1 + r)-T e. none of the above

Option Pricing Models: the Binomial Model

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f. Pe(S0,T) = Ce(S0,T) + (X – f0(T))(1 + r)-T g. Pe(S0,T,X) = Ce(S0,T) – (X – f0(T))(1 + r)-T h. Pe(S0,T,X) = Ce(S0,T,X) + (X – f0(T))(1 + r)-T i. Pe(S0,T,X) = Ce(S0,T,X)(X – f0(T))(1 + r)-T j. none of the above

Option Pricing Models: The Black-Scholes-Merton Model

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forgone, plus the risk premium

a. Pe(S0,T) = Ce(S0,T) + (X – f0(T))(1 + r)-T b. Pe(S0,T,X) = Ce(S0,T) – (X – f0(T))(1 + r)-T c. Pe(S0,T,X) = Ce(S0,T,X) + (X – f0(T))(1 + r)-T d. Pe(S0,T,X) = Ce(S0,T,X)(X – f0(T))(1 + r)-T e. none of the above

Managing Risk in an Organization

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c. cash-flow free gains d. gains on the underlying e. none of the above

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PART II

1. Explain how the implied repo rate on a spread transaction differs from that on a nearby futures contract.

2. For each of the following situations, determine whether a long or short hedge is appropriate. Justify your answers.

a. A firm anticipates issuing stock in three months. b. An investor plans to buy a bond in 30 days.

c. A firm plans to sell some foreign currency denominated assets and convert the proceeds to domestic currency.

3. The manager of a $20 million portfolio of domestic stocks with a beta of 1.10 would like to begin diversifying internationally. He would like to sell $5 million of domestic stock and purchase $5 million of foreign stock. He learns that he can do this using a futures contract on a foreign stock index. The index is denominated in dollars, thereby eliminating any currency risk. He would like the beta of the new foreign asset class to be 1.05. The domestic stock index futures contract is priced at $250,000 and can be assumed to have a beta of 1.0. The foreign stock index futures contract is priced at $150,000 and can also be assumed to have a beta of 1.0.

a. Determine the number of contracts he would need to trade of each type of futures in order to achieve this objective.

b. Determine the value of the portfolio if the domestic stock increases by 2 percent, the domestic stock futures contract increases by 1.8 percent, the foreign stock increases by 1.2 percent, and the foreign stock futures contract increases by 1.4 percent.

4. Consider the right-hand side of the Black-Scholes-Merton formula as consisting of the sum of two terms. Explain what each of those terms represents.

5. Explain each of the following concepts as they relate to call options. a. Delta