Question 1

Open interest refers to the dollar amount of outstanding option contracts.

Accepted Answer

A) True 
 B)False

Question 2

Using the proceeds from the simultaneous sale of a floor to finance the purchase of a cap is to open a position called a

Accepted Answer

A) open interest. 
B) pull-to-par. 
C) cap. 
D) floor. 
E) collar. 
A) open interest. 
B) pull-to-par. 
C) cap. 
D) floor. 
E) collar.

Question 3

In April 2012, an FI bought a one-month sterling T-bill paying £100 million in May 2012. The FI's liabilities are in dollars, and current exchange rate is $1.6401/£1. The bank can buy one-month options on sterling at an exercise price of $1.60/£1. Each contract has a size of £31,250, and the contracts currently have a premium of $0.014 per £. Alternatively, options on foreign currency futures contracts, which have a size of £62,500, are available for $0.0106 per £. How many options should the FI purchase, and what will be the cost?

Accepted Answer

A) 1,600 contracts for $16.96. 
B) 1,600 contracts for $1,060,000. 
C) 3,200 contracts for $44.80. 
D) 3,200 contracts for $1,400,000. 
E) 3,200 contracts for $2,800,000. 
A) 1,600 contracts for $16.96. 
B) 1,600 contracts for $1,060,000. 
C) 3,200 contracts for $44.80. 
D) 3,200 contracts for $1,400,000. 
E) 3,200 contracts for $2,800,000.

Question 4

Rising interest rates will cause the market value of

Accepted Answer

A) call options on bonds to increase. 
B) put options on bonds to decrease. 
C) call options on bonds to decrease. 
D) bond futures to increase. 
E) call options on bonds to increase, and put options on bonds to decrease. 
A) call options on bonds to increase. 
B) put options on bonds to decrease. 
C) call options on bonds to decrease. 
D) bond futures to increase. 
E) call options on bonds to increase, and put options on bonds to decrease.

Question 5

The loss to a buyer of bond put options is limited to the premium paid.

Accepted Answer

A) True 
 B)False

Question 6

An FI buys a collar by buying a floor and selling a cap.

Accepted Answer

A) True 
 B)False

Question 7

The writer 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

Credit spread call options are useful because

Accepted Answer

A) its value increases as the risk premium on a specified benchmark bond of the borrower increases above some exercise spread. 
B) an increase in the value of the call option will tend to offset the decreasing value of an FI's loan and net worth as the credit quality of the borrower decreases. 
C) they will always cause a loss at least equal to the required premium on the option. 
D) All of these. 
E) its value increases as the risk premium on a specified benchmark bond of the borrower increases above some exercise spread, and an increase in the value of the call option will tend to offset the decreasing value of an FI's loan and net worth as the credit quality of the borrower decreases. 
A) its value increases as the risk premium on a specified benchmark bond of the borrower increases above some exercise spread. 
B) an increase in the value of the call option will tend to offset the decreasing value of an FI's loan and net worth as the credit quality of the borrower decreases. 
C) they will always cause a loss at least equal to the required premium on the option. 
D) All of these. 
E) its value increases as the risk premium on a specified benchmark bond of the borrower increases above some exercise spread, and an increase in the value of the call option will tend to offset the decreasing value of an FI's loan and net worth as the credit quality of the borrower decreases.

Question 9

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:   Instead of a cap, if the bank had purchased a 3-year 6 percent floor and interest rates are 5 percent and 6 percent in years 2 and 3, respectively, what are the payoffs to the bank?

Accepted Answer

A) The bank will receive $50,000 at the end of year 2 and receive $50,000 at the end of year 3. 
B) The bank will receive $50,000 at the end of year 2 and pay $50,000 at the end of year 3. 
C) The bank will receive $0 at the end of year 2 and pay $50,000 at the end of year 3. 
D) The bank will receive $0 at the end of year 2 and receive $50,000 at the end of year 3. 
E) The bank will receive $50,000 at the end of year 2 and pay $0 at the end of year 3. 
A) The bank will receive $50,000 at the end of year 2 and receive $50,000 at the end of year 3. 
B) The bank will receive $50,000 at the end of year 2 and pay $50,000 at the end of year 3. 
C) The bank will receive $0 at the end of year 2 and pay $50,000 at the end of year 3. 
D) The bank will receive $0 at the end of year 2 and receive $50,000 at the end of year 3. 
E) The bank will receive $50,000 at the end of year 2 and pay $0 at the end of year 3.

Question 10

The tendency of the variance of a bond's price to decrease as maturity approaches is called

Accepted Answer

A) open interest. 
B) pull-to-par. 
C) digital default option. 
D) futures option. 
E) credit spread call option. 
A) open interest. 
B) pull-to-par. 
C) digital default option. 
D) futures option. 
E) credit spread call option.

Question 11

An option that does NOT identifiably hedge an underlying asset 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 12

Hedging the FI's interest rate risk by buying a put option on a bond is an attractive alternative to a manager.

Accepted Answer

A) True 
 B)False

Question 13

An FI concerned that the risk on a loan will increase can

Accepted Answer

A) purchase a credit spread call option 
B) sell a credit spread call option 
C) sell a credit spread put option. 
D) purchase a naked option. 
E) sell a naked option. 
A) purchase a credit spread call option 
B) sell a credit spread call option 
C) sell a credit spread put option. 
D) purchase a naked option. 
E) sell a naked option.

Open interest refers to the dollar amount of outstanding option contracts.

Using the proceeds from the simultaneous sale of a floor to finance the purchase of a cap is to open a position called a

Rising interest rates will cause the market value of

The loss to a buyer of bond put options is limited to the premium paid.

An FI buys a collar by buying a floor and selling a cap.

The writer of a bond put option

Credit spread call options are useful because

The tendency of the variance of a bond's price to decrease as maturity approaches is called

An option that does NOT identifiably hedge an underlying asset is a

Hedging the FI's interest rate risk by buying a put option on a bond is an attractive alternative to a manager.

An FI concerned that the risk on a loan will increase can

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

Open interest refers to the dollar amount of outstanding option contracts.

Using the proceeds from the simultaneous sale of a floor to finance the purchase of a cap is to open a position called a

Rising interest rates will cause the market value of

The loss to a buyer of bond put options is limited to the premium paid.

An FI buys a collar by buying a floor and selling a cap.

The writer of a bond put option

Credit spread call options are useful because

The tendency of the variance of a bond's price to decrease as maturity approaches is called

An option that does NOT identifiably hedge an underlying asset is a

Hedging the FI's interest rate risk by buying a put option on a bond is an attractive alternative to a manager.

An FI concerned that the risk on a loan will increase can

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