Question 1

Buying a cap is similar to

Accepted Answer

A) writing a call option on interest rates. 
B) buying a call option on interest rates. 
C) buying a put option on interest rates. 
D) buying a floor on interest rates. 
E) buying a collar on interest rates. 
A) writing a call option on interest rates. 
B) buying a call option on interest rates. 
C) buying a put option on interest rates. 
D) buying a floor on interest rates. 
E) buying a collar on interest rates.

Question 2

Exercise of a put option on interest rate futures by the buyer of the option results in the buyer putting to the writer the bond futures contract at an exercise price higher than the currently trading bond future.

Accepted Answer

A) True 
 B)False

Question 3

Giving the purchaser the right to sell the underlying security at a prespecified price is a

Accepted Answer

A) put option. 
B) call option. 
C) naked option. 
D) futures option. 
E) credit spread call option. 
A) put option. 
B) call option. 
C) naked option. 
D) futures option. 
E) credit spread call option.

Question 4

Selling an interest rate call option may hedge an FI when rates rise and bond prices fall.

Accepted Answer

A) True 
 B)False

Question 5

Which of the following holds true for the writer of a bond call option if interest rates decrease?

Accepted Answer

A) Makes profits limited to call premium 
B) Makes losses limited to call premium 
C) Potential to make large losses 
D) Potential to make unlimited profits 
E) Makes losses limited to call premium and potential to make unlimited profits 
A) Makes profits limited to call premium 
B) Makes losses limited to call premium 
C) Potential to make large losses 
D) Potential to make unlimited profits 
E) Makes losses limited to call premium and potential to make unlimited profits

Question 6

The buyer of a bond call option

Accepted Answer

A) receives a premium in return for standing ready to sell the bond at the exercise price. 
B) receives a premium in return for standing ready to buy bonds at the exercise price. 
C) pays a premium and has the right to sell the underlying bond at the agreed exercise price. 
D) pays a premium and has the right to buy the underlying bond at the agreed exercise price 
E) pays a premium and has the obligation to buy the underlying bond at the agreed exercise price 
A) receives a premium in return for standing ready to sell the bond at the exercise price. 
B) receives a premium in return for standing ready to buy bonds at the exercise price. 
C) pays a premium and has the right to sell the underlying bond at the agreed exercise price. 
D) pays a premium and has the right to buy the underlying bond at the agreed exercise price 
E) pays a premium and has the obligation to buy the underlying bond at the agreed exercise price

Question 7

As interest rates increase, the writer of a bond call option stands to make

Accepted Answer

A) limited gains. 
B) limited losses. 
C) unlimited losses. 
D) unlimited gains. 
E) limited gains and limited losses. 
A) limited gains. 
B) limited losses. 
C) unlimited losses. 
D) unlimited gains. 
E) limited gains and limited losses.

Question 8

Unlike futures and forward contracts, the use of options by FIs has deceased in recent years.

Accepted Answer

A) True 
 B)False

Question 9

Options become more valuable as the variability of interest rates increases.

Accepted Answer

A) True 
 B)False

Question 10

Buying a call option on a bond ensures an FI that it will be able to sell the bond at a given point in time for a price at least equal to the exercise price of the option.

Accepted Answer

A) True 
 B)False

Question 11

An investment company has purchased $100 million of 10 percent annual coupon, 6-year Eurobonds.The bonds have a duration of 4.79 years at the current market yields of 10 percent.The company wishes to hedge these bonds with Treasury-bond options that have a delta of 0.7.The duration of the underlying asset is 8.82, and the market value of the underlying asset is $98,000 per $100,000 face value.Finally, the volatility of the interest rates on the underlying bond of the options and the Eurobond is 0.84. Given this information, what type of T-bond option, and how many options should be purchased, to hedge this investment?

Accepted Answer

A) 792 put options. 
B) 792 call options. 
C) 942 put options. 
D) 942 call options. 
E) 554 put options. 
A) 792 put options. 
B) 792 call options. 
C) 942 put options. 
D) 942 call options. 
E) 554 put options.

Question 12

In April 2016, an FI bought a one-month sterling T-bill paying £100 million in May 2016.The FI's liabilities are in dollars, and current exchange rate is $1.6401/£1.The bank can buy one-month options on sterling at an exercise price of $1.60/£1.Each contract has a size of £31,250, and the contracts currently have a premium of $0.014 per £.Alternatively, options on foreign currency futures contracts, which have a size of £62,500, are available for $0.0106 per £. If the exchange rate in one month is $1.55/£1, what action should the FI take in regards to the hedge?

Accepted Answer

A) Call the £100 million proceeds of the T-bill from the option writer for $160 million 
B) Put the £100 million proceeds from the T-bill to the option writer for $160 million. 
C) Put the £100 million proceeds from the T-bill to the option writer for $155 million. 
D) Call the £100 million proceeds of the T-bill from the option writer for $155 million 
E) Allow the option contracts to expire since they are out of the money. 
A) Call the £100 million proceeds of the T-bill from the option writer for $160 million 
B) Put the £100 million proceeds from the T-bill to the option writer for $160 million. 
C) Put the £100 million proceeds from the T-bill to the option writer for $155 million. 
D) Call the £100 million proceeds of the T-bill from the option writer for $155 million 
E) Allow the option contracts to expire since they are out of the money.

