Deck 9: Demystifying Derivatives

Question 1

Financial institutions use futures contracts as a means of

A) risk management.
B) expanding capital.
C) minimizing taxes.
D) increasing assets.

Answer 1

A

Question 2

The clearing corporation associated with the Chicago Board of Trade consists of

A) government regulatory bodies.
B) major commercial banks.
C) members of the exchange.
D) major corporations.

Answer 2

C

Question 3

If person A sells a 2003 Treasury bond futures contract to person B, in market terminology,

A) A is long and B is short.
B) A is short and B is long.
C) A is short and B is the broker.
D) A is long and B is the dealer.

Answer 3

B

Question 4

Traders in futures markets settle gains and losses each day.

A) by making margin payments.
B) by using settlement-by-offset.
C) in a process called mark-to-market settlement.
D) by making arbitrage payments.

Question 5

Which of the following is not a derivative?

A) Treasury bond futures
B) Common stock
C) Swaps
D) Options

Question 6

Futures contracts are least likely to be traded on which of the following exchanges?

A) New York Stock Exchange
B) Chicago Board of Trade
C) Chicago Mercantile Exchange
D) All of the above are equally likely to trade futures contracts.

Question 7

The precise terms of each futures contract are

A) negotiated by the long and the short.
B) set by the short position.
C) set by the long position.
D) established by the exchange on which the trade takes place.

Question 8

Which of the following futures contracts is available on the Chicago Board of Trade?

A) New York Stock Exchange Composite Index futures
B) Foreign currency futures
C) U.S. Treasury bonds
D) Value Line Market Index futures

Question 9

Which of the following is a derivative financial asset?

A) A mortgage
B) Commercial paper
C) A Treasury bill
D) A financial futures contract

Question 10

The Chicago Board of Trade promotes liquidity in the futures market by

A) setting prices.
B) establishing a price floor.
C) allowing the short or the long to renegotiate contract terms.
D) standardizing contract terms.

Question 11

An asset that derives its value from some other underlying asset is a

A) stock.
B) bond.
C) derivative.
D) CD.

Question 12

__________ trading volume promotes __________ bid-asked spreads.

A) Large; wide
B) Large; narrow
C) Small; narrow
D) None of the above.

Question 13

Which of the following futures contracts is available on the various commodity exchanges in the United States?

A) Treasury bond futures
B) Investment-grade bonds
C) Over-the-counter stocks
D) U.S. savings bonds

Question 14

For the settlement of futures contracts, the clearing corporation requires that a margin be placed with the corporation by

A) the short position only.
B) the long position only.
C) the short and the long in all contracts.
D) the short and the long only in extraordinary circumstances.

Question 15

Rather than accept delivery, most traders in futures markets choose

A) to make margin payments.
B) settlement by offset.
C) to mark-to-market.
D) to make arbitrage payments.

Question 16

Futures contracts are marked-to-market

A) every day.
B) every week.
C) every month.
D) every quarter.

Question 17

The price of a Treasury bond futures contract is set

A) by the federal government.
B) by the Chicago Board of Trade.
C) by the Federal Reserve.
D) as a result of bidding and offering by market participants.

Question 18

Futures contract prices are established

A) through an auction process in the "pit" on the exchange floor.
B) through brokers.
C) through an over-the-counter network of futures dealers.
D) through specialists on the stock and bond exchanges.

Question 19

In the financial futures quotations, the total number of long positions outstanding is called

A) settlements.
B) market activity.
C) open interest.
D) arbitrage.

Question 20

A(n)__________ is a standardized agreement that calls for the delivery of a specific underlying commodity or security at some future date at a currently agreed-upon price.

A) option contract
B) swap
C) futures contract
D) forward contract

Question 21

In the options market, the right to buy an underlying asset rests with

A) call buyers.
B) put buyers.
C) call sellers.
D) put sellers.

Question 22

The buyer of a put option on Boeing with a strike price of $75 and an expiration date in November 2003 has the

A) right to buy 100 shares of Boeing at $75 on or before November 1999.
B) right to sell 100 shares of Boeing at $75 on or before November 1999.
C) right to buy 100 shares of Boeing at $75 on or after November 1999.
D) right to sell 100 shares of Boeing at $75 on or after November 1999.

