Exam 23: Options, Caps, Floors, and Collars

A naked option is an option written that has no identifiable underlying asset or liability position.

The purchaser of an option must pay the writer a

Regulators tend to discourage, and even prohibit in some cases, FIs from writing options because the upside potential is unlimited and the downside losses are potentially limited.

The premium on a credit spread call option is the maximum loss attainable to the buyer of the option in situations where the credit spread increases.

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. 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?

The payoff values on bond options are positively linked to the changes in interest rates.

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

Which of the following observations is NOT true?

Simultaneously buying a bond and a put option on a bond produces the same payoff as buying a call option on a bond.

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

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

The purchase often of a series of put options with multiple exercise dates results in a

Buying a cap is like buying insurance against a decrease in interest rates.

An option's delta has a value between 0 and 100.

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

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. Market interest rates are expected to increase 1 percent to 11 percent in the next year. If this occurs, what will be the effect on the market value of equity of Allright?

A contract that results in the delivery of a futures contract when exercised is a

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

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 6 percent cap if the current (spot) rates are also 6 percent? The face value is $5,000,000, and time periods are zero, one, and two.

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.