Deck 9: Derivative Securities and Derivative Markets

Question 1

Using forward transactions allows

A)holders of common stock to lock in future dividend payments.
B)the federal government to stabilize fluctuations in tax receipts.
C)corporations to reduce problems arising from future fluctuations in their dividend payments.
D)both buyers and sellers to reduce risks associated with price fluctuations.

Answer 1

both buyers and sellers to reduce risks associated with price fluctuations.

Question 2

The improper use of derivatives was blamed in part for all of the following EXCEPT

A)the stock market crash following September 11.
B)the bankruptcy of Enron.
C)the downfall of Long Term Capital Management.
D)the bankruptcy of Orange County in California.

Answer 2

the stock market crash following September 11.

Question 3

Spot transactions

A)involve immediate settlement.
B)may only take place in face-to-face trading.
C)take place on-the-spot, rather than on an organized exchange.
D)are relatively unimportant in financial markets.

Answer 3

involve immediate settlement.

Question 4

Forward transactions

A)provide little risk sharing.
B)are very liquid.
C)have information problems.
D)are widely used by sellers of commodities, but rarely used by buyers of commodities.

Question 5

Currently,

A)trading futures contracts on agricultural and mineral commodities makes up a majority of all trading.
B)trading in financial futures involves more transactions than trading in commodity futures.
C)futures trading is allowed only for financial assets.
D)futures trading is allowed only for commodities.

Question 6

Forward contracts are often illiquid because

A)any capital gains on them are heavily taxed, making investors reluctant to sell them.
B)government regulation has not provided for a secondary market in them.
C)they generally contain terms specific to the particular buyer and seller.
D)the brokerage fees involved in buying and selling them are very high.

Question 7

Fluctuations in the price of the underlying security or commodity during the life of forward transactions

A)have no effect on the contracting parties.
B)are disallowed under current government regulations.
C)confer capital gains and losses on the contracting parties.
D)will occur during times of extreme economic instability.

Question 8

Forward transactions originated in the market for

A)common stock.
B)corporate bonds.
C)government bonds.
D)agricultural and other commodities.

Question 9

Forward contracts

A)are highly liquid.
B)entail small information costs.
C)provide little risk sharing.
D)are subject to default risk.

Question 10

If the orange crop turns out to be unusually small,

A)orange growers will likely gain and orange juice sellers will likely lose.
B)orange growers will likely lose and orange juice sellers will likely gain.
C)both orange growers and orange juice sellers will likely lose.
D)both orange growers and orange juice sellers will likely gain.

Question 11

In derivative markets, trade takes place in

A)assets such as bonds or common stock that derive their value from the value of the companies which issue them.
B)assets whose rates of returns must be derived from information published in financial tables.
C)assets that derive their value from underlying assets.
D)assets which are not allowed to be traded on organized exchanges.

Question 12

A futures contract is

A)an agreement that specifies the delivery of a commodity or financial instrument at an agreed-upon future date at a currently agreed-upon price.
B)an agreement that specifies the delivery of a commodity or financial instrument at an agreed-upon future date, with the price to be negotiated at the time of delivery.
C)an agreement that specifies the delivery of a commodity or financial instrument at a currently agreed-upon price, with date of delivery to be negotiated subsequently.
D)an agreement that specifies the delivery of a commodity or financial instrument, with the price and date of delivery to be negotiated subsequently.

Question 13

The most important derivative instruments are

A)futures and options contracts.
B)common stocks.
C)corporate bonds.
D)government bonds.

Question 14

Forward transactions

A)allow savers and borrowers to conduct a transaction now and settle in the future.
B)allow savers and borrowers to postpone a transaction from now to the future.
C)always involve increased risk compared with spot transactions.
D)may not be conducted on organized exchanges.

Question 15

Derivative instruments are

A)assets such as bonds or common stock that derive their value from the value of the companies which issue them.
B)assets whose rates of returns must be derived from information published in financial tables.
C)assets which derive their value from underlying assets.
D)computers which display real-time financial information.

