CHAPTER 11
TRUE-FALSE QUESTIONS
to trade.
same way as the price of the item being hedged.
assets (i.e., negative GAP) might swap future fixed rate interest payments for variable
rate interest payments.
positions in swap contracts themselves.
deposited before participating in any trade.
futures contracts.
2
an asset for cash at some future date, with the price set today is called a future agreement.
might sell a T-bond futures contract or buy an interest rate cap to take advantage of your
expectations.
the volatility of the stock’s price decreases.
money but the put option is in-the-money.
MULTIPLE-CHOICE QUESTIONS
a. Derivative securities are used to minimize or eliminate an investor’s or a firm’s
exposure to various types of risk that they may be exposed to.
b. Derivatives are financial securities which are based upon or derived from
existing securities.
c. Risk to an investor or a firm can be caused by interest rate changes or foreign
exchange rate changes, commodity prices or stock prices.
d. all of the above
a. a call option on a stock index
b. a futures contract
c. an interest rate swap
d. a repurchase agreement
e. All of the above are derivative securities.
a. usually buys futures contracts.
b. usually sells futures contracts.
c. either buys or sells so that underlying asset gains/losses are directly related to
futures contract gains/losses.
d. either buys or sells so that underlying asset gains/losses are inversely related to
futures contract gains/losses.
3
a. seeks a position in the spot market to offset the price risk, which exists in the
futures market.
b. will purchase financial futures if holding financial assets in the spot market.
c. seeks to offset the price risk in its spot market position with the equal but
opposite price risk of the futures position.
d. will always short financial futures to create a perfect hedge.
dollars of T-Bills in sixty days is called a
a. a call option.
b. a forward contract.
c. a put option.
d. a long futures position.
a. Forward contracts involve an intermediary or exchange.
b. Futures contracts are standardized; forward contracts are not.
c. Futures markets are more formal than forward markets.
d. Delivery is made most often in forward contracts.
transaction.
a. stock
b. spot
c. futures
d. forward
e. swap
$1,000,000 in one month. The current price for three-month T-bills is $988,520. What is
the fair forward price if the current effective annual risk-free rate over one month is 4%?
a. $950,500
b. $985,236
c. $988,520
d. $991,815
e. $1,028,061
a. equal to the face value of the asset.
b. always higher than the current price of the asset.
c. the price that makes the forward contract have zero net present value.
d. adjusted downward to incorporate storage costs.
e. both c and d
or financial asset?
a. Spot prices represent expected forward prices.
b. Forward prices are always higher than spot prices.
c. Spot prices are always higher than forward prices.
d. Forward prices are expected future spot prices.
4
a. the futures exchange.
b. the stock exchange.
c. the counter-party of the forward contract.
d. the opposite swap party.
e. the hedger.
a. futures contracts are between the individual hedger and speculator.
b. futures contracts are personalized, unique contracts; forwards are standardized.
c. futures contracts are marked to market daily with changes in value added to or
subtracted from the accounts of the buyer and the seller.
d. forward contracts always require a margin deposit.
e. all of the above
project, it could
a. sell T-bill futures for when the funds were needed.
b. buy T-bill futures for when the funds were needed.
c. sell T-bond futures for when the funds were needed.
d. buy T-bond futures for when the funds were needed.
by
a. selling an IBM put option that matures in 30 days
b. buying an IBM call option that matures in 30 days
c. selling an IBM call option that matures in 30 days
d. buying an IBM put option that matures in 30 days
e. selling IBM stock short
the yield on the $1,000,000 of T-Bill she plans to buy in 3 months. She can hedge this
potential interest rate risk by
a. taking a short position in 3-month T-bill futures.
b. taking a long position in 3-month T-bill futures.
c. buying a call option on 3-month T-bill futures.
d. buying a put option on 3-month T-bill futures.
e. Either b or c would work.
a. locks in a particular price or rate of return for a hedger.
b. exposes a hedger to a risk of large losses.
c. allows a hedger to benefit from the upside potential of his spot position.
d. is free (i.e., creating the hedge is costless)
e. both b and c
5
notes at 98’14. Three month later, the contract expires at 101’10.5. How much did the
speculator gain (lose)?
a. $2,965
b. ($2,965)
c. $2,891
d. ($2,891)
e. $328
notes at 99’04.5. He posted a $2,500 margin on his account. The contract’s closing price
at the end of the day is 98’24. What is the amount of funds on the speculator’s account
after marking-to–market?
a. $2,500
b. $3,305
c. $2,891
d. $3,500
e. $2,109
position.
a. spot; futures
b. high; low
c. long; short
d. short; long
e. wide; narrow
a(n) _______ margin.
a. initial
b. maintenance
c. minimum
d. enforced
e. futures
a. determines the number of futures contracts to trade.
b. states that a hedging futures position must have the same sensitivity to interest
rate changes as the asset or portfolio whose value is being hedged.
c. requires determining the relative price variability of a futures contract and
underlying assets given a change in interest rates.
d. all of the above.
