Question 1

What is the advantage of a futures hedge over an options hedge?

Accepted Answer

A) The futures hedge has lower credit risk exposure. 
B) The futures hedge reduces volatility in profit gains on both sides. 
C) The futures hedge is marked to market less frequently. 
D) The futures hedge offers the least downside risk protection. 
E) The futures hedge completely offsets losses but only partly offsets gains. 
A) The futures hedge has lower credit risk exposure. 
B) The futures hedge reduces volatility in profit gains on both sides. 
C) The futures hedge is marked to market less frequently. 
D) The futures hedge offers the least downside risk protection. 
E) The futures hedge completely offsets losses but only partly offsets gains. B

Question 2

A hedge with a futures contract reduces volatility in payoff gains on both the upside and downside of interest rate movements.

Accepted Answer

A) True 
 B)False  True

Question 3

When interest rates rise, writing a bond call option may cause profits to offset the loss on an FI's bonds.

Accepted Answer

A) True 
 B)False  False

Question 4

A hedge using a put option contract completely offsets gains but only but only partially offsets losses on an FIs balance sheet.

Accepted Answer

A) True 
 B)False

Question 5

Which of the following shows the change in the value of a put option for each $1 change in the underlying bond?

Accepted Answer

A) Open interest. 
B) Volatility. 
C) Delta. 
D) Basis. 
E) Sigma. 
A) Open interest. 
B) Volatility. 
C) Delta. 
D) Basis. 
E) Sigma.

Question 6

An FI manager purchases a zero-coupon bond that has two years to maturity. The manager paid $826.45 per $1,000 for the bond. The current yield on a one-year bond of equal risk is 9 percent, and the one-year rate in one year is expected to be either 11.60 percent or 10.40 percent. Either rate is equally probable. What is the yield to maturity for the two-year bond if held to maturity?

Accepted Answer

A) 11.00 percent. 
B) 10.00 percent. 
C) 13.54 percent. 
D) 11.60 percent. 
E) 10.40 percent. 
A) 11.00 percent. 
B) 10.00 percent. 
C) 13.54 percent. 
D) 11.60 percent. 
E) 10.40 percent.

Question 7

The buyer of a bond put 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 8

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

Accepted Answer

A) True 
 B)False

Question 9

What is the advantage of an options hedge over a futures hedge?

Accepted Answer

A) The options hedge has lower credit risk exposure. 
B) The options hedge has lower transaction costs. 
C) The options hedge is marked to market less frequently. 
D) The options hedge offers the most downside risk protection. 
E) The options hedge offers the most upside gain potential. 
A) The options hedge has lower credit risk exposure. 
B) The options hedge has lower transaction costs. 
C) The options hedge is marked to market less frequently. 
D) The options hedge offers the most downside risk protection. 
E) The options hedge offers the most upside gain potential.

Question 10

The buyer of a bond call option stands to make a positive payoff if changes in market interest rates cause the bond price to rise above the exercise price.

Accepted Answer

A) True 
 B)False

Question 11

An FI manager purchases a zero-coupon bond that has two years to maturity. The manager paid $76.95 per $100 for the bond. The current yield on a one-year bond of equal risk is 12 percent, and the one-year rate in one year is expected to be either 16.65 percent or 15.35 percent. Either rate is equally probable. Given the expected one-year rates in one year, what are the possible bond prices in one year?

Accepted Answer

A) $85.22 and $86.25. 
B) $85.73 and $86.69. 
C) $85.22 and $86.69. 
D) $85.73 and $86.25. 
E) $83.35 and $84.65. 
A) $85.22 and $86.25. 
B) $85.73 and $86.69. 
C) $85.22 and $86.69. 
D) $85.73 and $86.25. 
E) $83.35 and $84.65.

Question 12

The losses on a purchased put option position when rates fall are limited to the option premium paid.

Accepted Answer

A) True 
 B)False

Question 13

An FI manager purchases a zero-coupon bond that has two years to maturity. The manager paid $76.95 per $100 for the bond. The current yield on a one-year bond of equal risk is 12 percent, and the one-year rate in one year is expected to be either 16.65 percent or 15.35 percent. Either rate is equally probable. If the manager buys a one-year option with an exercise price equal to the expected price of the bond in one year, what will be the exercise price of the option?

Accepted Answer

A) $84.00. 
B) $85.99. 
C) $86.21. 
D) $85.74. 
E) $85.96. 
A) $84.00. 
B) $85.99. 
C) $86.21. 
D) $85.74. 
E) $85.96.

Question 14

Giving the purchaser the right to buy 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 15

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

Accepted Answer

A) True 
 B)False

Question 16

An FI manager purchases a zero-coupon bond that has two years to maturity. The manager paid $826.45 per $1,000 for the bond. The current yield on a one-year bond of equal risk is 9 percent, and the one-year rate in one year is expected to be either 11.60 percent or 10.40 percent. Either rate is equally probable. Given the exercise price of the option, what premium should be paid for this option?

