In a floor with semiannual reset dates, the floor rate is 3.5% per annum and the notional
principal is $1 million. Suppose that the LIBOR rate is 3% per annum for a particular
6-month period. What is the approximate payoff at the end of the 6 months?
A. $10,000
B. $5,000
C. $2,500
D. $1,250
A speculator can choose between buying 100 shares of a stock for $40 per share and
buying 1000 European call options on the stock with a strike price of $45 for $4 per
option. For second alternative to give a better outcome at the option maturity, the stock
price must be above
A. $45
B. $46
C. $55
D. $50
What are teaser rates
A. Interest rates that appear lower than they are
B. Interest rates that depend on LIBOR
C. Interest rates on mortgages with a very long amortization period
D. Interest rates that apply only for the first two or three years
Which of the following is a definition of volatility
A. The standard deviation of the return, measured with continuous compounding, in one
year
B. The variance of the return, measured with continuous compounding, in one year
C. The standard deviation of the stock price in one year
D. The variance of the stock price in one year
A trader uses a stop-loss strategy to hedge a short position in a three-month call option
with a strike price of 0.7000 on an exchange rate. The current exchange rate is 0.6950
and value of the option is 0.1. The trader covers the option when the exchange rate
reaches 0.7005 and uncovers (i.e., assumes a naked position) if the exchange rate falls
to 0.6995. Which of the following is NOT true?
A. The exchange rate trading might cost nothing so that the trader gains 0.1 for each
option sold
B. The exchange rate trading might cost considerably more than 0.1 for each option
sold so that the trader loses money
C. The present value of the gain or loss from the exchange rate trading should be about
0.1 on average for each option sold
D. The hedge works reasonably well
A floating-rate borrower wants to use a collar as a hedge. Which of the following is
appropriate?
A. Buy a cap and sell a floor
B. Buy a cap and buy a floor
C. Sell a cap and sell a floor
D. Sell a cap and buy a floor
Which of the following is correct?
A. A calendar spread can be created by buying a call and selling a put when the strike
prices are the same and the times to maturity are different
B. A calendar spread can be created by buying a put and selling a call when the strike
prices are the same and the times to maturity are different
C. A calendar spread can be created by buying a call and selling a call when the strike
prices are different and the times to maturity are different
D. A calendar spread can be created by buying a call and selling a call when the strike
prices are the same and the times to maturity are different
Which of the following describes stressed VaR?
A. It is based on movements in market variables in stressed market conditions
B. It is VaR with a very high confidence level
C. It is VaR multiplied by a factor of 3
D. None of the above
Which of the following is assumed to be lognormal when a bond option is valued?
A. A future bond price
B. A future swap rate
C. A future short-term rate
D. A future bond yield
Prior to the credit crisis that started in 2007 which of the following was the proxy used
by derivatives traders for the risk-free rate
A. The Treasury rate
B. The LIBOR rate
C. The repo rate
D. The overnight indexed swap rate
Which of the following creates a bear spread?
A. Buy a low strike price call and sell a high strike price call
B. Buy a high strike price call and sell a low strike price call
C. Buy a low strike price call and sell a high strike price put
D. Buy a low strike price put and sell a high strike price call
The price of a stock, which pays no dividends, is $30 and the strike price of a one year
European call option on the stock is $25. The risk-free rate is 4% (continuously
compounded). Which of the following is a lower bound for the option such that there
are arbitrage opportunities if the price is below the lower bound and no arbitrage
opportunities if it is above the lower bound?
A. $5.00
B. $5.98
C. $4.98
D. $3.98
The risk-free rate is 5% and the dividend yield on an index is 2%. Which of the
following is the delta with respect to the index for a one-year futures on the index?
A. 0.98
B. 1.05
C. 1.03
D. 1.02
Which of the following is true of a non-recourse mortgage?
A. The house buyer, if unable to make payments, can lose all his or her possessions
B. The house buyer has an American-style put option on the house
C. The house buyer has a European-style put option on the house
D. The lender is less likely to lose money on the mortgage
What is the recommended way of making volatility a function of time in a Cox, Ross,
Rubinstein tree?
A. Make u a function of time
B. Make p a function of time
C. Make u and p a function of time
D. Make the lengths of the time steps unequal
Which of the following is true
A. Both forward and futures contracts are traded on exchanges.
B. Forward contracts are traded on exchanges, but futures contracts are not.
C. Futures contracts are traded on exchanges, but forward contracts are not.
D. Neither futures contracts nor forward contracts are traded on exchanges.
Which of the following describes the way that the parameters in a binomial tree are
chosen?
A. The expected return during each time step is the risk-free rate
B. The standard deviation of the return in each time step is, for small time steps, almost
exactly equal to the volatility per annum times the square root of the length of the time
step in years
C. The tree recombines
D. All of the above
A one-year call option on a stock with a strike price of $30 costs $3; a one-year put
option on the stock with a strike price of $30 costs $4. Suppose that a trader buys two
call options and one put option. The breakeven stock price above which the trader
makes a profit is
A. $35
B. $40
C. $30
D. $36
An employer has promised that it will grant employees three year options in one year’s
time and that the options will be at the money at the time they are granted. What
describes these options?
A. Chooser options
B. Forward start options
C. Compound options
D. Shout options
What is the cash settlement if a put futures option on 50 units of the underlying asset is
exercised?
A. (Current Futures Price – Strike Price) times 50
B. (Strike Price – Current Futures Price) times 50
C. (Most Recent Futures Settlement Price – Strike Price) times 50
D. (Strike Price – Most Recent Futures Settlement Price) times 50
Which of the following cannot be valued by simulating paths through a tree in the way
described in the chapter
A. European options
B. American options
C. Asian options (i.e., options on the average stock price)
D. An option which provides a payoff of $100 if the stock price is greater than the strike
price at maturity
Which of the following is true about a long forward contract
A. The contract becomes more valuable as the price of the asset declines
B. The contract becomes more valuable as the price of the asset rises
C. The contract is worth zero if the price of the asset declines after the contract has been
entered into
D. The contract is worth zero if the price of the asset rises after the contract has been
entered into
Which of the following describes the waterfall typically used for mortgages pre-crisis?
A. A distribution of cash flows to tranches with priority given to tranche with the
highest rating
B. A distribution of cash flows to tranches in proportion to their outstanding principals
C. A distribution of losses to tranches so that tranches bear losses in proportion to their
outstanding principals
D. None of the above
You sell one December futures contracts when the futures price is $1,010 per unit. Each
contract is on 100 units and the initial margin per contract that you provide is $2,000.
The maintenance margin per contract is $1,500. During the next day the futures price
rises to $1,012 per unit. What is the balance of your margin account at the end of the
day?
A. $1,800
B. $3,300
C. $2,200
D. $3,700
An exchange rate is 0.7000 and the six-month domestic and foreign risk-free interest
rates are 5% and 7% (both expressed with continuous compounding). What is the
six-month forward rate?
A. 0.7070
B. 0.7177
C. 0.7249
D. 0.6930