Question 23

Assume that the price of a futures contract is higher than the price of the underlying security during the delivery period. Arbitrageurs would

A) buy the futures, simultaneously sell the underlying asset, and pocket the price difference.
B) sell the futures, simultaneously buy the underlying asset, and pocket the price difference.
C) sell the futures, simultaneously sell the underlying asset, and pocket the price difference.
D) buy the futures, simultaneously buy the underlying asset, and pocket the price difference.

Question 24

An option premium is

A) paid by the short to the long as soon as the option is purchased.
B) paid by the long to the short as soon as the option is purchased.
C) paid by the long to the short when the option is exercised.
D) paid by the short to the long when the option is exercised.

Question 25

Puts and calls are the choices available to participants in the

A) options market.
B) futures market.
C) swap market.
D) stock market.

Question 26

Which of the following futures contracts would not have an interest rate component?

A) Treasury bonds
B) Treasury notes
C) Municipal Bond Index
D) Standard and Poor's 500 Stock Index

Question 27

A long put position

A) has a value of zero if the stock price is below the exercise price.
B) has a value equal to the stock price minus the exercise price if the stock price is above the exercise price.
C) has a value of zero if the stock price at the time of purchase exceeds the expected stock price at option expiration.
D) has a value equal to the exercise price minus the stock price if the stock price is below the exercise price.

Question 28

__________ buy or sell futures contracts to reduce their exposure to the risk of future price movements in the underlying asset.

A) Hedgers
B) Speculators
C) Arbitrageurs
D) None of the above.

Question 29

Speculators absorb additional risk in futures markets as a result of the actions taken by

A) longs.
B) hedgers.
C) brokers.
D) shorts.

Question 30

During the delivery period,

A) the futures price exceeds the price in the cash market.
B) the price in the cash market exceeds the futures price.
C) the futures price and the price in the cash market are equal.
D) there is no discernible relationship between the futures price and the price in the cash market.

Question 31

A call option has a strike price of $80. If the underlying stock is selling for $83 on the expiration date, the intrinsic value of the call option is __________ per share.

A) $163
B) $83
C) $3
D) $0

Question 32

Options on individual stocks are not listed on the

A) New York Stock Exchange.
B) American Stock Exchange.
C) Nasdaq.
D) Pacific Stock Exchange.

Question 33

The __________ is equal to the current stock price minus the option exercise price.

A) settlement price
B) discount price
C) intrinsic value
D) mark-to-market settlement

Question 34

The relationship between the price in the cash market and the price in the futures market is

A) nonexistent.
B) negative.
C) positive.
D) None of the above.

Question 35

In the futures market, the difference between the price of the futures and the underlying asset is eliminated by

A) speculators.
B) hedgers.
C) arbitrageurs.
D) longs.

Question 36

Which of the following statements is correct?

A) Option buyers have rights; option sellers have obligations.
B) Option sellers have rights; option buyers have obligations.
C) Option buyers and sellers have obligations but not rights.
D) Options buyers and sellers each have both rights and obligations.

Question 37

In order to reduce market risk associated with bonds held in inventory, a dealer can

A) take a long position in bond futures.
B) take a short position in bond futures.
C) purchase bonds at the mark-to-market settlement price.
D) use settlement by offset procedures.

Question 38

The price paid for an option is called the

A) settlement price.
B) mark-to-market price.
C) option premium.
D) call price.

Question 39

A call option has a strike price of $48. If the underlying stock is selling for $45 on the expiration date, the intrinsic value of the call option is __________ per share.

A) $93
B) $45
C) $3
D) $0

Question 40

The seller of a call option has the

A) right to buy shares at a specified price.
B) obligation to buy shares at a specified price if the option is exercised.
C) right to sell shares at a specified price.
D) obligation to sell shares at a specified price if the option is exercised.

Question 41

The fixed-rate payer in a swap contract pays a

A) current capital market rate.
B) capital market rate minus one percentage point.
C) capital market rate plus one percentage point.
D) capital market rate plus a premium based on creditworthiness.

Question 42

Swaps are __________ agreements involving the exchange of interest payments __________.

A) standardized; against a bundle of Treasury securities
B) standardized; on a stated notional principal amount
C) customized; against a bundle of Treasury securities
D) customized; on a stated notional principal amount

Question 43

The fixed rate in a swap contract is

A) a certain short rate in the market when the contract is signed.
B) a certain long rate in the market when the contract is signed.
C) negotiated by the parties in the contract.
D) the difference between stated long and short rates when the contract is signed.

Question 44

The value of the put option rises when the underlying asset

A) experiences price increases.
B) experiences price declines.
C) experiences reduced volatility.
D) has a relatively short maturity.

Question 45

The most popular floating rate in swaps is

A) LIBOR.
B) the Treasury note rate.
C) the prime rate.
D) the six-month Treasury bill rate.

Question 46

A speculator becomes the floating-rate payer in an interest-rate swap. She hopes that

A) long rates rise.
B) long rates fall.
C) short rates rise.
D) short rates fall.

Question 47

The strike price of a put option for a particular stock is $48. If the stock is selling for $45 on the expiration date, a put option on this stock has an intrinsic value of __________ per share.

A) $48
B) $45
C) $3
D) $0

Question 48

The __________ the price of the underlying stock, the __________ the call option premium will be.

A) higher; lower
B) lower; higher
C) lower; lower
D) None of the above.

Question 49

Which of the following pieces of information on individual stocks cannot be found in the options section of the financial news?

A) The closing price of the stock
B) Open interest
C) Option trading volume
D) Bid price

Question 50

A speculator may choose to buy a call option because

A) the possible gain is greater than with a futures contract.
B) the potential loss on the call is limited to the premium, while the potential loss is unlimited with a futures contract.
C) the possible gain with the option is great than the possible gain from buying the underlying stock itself.
D) calls eliminate the risk of loss so a speculator can lose nothing or just make a gain.

Question 51

For the buyer of a call option, the downside risk

A) is unlimited, but upside potential is limited.
B) is limited, but upside potential is unlimited.
C) and upside potential are unlimited.
D) and upside potential are limited.

Question 52

The parties to a swap are formally called the

A) counterparties.
B) optioners.
C) short and long positions.
D) bond- and billholders.

Question 53

To the options buyer, the premium paid for the contract represents the

A) maximum return.
B) largest potential loss.
C) yield.
D) transaction cost.

Question 54

A swap designed to compensate for mismatched securities is a type of __________ called a __________ swap.

A) speculation; currency
B) speculation; generic
C) hedging; London
D) hedging; plain vanilla

Question 55

Which of the following is not a determinant of option premiums?

A) The volatility of the underlying stock
B) The price of the underlying stock
C) The time to expiration of the option
D) All of the above are determinants of option premiums.

Question 56

A swap contract __________ be resold, which is particularly important for the __________ in swaps.

A) can; speculator
B) can; hedger
C) cannot; speculator
D) cannot; hedger

Question 57

A drop in six-month LIBOR is good news to __________ in a swap contract.

A) the fixed-rate payer
B) the floating-rate payer
C) both payers
D) neither payer

Question 58

A rise in six-month LIBOR is good news to __________ in a swap contract.

A) the fixed-rate payer
B) the floating-rate payer
C) both payers
D) neither payer

Question 59

The open interest on calls __________ the open interest on puts.

A) is always equal
B) is always larger
C) is always smaller
D) has no direct relationship with

Question 60

A speculator becomes the fixed-rate payer in an interest rate swap. He expects that

A) long rates rise.
B) long rates fall.
C) short rates rise.
D) short rates fall.

Question 61

A speculator who feels strongly that short rates will be rising over the next few years might want to be a __________ payer in a swap contract; if she is wrong there is __________ downside risk.

A) fixed-rate; no
B) fixed-rate; considerable
C) floating-rate; no
D) floating-rate; considerable

Question 62

A speculator who feels strongly that short rates will be falling over the next few years might want to be a __________ payer in a swap contract; if he is wrong there is __________ downside risk.

A) fixed-rate; no
B) fixed-rate; considerable
C) floating-rate; no
D) floating-rate; considerable