Accepted Answer

A) $2.2339 per $1,000 of bond option purchased. 
B) $4.0275 per $1,000 of bond option purchased. 
C) $2.2752 per $1,000 of bond option purchased. 
D) $2.2156 per $1,000 of bond option purchased. 
E) $3.8211 per $1,000 of bond option purchased. 
A) $2.2339 per $1,000 of bond option purchased. 
B) $4.0275 per $1,000 of bond option purchased. 
C) $2.2752 per $1,000 of bond option purchased. 
D) $2.2156 per $1,000 of bond option purchased. 
E) $3.8211 per $1,000 of bond option purchased.

Question 17

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?

Accepted Answer

A) puts; 447 contracts. 
B) calls; 625 contracts. 
C) puts; 625 contracts. 
D) calls; 447 contracts. 
E) puts; 206 contracts. 
A) puts; 447 contracts. 
B) calls; 625 contracts. 
C) puts; 625 contracts. 
D) calls; 447 contracts. 
E) puts; 206 contracts.

Question 18

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. The duration of the T-notes, Baa bonds, and GICs is 1.93 years, 6.9 years, and 4.5 years respectively. What is the leverage-adjusted duration gap for Allright?

Accepted Answer

A) 1.99 years. 
B) 5.13 years. 
C) 0.63 years. 
D) 1.91 years. 
E) 1.0 year. 
A) 1.99 years. 
B) 5.13 years. 
C) 0.63 years. 
D) 1.91 years. 
E) 1.0 year.

Question 19

The Black-Scholes model does not work well to value bond options because of violations of the underlying assumption of a constant variance of returns on the underlying asset.

Accepted Answer

A) True 
 B)False

Question 20

The trading process of options is the same as that of futures contracts.

Accepted Answer

A) True 
 B)False

What is the advantage of a futures hedge over an options hedge?

A hedge with a futures contract reduces volatility in payoff gains on both the upside and downside of interest rate movements.

When interest rates rise, writing a bond call option may cause profits to offset the loss on an FI's bonds.

A hedge using a put option contract completely offsets gains but only but only partially offsets losses on an FIs balance sheet.

Which of the following shows the change in the value of a put option for each $1 change in the underlying bond?

The buyer of a bond put option

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

What is the advantage of an options hedge over a futures hedge?

The buyer of a bond call option stands to make a positive payoff if changes in market interest rates cause the bond price to rise above the exercise price.

The losses on a purchased put option position when rates fall are limited to the option premium paid.

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

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

The Black-Scholes model does not work well to value bond options because of violations of the underlying assumption of a constant variance of returns on the underlying asset.

The trading process of options is the same as that of futures contracts.

Why Are Financial Institutions Special

Deposit-Taking Institutions

Finance Companies

Securities, Brokerage, and Investment Banking

Mutual Funds, Hedge Funds, and Pension Funds

Insurance Companies

Risks of Financial Institutions

Interest Rate Risk I

Interest Rate Risk II

Credit Risk: Individual Loans

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

Liability and Liquidity Management

Deposit Insurance and Other Liability Guarantees

Capital Adequacy

Product and Geographic Expansion

Futures and Forwards

Swaps

Loan Sales

Securitization Index

Filters

Exam 23: Options, Caps, Floors, and Collars

What is the advantage of a futures hedge over an options hedge?

A hedge with a futures contract reduces volatility in payoff gains on both the upside and downside of interest rate movements.

When interest rates rise, writing a bond call option may cause profits to offset the loss on an FI's bonds.

A hedge using a put option contract completely offsets gains but only but only partially offsets losses on an FIs balance sheet.

Which of the following shows the change in the value of a put option for each $1 change in the underlying bond?

The buyer of a bond put option

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

What is the advantage of an options hedge over a futures hedge?

The buyer of a bond call option stands to make a positive payoff if changes in market interest rates cause the bond price to rise above the exercise price.

The losses on a purchased put option position when rates fall are limited to the option premium paid.

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

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

The Black-Scholes model does not work well to value bond options because of violations of the underlying assumption of a constant variance of returns on the underlying asset.

The trading process of options is the same as that of futures contracts.

Why Are Financial Institutions Special

Deposit-Taking Institutions

Finance Companies

Securities, Brokerage, and Investment Banking

Mutual Funds, Hedge Funds, and Pension Funds

Insurance Companies

Risks of Financial Institutions

Interest Rate Risk I

Interest Rate Risk II

Credit Risk: Individual Loans

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

Liability and Liquidity Management

Deposit Insurance and Other Liability Guarantees

Capital Adequacy

Product and Geographic Expansion

Futures and Forwards

Swaps

Loan Sales

Securitization Index

Filters