Capital Markets
Exam Answer Key
Course Introduction
This course provides a comprehensive overview of capital markets, exploring their structure, functioning, and significance within the global financial system. Students will examine key instruments, including equities, bonds, derivatives, and hybrid securities, and learn how these assets are traded and valued. The course covers the roles of various market participants, such as institutional investors, brokers, and regulators, and delves into primary and secondary market processes. Emphasis is also placed on the impact of macroeconomic factors, risk management, financial regulations, and technological advancements shaping modern capital markets. Through case studies and practical applications, students gain a solid foundation for analyzing capital market trends and making informed investment decisions.
Recommended Textbook
Fundamentals of Futures and Options Markets 8th Edition by John C. Hull
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Page 2
Chapter 1: Introduction
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Q1) Which of the following describes European options?
A) Sold in Europe
B) Priced in Euros
C) Exercisable only at maturity
D) Calls (there are no puts)
Answer: C
Q2) The price of a stock on February 1 is $124. A trader sells 200 put options on the stock with a strike price of $120 when the option price is $5. The options are exercised when the stock price is $110. The trader's net profit or loss is
A) Gain of $1,000
B) Loss of $2,000
C) Loss of $2,800
D) Loss of $1,000
Answer: D
Q3) Which of the following best describes the term "spot price"?
A) The price for immediate delivery
B) The price for delivery at a future time
C) The price of an asset that has been damaged
D) The price of renting an asset
Answer: A
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Chapter 2: Mechanics of Futures Markets
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Q1) The frequency with which margin accounts are adjusted for gains and losses is
A) Daily
B) Weekly
C) Monthly
D) Quarterly
Answer: A
Q2) Which of the following are cash settled?
A) All futures contracts
B) All option contracts
C) Futures on commodities
D) Futures on stock indices
Answer: D
Q3) With bilateral clearing, the number of agreements between four dealers, who trade with each other, is
A) 12
B) 1
C) 6
D) 2
Answer: C
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Page 4
Chapter 3: Hedging Strategies Using Futures
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Q1) On March 1 a commodity's spot price is $60 and its August futures price is $59. On July 1 the spot price is $64 and the August futures price is $63.50. A company entered into futures contracts on March 1 to hedge its purchase of the commodity on July 1. It closed out its position on July 1. What is the effective price (after taking account of hedging) paid by the company?
A) $59.50
B) $60.50
C) $61.50
D) $63.50
Answer: A
Q2) Which of the following does NOT describe beta?
A) A measure of the sensitivity of the return on an asset to the return on an index
B) The slope of the best fit line when the return on an asset is regressed against the return on the market
C) The hedge ratio necessary to remove market risk from a portfolio
D) Measures correlation between futures prices and spot prices
Answer: D
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Chapter 4: Interest Rates
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Q1) The six month and one-year rates are 3% and 4% per annum with semiannual compounding. Which of the following is closest to the one-year par yield expressed with semiannual compounding?
A) 3.99%
B) 3.98%
C) 3.97%
D) 3.96%
Q2) Since the credit crisis that started in 2007 which of the following have derivatives traders started to use as the risk-free rate for some transactions?
A) The Treasury rate
B) The LIBOR rate
C) The repo rate
D) The overnight indexed swap rate
Q3) A repo rate is
A) An uncollateralized rate
B) A rate where the credit risk is relatively high
C) The rate implicit in a transaction where securities are sold and bought back at a higher price
D) None of the above
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Page 6
Chapter 5: Determination of Forward and Futures Prices
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Q1) Which of the following describes the way the forward price of a foreign currency is quoted?
A) The number of U.S. dollars per unit of the foreign currency
B) The number of the foreign currency per U.S. dollar
C) Some forward prices are always quoted as the number of U.S. dollars per unit of the foreign currency and some are always quoted the other way round
D) There are no quotation conventions for forward prices
Q2) An investor shorts 100 shares when the share price is $50 and closes out the position six months later when the share price is $43. The shares pay a dividend of $3 per share during the six months. How much does the investor gain?
A) $1,000
B) $400
C) $700
D) $300
Q3) Which of the following is a consumption asset?
A) The S&P 500 index
B) The Canadian dollar
C) Copper
D) IBM stock
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Page 7
Chapter 6: Interest Rate Futures
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Q1) The modified duration of a bond portfolio worth $1 million is 5 years. By approximately how much does the value of the portfolio change if all yields increase by 5 basis points?
A) Increase of $2,500
B) Decrease of $2,500
C) Increase of $25,000
D) Decrease of $25,000
Q2) The conversion factor for a bond is approximately
A) The price it would have if all cash flows were discounted at 6% per annum
B) The price it would have if it paid coupons at 6% per annum
C) The price it would have if all cash flows were discounted at 8% per annum
D) The price it would have if it paid coupons at 8% per annum
Q3) In the U.S. what is the longest maturity for 3-month Eurodollar futures contracts?