Question 16

The buyer of a futures contract

A)assumes the short position.
B)assumes the long position.
C)may not sell the contract without the permission of the original seller.
D)has the obligation to deliver the underlying financial instrument at the specified future date.

Question 17

Between 1981 and the early 2000s,

A)trading in financial futures declined in importance relative to trading in agricultural and mineral commodities futures.
B)trading in financial futures increased in importance relative to trading in agricultural and mineral commodities futures.
C)trading in agricultural and commodities futures was discontinued.
D)trading in financial futures was discontinued.

Question 18

Forward transactions

A)provide substantial liquidity.
B)entail small information costs.
C)provide risk sharing.
D)provide reduced tax payments.

Question 19

If a wheat crop turns out to be unusually large,

A)farmers will likely gain and millers will likely lose.
B)millers will likely gain and farmers will likely lose.
C)both farmers and millers will likely lose.
D)both farmers and millers will likely gain.

Question 20

Forward transactions would be useful to

A)a government wanting to know the size of its future debt.
B)a household wanting to reduce its future tax liability.
C)a business wanting to know the cost of its funds on future loans.
D)a business wanting to expand its operations in overseas markets.

Question 21

The seller of a futures contract

A)assumes the short position.
B)assumes the long position.
C)has the obligation to receive the underlying financial instrument at the specified future date.
D)is expecting the price of the underlying financial instrument to rise.

Question 22

The futures price

A)reflects traders' expectations of the spot price on the day of delivery.
B)is always above the spot price on the day of delivery.
C)is always below the spot price on the day of delivery.
D)is always equal to the spot price at every point in time.

Question 23

On the day of delivery

A)the spot price will equal the futures price.
B)the spot price will be greater than the futures price by an amount equal to the current interest rate times the futures price.
C)the futures price will be greater than the spot price by an amount equal to the current interest rate times the spot price.
D)there is no necessary relation between the spot price and the futures price.

Question 24

If you sell a futures contract for U.S. Treasury bills and on the delivery date the interest rate of T-bills is higher than you expected, you will have

A)lost money on your long position.
B)gained money on your long position.
C)lost money on your short position.
D)gained money on your short position.

Question 25

All of the following are roles of a clearinghouse EXCEPT

A)instituting margin requirements on futures contracts.
B)marking to market at the end of each day.
C)eliminate the need for buyers and sellers of futures contracts to be concerned about the creditworthiness of each other.
D)reducing the default risk involving forward contracts.

Question 26

Financial futures contracts are regulated by

A)the Commodity Futures Trading Commission.
B)the Federal Trade Commission.
C)the Interstate Commerce Commission.
D)the Options and Futures Commission.

Question 27

Marking to market involves

A)changing the futures price to the spot price each day.
B)engaging in arbitrage so as to reduce the risk involved with futures contracts.
C)crediting or debitting the margin account based on the net change in the value of the futures contract.
D)updating the futures price after the market closes each day.

Question 28

The buyer of a futures contract

A)assumes the short position.
B)has the obligation to deliver the underlying financial instrument at the specified date.
C)has the obligation to receive the underlying financial instrument at the specified future date.
D)may, at his or her option, deliver or receive the underlying financial instrument at the specified date.

Question 29

Which of the following financial futures contracts are traded in the United States?

A)Interest rates
B)Stock indexes
C)Currencies
D)All of the above

Question 30

Futures trading has traditionally been dominated by

A)the New York Stock Exchange.
B)the Chicago Board of Trade and the Chicago Mercantile Exchange.
C)the London Stock Exchange.
D)the Omaha Grain Exchange.

Question 31

The initial deposit required by a buyer or seller of a futures contract is known as

A)credit.
B)margin requirement.
C)debit.
D)marking.

Question 32

Marking to market refers to

A)the determination of the prices of options contracts by the interaction of demand and supply.
B)the determination of the prices of futures contracts by the interaction of demand and supply.
C)the settlement of gains and losses on futures contracts each day.
D)the settlement of gains and losses on forward contracts each day.

