Exam 23: Options, Caps, Floors, and Collars

Exercise of a put option on futures by the buyer of the option will occur if interest rates have increased.

Most bond options trade on the over the counter markets as opposed to organized exchanges such as the Chicago Board Options Exchange.

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

Contrast the marking to market characteristics of options versus futures contracts.

For put options, the delta has a negative sign

Futures options on bonds have interest rate futures contracts as the underlying asset.

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

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. TREASURY BILLS (IMM)- \1 million; 91-day ( \2 5.28 ea.) Strike Price Calls-Settle Puts-Settle 96.00 28 basis points 63 basis points 96.25 19 basis points 78 basis points 96.50 12 basis points 96 basis points 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?

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 net price of a $5,000,000 collar if the bank purchases a three-year 6 percent cap and sells a 5 percent floor, if the current (spot) rates are 6 percent?

As interest rates increase, the buyer of a bond put option stands to

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

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?

A contract whose payoff increases as a yield spread increases above some stated exercise spread is a

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