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Fundamentals of Derivatives Markets (McDonald)
Chapter 2 An Introduction to Forwards and Options
2.1 Multiple Choice Questions
1) The spot price of the market index is $900. A 3-month forward contract on this index is
priced at $930. What is the profit or loss to a short position if the spot price of the market
index rises to $920 by the expiration date?
A) $20 gain
B) $20 loss
C) $10 gain
D) $10 loss
2) The spot price of the market index is $900. A 3-month forward contract on this index is
priced at $930. The market index rises to $920 by the expiration date. The annual rate of
interest on treasuries is 4.8% (0.4% per month). What is the difference in the payoffs between
a long index investment and a long forward contract investment? (Assume monthly
compounding.)
A) $10.84
B) $19.16
C) $26.40
D) $43.20
3) The spot price of the market index is $900. A 3-month forward contract on this index is
priced at $930. The annual rate of interest on treasuries is 4.8% (0.4% per month). What
annualized rate of interest makes the net payoff zero? (Assume monthly compounding.)
A) 4.8%
B) 8.5%
C) 11.2%
D) 13.2%
4) The spot price of the market index is $900. After 3 months the market index is priced at $920.
An investor has a long call option on the index at a strike price of $930. After 3 months what
is the investor's profit or loss?
A) $10 loss
B) $0
C) $10 gain
D) $20 gain
5) The spot price of the market index is $900. After 3 months the market index is priced at $920.
The annual rate of interest on treasuries is 4.8% (0.4% per month). The premium on the long
put, with an exercise price of $930, is $8.00. What is the profit or loss at expiration for the
long put?
A) $2.00 gain
B) $2.00 loss
C) $1.90 gain
D) $1.90 loss
6) The spot price of the market index is $900. After 3 months the market index is priced at $920.
The annual rate of interest on treasuries is 4.8% (0.4% per month). The premium on the long
put, with an exercise price of $930, is $8.00. At what index price does a long put investor
have the same payoff as a short index investor? Assume the short position has a breakeven
price of $930.
A) $921.90
B) $930.00
C) $938.10
D) $940.00
7) All of the positions listed will benefit from a price decline, except:
A) Short put
B) Long put
C) Short call
D) Short stock
8) The spot price of the market index is $900. The annual rate of interest on treasuries is 4.8%
(0.4% per month). After 3 months the market index is priced at $920. An investor has a long
call option on the index at a strike price of $930. What profit or loss will the writer of the call
option earn if the option premium is $2.00?
A) $2.00 gain
B) $2.00 loss
C) $2.02 gain
D) $2.02 loss
9) The spot price of the market index is $900. After 3 months the market index is priced at $920.
The annual rate of interest on treasuries is 4.8% (0.4% per month). The premium on the long
put, with an exercise price of $930, is $8.00. Calculate the profit or loss to the short put
position if the final index price is $915.
A) $15.00 gain
B) $15.00 loss
C) $6.90 gain
D) $6.90 loss
10) If your homeowner's insurance premium is $1,000 and your deductible is $2000, what could
be considered the strike price of the policy if the home has a value of $120,000?
A) $118,000
B) $120,000
C) $117,000
D) $122,000
11) A put option if purchased and held for 1 year. The Exercise price on the underlying asset is
$40. If the current price of the asset is $36.45 and the future value of the original option
premium is (- $1.62 ), what is the put profit, if any at the end of the year?
A) $1.62
B) $1.93
C) $3.55
D) $5.17
12) The premium on a long term call option on the market index with an exercise price of 950 is
$12.00 when originally purchased. After 6 months the position is closed and the index spot
price is 965. If interest rates are 0.5% per month, what is the Call Payoff?
A) $2.64
B) $12.00
C) $12.36
D) $15.00
13) The premium on a call option on the market index with an exercise price of 1050 is $9.30
when originally purchased. After 2 months the position is closed and the index spot price is
1072. If interest rates are 0.5% per month, what is the Call Profit?
A) $9.30
B) $9.39
C) $12.61
D) $22.00
14) Which of the following phrases is used to describe an option where the strike price is
approximately equal to the asset price?
A) At-the-money
B) In-the-money
C) Near-the-money
D) Out-of-the-money
15) Which of the following phrases is used to describe an option where immediate exercise
results in a negative payoff?
A) At-the-money
B) In-the-money
C) Near-the-money
D) Out-of-the-money
16) Which of the following phrases is used to describe an option where immediate exercise
results in a positive payoff?
A) At-the-money
B) In-the-money
C) Near-the-money
D) Out-of-the-money
17) What term may be used to describe a long call position in which the exercise price is below
the asset price?
A) At-the-money
B) In-the-money
C) Near-the-money
D) Out-of-the-money
18) What term may be used to describe a long put position in which the exercise price is below
the asset price?
A) At-the-money
B) In-the-money
C) Near-the-money
D) Out-of-the-money
19) Which type of option is least likely to be exercised?
A) At-the-money
B) In-the-money
C) Near-the-money
D) Out-of-the-money
20) Which strike price is reflective of an out-of- the-money long call with an asset price of $34?
A) $32
B) $34
C) $36
D) $38
2.2 Short Answer Essay Questions
1) The spot price of the market index is $900. A 3-month forward contract on this index is
priced at $930. Draw the payoff graph for the short position in the forward contract.
Answer:
2) An investor has a long call option on the market index at a strike price of $930. At expiration
the index price is $920. Explain the profit and loss.
3) The spot price of the market index is $900. After 3 months the market index is priced at $920.
The annual rate of interest on treasuries is 4.8% (0.4% per month). The premium on the long
put, with an exercise price of $930, is $8.00. Draw the payoff graph for the long put position
at expiration. Include strike price, breakeven price, and max loss.
5
4) Develop the payoff table for the previous question, using at least five different possible
index prices, in addition to the strike price and breakeven price.
Answer:
5) As with Chrysler Corp. many years ago, the government occasionally guarantees loans.
What option is the government granting and to whom in a loan guarantee?
2.3 Class Discussion Question
1) Engage the class in a conversation about auto insurance. Why do people feel their premium
is wasted if they do not file a claim? Steer the class towards an understanding of put options
and potential gain should a loss occur. It may also be beneficial to ask students to relate
insurers' pooling of losses with the concept of risk management.
