Advanced Investments
Exam Review
Course Introduction
Advanced Investments delves into the sophisticated strategies and analytical techniques employed in contemporary investment management. The course covers topics such as asset pricing models, portfolio construction, behavioral finance, derivatives, and risk management. Students explore the application of quantitative methods for security analysis, assessment of market efficiency, and performance evaluation. Real-world case studies and simulations provide practical experience in constructing and managing diversified portfolios, analyzing market trends, and optimizing return relative to risk. By the end of the course, students gain the theoretical knowledge and practical tools necessary for making informed investment decisions in complex financial markets.
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) Which of the following is NOT true?
A) When a CBOE call option on IBM is exercised, IBM issues more stock
B) An American option can be exercised at any time during its life
C) An call option will always be exercised at maturity if the underlying asset price is greater than the strike price
D) A put option will always be exercised at maturity if the strike price is greater than the underlying asset price
Answer: A
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) 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
Q2) A haircut of 20% means that
A) A bond with a market value of $100 is considered to be worth $80 when used to satisfy a collateral request
B) A bond with a face value of $100 is considered to be worth $80 when used to satisfy a collateral request
C) A bond with a market value of $100 is considered to be worth $83.3 when used to satisfy a collateral request
D) A bond with a face value of $100 is considered to be worth $83.3 when used to satisfy a collateral request
Answer: A
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4
Chapter 3: Hedging Strategies Using Futures
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Q1) A company has a $36 million portfolio with a beta of 1.2. The futures price for a contract on an index is 900. Futures contracts on $250 times the index can be traded. What trade is necessary to reduce beta to 0.9?
A) Long 192 contracts
B) Short 192 contracts
C) Long 48 contracts
D) Short 48 contracts
Answer: D
Q2) Which of the following best describes "stack and roll"?
A) Creates long-term hedges from short term futures contracts
B) Can avoid losses on futures contracts by entering into further futures contracts
C) Involves buying a futures contract with one maturity and selling a futures contract with a different maturity
D) Involves two different exposures simultaneously
Answer: A
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Chapter 4: Interest Rates
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Q1) An interest rate is 5% per annum with continuous compounding. What is the equivalent rate with semiannual compounding?
A) 5.06%
B) 5.03%
C) 4.97%
D) 4.94%
Q2) 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
Q3) The zero curve is downward sloping. Define X as the 1-year par yield, Y as the 1-year zero rate and Z as the forward rate for the period between 1 and 1.5 year. Which of the following is true?
A) X is less than Y which is less than Z
B) Y is less than X which is less than Z
C) X is less than Z which is less than Y
D) Z is less than Y which is less than X
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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 futures 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 futures 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 futures prices
Q2) Which of the following is true for a consumption commodity?
A) There is no limit to how high or low the futures price can be, except that the futures price cannot be negative
B) There is a lower limit to the futures price but no upper limit
C) There is an upper limit to the futures price but no lower limit, except that the futures price cannot be negative
D) The futures price can be determined with reasonable accuracy from the spot price and interest rates
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Chapter 6: Interest Rate Futures
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Q1) Duration matching immunizes a portfolio against
A) Any parallel shift in the yield curve
B) All shifts in the yield curve
C) Changes in the steepness of the yield curve
D) Small parallel shifts in the yield curve
Q2) How much is a basis point?
A) 1.0%
B) 0.1%
C) 0.01%
D) 0.001%
Q3) Which of the following day count conventions applies to a US Treasury bond?
A) Actual/360
B) Actual/Actual (in period)
C) 30/360
D) Actual/365
Q4) 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
Page 8
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Chapter 7: Swaps
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Q1) Since the 2008 credit crisis
A) LIBOR has replaced OIS as the discount rate for non-collateralized swaps
B) OIS has replaced LIBOR as the discount rate for non-collateralized swaps
C) LIBOR has replaced OIS as the discount rate for collateralized swaps
D) OIS has replaced LIBOR as the discount rate for collateralized swaps
Q2) Which of the following describes a 3-month overnight indexed swap (OIS)?
A) A fixed rate is exchanged for the overnight rate every day for three months
B) LIBOR is exchanged for the overnight rate every day for three months
C) The arithmetic average of overnight rates is exchanged for a fixed rate at the end of three months
D) The geometric average of overnight rates is exchanged for a fixed rate at the end of three months
Q3) A company can invest funds for five years at LIBOR minus 30 basis points. The five-year swap rate is 3%. What fixed rate of interest can the company earn by using the swap?
A) 2.4%
B) 2.7%
C) 3.0%
D) 3.3%
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Page 9
Chapter 8: Securitization and the Credit Crisis of 2007
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Q1) Which of the following is NOT true?
A) The bonus structure at banks can lead to short-term horizons for decision making
B) Securitization involves the transfer of risk
C) The term "agency costs" describes the situation where the incentives of two parties in a business relationship are not perfectly aligned
D) Correlations decrease in stressed market conditions
Q2) Which of the following is true of a non-recourse mortgage?