Question 33

As the time of delivery in a futures contract gets closer

A)the futures price gets closer to the spot price.
B)the futures price generally rises further above the spot price.
C)the futures price generally falls further below the spot price.
D)the futures and spot prices remain the same as they were when the contract was first created.

Question 34

If market participants believe that the wheat crop is likely to be unusually small,

A)the spot price of wheat is likely to be above the futures price of wheat.
B)the spot price of wheat is likely to be below the futures price of wheat.
C)it will not be possible to find a seller of a futures contract in wheat.
D)it will not be possible to find a buyer of a futures contract in wheat.

Question 35

The elimination of riskless profit opportunities is known as

A)arbitrage.
B)options.
C)swaps.
D)liquidity.

Question 36

Clearinghouses help to reduce default risk by

A)being the intermediary in trades for buyers and sellers.
B)margin requirements.
C)marking to market.
D)all of the above.

Question 37

The seller of a futures contract

A)assumes the short position.
B)has the obligation to deliver the underlying financial instrument at the specified date.
C)has the obligation to receive the underlying financial instrument at the specified future date.
D)may, at his or her option, deliver or receive the underlying financial instrument at the specified date.

Question 38

The futures price

A)is established each year by act of Congress.
B)is established each month by the Chairman of the Chicago Board of Trade.
C)is specified in each futures contract.
D)is set by supply and demand in the futures market.

Question 39

The role of the Commodity Futures Trading Commission is to

A)set the prices of futures contracts.
B)operate the Chicago Mercantile Exchange.
C)operate the Chicago Board of Trade.
D)monitor potential price manipulation in futures trading.

Question 40

If you buy a futures contract for U.S. Treasury bills and on the delivery date the interest rate on T-bills is lower than you expected, you will have

A)lost money on your long position.
B)gained money on your long position.
C)lost money on your short position.
D)gained money on your short position.

Question 41

If a futures contract for U.S. Treasury bonds increases by "15" in the financial page listings, the value of the contract increased by

A)$15.00.
B)$468.75.
C)$2133.33.
D)$15,000.00.

Question 42

In a call options contract, the

A)seller has the obligation to deliver the instrument at a specified time.
B)buyer has the obligation to receive the instrument at a specified time.
C)seller may choose whether or not to deliver the instrument at a specified time.
D)buyer will choose to exercise his option only if the value of the underlying security falls.

Question 43

Which of the following is NOT a way that hedgers can benefit by participating in financial futures markets?

A)They can reduce their tax liabilities.
B)They can reduce their exposure to price fluctuations.
C)They can access liquid markets.
D)They can reduce their information costs by using organized exchanges.

Question 44

Profits from speculation arise because of

A)the spread between the bid and ask prices on bonds.
B)the illiquidity of markets for derivative instruments.
C)the high information costs in markets for derivative instruments.
D)disagreements among traders about future prices of a commodity or financial instrument.

Question 45

The price at which an option may be exercised is called the

A)market price.
B)equilibrium price.
C)strike price.
D)fixed price.

Question 46

The futures hedge

A)eliminates all risk from price movements.
B)is most valuable for protecting against anticipated price changes.
C)is most valuable for protecting against unanticipated price changes.
D)is most valuable for protecting against price increases.

Question 47

Basis risk refers to the risk

A)associated with anticipated price movements.
B)associated with unanticipated price movements.
C)of default on the futures contract.
D)from a change in the spread between the rate on the hedged instrument and the rate on the instrument actually traded.

Question 48

A lender who is worried that its cost of funds might rise during the term of a loan it has made can hedge against this rise by

A)buying futures contracts on Treasury bills.
B)selling futures contracts on Treasury bills.
C)buying call options on Treasury bills.
D)increasing the amount of money which it lends.

Question 49

In comparing futures contracts with options contracts, we can say that

A)in a futures contract, the buyer and seller have symmetric rights, whereas in an options contract, the buyer and seller have asymmetric rights.
B)in a futures contract, the buyer and seller have asymmetric rights, whereas in an options contract ,the buyer and seller have symmetric rights.
C)in both futures and options contracts, the buyer and seller have symmetric rights.
D)in both futures and options contracts, the buyer and seller have asymmetric rights.

