Chapter 14 – An Introduction to Derivative Markets and Securities
1. A cash or spot contract is an agreement for the immediate delivery of an asset, such as the purchase of stock on the
NYSE.
a.
True
b.
False
2. Forward and future contracts, as well as options, are types of derivative securities.
a.
True
b.
False
3. All features of a forward contract are standardized, except for price and number of contracts.
a.
True
b.
False
4. Forward contracts are traded over-the-counter and are generally not standardized.
a.
True
Chapter 14 – An Introduction to Derivative Markets and Securities
b.
False
5. The forward market has low liquidity relative to the futures market.
a.
True
b.
False
6. A futures contract is an agreement between a trader and the clearinghouse of the exchange for delivery of an asset in the
future.
a.
True
b.
False
7. A primary function of futures markets is to allow investors to transfer risk.
a.
True
b.
False
8. The futures market is a dealer market in which all the details of the transactions are negotiated.
a.
True
b.
False
9. Futures contracts are slower to absorb new information than forward contracts.
a.
True
b.
False
10. The initial value of a future contract is the price agreed upon in the contract.
a.
True
b.
False
11. A futures contract eliminates uncertainty about the future spot price that an individual can expect to pay for an asset at
the time of delivery.
a.
True
b.
False
12. Investment costs are generally higher in the derivative markets than in the corresponding cash markets.
a.
True
b.
False
13. An option buyer must exercise the option on or before the expiration date.
a.
True
b.
False
14. The minimum value of an option is zero.
a.
True
b.
False
15. An option to sell an asset is referred to as a call, whereas an option to buy an asset is called a put.
a.
True
b.
False
16. If an investor wants to acquire the right to buy or sell an asset, but not the obligation to do it, the best instrument is an
option rather than a futures contract.
a.
True
b.
False
17. Investors buy call options because they expect the price of the underlying stock to increase before the expiration of the
option.
a.
True
b.
False
18. A call option is in the money if the current market price is above the strike price.
a.
True
b.
False
19. A put option is in the money if the current market price is above the strike price.
a.
True
b.
False
20. The price at which the stock can be acquired or sold is the exercise price.
a.
True
b.
False
21. The minimum amount that must be maintained in an account is called the maintenance margin.
a.
True
b.
False
22. A forward contract gives its holder the option to conduct a transaction involving another security or commodity.
a.
True
b.
False
23. In the forward market, both parties are required to post collateral or margin.
a.
True
b.
False
24. The option premium is the price the call buyer will pay to the option seller if the option is exercised
a.
True
b.
False
25. The payoffs to both the long and short position in the forward contact are symmetric around the contract price.
a.
True
b.
False
26. The payoffs diagrams to both long and short positions in a forward contract are asymmetrical around the contract
price.
a.
True
b.
False
27. Forward contracts are much easier to unwind than futures contracts due to the standardization of the contracts.
a.
True
b.
False
28. Forward contracts do not require an upfront premium.
a.
True
b.
False
29. Which of the following statements is FALSE?
a.
Derivatives help shift risk from risk-adverse investors to risk-takers.
b.
Derivatives assist in forming cash prices.
c.
Derivatives provide additional information to the market.
d.
In many cases, the investment in derivatives (both commissions and required investment) is more than in the
cash market.
e.
Some derivatives trade hypothetical underlying assets.
30. Derivative instruments exist because
a.
b.
c.
d.
e.
31. There are a number of differences between forward and futures contracts. Which of the following statements is
FALSE?
a.
Futures have less liquidity risk than forward contracts.
b.
Futures have less credit risk than forward contracts.
c.
Futures have more default risk than forward contracts.
d.
In futures, the exchange becomes the counterparty to all transactions.
e.
Futures have standardized terms of agreement.
32. Futures differ from forward contracts because
a.
futures have more liquidity risk.
b.
futures have more credit risk.
c.
futures have more maturity risk.
d.
futures do not require collateral.
e.
None of these are correct.
33. The price at which a futures contract is set at the end of the day is the
a.
stock price.
b.
strike price.
c.
maintenance price.
d.
settlement price.
e.
parity price.
34. Which of the following statements is TRUE?
Chapter 14 – An Introduction to Derivative Markets and Securities
a.
The buyer of a futures contract is said to be long futures.
b.
The buyer of a futures contract is said to be long futures.
c.
The seller of a futures contract is said to be long futures.
d.
The buyer of a futures contract is said to be short futures.
e.
The buyer of a futures contract is unwinding a long position.
35. The CBOE brought numerous innovations to the option market. Which of the following is NOT such an innovation?
a.
creation of a central marketplace
b.
creation of a non-liquid secondary option market
c.
introduction of a Clearing Corporation
d.
standardization of all expiration dates
e.
standardization of all exercise prices
36. Which of the following factors is NOTconsidered in the valuation of call and put options?
a.
current stock price
b.
exercise price
c.
market interest rate
d.
volatility of underlying stock price
e.
the option trading market
37. Which of the following statements is a true definition of an in-the-money option?
a.
a call option in which the stock price exceeds the exercise price
b.
a call option in which the exercise price exceeds the stock price
c.
a put option in which the stock price exceeds the exercise price
d.
an index option in which the exercise price exceeds the stock price
e.
a call option in which the call premium exceeds the stock price
38. The value of a call option just prior to expiration is (where V is the underlying asset’s market price and X is the
option’s exercise price)
a.
max [0, V − X].
b.
max [0, X − V].
c.
min [0, V − X].
d.
min [0, X − V].
e.
max [0, V > X].
