Chapter 09
Derivatives: Futures, Options, and Swaps
Multiple-Choice Questions
1. Derivatives are financial instruments that:
a. present high levels of risk and should only be used by the wealthy.
b. when used correctly can actually lower risk.
c. should only be used by people seeking high returns from low risk.
d. represent the outright purchase of a bond.
2. The value of a derivative is determined by:
a. the Federal Reserve.
b. SEC regulation.
c. the value of the underlying asset.
d. the risk-free rate.
3. In a derivative transaction:
a. the dollar amount of the transaction increases as the contract date approaches.
b. the risk is less than if actually purchasing the underlying asset.
c. what one person gains is what the other person loses.
d. there is always a futures contract.
4. The purpose of derivatives is to:
a. increase the risk so the return is larger.
b. eliminate risk for both parties in the transaction.
c. postpone the risk for both parties in the transaction.
d. transfer the risk from one person to another.
5. Forward contracts are:
a. an agreement between more than two parties.
b. contracts usually involving the exchange of a commodity or financial instrument.
c. always standardized.
d. easily resold.
6. The short position in a futures contract is the party that will:
a. deliver a commodity or financial instrument to the buyer at a future date.
b. suffer the loss.
c. accept the risk.
d. benefit from increases in price of the underlying asset.
7. The long position in a futures contract is the party that will:
a. benefit from decreases in the price of the underlying asset.
b. agree to make delivery of a commodity or financial instrument at a future date.
c. benefit from increases in the price of the underlying asset.
d. accept the greater share of the risk.
8. With a futures contract:
a. payment is made when the contract is created.
b. no payment is made until the settlement date.
c. the short position agrees to purchase the underlying asset.
d. the risk is eliminated for both parties.
9. The key difference between a forward and a futures contract is:
a. a forward contract is customized where a futures contract is not.
b. a forward contract is bought and sold on organized exchanges.
c. only the forward contracts have settlement dates.
d. the amount of time involved.
10. The clearing corporation’s main role in the futures market is to:
a. set the market price of the contract.
b. act as the counterparty to both sides of the transaction, thereby guaranteeing payment. c.
provide the underlying assets so the contracts can be created.
d. all of the above.
11. The process of marking to market:
a. is done by the clearing corporation to reduce risk in futures contracts.
b. involves the margin accounts of only the buyers of future contracts.
c. involves the margin accounts of only the sellers of future contracts.
d. usually requires margin accounts to be adjusted weekly by the clearing corporation.
12. Marking to market is a process that:
a. involves a transfer of risk.
b. ensures that the buyers and sellers receive what the contract promises.
c. always requires the sellers of contracts to transfer funds to the buyers of contracts.
d. buyers and sellers can request for an additional fee when the contract is created.
13. There is a futures contract for the purchase of 100 bushels of wheat at $2.50 per bushel. At
the end of the day when the market price of wheat increases to $3.00 per bushel:
a. the buyer (long position) needs to transfer $50 to the seller (short position).
b. the seller (short position) needs to transfer $50 to the buyer (long position).
c. nothing happens since with a futures contract all payments are made at the settlement
date
.
d. nothing happens since marked to market adjustments only take place when the market price
falls below the contract price.
14. There is a futures contract for the purchase of 1,000 bushels of corn at $3.00 per bushel.
At the end of the day when the market price of corn falls to $2.50:
a. the buyer (long position) needs to transfer $500 to the seller (short position).
b. the seller (long position) needs to transfer $500 to the buyer (short position).
c. nothing happens since marked to market adjustments only occur if the market price rises
above the contract price.
d. nothing happened since no funds are transferred until the settlement date.
15. A U.S. Treasury bond dealer with a large portfolio who sells a futures contract for U.S.
Treasury bonds is:
a. taking on additional risk in hopes of getting a larger return.
b. ensuring the sales price of the bond through hedging.
c. not likely to find a buyer for this transaction.
d. should see the value of the futures contract increase as bond prices rise.