A) 2 years
B) 5 years
C) 10 years
D) 20 years
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Chapter 7: Swaps
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Q1) A floating-for-fixed currency swap is equivalent to A) Two interest rate swaps, one in each currency
B) A fixed-for-fixed currency swap and one interest rate swap
C) A fixed-for-fixed currency swap and two interest rate swaps, one in each currency
D) None of the above
Q2) When LIBOR is used as the discount rate
A) The value of a swap is worth zero immediately after a coupon payment
B) The value of a swap is worth zero immediately before a coupon payment
C) The value of the floating rate bond underlying a swap is worth par immediately after a coupon payment
D) The value of the floating rate bond underlying a swap is worth par immediately before a coupon payment
Q3) Which of the following is a typical bid-offer spread on the swap rate for a plain vanilla interest rate swap?
A) 3 basis points
B) 8 basis points
C) 13 basis points
D) 18 basis points
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9
Chapter 8: Securitization and the Credit Crisis of 2007
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Q1) What are teaser rates?
A) Interest rates that appear lower than they are
B) Interest rates that depend on LIBOR
C) Interest rates on mortgages with a very long amortization period
D) Interest rates that apply only for the first two or three years
Q2) Which of the following would be described by the term "liar loan"?
A) A situation where the lender concealed information from the borrower
B) A situation where the lender lied to the borrower about the interest rate
C) A situation where the borrower lied about his or her income
D) None of the above
Q3) Which of the following describes a waterfall?
A) A distribution of cash flows to tranches with priority given to tranche with the highest rating
B) A distribution of cash flows to tranches in proportion to their outstanding principals
C) A distribution of losses to tranches so that tranches bear losses in proportion to their outstanding principals
D) None of the above
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Chapter 9: Mechanics of Options Markets
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Q1) Which of the following describes LEAPS?
A) Options which are partly American and partly European
B) Options where the strike price changes through time
C) Exchange-traded stock options with longer lives than regular exchange-traded stock options
D) Options on the average stock price during a period of time
Q2) Which of the following is NOT traded by the CBOE?
A) Weeklys
B) Monthlys
C) Binary options
D) DOOM options
Q3) Which of the following is true?
A) A long call is the same as a short put
B) A short call is the same as a long put
C) A call on a stock plus a stock the same as a put
D) None of the above
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11
Chapter 10: Properties of Stock Options
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Q1) Which of the following is true when dividends are expected?
A) Put-call parity does not hold
B) The basic put-call parity formula can be adjusted by subtracting the present value of expected dividends from the stock price
C) The basic put-call parity formula can be adjusted by adding the present value of expected dividends to the stock price
D) The basic put-call parity formula can be adjusted by subtracting the dividend yield from the interest rate
Q2) Which of the following is true for American options?
A) Put-call parity provides an upper and lower bound for the difference between call and put prices
B) Put call parity provides an upper bound but no lower bound for the difference between call and put prices
C) Put call parity provides an lower bound but no upper bound for the difference between call and put prices
D) There are no put-call parity results
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Chapter 11: Trading Strategies Involving Options
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Q1) Six-month call options with strike prices of $35 and $40 cost $6 and $4, respectively. What is the maximum gain when a bull spread is created by trading a total of 200 options?
A) $100
B) $200
C) $300
D) $400
Q2) How can a strangle trading strategy be created?
A) Buy one call and one put with the same strike price and same expiration date
B) Buy one call and one put with different strike prices and same expiration date
C) Buy one call and two puts with the same strike price and expiration date
D) Buy two calls and one put with the same strike price and expiration date
Q3) Which of the following creates a bear spread?
A) Buy a low strike price put and sell a high strike price put
B) Buy a high strike price put and sell a low strike price put
C) Buy a high strike price call and sell a low strike price put
D) Buy a high strike price put and sell a low strike price call
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Chapter 12: Introduction to Binomial Trees
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Q1) A tree is constructed to value an option on an index which is currently worth 100 and has a volatility of 25%. The index provides a dividend yield of 2%. Another tree is constructed to value an option on a non-dividend-paying stock which is currently worth 100 and has a volatility of 25%.
A) The parameters p and u are the same for both trees
B) The parameter p is the same for both trees but u is not C) The parameter u is the same for both trees but p is not D) None of the above
Q2) The current price of a non-dividend-paying stock is $30. Over the next six months it is expected to rise to $36 or fall to $26. Assume the risk-free rate is zero. An investor sells call options with a strike price of $32. What is the value of each call option?
