Deck 24: Hedging With Financial Derivatives

Question 1

Financial derivatives include ________.

A)stocks
B)bonds
C)forward contracts
D)both A and B

Answer 1

forward contracts

Question 2

A long contract requires that the investor

A)sell securities in the future.
B)buy securities in the future.
C)hedge in the future.
D)close out his position in the future.

Answer 2

buy securities in the future.

Question 3

If you buy a long contract on financial futures, you hope interest rates will ________.

A)rise
B)fall
C)not change
D)fluctuate

Answer 3

fall

Question 4

The agency responsible for regulation of the futures exchanges and trading in financial futures is the

A)Commodity Futures Trading Commission.
B)Securities and Exchange Commission.
C)Federal Trade Commission.
D)Futures Exchange Commission.

Question 5

The elimination of riskless profit opportunities in the futures market is referred to as ________.

A)speculation
B)hedging
C)arbitrage
D)open interest
E)mark to market

Question 6

A contract that requires the investor to sell securities on a future date is called a ________.

A)short contract
B)long contract
C)hedge
D)micro hedge

Question 7

By selling short a futures contract of $100,000 at a price of 115, you are agreeing to deliver ________ face value securities for ________.

A)$100,000; $115,000
B)$115,000; $110,000
C)$100,000; $100,000
D)$115,000; $115,000

Question 8

Financial derivatives include ________.

A)stocks
B)bonds
C)futures
D)none of the above

Question 9

The purpose of the Commodity Futures Trading Commission is to do all of the following except

A)oversee futures trading.
B)see that prices are not manipulated.
C)approve proposed futures contracts.
D)establish minimum prices for futures contracts.

Question 10

The number of contracts outstanding in a particular financial future is the ________.

A)demand coefficient
B)open interest
C)index level
D)outstanding balance

Question 11

Futures contracts are regularly traded on the

A)Chicago Board of Trade.
B)New York Stock Exchange.
C)American Stock Exchange.
D)Chicago Board Options Exchange.

Question 12

If you sell a short contract on financial futures, you hope interest rates will ________.

A)rise
B)fall
C)not change
D)fluctuate

Question 13

By selling short a futures contract of $100,000 at a price of 96, you are agreeing to deliver ________ face value securities for ________.

A)$100,000; $104,167
B)$96,000; $100,000
C)$100,000; $96,000
D)$100,000; $100,000

Question 14

Which is not a problem of forward contracts?

A)a lack of liquidity
B)a lack of flexibility
C)the difficulty of finding a counterparty
D)default risk

Question 15

By buying a long $100,000 futures contract for 115, you agree to pay ________ for ________ face value securities.

A)$100,000; $115,000
B)$115,000; $100,000
C)$86,956; $100,000
D)$86,956; $115,000

Question 16

Financial futures are regularly traded on all of the following except the

A)Chicago Board of Trade.
B)Chicago Mercantile Exchange.
C)New York Futures Exchange.
D)Chicago Commodity Markets Board.

Question 17

A contract that requires the investor to buy securities on a future date is called a ________.

A)short contract
B)long contract
C)hedge
D)cross

Question 18

Which of the following is not a financial derivative?

A)stocks
B)futures
C)options
D)forward contracts

Question 19

A short contract requires that the investor

A)sell securities in the future.
B)buy securities in the future.
C)hedge in the future.
D)close out his position in the future.

Question 20

If you sell a short futures contract, you hope that bond prices will ________.

A)rise
B)fall
C)not change
D)fluctuate

Question 21

Futures differ from forwards because they are

A)used to hedge portfolios.
B)used to hedge individual securities.
C)used in both financial and foreign exchange markets.
D)marked to market daily.

Question 22

The advantage of forward contracts over futures contracts is that forward contracts

A)are standardized.
B)have lower default risk.
C)are more flexible.
D)both A and B are true.

Question 23

If you sell a futures contract on the S&P 500 Index at a price of 450 and the index rises to 500, you will ________.

A)lose $12,500
B)gain $12,500
C)lose $50
D)gain $50

Question 24

Which of the following is a likely reason for a portfolio manager to sell a stock index future short?

A)He believes the market will rise.
B)He wants to lock in current prices.
C)He wants to reduce stock market risk.
D)Both B and C are correct.

Question 25

If a portfolio manager believes stock prices will fall and knows that a block of funds will be received in the future, then he should

A)sell stock index futures short.
B)buy stock index futures long.
C)stay out of the futures market.
D)borrow and buy securities now.

Question 26

Futures differ from forwards because they are

A)used to hedge portfolios.
B)used to hedge individual securities.
C)used in both financial and foreign exchange markets.
D)standardized contracts.

Question 27

Who would be most likely to buy a long stock index future?

A)a mutual fund manager who believes the market will rise
B)a mutual fund manager who believes the market will fall
C)a mutual fund manager who believes the market will be stable
D)none of the above would be likely to purchase a futures contract

Question 28

The risk that occurs because stock prices fluctuate is called ________.

