Deck 7: Pricing Derivatives

Question 1

Consider a portfolio which uses an European index as the underlying asset.The pay offs of the underlying asset in the up node and down node is 1,390 and 1,330 respectively.If the risk-free rate is 3.5% and the pay-offs of structured bond in the up node and down nodes are €214.50 and €169.50 respectively.Calculate the number of units of the underlying asset.

A)0.75
B)0.50
C)0.80
D)0.70

Answer 1

A

Question 2

The underlying asset of a call option that is _____ has a current price that is greater than the strike price.

A)on the money
B)in the money
C)out of the money
D)at the money

Answer 2

B

Question 3

What are the unique features of warrants over other options?

Answer 3

Warrants are usually call options that companies issue on their own equity.In contrast to exchange-traded options,which are mere bets between investors on the value of a company's underlying equity,warrants are contracts between a corporation and an investor.The major distinction between a warrant and other types of call options is that the company issues additional equity when an investor exercises a warrant.Upon exercise,the equity is sold to the warrant holder at the strike price.Since exercise occurs only when the strike price is less than the current share price,the exercise of the warrant involves the issuance of new shares of equity at bargain prices.The new shares dilute the value of existing shares.Because of this dilution,option pricing models used to value warrants differ from option pricing models used to value exchange-traded options.

Question 4

Consider a portfolio which uses an European index as the underlying asset.The pay offs of the underlying asset in the up node and down node is 1,390 and 1,330 respectively.If the risk-free rate is 3.5% and the pay-offs of structured bond in the up node and down nodes are €214.50 and €169.50 respectively.Calculate the amount of money invested in a risk-free security.

A)+€900
B)-€850
C)-€800
D)+€950

Question 5

The main difference between forward and future contracts is that the _____.

A)forward contracts are standardized
B)forward contracts are traded through an exchange
C)profit or loss on future contracts is settled on a daily basis
D)default risk of future contract is higher than that of forward contract

Question 6

_____ is a method that uses random numbers obtained from a computer to generate outcomes,and then averages the outcomes of some variable to obtain values.

A)Binomial-like numerical method
B)Randomization
C)Simulation
D)Numerical method

Question 7

Explain the assumptions in the valuation of derivatives.

Question 8

Julian has purchased a derivative that will allow him to purchase a security at a specific price.The seller of the derivative has allowed Julian to purchase the security or let the derivative expire without being exercised for a certain premium.Julian intends to purchase the security only if the underlying security's price goes above the strike price.Which of the following kinds of derivative does Julian hold?

A)Forwards
B)Swaps
C)Options
D)Futures

Question 9

Swaps can be beneficial for both counterparties.Justify the statement.

Question 10

A(n)_____ is a financial instrument on which the price of a derivative is derived.

A)notional amount
B)marginal asset
C)underlying asset
D)exotic instrument

Question 11

The most commonly used risk-free rate by industry practitioners is the _____.

A)federal funds rate
B)prime rate
C)EURIBOR
D)LIBOR

Question 12

Consider a portfolio which uses an European index as the underlying asset.The pay offs of the underlying asset in the up node and down node is 1,390 and 1,330 respectively.If the risk-free rate is 3.5% and the pay-offs of structured bond in the up node and down nodes are €214.50 and €169.50 respectively.Find the value of the derivative assuming no-arbitrage.

A)€214.00
B)€169.50
C)€220.00
D)€250.50

Question 13

Which of the following is true of the multi-period binomial valuation?

A)It permits more than two outcomes for a single period.
B)Its empirical accuracy increases as time is divided into finer binomial periods.
C)Even the most complex valuations can be done without using computers.
D)It does not depend on probabilities for valuations.

Question 14

Assume two borrowers,A and B,enter into an interest rate swap agreement and the settlement date is one year after the date of initiation.B exchanges his fixed interest rate with A for a floating rate.The fixed and the floating rate as of the initiation of the agreement is 9%.Which one of the following is true if the interest rate increases to 9.5% at the time of settlement?

A)A will have to pay money to B on the settlement date
B)B will have to pay money to A on the settlement date
C)Both A and B will have to pay on the settlement date
D)Neither A nor B will have to pay on the settlement date

Question 15

Is it true that forward contracts are always riskier than the futures contracts? If so,will there be any forward contracts in a practical world?

Question 16

Which of the following is a condition to perfectly track a derivative?s pay-offs with a dynamic strategy?

A)Markets should be frictionless.
B)The price of the underlying security must make large jumps.
C)Trading on the derivative and the underlying security should be restricted.
D)Arbitraging opportunities must be there.

Question 17

Which of the following is an assumption in derivative valuation models?

A)An arbitrageur has limited financial resources and has little access to different markets at the same time.
B)All of the risk is due to existence of mispriced derivatives in relation to their underlying.
C)A portfolio can be formed that perfectly tracks the cash flows of the derivative being evaluated.
D)There will be transaction related charges on all trades made in the market.

Question 18

Which of the following is true about the notional amount in interest rate swaps?

A)It represents the size of the principal for interest calculation on settlement.
B)It is the amount placed with brokers as security against default on interest payment.
C)It is the amount transferred when the contract is initiated.
D)It is the total interest paid when the contract is initiated.