Question 50

If you look at the financial page listings for futures contracts and find that futures prices on Treasury bonds are falling over a particular time period, futures market investors must expect that

A)Treasury bond prices will be higher in the future.
B)Treasury bond yields will be higher in the future.
C)Treasury bond yields will be lower in the future.
D)futures prices will rise again at the end of the period.

Question 51

One difference between futures and options contracts is

A)funds change hands daily in the case of options but not with futures.
B)funds change hands daily in the case of futures, but not with options.
C)in the case of futures funds only change hands when they are exercised.
D)futures are designed to reduce risk while options are not.

Question 52

Speculators are primarily interested in

A)betting on anticipated changes in prices.
B)reducing their exposure to the risk of price fluctuations.
C)increasing market liquidity.
D)reducing the spread between bid and ask prices on bonds.

Question 53

A speculator who believes strongly that interest rates will fall would be likely to

A)buy futures contracts on Treasury bills.
B)sell futures contracts on Treasury bills.
C)sell Treasury bonds in the spot market.
D)decrease now the amount of money which he lends.

Question 54

Which of the following statements about the presence of speculators in futures markets is correct?

A)Their main objective is to reduce their exposure to risk.
B)They aid hedgers by increasing the liquidity in futures markets.
C)They make it difficult for hedgers to find someone to take the opposite side of their positions.
D)Once a futures market participant is known to be a speculator he or she is no longer allowed to participate in the market.

Question 55

An options contract

A)confers the rights to buy or sell an underlying asset at a predetermined price by a predetermined time.
B)is another name for a futures contract.
C)may be written for debt instruments, but not equities.
D)may be written for equities, but not for debt instruments.

Question 56

Savers and borrowers began to make greater use of derivative markets during the 1980s because of the

A)increased volatility of interest rates.
B)fall in marginal income tax rates.
C)decline in inflation rates.
D)decline in unemployment rates.

Question 57

Hedgers are primarily interested in

A)betting on anticipated changes in prices.
B)reducing their exposure to the risk of price fluctuations.
C)increasing market liquidity.
D)reducing the spread between bid and ask prices on bonds.

Question 58

A speculator who believes strongly that interest rates will rise would be likely to

A)buy futures contracts on Treasury bills.
B)sell futures contracts on Treasury bills.
C)buy Treasury bonds in the spot market.
D)increase now the amount of money which he lends.

Question 59

If the price of a futures contract increases, then

A)the exchange will collect the amount of the increase from the seller of the contract and transfer it to the account of the buyer of the contract.
B)the exchange will collect the amount of the increase from the buyer of the contract and transfer it to the account of the seller of the contract.
C)the exchange will collect the amount of the increase from both the buyer and the seller and place it in escrow until the delivery date.
D)the additional funds will be required from either the buyer or the seller until the delivery date.

Question 60

In a put options contract, the

A)seller has the obligation to receive the instrument at a specified time.
B)buyer has the obligation to deliver the instrument at a specified time.
C)buyer has the obligation to receive the instrument at a specified time.
D)seller has the obligation to deliver the instrument at a specified time.

Question 61

A lender who is worried that its cost of funds might rise during the term of a loan it has made can hedge against this rise without eliminating the chance to profit from a decline in the cost of funds by

A)buying futures contracts on Treasury bills.
B)selling futures contracts on Treasury bills.
C)buying put options on Treasury bills.
D)buying call options on Treasury bills.

Question 62

A put option is said to be in the money if

A)it is written on a Treasury bill or other money-market asset.
B)it has increased in price since it was first written.
C)the price of the underlying asset is currently less than the strike price.
D)the price of the underlying asset is currently less than the strike price plus the option premium.

Question 63

Index arbitrage refers to

A)simultaneous trading in stock index futures and the underlying stocks.
B)selling futures contracts and buying options contracts on the same stock.
C)buying futures contracts and selling options contracts on the same stock.
D)selling futures contracts on stocks and buying equivalent futures contracts on bonds.