A)stock market risk
B)reinvestment risk
C)interest-rate risk
D)default risk

Question 29

Options are contracts that give the purchasers the

A)opportunity to buy or sell an underlying asset.
B)the obligation to buy or sell an underlying asset.
C)the right to hold an underlying asset.
D)the right to switch payment streams.

Question 30

If you buy a futures contract on the S&P 500 Index at a price of 450 and the index rises to 500, you will ________.

A)lose $12,500
B)gain $12,500
C)lose $50
D)gain $50

Question 31

Futures markets have grown rapidly because futures contracts

A)are standardized.
B)have lower default risk.
C)are liquid.
D)are all of the above.

Question 32

The most widely traded stock index future is on the

A)Dow Jones 1000 index.
B)S&P 500 index.
C)NASDAQ index.
D)Dow Jones 30 index.

Question 33

When a financial institution hedges the interest-rate risk for a specific asset, the hedge is called a ________.

A)macro hedge
B)micro hedge
C)cross hedge
D)futures hedge

Question 34

Which of the following features of Treasury bond futures contracts were not designed to increase liquidity?

A)standardized contracts
B)traded up until maturity
C)not tied to one specific type of bond
D)can be closed with offsetting trade

Question 35

If a firm is due to be paid in euros in two months, to hedge against exchange rate risk the firm should

A)sell foreign exchange futures short.
B)buy foreign exchange futures long.
C)stay out of the exchange futures market.
D)do none of the above.

Question 36

When a financial institution is hedging interest-rate risk on its overall portfolio, the hedge is a ________.

A)macro hedge
B)micro hedge
C)cross hedge
D)futures hedge

Question 37

The futures markets have grown rapidly in recent years because

A)interest rate volatility has increased.
B)financial managers are more risk averse.
C)of both A and B.
D)of neither A nor B.

Question 38

Which of the following features of Treasury bond futures contracts were not designed to increase liquidity?

A)standardized contracts
B)traded up until maturity
C)not tied to one specific type of bond
D)marked to market daily

Question 39

The advantage of forward contracts over futures contracts is that forward contracts

A)are standardized.
B)have lower default risk.
C)are more liquid.
D)are none of the above.

Question 40

If a firm must pay for goods it has ordered with foreign currency, it can hedge its foreign exchange rate risk by

A)selling foreign exchange futures short.
B)buying foreign exchange futures long.
C)staying out of the exchange futures market.
D)doing none of the above.

Question 41

A put option gives the seller the ________ to ________ the underlying security.

A)right; sell
B)obligation; sell
C)right; buy
D)obligation; buy

Question 42

Options on futures contracts are referred to as ________.

A)stock options
B)futures options
C)American options
D)individual options

Question 43

An option that can be exercised only at maturity is called a(n)________.

A)swap
B)stock option
C)European option
D)American option

Question 44

A call option gives the seller the ________ to ________ the underlying security.

A)right; sell
B)obligation; sell
C)right; buy
D)obligation; buy

Question 45

An option that can be exercised at any time up to maturity is called a(n)________.

A)swap
B)stock option
C)European option
D)American option

Question 46

The seller of an option has the ________ to buy or sell the underlying asset, while the purchaser of an option has the ________ to buy or sell the asset.

A)obligation; right
B)right; obligation
C)obligation; obligation
D)right; right

Question 47

If you buy an option to sell Treasury futures at 110, and at expiration the market price is 115,

A)the call will be exercised.
B)the put will be exercised.
C)the call will not be exercised.
D)the put will not be exercised.

Question 48

Options on individual stocks are referred to as ________.

A)stock options
B)futures options
C)American options
D)individual options

Question 49

If you buy an option to buy Treasury futures at 110, and at expiration the market price is 115,

A)the call will be exercised.
B)the put will be exercised.
C)the call will not be exercised.
D)the put will not be exercised.

Question 50

The agency which regulates stock options is the

A)Securities and Exchange Commission.
B)Commodities Futures Trading Commission.
C)Federal Trade Commission.
D)Both A and B are true.

Question 51

The price specified in an option contract at which the holder can buy or sell the underlying asset is called the ________.

A)premium
B)strike price
C)exercise price
D)both B and C of the above.

Question 52

If you buy an option to buy Treasury futures at 115, and at expiration the market price is 110,

A)the call will be exercised.
B)the put will be exercised.
C)the call will not be exercised.
D)the put will not be exercised.

Question 53

The agency which regulates futures options is the

A)Securities and Exchange Commission.
B)Commodities Futures Trading Commission.
C)Federal Trade Commission.
D)Both A and B are true.

Question 54

A call option gives the owner the ________ to ________ the underlying security.

A)right; sell
B)obligation; sell
C)right; buy
D)obligation; buy

Question 55

If you buy an option to sell Treasury futures at 115, and at expiration the market price is 110,

A)the call will be exercised.
B)the put will be exercised.
C)the call will not be exercised.
D)the put will not be exercised.

Question 56

The seller of an option has the

A)right to buy or sell the underlying asset.
B)the obligation to buy or sell the underlying asset.
C)ability to reduce transaction risk.
D)right to exchange one payment stream for another.