6
the portfolio, you decide to trade S&P 500 futures contracts. Each contract is worth $250
per index point. How many contracts do you need to buy or sell if the S&P 500 index is
currently at 1,500?
a. sell 10 contracts
b. buy 10 contracts
c. sell 8 contracts
d. buy 8 contracts
e. buy 20 contracts
futures contracts at 1,450. Each contract is worth $250 per index point. Recently, your
portfolio lost 4% of its value, while the S&P 500 index declined to 1,400. What is your
total (spot plus futures) gain (loss)?
a. $80,000
b. $20,000
c. ($20,000)
d. (80,000)
e. (180,000)
a. the seller of a futures contract
b. the buyer of a put
c. the writer of a call
d. the buyer of a futures contract
e. both b and c
a. A swap is like a forward contract in that it guarantees the exchange of two items
of value at some future point in time.
b. Only the net interest difference is swapped in an interest rate swap.
c. Swap parties always have the same level of credit risk.
d. Unlike in a forward contract, the exact terms of exchange of the swap will vary
with changes in interest rates.
e. All of the above statements are true.
a. to approve new futures contracts
b. to monitor enforcement of exchange rules
c. to make sure traders maintain their margin level
d. to investigate violations of laws
a. short; long
b. short; selling
c. long; buying
d. long; selling
7
balance cannot fall below a(n) _______ margin.
a. initial; maintenance
b. initial; enforced
c. net; seller’s
d. safe; double
e. first; second
a. sell financial futures.
b. purchase financial futures.
c. sell puts on financial futures.
d. both a and c
the bank. If the price of the futures contract is increasing,
a. First National is “gaining.”
b. First National is “losing.”
c. First National is neither “gaining” nor “losing.”
d. First National’s risk exposure is increasing.
e. both b and d
sells T-bill futures. The bank is
a. speculating.
b. hedging.
c. neither hedging nor speculating.
d. both hedging and speculating.
(b) 32. Daily changes in futures prices means one party (hedger or speculator) has gained while
another lost money on the contract. How are the exchanges able to keep the “daily” loser
in the contract and prevent default?
a. by the threat of bankruptcy
b. by daily margin calls if needed
c. by loans
d. by guarantees by third parties
the futures market is the
a. Chicago Mercantile Exchange.
b. Federal Commodity Futures Commission.
c. Commodity Futures Trading Commission.
d. Chicago Board of Trade.
8
today’s interest rates by
a. selling calls on financial futures.
b. buying puts on financial futures.
c. buying financial futures.
d. selling financial futures.
e. taking no action.
a. hedging perfectly.
b. accepting some basis risk.
c. speculating.
d. accepting some default risk in the futures position.
a. The institution may hedge its earnings and its net worth simultaneously.
b. If market value weighted asset duration is greater than the liability counterpart,
sell financial futures to “immunize.”
c. If market value weighted asset duration is greater than the liability counterpart,
buy financial futures to “immunize.”
d. Maturity hedging provides the same hedging as duration hedging.
a. the price volatility of the underlying asset.
b. the time to expiration.
c. the level of interest rates.
d. both a and b above.
e. all of the above.
a. margin risk.
b. basis risk.
c. default risk.
d. manipulation risk.
$300, had a strike price of $50, and the market value of the stock was $52?
a. let the option expire unexercised
b. exercise the option
c. request that the $300 be returned
d. none of the above
expiration date _______ when the spot price of an underlying increases.
a. increases; increases
b. increases; falls
c. does not change; does not change
d. falls; increases
e. falls; falls
9
this security.
a. bought a forward contract
b. sold a futures contract
c. bought a put option
d. sold a call option
e. bought a call option
a. exercise price
b. premium
c. marking-to-market
d. naked
a. exercise the option only on the expiration date.
b. exercise the option on or before the expiration date.
c. exercise the option before but not on the expiration date.
d. exercise the option after the expiration date.
e. none of the above.
decided to taken an option position of this stock to make profit. For that position,
if the stock’s price drops you will get a level gain no matter how huge prices
decrease. However, you could go bankrupt if the stock’s price rises. What is your
option position?
a. Bought a call option
b. Bought a put option
c. Written a put option
d. Written a call option
likely to use:
a. A short or selling hedge in futures.
b. A long or buying hedge in futures.
c. A call option on futures contracts.
d. b and c above.
bank’s overall interest rate risk exposure and protect the bank’s net worth depends
upon:
a. The difference in the durations of bank assets and liabilities.
b. The duration of the underlying security named in the futures contract.
c. The price of the futures contract.
d. All of the above.
10
stock is $100. Its March options are about to expire. One of its puts is worth $10
and one of its calls is worth $5. The exercise price of the put must be _____ and
the exercise price of the call must be _____.
a. 110, 95
b. 105, 95
c. 90, 105
d. 105, 90
a. The Federal Reserve
b. The SEC
c. The CFTC
d. The NYSE
ESSAY QUESTIONS
1. Explain how a savings and loan manager could use futures or options to hedge against the
possibility that interest rates will rise.
2. Explain how forward and futures markets differ.
3. What determines whether a buyer or a seller of a derivative security is a hedger or a speculator?
11
4. What role does the SEC have in regulating options markets? How does it differ from the role of
CFTC?
5. A manager of a large stock portfolio has earned a respectable return by October, and would like
to protect that return for the year. How might she guarantee a certain portfolio return with trades
in derivative securities?
6. Suppose a stock is priced at $100 currently. You are bullish on the stock and are
considering buying May calls with an exercise price of $95 and $105 respectively. The
call with an exercise price $95 is priced at $8.50 and the 105 call is quoted at $2.75.
Consider different price projection, what should you consider in deciding which to
purchase if you do not plan on exercising prior to maturity?