Exam 24: Options, Caps, Floors, and Collars

A call option on the loss ratio incurred in writing catastrophe insurance with a capped payout is referred to as a maximum call spread.

A digital default option pays a stated amount in the event that a portion of the loan is not paid.

As interest rates increase, the buyer of a bond put option stands to

The payoffs on bond call options move symmetrically with changes in interest rates.

Assume a binomial pricing model where there is an equal probability of interest rates increasing or decreasing 1 percent per year. What should be the price of a three-year 5 percent floor if the current (spot) rates are also 6 percent? The face value is $5,000,000, and time periods are zero, one, and two.

FIs may increase fee income by serving as a counterparty for other entities wanting to hedge risk on their own balance sheet.

Allright Insurance has total assets of $140 million consisting of $50 million in 2-year, 6 percent Treasury notes and $90 million in 10-year, 7.2 percent fixed-rate Baa bonds.These assets are funded by $100 million 5-year, 5 percent fixed rate GICs and equity. If rates increase 1 percent, what will be the change in value of the option position?

The outstanding number of put or call contracts is called

Buying a put option truncated the downside losses on the bond following interest rate rises to some maximum amount and scales down the upside profits by the cost of bond price risk insurance, leaving some positive upside profit potential.

The payoff of a credit spread call option increases as the yield spread on a specified benchmark bond increases above some exercise spread.

As of 2015, commercial banks had listed for sale option contracts with a notational value of approximately

A bank with total assets of $271 million and equity of $31 million has a leverage adjusted duration gap of +0.21 years.Use the following quotation from the Wall Street Journal to construct an at-the-money futures option hedge of the bank's duration gap position. TREASURY BILLS (IMM)- \1 million; 91-day ( \2 5.28 ea.) Strike Price Calls-Settle Puts-Settle 96.00 28 basis points 63 basis points 96.25 19 basis points 78 basis points 96.50 12 basis points 96 basis points If 91-day Treasury bill rates increase from 3.75 percent to 4.75 percent, what will be the profit/loss per contract on the bank's futures option hedge?

Futures options on bonds have interest rate futures contracts as the underlying asset.

Purchasing a succession of call options on interest rates is called a

The writer of a bond call option

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. Using the above information and your answer to the previous question, will the investment company gain or lose on the option position if interest rates decrease 1 percent to 9 percent?

The Chicago Board Options Exchange (CBOE) was the first exchange devoted solely to the trading of options.

Allright Insurance has total assets of $140 million consisting of $50 million in 2-year, 6 percent Treasury notes and $90 million in 10-year, 7.2 percent fixed-rate Baa bonds.These assets are funded by $100 million 5-year, 5 percent fixed rate GICs and equity. On the advice of its chief financial officer, Allright wants to hedge the balance sheet with T-bond option contracts.The underlying bonds currently have a duration of 8.82 years and a market value of $97,000 per $100,000 face value.Further, the delta of the options is 0.5.What type of contract, and how many contracts should Allright use to hedge this balance sheet?

A bank purchases a 3-year, 6 percent $5 million cap (call options on interest rates), where payments are paid or received at the end of year 2 and 3 as shown below: End of Year: 0 1 2 3 Cash Flow at end of year: - - In addition to purchasing the cap, if the bank also sells a 3-year 6 percent floor and interest rates are 5 percent and 7 percent in years 2 and 3, respectively, what are the payoffs to the bank? Specifically, the bank will

All else equal, the value of an option increases with an increase in the variance of returns in the underlying asset.