Question 64

In a covered option,

A)the strike price is always above the exercise price.
B)the seller owns the underlying asset.
C)the seller does not have an interest in the underlying asset.
D)the option premium never deviates from the intrinsic value.

Question 65

A stock option is said to be "out of the money" if:

A)the strike price equals the exercise price
B)stock price equals the strike price
C)strike price exceeds the stock price
D)stock price exceeds the strike price

Question 66

Suppose that Acme Widget is currently selling for $100 per share and you own a call option to buy Acme Widget at $75 per share. The intrinsic value of your option is

A)$25.
B)$75.
C)$100.
D)not possible to determine in the absence of information on values of the share price of Acme Widget between now and the expiration date of the call.

Question 67

As an option nears its expiration date, the size of the premium approaches

A)zero.
B)infinity.
C)its intrinsic value.
D)an amount which varies, depending on prevailing market interest rates on the expiration date.

Question 68

The fee charged by the seller of an option is referred to as the

A)market price.
B)option premium.
C)futures fee.
D)call price.

Question 69

If you look at the financial page listings for options contracts and find that prices on call options on Treasury bonds are rising over a particular time period, options market investors must expect that

A)Treasury bond prices will be higher in the future.
B)Treasury bond prices will be lower in the future.
C)Treasury bond yields will be higher in the future.
D)Call option prices will fall again at the end of the period.

Question 70

Options on securities are regulated by the

A)CFTC.
B)Federal Reserve.
C)SEC.
D)FBI.

Question 71

An option buyer

A)has a greater insurance benefit than the purchaser of a futures contract.
B)bears the risk of unfavorable price movements.
C)is purchasing a naked option if he or she does not also own the underlying asset.
D)generally will incur a lower cost than will the purchaser of a futures contract.

Question 72

The intrinsic value of an option

A)is equal to the option premium.
B)is the amount the option actually is worth if it is immediately exercised.
C)is the amount the option is expected to be worth on its expiration date.
D)is impossible to determine in the absence of information on the future prices of the underlying asset.

Question 73

Which of the following factors would tend to increase the size of the premium on an options contract?

A)The option is near its expiration date.
B)The current default-risk-free interest rate is high.
C)The price volatility of the underlying asset is low.
D)The option is far away from its expiration date.

Question 74

The period over which a call or put option exists is

A)determined by its delivery date.
B)determined by its expiration date.
C)determined by whether the contract is written for a commodity or for a financial instrument.
D)indeterminate; options contracts continue in existence until either the buyer or the seller desires to discontinue it.

Question 75

Speculators in futures and options markets

A)reduce the efficiency of these markets.
B)are acting contrary to U.S. securities laws.
C)accept risk transferred to them by hedgers.
D)reduce the liquidity of these markets.

Question 76

In an options contract, another name for the strike price is the

A)market price.
B)exercise price.
C)equilibrium price.
D)fixed price.

Question 77

The mathematicians and economists who have been hired by Wall Street firms to build mathematical models to aid the pricing of derivatives are generally referred to as

A)speculators.
B)hedgers.
C)rocket scientists.
D)market makers.

Question 78

The choice between futures and options

A)depends on whether the underlying instrument is a debt instrument or an equity.
B)reflects a trade-off between the higher cost of using options and the extra insurance benefits that options provide.
C)reflects a trade-off between the higher cost of using futures and the extra insurance benefits that futures provide.
D)reflects a trade-off between the greater risk from using options and the extra insurance benefits that options provide.

Question 79

The big decline in share prices on the New York Stock Exchange that occurred in October 1987

A)was almost entirely attributable to the effects of index arbitrage.
B)occurred despite the complete ban on index arbitrage in existence at the time.
C)was not mainly the result of index arbitrage.
D)was made less severe than it might have been because of the effects of index arbitrage.

Question 80

A call option is said to be in the money if

A)it is written on a Treasury bill or other money-market asset.
B)it has increased in price since it was first written.
C)the price of the underlying asset is currently greater than the strike price.
D)the price of the underlying asset is currently greater than the strike price plus the option premium.