29) A speculator who believes strongly that interest rates will rise would be likely to
A) buy futures contracts on Treasury bills.
B) sell futures contracts on Treasury bills.
C) buy Treasury bonds in the spot market.
D) increase now the amount of money which he lends.
30) A speculator who believes strongly that interest rates will fall would be likely to
A) buy futures contracts on Treasury bills.
B) sell futures contracts on Treasury bills.
C) sell Treasury bonds in the spot market.
D) decrease now the amount of money which he lends.
31) All of the following are roles of a exchange EXCEPT
A) instituting margin requirements on futures contracts.
B) marking to market at the end of each day.
C) eliminate the need for buyers and sellers of futures contracts to be concerned about the
creditworthiness of each other.
D) reducing the default risk involving forward contracts.
32) Clearinghouses help to reduce default risk by
A) being the intermediary in trades for buyers and sellers.
B) margin requirements.
C) marking to market.
D) all of the above.
33) Explain how each of the following might make use of the futures market.
(a) A lender who is worried that its cost of funds might rise during the term of a loan it has made
(b) A speculator who believes strongly that interest rates will rise
34) In what ways do futures contracts differ from forward contracts?
35) Why may some investors prefer forward contracts to futures?
36) Why do futures have lower information costs and higher liquidity than forward contracts?
37) Why must the spot price equal the futures price on the settlement date?
38) Southwest Airlines relies on jet fuel to operate its planes. If it chooses to hedge against future
changes in fuel prices, what positions (long or short) will it take in the spot and futures markets?
39) How do exchanges seek to reduce default risk in the futures market?
7.4 Options
1) An options contract
A) confers the rights to buy or sell an underlying asset at a predetermined price by a
predetermined time.
B) is another name for a futures contract.
C) may be written for debt instruments, but not equities.
D) may be written for equities, but not for debt instruments.
2) One difference between futures and options contracts is
A) funds change hands daily in the case of options but not with futures.
B) funds change hands daily in the case of futures, but not with options.
C) in the case of futures funds only change hands when they are exercised.
D) futures are designed to reduce risk while options are not.
3) In comparing futures contracts with options contracts, we can say that
A) in a futures contract, the buyer and seller have symmetric rights, whereas in an options
contract, the buyer and seller have asymmetric rights.
B) in a futures contract, the buyer and seller have asymmetric rights, whereas in an options
contract,the buyer and seller have symmetric rights.
C) in both futures and options contracts, the buyer and seller have symmetric rights.
D) in both futures and options contracts, the buyer and seller have asymmetric rights.
4) In a call options contract, the
A) seller has the obligation to deliver the instrument at a specified time.
B) buyer has the obligation to receive the instrument at a specified time.
C) seller may choose whether or not to deliver the instrument at a specified time.
D) buyer will choose to exercise his option only if the value of the underlying security falls.
5) In a put options contract, the
A) seller has the obligation to receive the instrument at a specified time.
B) buyer has the obligation to deliver the instrument at a specified time.
C) buyer has the obligation to receive the instrument at a specified time.
D) seller has the obligation to deliver the instrument at a specified time.
6) The price at which an option may be exercised is called the
A) market price.
B) equilibrium price.
C) strike price.
D) fixed price.
7) In an options contract, another name for the strike price is the
A) market price.
B) exercise price.
C) equilibrium price.
D) fixed price.
8) The mathematicians and economists who have been hired by Wall Street firms to build
mathematical models to aid the pricing of derivatives are generally referred to as
A) speculators.
B) hedgers.
C) rocket scientists.
D) market makers.
9) The period over which a call or put option exists is
A) determined by its delivery date.
B) determined by its expiration date.
C) determined by whether the contract is written for a commodity or for a financial instrument.
D) indeterminate; options contracts continue in existence until either the buyer or the seller
desires to discontinue it.
10) The fee charged by the seller of an option is referred to as the
A) market price.
B) option premium.
C) futures fee.
D) call price.
11) The intrinsic value of an option
A) is equal to the option premium.
B) is the amount the option actually is worth if it is immediately exercised.
C) is the amount the option is expected to be worth on its expiration date.
D) is impossible to determine in the absence of information on the future prices of the underlying
asset.
12) As an option nears its expiration date, the size of the premium approaches
A) zero.
B) infinity.
C) its intrinsic value.
D) an amount which varies, depending on prevailing market interest rates on the expiration date.
13) A stock option is said to be “out of the money” if:
A) the strike price equals the exercise price.
B) stock price equals the strike price.
C) strike price exceeds the stock price.
D) stock price exceeds the strike price.
14) Suppose that Acme Widget is currently selling for $100 per share and you own a call option
to buy Acme Widget at $75 per share. The intrinsic value of your option is
A) $25.
B) $75.
C) $100.
D) not possible to determine in the absence of information on values of the share price of Acme
Widget between now and the expiration date of the call.
15) A call option is said to be in the money” if
A) it is written on a Treasury bill or other money-market asset.
B) it has increased in price since it was first written.
C) the price of the underlying asset is currently greater than the strike price.
D) the price of the underlying asset is currently greater than the strike price plus the option
premium.
16) A put option is said to be “in the money” if
A) it is written on a Treasury bill or other money-market asset.
B) it has increased in price since it was first written.