A) $1.6
B) $2.0
C) $2.4
D) $3.0
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14
Chapter 13: Valuing Stock Options: the Bsm Model
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Q1) Which of the following is a way of extending the Black-Scholes-Merton formula to value a European call option on a stock paying a single dividend?
A) Reduce the maturity of the option so that it equals the time of the dividend
B) Subtract the dividend from the stock price
C) Add the dividend to the stock price
D) Subtract the present value of the dividend from the stock price
Q2) What does N(x) denote?
A) The area under a normal distribution from zero to x
B) The area under a normal distribution up to x
C) The area under a normal distribution beyond x
D) The area under the normal distribution between -x and x
Q3) When there are two dividends on a stock, Black's approximation sets the value of an American call option equal to which of the following?
A) The value of a European option maturing just before the first dividend
B) The value of a European option maturing just before the second (final) dividend
C) The greater of the values in A and B
D) The greater of the value in B and the value assuming no early exercise
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Chapter 14: Employee Stock Options
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Q1) Which of the following are true of employee stock options?
A) They are commonly valued as though they are regular American options
B) They are commonly valued as though they are regular American options, but with a reduced life
C) They are commonly valued as though they are regular European option
D) They are commonly valued as though they are regular European options but with a reduced life
Q2) A company surprises the market with an announcement that it has granted stock options to senior executives. The options are exercised four years later. When does dilution take place?
A) Dilution takes place when the options are exercised
B) Dilution takes place on the announcement date
C) Dilution takes place gradually over the four years
D) There is no dilution
Q3) Which of the following increases the expected life of employee stock options?
A) An increase in the vesting period
B) An increase in employee turnover
C) A fast growth rate for the stock price
D) A tendency for employees to exercise earlier than in the past
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Page 16
Chapter 15: Options on Stock Indices and Currencies
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Q1) The domestic risk-free rate is 3%. The foreign risk-free rate is 5%. What is the risk-neutral growth rate of the exchange rate?
A) +2%
B) -2%
C) +5%
D) +3%
Q2) What is the size of one option contract on the S&P 500?
A) 250 times the index
B) 100 times the index
C) 50 times the index
D) 25 times the index
Q3) A European at-the-money call option on a currency has four years until maturity. The exchange rate volatility is 10%, the domestic risk-free rate is 2% and the foreign risk-free rate is 5%. The current exchange rate is 1.2000. What is the value of the option?
A) 1.11N(0.7)-0.98N(0.5)
B) 1.11N(-0.7)-0.98N(-0.5)
C) 1.11N(0.7)-0.98N(0.4)
D) 1.11N(-0.06)-0.98N(-0.10)
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17
Chapter 16: Futures Options
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Q1) Which of the following is acquired (in addition to a cash payoff) when the holder of a put futures exercises?
A) A long position in a futures contract
B) A short position in a futures contract
C) A long position in the underlying asset
D) A short position in the underlying asset
Q2) A futures price is currently 40 cents. It is expected to move up to 44 cents or down to 34 cents in the next six months. The risk-free interest rate is 6%. What is the probability of an up movement in a risk-neutral world?
A) 0.4
B) 0.5
C) 0.72
D) 0.6
Q3) What is the growth rate of an index futures price in the risk-neutral world?
A) The excess of the risk-free rate over the dividend yield
B) The risk-free rate
C) The dividend yield on the index
D) Zero
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Chapter 17: The Greek Letters
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Q1) What does gamma measure?
A) The rate of change of delta with the asset price
B) The rate of change of the portfolio value with the passage of time
C) The sensitivity of a portfolio value to interest rate changes
D) None of the above
Q2) Which of the following is true for a call option on a non-dividend-paying stock?
A) If the option is at the money (stock price equals strike price) it must have a delta of 0.5
B) If the strike price equals the forward price of the stock, it must have a delta of 0.5
C) If the option has a delta of 0.5, it must be out of the money
D) If the option has a delta of 0.5, it must be in of the money
Q3) Which of the following is NOT a letter in the Greek alphabet?
A) delta
B) rho
C) vega
D) gamma
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Chapter 18: Binomial Trees in Practice
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Q1) For an option on futures, the volatility is 35%, the time step is three months, and the risk-free rate is 5%. What is the Cox, Ross, Rubinstein parameter, u?
A) 1.34
B) 1.29
C) 1.09
D) 1.19
Q2) Which of the following cannot be estimated from a single binomial tree?
A) delta
B) gamma
C) theta
D) vega
Q3) Which of the following is possible in a modified Cox, Ross, Rubinstein binomial tree?