Question 13

The total premium cost to an FI of hedging by buying put options is the price of each put option times the number of put options purchased.

Accepted Answer

A) True 
 B)False

Question 14

What reflects the degree to which the rate on the option's underlying asset moves relative to the spot rate on the asset or liability that is being hedged?

Accepted Answer

A) Credit risk. 
B) Basis risk. 
C) Hedge risk. 
D) Volatility. 
E) Open interest. 
A) Credit risk. 
B) Basis risk. 
C) Hedge risk. 
D) Volatility. 
E) Open interest.

Question 15

The buyer of a bond put option stands to make a profit if changes in market interest rates cause the bond price to fall below the exercise price by enough to recoup the option premium paid.

Accepted Answer

A) True 
 B)False

Question 16

The most a call option buyer stands to lose is the amount of the call premium paid for the option.

Accepted Answer

A) True 
 B)False

Question 17

The premium on a credit spread call option is the maximum potential loss to the buyer of the option when the credit spread increases.

Accepted Answer

A) True 
 B)False

Question 18

A hedge of interest rate risk with a put option on futures completely offsets gains but only partly offsets losses.

Accepted Answer

A) True 
 B)False

Question 19

A contract whose payoff increases as a yield spread increases above some stated exercise spread is a

Accepted Answer

A) put option. 
B) call option. 
C) digital default option. 
D) futures option. 
E) credit spread call option. 
A) put option. 
B) call option. 
C) digital default option. 
D) futures option. 
E) credit spread call option.

Question 20

Which of the following observations is NOT true?

Accepted Answer

A) Variance of bond prices is nonconstant over time. 
B) Variance of bond prices rises at first and then falls as the bond approaches maturity. 
C) As the bond approaches maturity, all price paths must lead to 100 percent of the face value of the bond. 
D) As the bond approaches maturity, all price paths must lead to the principal paid by the issuer on maturity. 
E) Variance of a bond's price or return increases as maturity approaches. 
A) Variance of bond prices is nonconstant over time. 
B) Variance of bond prices rises at first and then falls as the bond approaches maturity. 
C) As the bond approaches maturity, all price paths must lead to 100 percent of the face value of the bond. 
D) As the bond approaches maturity, all price paths must lead to the principal paid by the issuer on maturity. 
E) Variance of a bond's price or return increases as maturity approaches.

Exam 24: Options, Caps, Floors, and Collars

Buying a cap is similar to

Exercise of a put option on interest rate futures by the buyer of the option results in the buyer putting to the writer the bond futures contract at an exercise price higher than the currently trading bond future.

Giving the purchaser the right to sell the underlying security at a prespecified price is a

Selling an interest rate call option may hedge an FI when rates rise and bond prices fall.

Which of the following holds true for the writer of a bond call option if interest rates decrease?

The buyer of a bond call option

As interest rates increase, the writer of a bond call option stands to make

Unlike futures and forward contracts, the use of options by FIs has deceased in recent years.

Options become more valuable as the variability of interest rates increases.

Buying a call option on a bond ensures an FI that it will be able to sell the bond at a given point in time for a price at least equal to the exercise price of the option.

The total premium cost to an FI of hedging by buying put options is the price of each put option times the number of put options purchased.

What reflects the degree to which the rate on the option's underlying asset moves relative to the spot rate on the asset or liability that is being hedged?

The buyer of a bond put option stands to make a profit if changes in market interest rates cause the bond price to fall below the exercise price by enough to recoup the option premium paid.

The most a call option buyer stands to lose is the amount of the call premium paid for the option.

The premium on a credit spread call option is the maximum potential loss to the buyer of the option when the credit spread increases.

A hedge of interest rate risk with a put option on futures completely offsets gains but only partly offsets losses.

A contract whose payoff increases as a yield spread increases above some stated exercise spread is a

Which of the following observations is NOT true?

Why Are Financial Institutions Special

Financial Services: Depository Institutions

Financial Services: Finance Companies

Financial Services: Securities Brokerage and Investment Banking

Financial Services: Mutual Funds and Hedge Funds

Financial Services: Insurance

Risks of Financial Institutions

Interest Rate Risk I

Interest Rate Risk II

Credit Risk: Individual Loan Risk

Credit Risk: Loan Portfolio and Concentration Risk

Liquidity Risk

Foreign Exchange Risk

Sovereign Risk

Market Risk

Off-Balance-Sheet Risk

Technology and Other Operational Risks

Fintech Risks

Liability and Liquidity Management

Deposit Insurance and Other Liability Guarantees

Capital Adequacy

Product and Geographic Expansion

Futures and Forwards

Swaps

Loan Sales

Securitization

Filters