A) The house buyer, if unable to make payments, can lose all possessions
B) The house buyer has an American style put option on the house
C) The house buyer has a European style put option on the house
D) The lender is less likely to lose money on the mortgage
Q3) AIG lost money because
A) It bought tranches created from mortgages
B) It invested heavily in real estate
C) It invested heavily in the stock market
D) It insured AAA tranches of ABS CDOs
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Chapter 9: Mechanics of Options Markets
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Q1) Which of the following describes a call option?
A) The right to buy an asset for a certain price
B) The obligation to buy an asset for a certain price
C) The right to sell an asset for a certain price
D) The obligation to sell an asset for a certain price
Q2) Which of the following are true for CBOE stock options?
A) There are no margin requirements
B) The initial margin and maintenance margin are determined by formulas and are equal
C) The initial margin and maintenance margin are determined by formulas and are different
D) The maintenance margin is usually about 75% of the initial margin
Q3) Which of the following is an example of an option series?
A) All calls on a certain stock
B) All calls with a particular strike price on a certain stock
C) All calls with a particular time to maturity on a certain stock
D) All calls with a particular time to maturity and strike price on a certain stock
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Chapter 10: Properties of Stock Options
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Q1) 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
Q2) The price of a European call option on a non-dividend-paying stock with a strike price of $50 is $6. The stock price is $51, the continuously compounded risk-free rate (all maturities) is 6% and the time to maturity is one year. What is the price of a one-year European put option on the stock with a strike price of $50?
A) $9.91
B) $7.00
C) $6.00
D) $2.09
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Chapter 11: Trading Strategies Involving Options
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Q1) Which of the following describes a covered call?
A) A long call option on a stock plus a long position in the stock
B) A long call option on a stock plus a short put option on the stock
C) A short call option on a stock plus a short position in the stock
D) A short call option on a stock plus a long position in the stock
Q2) How can a strip 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) How can a strap 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
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Chapter 12: Introduction to Binomial Trees
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Q1) Which of the following is NOT true in a risk-neutral world?
A) The expected return on a call option is independent of its strike price
B) Investors expect higher returns to compensate for higher risk
C) The expected return on a stock is the risk-free rate
D) The discount rate used for the expected payoff on an option is the risk-free rate
Q2) The current price of a non-dividend paying stock is $50. Use a two-step tree to value an American put option on the stock with a strike price of $48 that expires in 12 months. Each step is 6 months, the risk free rate is 5% per annum, and the volatility is 20%. Which of the following is the option price?
A) $1.95
B) $2.00
C) $2.05
D) $2.10
Q3) In a binomial tree created to value an option on a stock, the expected return on stock is
A) Zero
B) The return required by the market
C) The risk-free rate
D) It is impossible to know without more information
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Page 14
Chapter 13: Valuing Stock Options: the Bsm Model
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Q1) Which of the following is a definition of volatility?
A) The standard deviation of the return, measured with continuous compounding, in one year
B) The variance of the return, measured with continuous compounding, in one year
C) The standard deviation of the stock price in one year
D) The variance of the stock price in one year
Q2) 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
Q3) A stock price is 20, 22, 19, 21, 24, and 24 on six successive Fridays. Which of the following is closest to the volatility per annum estimated from this data?
A) 50%
B) 60%
C) 70%
D) 80%
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Chapter 14: Employee Stock Options
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Q1) Which of the following is NOT usually true about employee stock options?
A) There is a vesting period
B) They can be sold to other employees
C) They are often at-the-money when issued
D) Their value is currently a charge to the income statement
Q2) Which of the following is true about the practice of backdating a stock options grant?
A) It is illegal
B) It is illegal in the majority of states in the U.S., but not all states
C) It is illegal in roughly half the states in the U.S.
D) It is unethical, but not illegal
Q3) Which of the following hypotheses is supported by empirical research?
A) The grant date for executive stock options tends to be when the stock price is high
B) The grant date for executive stock options tends to be when the stock price is low
C) The grant date for executive stock options tends to be after a growth spurt in the stock price
D) The is no relationship between the timing of grants and the stock price
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Chapter 15: Options on Stock Indices and Currencies
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Q1) Which of the following describes what a company should do to create a range forward contract in order to hedge foreign currency that will be paid?
A) Buy a put and sell a call on the currency with the strike price of the put higher than that of the call
B) Buy a put and sell a call on the currency with the strike price of the put lower than that of the call
C) Buy a call and sell a put on the currency with the strike price of the put higher than that of the call
D) Buy a call and sell a put on the currency with the strike price of the put lower than that of the call
Q2) Index put options are used to provide protection against the value of the portfolio falling below a certain level. Which of the following is true as the beta of the portfolio increases?
A) The cost of hedging increases
B) The options require a lower strike price
C) The number of options required increases
D) All of the above
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Chapter 16: Futures Options
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Q1) Which of the following are true?
A) Futures options are usually European
B) Futures options are usually American
C) Both American and European futures options trade actively are exchanges
D) Both American and European futures options trade actively in the OTC market
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 value of a six-month put option with a strike price of 37 cents?