C) the price of the underlying asset is currently less than the strike price.
D) the price of the underlying asset is currently less than the strike price plus the option
premium.
17) Which of the following factors would tend to increase the size of the premium on an options
contract?
A) The option is near its expiration date.
B) The current default-risk-free interest rate is high.
C) The price volatility of the underlying asset is low.
D) The option is far away from its expiration date.
18) A lender who is worried that its cost of funds might rise during the term of a loan it has made
can hedge against this rise without eliminating the chance to profit from a decline in the cost of
funds by
A) buying futures contracts on Treasury bills.
B) selling futures contracts on Treasury bills.
C) buying put options on Treasury bills.
D) buying call options on Treasury bills.
19) The choice between futures and options
A) depends on whether the underlying instrument is a debt instrument or an equity.
B) reflects a trade-off between the higher cost of using options and the extra insurance benefits
that options provide.
C) reflects a trade-off between the higher cost of using futures and the extra insurance benefits
that futures provide.
D) reflects a trade-off between the greater risk from using options and the extra insurance
benefits that options provide.
20) An option buyer
A) has a greater insurance benefit than the purchaser of a futures contract.
B) bears the risk of unfavorable price movements.
C) is purchasing a naked option if he or she does not also own the underlying asset.
D) generally will incur a lower cost than will the purchaser of a futures contract.
21) Which of the following statements is NOT true of the VIX?
A) it is calculated based on prices of call and put options of the S&P 500.
B) investors who want to hedge against stock market volatility can sell VIX options.
C) a VIX of 10 indicates investors expect the S&P 500 to fluctuate by 10% at an annual rate over
the next 30 days.
D) the VIX is a measure of fear in the stock market.
22) Compare the rights and obligations of buyers and sellers of futures contracts with the rights
of buyers and sellers of options contracts.
23) Suppose you purchase a call option to buy IBM common stock at $35 per share in
September. The current price of IBM is 37 and the option premium is 4. What is the intrinsic
value of the option? As the expiration date on the option approaches, what will happen to the size
of the option premium?
24) What are the steps involved in using options for a short sale of a stock?
25) What does it mean to “cover a short”?
26) Suppose you purchase a call option with a strike price of $85 for an options price of $10
How much profit will you earn if you exercise it when the price is $100?
7.5 Swaps
1) A swap is
A) another name for a put option.
B) another name for a call option.
C) an agreement between two or more persons to exchange sets of cash flows over some future
period.
D) the name for the replacement of a futures contract by an options contract.
2) One benefit of a swap compared to futures and options is that they
A) promote liquidity.
B) reduce the risk for both the buyer and seller.
C) can be better tailored to meet the needs of market participants.
D) can involve financial instruments and not just commodities.
3) Swaps differ from futures and options in all of the following ways EXCEPT:
A) intended to reduce the risk faced by participants.
B) more flexibility.
C) more privacy.
D) less regulation.
4) A shortcoming of swaps that has led to the participation of large firms and financial
institutions is
A) the lack of privacy.
B) need to assess creditworthiness.
C) desire for more flexibility.
D) limited size of the market.
5) An interest rate swap involving the exchange of floating-rate obligations for fixed-rate
obligations is known as
A) swaption.
B) swap option.
C) forward swaps.
D) plain vanilla.
6) An advantage of a swap over futures and options is that
A) they can be written for long periods.
B) they are more liquid.
C) they carry less default risk.
D) there is no need to assess the creditworthiness of participants.
7) A key reason that firms and financial institutions might participate in an interest rate swap is
A) to transfer interest rate risk to parties that are more willing to bear it.
B) the low information costs of swaps compared with other derivative contracts.
C) the greater liquidity of swaps compared with other derivative contracts.
D) the favorable tax implications of swaps compared with other derivative contracts.
8) All of the following are steps involved in basic currency swaps EXCEPT
A) counterparties exchange the net interest at the end of the swap.
B) the parties exchange principals in two currencies.
C) the parties exchange periodic interest payments over the life of the agreement.
D) the parties exchange the principal amount at the end of the agreement.
9) Which best describes a credit default swap?
A) It is designed to reduce interest-rate risk.
B) The issuer receives payments from the buyer in return for agreeing to make payments to the
buyer if the security goes into default.
C) Issuers are taking out insurance in case of default.
D) It represents a way for the issuer to establish its creditworthiness.
10) All of the following describe the market for credit default swaps on mortgage-backed
securities in the mid 2000s EXCEPT
A) an increasing number of buyers were speculators.
B) AIG apparently underestimated the risk involved with mortgage-backed securities.
C) the volume of credit default swaps was too low making it difficult to assess their value.
D) payments by buyers were too low relative to risk.
11) AIG almost went bankrupt in 2008 because
A) the value of the securities underlying its credit default swaps declined significantly.
B) it lacked the collateral required by buyers of its credit default swaps.
C) prices of securities underlying their credit default swaps were hard to determine since they
were no longer actively traded.
D) all of the above.
12) All of the following are problems cited by Warren Buffet as problems with derivatives not
traded on exchanges EXCEPT
A) they are thinly traded which makes it difficult to determine their value.
B) firms do not set aside reserves against potential losses.
C) they involve substantial counterparty risk.
D) they were not flexible enough due to lack of standardization.