39. Which of the following is NOT a factor needed to calculate the value of an American call option?
a.
price of the underlying stock
b.
exercise price
c.
price of an equivalent put option
d.
volatility of the underlying stock
e.
interest rate
40. You own a stock that has risen from $10 per share to $32 per share. You wish to delay taking the profit, but you are
troubled about the short-run behavior of the stock market. An effective action on your part would be to
a.
buy a put option on the stock.
b.
write a call option on the stock.
c.
purchase an index option.
d.
purchase an interest rate option.
e.
write a put option on the stock.
41. Intrinsic value represents the value
a.
the seller could extract from the option if they exercised it immediately.
b.
the buyer could extract from the option if they exercised it immediately.
c.
seller pays for the time premium.
d.
buyer pays for time premium.
e.
below zero.
42. The value of a put option at expiration is
a.
max [0, S(T) − X].
b.
max [0, X − S(T)].
c.
min [0, X − S(T)].
d.
X
43. Which of the following does NOT influence the option price?
a.
past stock price
b.
up and down factors u and d
c.
risk free rate
d.
exercise price
e.
current stock price
44. A call option in which the stock price is higher than the exercise price is said to be
a.
at-the-money.
b.
in-the-money.
c.
before-the-money.
d.
out–of-the-money.
e.
above-the-money.
45. The price paid for the option contract is referred to as the
a.
forward price.
b.
exercise price.
c.
striking price.
d.
option premium.
e.
call price.
46. A stock currently sells for $75 per share. A call option on the stock with an exercise price of $70 currently sells for
$5.50. The call option is
a.
at-the-money.
b.
in-the-money.
c.
out–of-the-money.
d.
at breakeven.
e.
above-the-money.
47. A stock currently sells for $150 per share. A call option on the stock with an exercise price of $155 currently sells for
$2.50. The call option is
a.
at-the-money.
b.
in-the-money.
Chapter 14 – An Introduction to Derivative Markets and Securities
c.
out–of-the-money.
d.
at breakeven.
e.
above-the-money.
48. A stock currently sells for $75 per share. A put option on the stock with an exercise price of $70 currently sells for
$0.50. The put option is
a.
at-the-money.
b.
in-the-money.
c.
out–of-the-money.
d.
at breakeven.
e.
above-the-money.
49. A stock currently sells for $15 per share. A put option on the stock with an exercise price of $15 currently sells for
$1.50. The put option is
a.
at-the-money.
b.
in-the-money.
c.
out–of-the-money.
d.
at breakeven.
e.
above-the-money.
50. A stock currently sells for $15 per share. A put option on the stock with an exercise price of $20 currently sells for
$6.50. The put option is
a.
at-the-money.
b.
in-the-money.
c.
out–of-the-money.
d.
at breakeven.
e.
above-the-money.
51. A call option differs from a put option in that
a.
a call option obliges the investor to purchase a given number of shares in a specific common stock at a set
price; a put obliges the investor to sell a certain number of shares in a common stock at a set price.
b.
both give the investor the opportunity to participate in stock market dealings without the risk of actual stock
ownership.
c.
a call option gives the investor the right to purchase a given number of shares of a specified stock at a set
price; a put option gives the investor the right to sell a given number of shares of a stock at a set price.
d.
a put option has risk because leverage is not as great as with a call.
e.
All of these are correct.
52. A buyer of the call option is NOT speculating on the
Chapter 14 – An Introduction to Derivative Markets and Securities
a.
direction of the price movement of the underlying investment.
b.
timing of the price movement of the underlying investment.
c.
leverage that a call option creates with respect to the underlying investment.
d.
volatility of the price movement of the underlying investment.
e.
liquidity of the underlying investment.
53. Which of the following statements is a true definition of an out–of-the-money option?
a.
a call option in which the stock price exceeds the exercise price
b.
a call option in which the exercise price exceeds the stock price
c.
a call option in which the exercise price exceeds the stock price
d.
a put option in which the exercise price exceeds the stock price
e.
a call option in which the call premium exceeds the stock price
54. Futures contracts are similar to forward contracts in that they both
a.
have volatile price movements and strong interest from buyers and sellers.
b.
give the holder the option to make a transaction in the future.
c.
have similar liquidity.
d.
have similar credit risk.
e.
trade on the same exchange.
55. Which of the following statements are TRUE?
a.
Futures contracts have less liquidity risk and credit risk than forward contracts.
b.
Futures contract prices are strongly linked to the prevailing level of the underlying spot index.
c.
Futures contract decrease in price the further forward in time the delivery date is set.
d.
Futures contracts have more liquidity risk and credit risk than forward contracts.
e.
Futures contract prices are weakly linked to the prevailing level of the underlying spot index.
56. An advantage of a forward contract over a futures contract is that
a.
the terms of the contract are flexible.
b.
it is more liquid.
c.
it trades through a centralized market exchange.
d.
it is easier to unwind due to contract homogeneity.
e.
the counterparty is anonymous.
57. A forward contract is similar to an option contract because they both
a.
can provide insurance against the price of the underlying stock.
b.
are paid for up front in the form of premiums.
c.
are paid for at the end of the contract in the form of premiums.