16. A pension fund manager who plans on purchasing bonds in the future:
a. wants to insure against the price of bonds falling.
b. can offset the risk of bond prices rising by selling a futures contract.
c. will take the long position in a futures contract.
d. will take the short position in a futures contract.
17. A baker of bread has a long-term fixed-price contract to supply bread. Which of the
following would NOT reduce her risk?
a. Taking the long position in wheat futures contract
b. Hedging this risk in the wheat futures market
c. Finding a wheat farmer who will take the short position in a wheat futures contract
d. Finding a wheat farmer who will take the long position in a wheat futures contract
18. A wheat farmer who must purchase his inputs now but will sell his wheat at a market price
at a future date:
a. faces a market risk that cannot be offset.
b. is a good example of what the chapter refers to as a speculator.
c. would hedge by taking the short position in a wheat futures contract.
d. would hedge by taking the long position in a wheat futures contract.
19. Users of commodities are:
a. usually not participants in futures contracts.
b. speculators preferring to get the large returns which result from large risk.
c. likely to take the short position in a futures contract.
d. buyers of futures.
20. Speculators differ from hedgers in the sense that:
a. speculators do not like
ri
sk.
b. hedgers seek to transfer risk.
c. speculators seek to transfer risk.
d. speculators are hedgers, there isn’t any difference.
21. One argument why farmers in poor countries remain poor is:
a. they know very little about farming techniques needed for the crop they are growing.
b. they are poor assessors of the risks they face.
c. risk taking is a deterrent to growth.
d. poor farmers in many countries lack access to commodity futures markets.
22. Futures markets and derivatives contribute to economic growth by:
a. decreasing speculation.
b. increasing the risk-taking capacity of the economy.
c. deterring the transfer of risk.
d. forcing people to accept the risk their decisions create.
8
23. On the settlement date of a futures contract:
a. the future’s price is always above the price of the underlying asset.
b. the future’s price is always below the price of the underlying asset.
c. the future’s price is equal to the price of the underlying asset.
d. the future’s price may be above or below the price of the underlying asset but not equal to it.
24. As the time of settlement gets closer:
a. the price of the futures contract will diverge from the price of the underlying asset.
b. the price of the futures contract will always be above the price of the underlying asset.
c. the price of the underlying asset and the future’s price will show no correlation at all.
d. the price of the futures contract will move in lockstep with the price of the underlying asset.
25. Tom buys a futures contract for U.S. Treasury bonds and on the settlement date the interest
rate on U.S. Treasury bonds is lower than Tom expected. Tom will have:
a. lost money on his long position.
b. gained money on his long position.
c. lost money on his short position.
d. gained money on his short position.
26. Sue sells a futures contract for U.S. Treasury bonds and on the settlement date the interest
rate on U.S. Treasury bonds is lower than Sue expected. Sue will have:
a. lost money on her short position.
b. gained money on her long position.
c. gained money on her short position.
d. lost money on her long position.
27. Tom buys a futures contract for U.S. Treasury bonds and on the settlement date the interest
rate on U.S. Treasury bonds is higher than Tom expected. Tom will have:
a. gained money on his short position.
b. lost money on his long position.
c. gained money on his long position.
d. lost money on his short position.
28. Sue buys a futures contract for U.S. Treasury bonds and on the settlement date the interest
rate on U.S. Treasury bonds is higher than Sue expected. Sue will have:
a. gained money on her short position.
b. gained money on her long position.
c. lost money on her long position.
d. lost money on her short position.
29. If market participants believe next year’s corn crop is likely to be unusually large:
a. the current spot market price of corn is likely to be below the futures price of corn.
b. the current spot market price of corn is likely to be above the futures price of corn.
c. it would be impossible to find someone to take the short position in a futures contract.
d. it will be impossible to find someone to take the long position in a futures contract.
