Question 1

Options are popular because of all of the following EXCEPT:

Accepted Answer

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. 
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. C

Question 2

What is the process that makes sure the market price of an underlying asset equals the price of a futures contract at the settlement date? Provide an example.

Accepted Answer

The process that makes sure the price of the underlying asset and the price of the futures contract are the same at the settlement date is arbitrage. Arbitrage is the process where an individual earns a profit without incurring any risk. For example, let's say one year before the settlement date the futures price for delivery of a 5 percent 10-year coupon bond is $1,100. Currently the spot market price of the bond is $1,000 and the investor can borrow at 5 percent. An investor could borrow $1,000, purchase the 10-year bond, and sell a bond future for $1,100 promising delivery of the bond in one year. The investor can use the interest payment on the bond to pay the interest on the loan and deliver the bond to the buyer of the futures contract on the delivery date. This transaction is riskless and nets the investor a profit of $100 without putting up any funds.

Question 3

Standardization of derivative contracts:

Accepted Answer

A)  results in increased risk for the parties involved. 
B)  makes them more difficult to understand and therefore leads to increased misuse. 
C)  makes the premiums involved with these contracts increase. 
D)  leads to greater liquidity and lower risk. 
A)  results in increased risk for the parties involved. 
B)  makes them more difficult to understand and therefore leads to increased misuse. 
C)  makes the premiums involved with these contracts increase. 
D)  leads to greater liquidity and lower risk. D

Question 4

One key difference between options contracts and futures contracts is:

Accepted Answer

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. 
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.

Question 5

One key difference between swaps and option contracts is:

Accepted Answer

A)  swaps are derivative agreements and options are not. 
B)  swaps do not involve any risk and options do. 
C)  options transfer risk, swaps create risk. 
D)  options trade on organized exchanges and swaps do not. 
A)  swaps are derivative agreements and options are not. 
B)  swaps do not involve any risk and options do. 
C)  options transfer risk, swaps create risk. 
D)  options trade on organized exchanges and swaps do not.

Question 6

As the volatility of the stock price increases, the time value of the option:

Accepted Answer

A)  decreases. 
B)  is zero. 
C)  increases. 
D)  doesn't change. 
A)  decreases. 
B)  is zero. 
C)  increases. 
D)  doesn't change.

Question 7

The intrinsic value of an option:

Accepted Answer

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. 
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.

Question 8

If a futures contract for U.S. Treasury bonds decreases by "17" in the financial page listings, the price of the contract decreased by:

Accepted Answer

A)  $531.25. 
B)  $170.00. 
C)  $340.00. 
D)  $1700.00. 
A)  $531.25. 
B)  $170.00. 
C)  $340.00. 
D)  $1700.00.

Question 9

The intrinsic value of a call option:

Accepted Answer

A)  is the difference between the option price and the interest rate. 
B)  must be less than or equal to zero. 
C)  is the greater of zero or the difference between the price of the underlying asset and the strike price. 
D)  will be negative if the time value of the option is negative. 
A)  is the difference between the option price and the interest rate. 
B)  must be less than or equal to zero. 
C)  is the greater of zero or the difference between the price of the underlying asset and the strike price. 
D)  will be negative if the time value of the option is negative.

Question 10

We have a futures contract for the purchase of 10,000 bushels of wheat at $3.00 per bushel. If the price of wheat were to increase to $3.50, explain what happens to the parties involved in the contract in terms of marking to market. Be sure to identify who is long and short and specifically how much is transferred.

Accepted Answer

The buyer of the contract, the long posi

Question 11

We have a stock selling for $90.00. There is a put option for this stock with a strike price of $85 and an option price of $1.20:

Accepted Answer

A)  the intrinsic value of this option is $0.00 and the time value of the option is $1.20. 
B)  the intrinsic value of this option is $90.00 and the time value of the option is $1.20. 
C)  the intrinsic value of this option is -$5.00 and the time value of the option is $1.20. 
D)  you cannot determine the intrinsic value or time value of the option since the strike price is less than the underlying asset price. 
A)  the intrinsic value of this option is $0.00 and the time value of the option is $1.20. 
B)  the intrinsic value of this option is $90.00 and the time value of the option is $1.20. 
C)  the intrinsic value of this option is -$5.00 and the time value of the option is $1.20. 
D)  you cannot determine the intrinsic value or time value of the option since the strike price is less than the underlying asset price.

Question 12

Explain the difference between American and European options.

Accepted Answer

American options can be exercised on any

Question 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:

Accepted Answer

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. 
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.

Question 14

The option holder is:

Accepted Answer

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. 
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.

Question 15

Explain how the clearing corporation reduces the risk it faces in the futures market through the use of margin accounts and marking-to-market.

Accepted Answer

The clearing corporation requires each p

Question 16

With a put option, what specifically does the option holder receive for the price paid for the option?

Accepted Answer

The option holder (buyer) receives the r

Question 17

If the option holder is the individual with the options, why is anyone an option writer?

Accepted Answer

Option writers really fall into two cate

Question 18

A wheat farmer who must purchase his inputs now but will sell his wheat at a market price at a future date:

Accepted Answer

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. 
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.

Question 19

Why does the time value of the option tend to vary directly with the time to expiration?

Accepted Answer

Prior to expiration there is always the

Question 20

What would be the value of an option on a stock that sells at a fixed price with a standard deviation of zero? Explain.

Accepted Answer

Absent intrinsic value in the option, a

Exam 9: Derivatives: Futures, Options, and Swaps

Options are popular because of all of the following EXCEPT:

What is the process that makes sure the market price of an underlying asset equals the price of a futures contract at the settlement date? Provide an example.

Standardization of derivative contracts:

One key difference between options contracts and futures contracts is:

One key difference between swaps and option contracts is:

As the volatility of the stock price increases, the time value of the option:

The intrinsic value of an option:

If a futures contract for U.S. Treasury bonds decreases by "17" in the financial page listings, the price of the contract decreased by:

The intrinsic value of a call option:

We have a stock selling for $90.00. There is a put option for this stock with a strike price of $85 and an option price of $1.20:

Explain the difference between American and European options.

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:

The option holder is:

Explain how the clearing corporation reduces the risk it faces in the futures market through the use of margin accounts and marking-to-market.

With a put option, what specifically does the option holder receive for the price paid for the option?

If the option holder is the individual with the options, why is anyone an option writer?

A wheat farmer who must purchase his inputs now but will sell his wheat at a market price at a future date:

Why does the time value of the option tend to vary directly with the time to expiration?

What would be the value of an option on a stock that sells at a fixed price with a standard deviation of zero? Explain.

An Introduction to Money and the Financial System

Money and the Payments System

Financial Instruments, Financial Markets, and Financial Institutions

Future Value, Present Value and Interest Rates

Understanding Risk

Bonds, Bond Prices, and the Determination of Interest Rates

The Risk and Term Structure of Interest Rates

Stocks, Stock Markets and Market Efficiency

Foreign Exchange

The Economics of Financial Intermediation

Depository Institutions: Banks and Bank Management

Financial Industry Structure

Regulating the Financial System

Central Banks in the World Today

The Structure of Central Banks: The Federal Reserve and the European Central Bank

The Central Bank Balance Sheet and the Money Supply Process

Monetary Policy: Stabilizing the Domestic Economy

Exchange Rate Policy and the Central Bank

Money Growth, Money Demand and Modern Monetary Policy

Output, Inflation, and Monetary Policy

Understanding Business Cycle Fluctuations

Modern Monetary Policy and the Challenges Facing Central Bankers

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