A) 3.00 cents
B) 2.91 cents
C) 1.16 cents
D) 1.20 cents
Q3) 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
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18
Chapter 17: The Greek Letters
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Q1) What does rho 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) A call option on a non-dividend-paying stock has a strike price of $30 and a time to maturity of six months. The risk-free rate is 4% and the volatility is 25%. The stock price is $28. What is the delta of the option?
A) N(-0.1342)
B) N(-0.1888)
C) N(-0.2034)
D) N(-0.2241)
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Chapter 18: Binomial Trees in Practice
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Q1) What is the recommended way of making interest rates a function of time in a Cox, Ross, Rubinstein tree?
A) Make u a function of time
B) Make p a function of time
C) Make u and p a function of time
D) Make the lengths of the time steps unequal
Q2) 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, p?
A) 0.52
B) 0.46
C) 0.48
D) 0.50
Q3) Which of the following cannot be estimated from a single binomial tree?
A) delta
B) gamma
C) theta
D) vega
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Chapter 19: Volatility Smiles
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Q1) 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
Q2) Which of the following could cause the volatility smile typically seen for foreign currency options?
A) Currencies are traded in different countries at different times of the day
B) Currencies tend to have low volatilities
C) The activities of central banks causes occasional jumps in the exchange rate
D) Interest rates may be different in the two countries
Q3) Which of the following is true?
A) Volatility smile for European puts is the same as for European calls
B) Volatility smile for European puts is the same as for American puts
C) Volatility smile for European calls is the same as for American calls
D) Volatility smile for American puts is the same as for American calls
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Chapter 20: Value at Risk
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Q1) If the volatility for a portfolio is 20% per year, what is the volatility per quarter?
A) 20%
B) 10%
C) 5%
D) 2%
Q2) 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
Q3) The gain from a project is equally likely to have any value between -$0.15 million and +$0.85 million. What is the 99% value at risk?
A) $0.145 million
B) $0.14 million
C) $0.13 million
D) $0.10 million
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Chapter 21: Interest Rate Options
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Q1) A Eurodollar futures option contract has a strike price of 97 and the Eurodollar interest rate is 2.50%. What is the intrinsic value of the contract if the option is a call?
A) $0
B) $1,250
C) $1,750
D) $2,500
Q2) At the maturity of a bond option, it is estimated that the underlying bond will have a duration of 6 years and a yield of 5%. The forward yield volatility is quoted as 25%. What is the volatility of the forward bond price?
A) 3%
B) 30%
C) 20.8%
D) 7.5%
Q3) 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
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Chapter 22: Exotic Options and Other Nonstandard Products
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Q1) There are two types of regular options (calls and puts). How many types of barrier options are there?
A) Two
B) Four
C) Six
D) Eight
Q2) In a LIBOR-in-arrears swap, which of the following is true?
A) The floating payment made on a date is the LIBOR rate on the previous payment date
B) The floating payment on a date is the LIBOR rate two payment dates ago
C) The floating payment on a date is the LIBOR rate on that date
D) The floating payment on a date is the LIBOR rate on that date only when it is higher than the LIBOR rate on the previous payment date
Q3) 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
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Page 24
Chapter 23: Credit Derivatives
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Q1) If the CDS-bond basis is X minus Y, what are X and Y?
A) X is the CDS spread and Y is the excess of the bond yield over the swap rate
B) X is the excess of the bond yield over the swap rate and Y is the CDS spread
C) X is the CDS spread and Y is the excess of the bond yield over the Treasury rate
D) X is the excess of the bond yield over the Treasury rate and Y is the CDS spread
Q2) If a tranche spread is 55 basis points and the fixed coupon is 60 basis points, which of the following happens when a trader buys protection?
A) The trader pays an estimate of the present value of 5 basis points per year and then pays 55 basis points per year
B) The trader pays an estimate of the present value of 5 basis points per year and then pays 60 basis points per year
C) The trader receives an estimate of the present value of 5 basis points per year and then pays 55 basis points per year
D) The trader receives an estimate of the present value of 5 basis points per year and then pays 60 basis points per year
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Chapter 24: Weather, Energy, and Insurance Derivatives
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Q1) When a reinsurer covers the layer of hurricane losses for an insurance company between $20 million and $30 million, which of the following describes the insurance company's losses?
A) A bull spread on total hurricane losses
B) A bear spread on total hurricane losses
C) A long call option on total hurricane losses
D) A short put option on total hurricane losses
Q2) Which of the following is the basis for calculating HDD and CDD?
A) The average temperature during the day
B) The average of the highest and lowest temperature during the day
C) The temperature at 12 noon during the day
D) None of the above
Q3) Which of the following is a common use of weather derivatives?
A) Hedge the volume of electricity that will be demanded by customers in the summer
B) Hedge the price of oil that must be purchased in the winter
C) Hedge the price of electricity that must be purchased in the summer
D) Hedge the price and volume of gas that must be purchased for heating in the winter
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