30. An arbitrageur is someone who:
a. always takes the long position in a futures contract.
b. always takes the short position in a futures contract.
c. seeks the high returns that come from the high risk inherent in futures markets.
d. simultaneously buys and sells financial instruments to benefit from temporary price
differences.
31. If a futures contract for U.S. Treasury bonds increases by “12” in the financial page
listings, the value of the contract increased by:
a. $120.00.
b. $1,200.00.
c. $375.00.
d. $240.00.
32. If a futures contract for U.S. Treasury bonds decreases by “17” in the financial page
listings, the price of the contract decreased by:
a. $531.25.
b. $170.00.
c. $340.00.
d. $1700.00.
33. A price of a futures contract for U.S. Treasury bonds listed as “111-15” is measured in:
a. 32nds.
b. 12ths.
c. 4ths.
d. dollars; it stands for $111.15 but a dash is used instead of a period.
34. The user of a commodity who is trying to insure against the price of the commodity rising
would:
a. take the short position in a futures contract.
b. take the long position in a futures contract.
c. be better off speculating on price movements and earning higher profits.
d. want to hedge by selling a futures contract.
35. An individual who neither uses nor produces a commodity but sells a futures contract for the
asset is:
a. speculating that the price of the commodity is going to fall.
b. speculating that the price of the commodity is going to increase.
c. hedging trying to transfer risk.
d. using arbitrage to earn profits without taking a risk.
36. An individual who neither uses nor produces a commodity but buys a futures contract for the
asset is:
a. speculating that the price of the commodity is going to fall.
b. speculating that the price of the commodity is going to increase.
c. is using arbitrage to earn profits without taking a risk.
d. is hedging and transferring risk.
37. The option holder is:
a. the seller of an option.
b. another name for the clearinghouse used in futures contracts.
c. the buyer of an option.
d. always a speculator.
38. The option writer
i
s
:
a
. the seller of an option.
b. the buyer of an option.
c. the underlying asset of the option.
d. the individual who obtains the rights.
39. The right to buy a given quantity of an underlying asset at a predetermined price on or
before a specific date is called a(n):
a. put option.
b. option writer.
c. call option.
d. arbitrage contract.
40. A call option is:
a. any option written more than sixty days into the future.
b. an option giving the holder the right to buy a given quantity of an asset at a specific price on or
before a specified date.
c. an option giving the seller the right to sell a given quantity of an asset at a specific price on or
before a specified date.
d. an option where all rights are granted to the seller of the option.
41. The strike price of an option is:
a. the market price at the time the option is written.
b. the market price at the time the option is exercised.
c. the price at which the option holder has the right to buy or sell.
d. always above the market price.
42. With a call option, the option holder:
a. has the right to sell the asset.
b. has the right to buy the asset.
c. can buy or sell, it is their option.
d. can buy the asset but only after the date specified.
43. With a put option, the option holder:
a. has the right to buy the asset.
b. can buy or sell the asset, it is their option.
c. has the right to sell the asset.
d. can buy the asset but only on the date specified.
44. There’s a call option written for 100 shares of GM stock for $85.00 a share, prior to the third
Friday of October 2017: The option writer:
a. has the option but not the requirement of selling 100 shares of GM for $85.00.
b. will sell 100 shares of GM for $85.00 on the third Friday of October 2017.
c. has the option to back out of this contract prior to the third Friday of October 2017.
d. is required to post margin.
45. There’s a call option written for 100 shares of GM stock for $85.00 a share, prior to the third
Friday of October 2017: The option writer:
a. has the requirement to sell 100 shares of GM for $85 a share on or before the third Friday of
October 2017 if the option holder wants to exercise the option.
b. has the option to sell 100 shares of GM for $85 a share on or before the third Friday of
October 2017.
c. can cancel the option before the third Friday of October 2017.
d. does not have to post margin while the option holder does.
