Question 1

The opportunity to exercise the quality option will occur when one deliverable bond becomes more favorably priced than another.

Accepted Answer

A) True 
 B)False

Question 2

The implied interest rate based on stock index carry arbitrage will increase when the spot price increases, everything else held constant.

Accepted Answer

A) True 
 B)False

Question 3

In theory, the foreign exchange futures price is based on four parameters only, the spot foreign exchange rate, the risk-free rate in the domestic currency, the risk-free rate in the foreign currency, and time to maturity.

Accepted Answer

A) True 
 B)False

Question 4

The transaction in which money is borrowed by selling a security and promising to buy it back in several weeks is called a

Accepted Answer

A)  term repo 
B)  overnight repo 
C)  term arbitrage 
D)  MOB spread 
E)  none of the above

Question 5

Fed fund futures arbitrage is based on the assumption that LIBOR and Fed funds are perfect substitutes.

Accepted Answer

A) True 
 B)False

Question 6

Selling an index futures and holding an undiversified portfolio would eliminate unsystematic risk.

Accepted Answer

A) True 
 B)False

Question 7

The implied repo rate is similar to the

Accepted Answer

A)  internal rate of return 
B)  cost of hedging 
C)  yield on the futures contract 
D)  all of the above 
E)  none of the above

Question 8

Which of the following is not needed when calculating the implied repo rate for stock index futures?

Accepted Answer

A)  futures price 
B)  conversion factor 
C)  time-to-expiration 
D)  spot price 
E)  none of the above
Use the following information to answer questions 22 through 24. On October 1, the one-month LIBOR rate is 4.50 percent and the two month LIBOR rate is 5.00 percent. The November Fed funds futures is quoted at 94.50. The contract size is $5,000,000.

Question 9

How is the cost of a delivery option paid?

Accepted Answer

A)  the long pays the short with a cash settlement 
B)  the short pays the long with a cash settlement 
C)  a higher closing futures price 
D)  a lower closing futures price 
E)  none of the above

Question 10

Covered interest arbitrage from a U. S. dollar perspective when the euro futures price (expressed in $/€) is too high involves

Accepted Answer

A)  buying foreign exchange futures contracts 
B)  selling interest rate futures contracts 
C)  lending funds in risk-free euro investment 
D)  selling euros 
E)  buying euro stock index ETFs

Question 11

Use the following information to answer questions .  On October 1, the one-month LIBOR rate is 4.50 percent and the two month LIBOR rate is 5.00 percent.  The November Fed funds futures is quoted at 94.50.  The contract size is $5,000,000.
-Compute the dollar profit or loss from borrowing the present value of $5,000,000 at one month LIBOR and lending the same amount at two month LIBOR while simultaneously selling one November Fed funds futures contract. Assume that rates on November 1 were 7 percent, there is no basis risk, and the position is unwound on November 1. Select the closest answer.

Accepted Answer

A)  -$3,150 
B)  $0 
C)  $3,150 
D)  $940 
E)  -$940

Question 12

The implied repo rate on a spread is the implicit return on a risk-free spread transaction.

Accepted Answer

A) True 
 B)False

Question 13

Suppose the number of days between two coupon payment dates is 181, the number of days since the last coupon payment is 100, the annual coupon rate is 8 percent and the par value is $100,000, then the accrued interest is $2,210.

Accepted Answer

A) True 
 B)False

Question 14

If the invoice price of bond A is 122, the invoice price of bond B is 95, the adjusted spot price of bond A is 127 and the adjusted spot price of bond B is 97, the better bond to deliver is bond B.

Accepted Answer

A) True 
 B)False

Question 15

Suppose you observe the spot S&P 500 index at 1,210 and the three month S&P 500 index futures at 1,205. Based on carry arbitrage, you conclude

Accepted Answer

A)  this futures market is inefficient because the futures price is below the spot price 
B)  this futures market is indicating that the spot price is expected to fall 
C)  the spot price is too high relative to the observed futures price 
D)  the dividend yield is higher than the risk-free interest rate 
E)  none of the above

Question 16

If the stock index is at 148, the three-month futures price is 151, the dividend yield is 5 percent and the interest rate is 8 percent, determine the profit from an index arbitrage if the stock ends up at 144 at expiration. (Ignore transaction costs.)

Accepted Answer

A)  1.89 
B)  4.00 
C)  7.00 
D)  5.11 
E)  -7.00

Question 17

The conversion factor is the price of a bond with a face value of $1, coupon and maturity equal to that of the deliverable bond, and yield of 6 percent.

Accepted Answer

A) True 
 B)False

Question 18

Foreign exchange carry arbitrage is based on a trader's expectations regarding purchasing power parity.

Accepted Answer

A) True 
 B)False

Question 19

The coupon assumption for the conversion factor is 8 percent.

Accepted Answer

A) True 
 B)False

Exam 10: Futures Arbitrage Strategies

The opportunity to exercise the quality option will occur when one deliverable bond becomes more favorably priced than another.

The implied interest rate based on stock index carry arbitrage will increase when the spot price increases, everything else held constant.

In theory, the foreign exchange futures price is based on four parameters only, the spot foreign exchange rate, the risk-free rate in the domestic currency, the risk-free rate in the foreign currency, and time to maturity.

The transaction in which money is borrowed by selling a security and promising to buy it back in several weeks is called a

Fed fund futures arbitrage is based on the assumption that LIBOR and Fed funds are perfect substitutes.

Selling an index futures and holding an undiversified portfolio would eliminate unsystematic risk.

The implied repo rate is similar to the

Which of the following is not needed when calculating the implied repo rate for stock index futures?

How is the cost of a delivery option paid?

Covered interest arbitrage from a U. S. dollar perspective when the euro futures price (expressed in $/€) is too high involves

The implied repo rate on a spread is the implicit return on a risk-free spread transaction.

Suppose the number of days between two coupon payment dates is 181, the number of days since the last coupon payment is 100, the annual coupon rate is 8 percent and the par value is $100,000, then the accrued interest is $2,210.

If the invoice price of bond A is 122, the invoice price of bond B is 95, the adjusted spot price of bond A is 127 and the adjusted spot price of bond B is 97, the better bond to deliver is bond B.

Suppose you observe the spot S&P 500 index at 1,210 and the three month S&P 500 index futures at 1,205. Based on carry arbitrage, you conclude

If the stock index is at 148, the three-month futures price is 151, the dividend yield is 5 percent and the interest rate is 8 percent, determine the profit from an index arbitrage if the stock ends up at 144 at expiration. (Ignore transaction costs.)

The conversion factor is the price of a bond with a face value of $1, coupon and maturity equal to that of the deliverable bond, and yield of 6 percent.

Foreign exchange carry arbitrage is based on a trader's expectations regarding purchasing power parity.

The coupon assumption for the conversion factor is 8 percent.