Derivatives Markets 3e McDonald Chap 1

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Derivatives Markets, 3e (McDonald) Chapter 1 Introduction to Derivatives 1.1

Multiple Choice Question: Which of the following is not a derivative instrument? A)

Contract to sell corn B) Option agreement to buy land C) Installment sales agreement D)

Mortgage backed security Answer:

Question: Who from the following list would be considered a speculator by entering into a

futures or options contract on commodities? A) Farmer B) Corn delivery truck driver C)

Food manufacturer D) None of the above Answer:

Question: A mutual fund is engaged in the short term and temporary purchase of index

futures, for purposes of minimizing its cash exposures. Which “use” most closely explains

their actions? A) Risk management B) Speculation C) Reduced transaction costs D)

Regulatory arbitrage Answer:

Question: During the growing season, a corn farmer sells short corn futures contracts in an

amount equal to her crop. If upon harvesting and selling her crop she maintains the

contracts, she is then considered a(n): A) Hedger B) Speculator C) Arbitrager D) None of

the above Answer:

Question: All of the following are financially engineered products, except: A) Mortgage B)

Mortgage backed security C) Interest only D) Principal only Answer:

Question: Select the family member who is offering the most diversification to the rest of

the family. A) Dad works for General Motors B) Mom works for Goodyear C) Daughter

works for Jiffy Lube D) Son works for Eli Lilly & Company Answer:

Question: What is the cost of 100 shares of Jiffy, Inc. stock given that the bid-ask prices

are

$31.25 – $32.00 and a $15.00 commission per transaction exists? A) $3215 B) $3140 C)

$3125 D) $3200 Answer:

Question: Assume that you purchase 100 shares of Jiffy, Inc. common stock at the bid-ask

prices of $32.00 – $32.50. When you sell, the bid-ask prices are $32.50 – $33.00. If you

pay a commission rate of 0.5%, what is your profit or loss? A) $0 B) $16.25 loss C) $32.50

gain D) $32.50 loss Answer:

Question: Assume that you open a 100-share short position in Jiffy, Inc. common stock at

the bid-ask price of $32.00 – $32.50. When you close your position, the bid-ask prices are

$32.50 – $33.00. If you pay a commission rate of 0.5%, what is your profit or loss on the

short investment? A) $32.50 gain B) $16.25 loss C) $132.50 loss D) $100.00 gain Answer:

Question: Assume that you open a 100-share short position in Jiffy, Inc. common stock at

the bid-ask prices of $32.00 – $32.50. When you close your position, the bid-ask prices are

$32.50 – $33.00. You pay a commission rate of 0.5%. The market interest rate is 5.0% and

the short rebate rate is 3.0%. What is your additional gain or loss due to leasing the asset?

A) $64.00 loss B) $160.00 loss C) $96.00 gain D) $0 Answer:

Question: Assume that an investor lends 100 shares of Jiffy, Inc. common stock to a short

seller. The bid-ask prices are $32.00 – $32.50. When the position is closed, the bid-ask

prices are

$32.50 – $33.00. The commission rate is 0.5%. The market interest rate is 5.0% and the

short rebate rate is 3.0%. Calculate the gain or loss to the lender. Assume the lender is not

subject to a bid-ask loss or commissions. A) $164.00 gain B) $164.00 loss C) $100.00 gain

D) $100.00 loss Answer:

Question: According to trading volume data tabulated by the Wall Street Journal for April

15, 2010, which index futures contact experienced the highest total open interest? A) DJ

Industrial Average B) S&P 500 Index C) Mini S&P 500 D) Mini Nasdaq 100 Answer:

Question: A firm provides a service that benefits from decreasing employment. This firm

has a risk exposure to macro event. All other variables being equal, which of the following

derivative securities is the firm most likely use to hedge its exposure? A) Short position in

an economic futures B) Long position in an economic futures C) Short position in an

interest rate futures D) Long position in an interest rate futures Answer:

Question: Why might a variable rate mortgage be considered a “derivative” and a fixed

rate mortgage not? Answer:

Question: Why would a corn farmer, who maintains a short futures contract after

harvesting and selling her crop, be considered a speculator? Answer:

Question: For families employed and living in “company towns” (i.e., where the major

employer owns all homes, retail stores, etc.), explain the lack of diversification. Answer:

Question: Describe the concept of a bid-ask spread and how that impacts the cash flows of

an investor. Answer:

Question: What would cause the spread between the market rate of interest and the repo

rate to be small? Answer: