Derivative Securities
Exam Materials
Course Introduction
This course offers an in-depth exploration of derivative securities, including forwards, futures, options, and swaps. Students will learn the fundamental principles of pricing, hedging, and risk management associated with these financial instruments. The curriculum covers valuation models such as the Black-Scholes-Merton framework, binomial models, and practical applications in financial markets. Emphasis is placed on understanding the role of derivatives in investment strategies and corporate risk management, as well as regulatory and ethical considerations in their use.
Recommended Textbook
Introduction to Derivatives and Risk Management 8th Edition by Don M. Chance
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16 Chapters
781 Verified Questions
781 Flashcards
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Chapter 1: Introduction
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Sample Questions
Q1) A forward contract has which of the following characteristics?
A)has a buyer and a seller
B)trades on an organized exchange
C)has a daily settlement
D)gives the right but not the obligation to buy
E)all of the above
Answer: A
Q2) Investors who do not consider risk in their decisions are said to be
A)speculating
B)short selling
C)risk neutral
D)traders
E)none of the above
Answer: C
Q3) Speculation is equivalent to gambling.
A)True
B)False
Answer: False
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Chapter 2: Structure of Options Markets
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Sample Questions
Q1) A writer selected to exercise an option is said to be
A)marginal
B)assigned
C)restricted
D)designated
E)none of the above
Answer: B
Q2) Index options trading on organized exchanges expire according to which of the following cycles?
A)March,June,September,and December
B)each of the next four consecutive months
C)the current month,the next month,and the next two months in one of the other cycles
D)every other month for each of the next nine months
E)none of the above
Answer: C
Q3) An out-of-the-money call option has an exercise price less than the stock price.
A)True
B)False
Answer: False
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Page 4
Chapter 3: Principles of Option Pricing
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Sample Questions
Q1) Which of the following statements about an American call is not true?
A)Its time value decreases as expiration approaches
B)Its maximum value is the stock price
C)It can be exercised prior to expiration
D)It pays dividends
E)none of the above
Answer: D
Q2) Put-call parity is a relationship that can be used to provide the price of both a European put and call simultaneously.
A)True
B)False
Answer: False
Q3) The difference between a Treasury bill's face value and its price is called the A)time value
B)discount
C)coupon rate
D)bid
E)none of the above
Answer: B
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Page 5
Chapter 4: Option Pricing Models: the Binomial Model
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Sample Questions
Q1) The binomial option pricing formula is based on the weighted average of the next two possible values,discounted back to the present.
A)True
B)False
Q2) A stock priced at 50 can go up or down by 10 percent over two periods.The risk-free rate is 4 percent.Which of the following is the correct price of an American put with an exercise price of 55?
A)7.88
B)3.38
C)4.00
D)5.00
E)1.65
Q3) When puts are priced with the binomial model,which of the following is true?
A)the puts must be American
B)the puts cannot be properly hedged
C)the puts will violate put-call parity
D)the hedge ratio is one throughout the tree
E)none of the above
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Chapter 5: Option Pricing Models: the
Black-Scholes-Merton Model
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Sample Questions
Q1) Vega captures the combined effects of time decay and volatility.
A)True
B)False
Q2) Which of the following statements about the delta is not true?
A)it ranges from zero to one
B)it converges to zero or one at expiration
C)it is given by N(d1)in the Black-Scholes-Merton model
D)it changes slowly near expiration if the option is at-the-money E)none of the above
Q3) What value does the Black-Scholes-Merton model predict for the call? (Due to differences in rounding your calculations may be slightly different."none of the above" should be selected only if your answer is different by more than 10 cents. )
A)5.35
B)1.10
C)4.73
D)6.50
E)none of the above
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Chapter 6: Basic Option Strategies
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Sample Questions
Q1) Buying a call with a lower exercise price offers a greater profit potential than one with a higher exercise price.
A)True B)False
Q2) An advantage of using a put over a short sale is that the short sale requires an uptick or zero-plus tick while a put does not.
A)True B)False
Q3) Buying a put is the mirror image of buying a call.
A)True B)False
Q4) In the context of insurance,protective put buyers who choose lower exercise prices are using higher deductibles.
A)True B)False
Q5) Both call and put writers have the potential for unlimited losses. A)True B)False
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Chapter 7: Advanced Option Strategies
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Sample Questions
Q1) What is the cost of the box spread?
A)$500
B)$2,018
C)$76
D)$484
E)none of the above
Q2) A call butterfly spread is a bullish strategy that is profitable if stock prices increase.
A)True
B)False
Q3) What is the maximum loss on the spread?
A)$500
B)$698
C)$198
D)$802
E)none of the above
Q4) A box spread is a combination of a call bull spread and a put bear spread.
A)True
B)False
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Page 9
Chapter 8: The Structure of Forward and Futures Markets
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Sample Questions
Q1) Which of the following duties is not performed by the clearinghouse?
A)holding margin deposits
B)guaranteeing performance of buyer and writer
C)maintaining records of transactions
D)lending money to meet margin requirements
E)none of the above
Q2) Most futures contracts are closed by
A)delivery
B)offset
C)exercise
D)default
E)none of the above
Q3) The clearinghouse is the middleman in a futures trade.
A)True
B)False
Q4) The federal regulator of the futures markets is the National Futures Association.
A)True
B)False
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Page 10
Chapter 9: Principles of Pricing Forwards, Futures, and Options on Futures
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Sample Questions
Q1) Find the value of a European put option on futures if the futures price is 72,the exercise price is 70,the continuously compounded risk-free rate is 8.5 percent,the volatility is .38 and the time to expiration is three months.
A)6.30
B)12.90
C)4.34
D)2.00
E)none of the above
Q2) Find the forward rate of foreign currency Y if the spot rate is $4.50,the domestic interest rate is 6 percent,the foreign interest rate is 7 percent,and the forward contract is for nine months.
A)$4.458
B)$5.104
C)$4.468
D)$4.532
E)none of the above
Q3) The daily settlement brings the value of a futures contract back to zero.
A)True
B)False
11
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Chapter 10: Futures Arbitrage Strategies
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Sample Questions
Q1) The coupon assumption for the conversion factor is 8 percent.
A)True
B)False
Q2) On the basis of liquidity,the best futures contract for hedging short-term interest rates is
A)Treasury bills
B)the prime rate
C)commercial paper
D)Eurodollars
E)none of the above
Q3) Find the annualized implied repo rate on a T-bond arbitrage if the spot price is 112.25,the accrued interest is 1.35,the futures price is 114.75,the CF is 1.0125,the accrued interest at delivery is 0.95,and the holding period is three months.
A)1.85 percent
B)0.77 percent
C)14.77 percent
D)13.04 percent
E)2.23 percent
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Chapter 11: Forward and Futures Hedging, Spread, and Target Strategies
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Sample Questions
Q1) An anticipatory hedge is one in which
A)the basis is expected to fall
B)the hedger expects to make a profit on the futures
C)the spot position will be taken in the future
D)all of the above
E)none of the above
Q2) Although a hedge might not be perfect,it should be partially effective if the spot and futures prices move in opposite directions.
A)True
B)False
Q3) An optimal hedge ratio is one in which the change in the futures price equals the change in the spot price.
A)True
B)False
Q4) Which of the following correctly expresses the profit on a hedge?
A)the basis when the hedge is closed
B)the change in the basis
C)the spot profit minus the futures profit
D)the futures profit minus the spot profit
E)none of the above
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Chapter 12: Swaps
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Sample Questions
Q1) A currency swap with no notional principal can be used to synthetically convert a bond issued in one currency into a bond issued in another currency.
A)True
B)False
Q2) The settlement period in a swap refers to the full life of the swap.
A)True
B)False
Q3) In an interest rate swap,the upcoming floating payment will not be determined until the end of the current settlement period.
A)True
B)False
Q4) A strategy to replicate an equity swap involving two stock indices is to buy one index and sell short the other.
A)True
B)False
Q5) The level of the stock is irrelevant to the pricing of equity swaps.
A)True
B)False
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Chapter 13: Interest Rate Forwards and Options
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Sample Questions
Q1) The Black model's accuracy in pricing interest rate options is greatest when the options have short maturities.
A)True
B)False
Q2) In an FRA on an m-day rate,payment is made when the interest rate is determined rather than m days later.
A)True
B)False
Q3) The pricing of a forward swap is done in the same manner as pricing a spot started today,except that forward rates are used instead of spot rates.
A)True
B)False
Q4) All of the following are uses of swaptions except
A)to speculate on interest rates
B)to give a firm flexibility in future borrowings
C)to borrow money
D)to create callable from non-callable bonds
E)none of the above
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Chapter 14: Advanced Derivatives and Strategies
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Sample Questions
Q1) In a weather derivative,the number of days times the average temperature above 65 degrees Fahrenheit is called
A)temperature day count
B)day-temps
C)cooling degree days
D)temp-days
E)heating degree days
Q2) A lookback call option provides the right
A)to change the stock on which the option is written
B)to buy the stock at its lowest price over the option's life
C)to insure a stock against loss
D)to change your mind about the exercise price
E)none of the above
Q3) What is the minimum value of the insured portfolio?
A)$16,672,344
B)$12,500,000
C)$12,091,709
D)$12,244,898
E)$13,375,000
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Page 16
Chapter 15: Financial Risk Management Techniques and Applications
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Sample Questions
Q1) Netting permits a firm to?
A)subtract losses from price increases from losses from price decreases
B)net its transactions with a given counterparty against each other
C)net all of its gains against all of its losses
D)all of the above
E)none of the above
Q2) Model risk can occur when the wrong pricing models are used.
A)True
B)False
Q3) Which of the following is approximately the Value at Risk at 5 percent of a portfolio of
$10 million of asset A,whose expected return is 15 percent and volatility is 35 percent,and $15 million of asset B,whose expected return is 21 percent and volatility is 30 percent,where the correlation between the two assets is 0.2.
A)$5.6 million
B)$10 million
C)$15 million
D)$1.25 million
E)none of the above
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Chapter 16: Managing Risk in an Organization
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Sample Questions
Q1) Under FAS 133 executive stock options must be accounted for as short call options.
A)True
B)False
Q2) An effective risk management system requires that the risk manager be independent of the derivatives traders.
A)True
B)False
Q3) 18.Transactions that do not qualify as hedges must be accounting for as speculation and marked to market each period.
A)True
B)False
Q4) Cash flow accounting must be used for all hedges involving cash outlays.
A)True
B)False
Q5) A fair value hedge is a transaction designed to protect the market value of an asset held.
A)True
B)False
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