Question 57

The price specified in an option contract at which the holder can buy or sell the underlying asset is called the ________.

A)premium
B)call
C)strike price
D)put

Question 58

An option that gives the owner the right to buy a financial instrument at the exercise price within a specified period of time is a(n)________.

A)call option
B)put option
C)American option
D)European option

Question 59

An option that gives the owner the right to sell a financial instrument at the exercise price within a specified period of time is a(n)________.

A)call option
B)put option
C)American option
D)European option

Question 60

A put option gives the owner the ________ to ________ the underlying security.

A)right; sell
B)obligation; sell
C)right; buy
D)obligation; buy

Question 61

A financial contract that obligates one party to exchange a set of payments it owns for another set of payments owned by another party is called a ________.

A)cross hedge
B)cross call option
C)cross put option
D)swap

Question 62

An increase in the volatility of the underlying asset, all other things held constant, will ________ the option premium.

A)increase
B)decrease
C)not affect
D)Not enough information is given.

Question 63

If a bank manager wants to protect the bank against losses that would be incurred on its portfolio of Treasury securities should interest rates rise, he could ________ options on financial futures.

A)buy put
B)buy call
C)sell put
D)sell call

Question 64

The disadvantage of swaps is that

A)they lack liquidity.
B)it is difficult to arrange for a counterparty.
C)they suffer from default risk.
D)they are all of the above.

Question 65

Intermediaries are active in the swap markets because

A)they increase liquidity.
B)they reduce default risk.
C)they reduce search cost.
D)all of the above are true.

Question 66

If Second National Bank has more rate-sensitive liabilities than rate-sensitive assets, it can reduce interest-rate risk with a swap which requires Second National to

A)pay a fixed rate while receiving a floating rate.
B)receive a fixed rate while paying a floating rate.
C)both receive and pay a fixed rate.
D)both receive and pay a floating rate.

Question 67

A swap that involves the exchange of one set of interest payments for another set of interest payments is called a(n)________.

A)interest-rate swap
B)currency swap
C)swaption
D)notional swap

Question 68

A swap that involves the exchange of a set of payments in one currency for a set of payments in another currency is a(n)________.

A)interest-rate swap
B)currency swap
C)swaption
D)notional swap

Question 69

As compared to a default on the notional principle, a default on a swap

A)is more costly.
B)is about as costly.
C)is less costly.
D)may cost more or less than default on the notional principle.

Question 70

The main advantage of using options on futures contracts rather than the futures contracts themselves is that interest-rate risk is

A)controlled while preserving the possibility of gains.
B)controlled while removing the possibility of losses.
C)not controlled but the possibility of gains is preserved.
D)not controlled but the possibility of gains is lost.

Question 71

If Second National Bank has more rate-sensitive assets than rate-sensitive liabilities, it can reduce interest-rate risk with a swap which requires Second National to

A)pay a fixed rate while receiving a floating rate.
B)receive a fixed rate while paying a floating rate.
C)both receive and pay a fixed rate.
D)both receive and pay a floating rate.

Question 72

The main reason to buy an option on a futures contract rather than the futures contract itself is

A)to reduce transaction cost.
B)to preserve the possibility for gains.
C)to limit losses.
D)to remove the possibility for gains.

Question 73

All other things held constant, premiums on put options will increase when the

A)exercise price increases.
B)volatility of the underlying asset falls.
C)term to maturity increases.
D)A and C are both true.

Question 74

The main disadvantage of futures contracts as compared to options on futures contracts is that futures

A)remove the possibility of gains.
B)increase the transactions cost.
C)are not as effective a hedge.
D)do not remove the possibility of losses.

Question 75

A valid concern about financial derivatives is that

A)they allow financial institutions to increase their leverage.
B)they are too sophisticated because they are so complicated.
C)the notional amounts can greatly exceed a financial institution's capital.
D)all of the above are valid concerns.
E)none of the above are valid concerns.

Question 76

If a bank has a gap of -$10 million, it can reduce its interest-rate risk by

A)paying a fixed rate on $10 million and receiving a floating rate on $10 million.
B)paying a floating rate on $10 million and receiving a fixed rate on $10 million.
C)selling $20 million fixed-rate assets.
D)buying $20 million fixed-rate assets.

Question 77

All other things held constant, premiums on call options will increase when the

A)exercise price falls.
B)volatility of the underlying asset falls.
C)term to maturity decreases.
D)futures price increases.

Question 78

All other things held constant, premiums on both put and call options will increase when the

A)exercise price increases.
B)volatility of the underlying asset increases.
C)term to maturity decreases.
D)futures price increases.

Question 79

An increase in the exercise price, all other things held constant, will ________ the premium on call options.

A)increase
B)decrease
C)not affect
D)Not enough information is given.

Question 80

One advantage of using swaps to eliminate interest-rate risk is that swaps

A)are less costly than futures.
B)are less costly than rearranging balance sheets.
C)are more liquid than futures.
D)have better accounting treatment than options.