Exam 28: Pricing of Futures and Options Contracts

The put-call parity relationship is the relationship between the price of a call option and the price of a put option on the same underlying instrument, with the same strike price and the same expiration date.

Suppose a portfolio consisting of the long position in the asset and the short position in the call option is riskless and will produce a return that equals the risk-free interest rate. A portfolio constructed in this way is called ________.

You lend $200 at 8% per year for three months and proceed to short sell Asset XYZ for $200 in the cash market. You are required to pay $6 to the lender of Asset XYZ (which is the proceeds the lender would have received). You then immediately buy a futures contract at $184 for delivery of asset XYZ in three months (this will cover your short position). What is the net profit or loss from your strategy of lending money, short selling, and buying the futures contract?

All other factors equal, the ________ the expected volatility (as measured by ________) of the price of the underlying asset, the more an investor would be willing to pay for the option, and the more an option writer would demand for it.

For ________ options, as the time remaining until expiration decreases, the option price approaches its intrinsic value.

There are six factors that influence the price of an option: the current price of the underlying asset, the strike price, the time to expiration of the option, the expected price volatility of the underlying asset over the life of the option, the short-term, risk-free interest rate over the life of the option, and the anticipated cash payments on the underlying asset over the life of the option.

The actual futures price will diverge from the theoretical futures price because of interim cash flows, differences between lending and borrowing rates, transaction costs, restrictions on short selling, and uncertainty about the deliverable asset and the date it will be delivered.

________ is an important relationship between the price of a call option and the price of a put option on the same underlying instrument, with the same strike price and the same expiration date.

You borrow $1,000 at 16% per year and proceed to buy Asset XYZ for $1,000 in the cash market. This asset pays $10 quarterly. You then immediately sell a futures contract at $1,025 requiring delivery of asset XYZ in three months. What is the net profit or loss from your strategy of selling the futures contract after borrowing money to buy the asset ?

If the strike price for a call option is $10 and the current asset price is $9, the intrinsic value is ________.

The strategy that can be used to capture the arbitrage profit for an overpriced futures contract is the reverse cash and carry trade; the strategy that can be used to capture the arbitrage profit for an underpriced futures contract is the cash and carry trade.

You lend $1,000 at 10% per year for three months and proceed to short sell Asset XYZ for $1,000 in the cash market. You are required to pay $75 to the lender of Asset XYZ (which is the proceeds the lender would have received). You then immediately buy a futures contract at $950 for delivery of asset XYZ in three months (this will cover your short position). What is the net profit or loss from your strategy of lending money, short selling, and buying the futures contract?

You borrow $5,000 at 8% per year and proceed to buy Asset XYZ for $5,000 in the cash market. This asset pays $100 quarterly. You then immediately sell a futures contract at $5,500 requiring delivery of asset XYZ in three months. Which of the below statements is TRUE?

It can be shown that the put-call parity relationship for options where the underlying asset makes cash distributions and where the time value of money is recognized is: Put option price - Call option price = ________.

At the delivery date, the price of a futures contract diverges from the cash market price.

Consider the "reverse cash and carry trade" where you buy the futures contract, short sell Asset XYZ, and invest or lend at a rate of r until the settlement date. In computing the value "from settlement of the futures contract," which of the below statements is TRUE?

If the strike or exercise price for a put option is $75, and the current asset price is $75, and the market value of the put option is $77. What is the time premium of the put option?

Because of the assumptions required for the binomial model described above, such models may have limited applicability to the pricing of options on ________.

The value of an option is greater than the cost of creating a replicating hedge portfolio.

To determine the value of the hedge ratio, H, what two values must we know? What are these values equal to?