A) The interest rate and volatility can both be functions of time
B) The interest rate or the volatility can be a function of time, but not both
C) The interest rate can be a function of time but the volatility cannot
D) The interest rate and volatility must be constant
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20
Chapter 19: Volatility Smiles
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Q1) Which of the following causes a volatility smile that is a "frown"?
A) There is a small probability of a large stock price decrease in one week
B) There is a small probability of a large stock price increase in one week
C) The outcome of a lawsuit (roughly equal chance of being favorable or unfavorable) will create a large movement up or down in one week
D) None of the above
Q2) Which of the following is true of a volatility smile?
A) Implied volatility is on the horizontal axis and strike price is on the vertical axis
B) Historical volatility is on the horizontal axis and strike price is on the vertical axis
C) Implied volatility is on the vertical axis and strike price is on the horizontal axis
D) Historical volatility is on the vertical axis and strike price is on the horizontal axis
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Chapter 20: Value at Risk
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Q1) Which of the following is true of the 99.9% value at risk?
A) There is 1 chance in 10 that the loss will be greater than the value of risk
B) There is 1 chance in 100 that the loss will be greater than the value of risk
C) There is 1 chance in 1000 that the loss will be greater than the value of risk
D) None of the above
Q2) The 10-day VaR is often assumed to be which of the following?
A) The 1-day VaR multiplied by 10
B) The 1-day VaR multiplied by the square root of 10
C) The 1-day VaR divided by 10
D) The 1-day VaR divided by the square root of 10
Q3) Which of the following is true of the historical simulation method for calculating VaR?
A) It fits historical data on the behavior of variables to a normal distribution
B) It fits historical data on the behavior of variables to a lognormal distribution
C) It assumes that what will happen in the future is a random sample from what has happened in the past
D) It uses Monte Carlo simulation to create random future scenarios
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Page 22
Chapter 21: Interest Rate Options
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Q1) In put-call parity for caps and floors, which of the following is true?
A) Long cap plus long floor equals swap
B) Long cap plus swap equals short floor
C) Long cap equals long floor plus swap
D) Long cap minus long floor equals swaption
Q2) Which of the following is true?
A) A callable bond allows the lender to ask for the principal to be repaid early
B) A callable bond allows the borrower to repay the principal early
C) A callable bond is a bond with an embedded stock option
D) None of the above
Q3) Which of the following is true?
A) A swaption that gives the holder the right to pay fixed is equivalent to a call option on a bond
B) A swaption that gives the holder the right to pay fixed is equivalent to a put option on a bond
C) A swaption that gives the holder the right to pay fixed is equivalent to a put option on one bond combined with a call option on another bond
D) None of the above
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Chapter 22: Exotic Options and Other Nonstandard Products
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Q1) An Asian option is a term used to describe which of the following?
A) An option where the payoff depends on whether a barrier is hit
B) An option where the payoff depends on the average value of a variable over a period of time
C) An option that trades on an exchange in the Far East
D) Any option with a nonstandard payoff
Q2) Which of the following is the payoff from an average strike put option?
A) The excess of the strike price over the average stock price, if positive
B) The excess of the final stock price over the average stock price, if positive
C) The excess of the average stock price over the strike price, if positive
D) The excess of the average stock price over the final stock price, if positive
Q3) Which of the following are subject to prepayment risk?
A) Collateralized mortgage obligations
B) POs
C) IOs
D) All of the above
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Chapter 23: Credit Derivatives
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Q1) A CDS with a number of reference entities provides a payoff when any of the reference entities defaults. What is a name for this CDS?
A) Binary CDS
B) Add-up Basket CDS
C) First-to-Default CDS
D) n-to-Default CDS
Q2) Which of the following happens when the default correlation of the companies underlying a CDO increases?
A) The value of the senior tranche and the equity tranche to the protection buyer both increase
B) The value of the senior tranche and the equity tranche to the protection buyer both decrease
C) The value of the senior tranche to the protection buyer decreases and the value of the equity tranche to the protection buyer increases
D) The value of the senior tranche to the protection buyer increases and the value of the equity tranche to the protection buyer decreases
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Chapter 24: Weather, Energy, and Insurance Derivatives
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Q1) Which of the following describes a CAT bond?
A) Has a great deal of systematic risk
B) Has very little systematic risk
C) Has a moderate amount of systematic risk
D) Has negative systematic risk
Q2) Which of the following typically has the highest volatility?
A) Crude oil
B) Natural gas
C) Electricity
D) Sometimes crude oil and sometimes natural gas
Q3) Which of the following are products refined from crude oil?
A) Heating oil
B) Gasoline
C) Kerosene
D) All of the above
Q4) Which of the following are least likely to use weather derivatives?
A) Energy producers
B) Food and drink manufacturers
C) Companies in the leisure industry
D) Automobile manufacturers
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