46. With a call option that is described as in the money:
a. the market price of the stock is below the strike price.
b. the market price of the stock equals the strike price.
c. the market price of the stock is above the strike price.
d. the option has been exercised.
47. A put option that is described as in the money would find:
a. the market price of the stock above the strike price.
b. the strike price is above the market price of the stock.
c. the market and strike prices are the same.
d. the option has been exercised.
48. A call option described as at the money would find:
a. the market price of the stock is above the strike price.
b. the market price of the stock is below the strike price.
c. the option has been exercised.
d. the market price of the stock equals the strike price.
49. A put option described as out of the money would find:
a. the strike price is below the market price of the stock.
b. the market price of the stock and the strike price are equal.
c. the market price of the stock is below the strike price.
d. the option has expired.
50. A call option described as out of the money would find:
a. the market price of the stock is above the strike price.
b. the option has been exercised.
c. the option has expired.
d. the strike price is above the market price of the stock.
51. The main difference between European and American options is:
a. holders of European options have more options than holders of American options.
b. American option holders have more options than European option holders.
c. European option holders can exercise the option prior to expiration.
d. European options cannot be resold.
52. One key difference between options contracts and futures contracts is:
a. in a futures contract, one part has more rights than the other.
b. with an options contract both parties have equal rights.
c. in an options contract, the rights belong to one party.
d. in a futures contract all rights are held by just one party.
53. Which of the following statements is true?
a. Call options can be sold prior to expiration but put options cannot.
b. Put options can be sold prior to expiration but call options cannot.
c. No option can be sold prior to expiration.
d. Both American and European options can be sold prior to expiration.
54. The seller of a put option is transferring the risk:
a. of a price decrease of the stock to the buyer of the option.
b. of a price increase of the stock to the buyer of the option.
c. this statement is incorrect since options do not transfer risk.
d. this statement is incorrect since only sellers of call options are transferring risk.
55. Someone who purchases a call option is really buying insurance to protect against:
a. the stock not being available when they want to purchase it.
b. the price of the stock falling.
c. a seller not being able to deliver the stock.
d. the price of the stock rising.
56. Comparing an option to a futures contract it would be correct to say:
a. the risk involved in each is equal.
b. a futures contract carries more risk than the option
contract
.
c
. an option contract carries more risk than the futures contract.
d. neither involves risk; they are tools to eliminate risk.
57. An investor who purchases a call option is:
a. highly leveraged for a gain but is limited in losses.
b. limited in his or her gain but is highly leveraged in losses.
c. highly leveraged for both gains and losses.
d. limited in both gains and losses.
58. Options are popular because of all of the following EXCEPT:
a. stock prices are volatile.
b. they offer a tool to transfer risk.
c. they present a tool to limit losses but also limit gains.
d. they offer opportunities for high leverage.
59. The two parts that make up an option’s price are:
a. extrinsic value and the time value of the option.
b. the commission and the time value of the option.
c. the intrinsic value and the time value of the option.
d. the price of the underlying asset and the time value of the option.
60. The intrinsic value of an option:
a. is the amount the investor believes the option will be worth on the expiration date.
b. is the amount the option is worth if it is exercised immediately.
c. is equal to price of the underlying asset.
d. cannot be determined without knowing the future price of the underlying asset.
61. As an option approaches its expiration date, the value of the option approaches:
a. the intrinsic value.
b. the price of the underlying asset.
c. zero.
d. infinity.
62. The time value of the option can best be defined as
a. the commission earned by a broker.
b. the fee earned for the potential benefits from buying the option.
c. the service fee charged by the SEC for regulating the option market.
d. the fee paid for the potential benefits from buying an option (excluding its intrinsic value).
63. Assume we have a stock currently worth $100. We also assume the interest rate is zero, and
we can buy options for this stock with a strike price of $100. If the stock can rise or fall by $20
with equal probability over the option period, and the option cannot be exercised until the
expiration date, what is the time value of the option?
a. $20
b. $0
c. $10
d. $100