Applied Finance Exam
Bank
Course Introduction
Applied Finance explores the practical application of financial theories, models, and tools to real-world decision-making within businesses, investment institutions, and financial markets. The course covers key areas such as financial statement analysis, valuation techniques, capital budgeting, risk management, and portfolio optimization. Students will gain hands-on experience in analyzing financial data, assessing investment opportunities, managing corporate finance decisions, and understanding how financial strategies are implemented to maximize value in a dynamic economic environment.
Recommended Textbook
Fundamentals of Futures and Options Markets 9th Edition by John C. Hull
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Page 2
Chapter 1: Introduction
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Q1) Which of the following is NOT true about call and put options:
A) An American option can be exercised at any time during its life
B) A European option can only be exercised only on the maturity date
C) Investors must pay an upfront price (the option premium) for an option contract
D) The price of a call option increases as the strike price increases
Answer: D
Q2) The price of a stock on February 1 is $84. A trader buys 200 put options on the stock with a strike price of $90 when the option price is $10. The options are exercised when the stock price is $85. The trader's net profit or loss is
A) Loss of $1,000
B) Loss of $2,000
C) Gain of $200
D) Gain of $1000
Answer: A
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Chapter 2: Futures Markets and Central Counterparties
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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) Which of the following best describes central clearing parties
A) Help market participants to value derivative transactions
B) Must be used for all OTC derivative transactions
C) Are used for futures transactions
D) Perform a similar function to exchange clearing houses
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) Which of the following best describes the capital asset pricing model?
A) Determines the amount of capital that is needed in particular situations
B) Is used to determine the price of futures contracts
C) Relates the return on an asset to the return on a stock index
D) Is used to determine the volatility of a stock index
Answer: C
Q2) The basis is defined as spot minus futures. A trader is hedging the sale of an asset with a short futures position. The basis increases unexpectedly. Which of the following is true?
A) The hedger's position improves.
B) The hedger's position worsens.
C) The hedger's position sometimes worsens and sometimes improves.
D) The hedger's position stays the same.
Answer: A
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Chapter 4: Interest Rates
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Q1) At what interest rate does a government borrow in its own currency?
A) Treasury rate
B) LIBOR
C) LIBID
D) Repo rate
Q2) Under liquidity preference theory, which of the following is always true?
A) The forward rate is higher than the spot rate when both have the same maturity.
B) Forward rates are unbiased predictors of expected future spot rates.
C) The spot rate for a certain maturity is higher than the par yield for that maturity.
D) Forward rates are higher than expected future spot rates.
Q3) 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%
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6
Chapter 5: Determination of Forward and Futures Prices
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Q1) The spot price of an investment asset is $30 and the risk-free rate for all maturities is 10% with continuous compounding. The asset provides an income of $2 at the end of the first year and at the end of the second year. What is the three-year forward price?
A) $19.67
B) $35.84
C) $45.15
D) $40.50
Q2) The spot price of an investment asset that provides no income is $30 and the risk-free rate for all maturities (with continuous compounding) is 10%. What is the three-year forward price?
A) $40.50
B) $22.22
C) $33.00
D) $33.16
Q3) As the convenience yield increases, which of the following is true?
A) The one-year futures price as a percentage of the spot price increases
B) The one-year futures price as a percentage of the spot price decreases
C) The one-year futures price as a percentage of the spot price stays the same
D) Any of the above can happen
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Page 7
Chapter 6: Interest Rate Futures
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Q1) It is May 1. The quoted price of a bond with an Actual/Actual (in period) day count and 12% per annum coupon in the United States is 105. It has a face value of 100 and pays coupons on April 1 and October 1. What is the cash price??
A) 106.00
B) 106.02
C) 105.98
D) 106.04
Q2) The time-to-maturity of a Eurodollars futures contract is 4 years, and the time-to-maturity of the rate underlying the futures contract is 4.25 years. The standard deviation of the change in the short term interest rate, \(\sigma\) = 0.011. What is the difference between the futures and the forward interest rate.
A) 0.105%
B) 0.103%
C) 0.098%
D) 0.093%
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Chapter 7: Swaps
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Q1) Which of the following is a way of valuing interest rate swaps where LIBOR is exchanged for a fixed rate of interest?
A) Assume that floating payments will equal forward LIBOR rates and discount net cash flows at the risk-free rate
B) Assume that floating payments will equal forward OIS rates and discount net cash flows at the risk-free rate
C) Assume that floating payments will equal forward LIBOR rates and discount net cash flows at the swap rate
D) Assume that floating payments will equal forward OIS rates and discount net cash flows at the swap rate
Q2) Which of the following is a use of a currency swap?
A) To exchange an investment in one currency for an investment in another currency
B) To exchange borrowing in one currency for borrowings in another currency
C) To take advantage situations where the tax rates in two countries are different
D) All of the above
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9
Chapter 8: Securitization and the Credit Crisis of 2007
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Q1) Suppose that ABSs are created from portfolios of subprime mortgages with the following allocation of the principal to tranches: senior 94.5% (rated AAA), mezzanine 0.1% (rated BBB), and equity 5% (rated C) . The portfolios of subprime mortgages have the same default rates. An ABS CDO is then created from the mezzanine tranches. Which of the following is true?
A) The ABS CDO tranches should have similar ratings ranging from AAA to C
B) The ABS CDO tranches should all be rated BBB
C) The ABS CDO tranches should all be rated C
D) The ABS CDO tranches are almost worthless because the mezzanine tranches are so thin
Q2) 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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Page 10
Chapter 9: Mechanics of Options Markets
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Q1) An investor has exchange-traded put options to sell 100 shares for $20. There is 25% stock dividend. Which of the following is the position of the investor after the stock dividend?
A) Put options to sell 100 shares for $20
B) Put options to sell 75 shares for $25
C) Put options to sell 125 shares for $15
D) Put options to sell 125 shares for $16
Q2) 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
Q3) The price of a stock is $64. A trader buys 1 put option contract on the stock with a strike price of $60 when the option price is $10. When does the trader make a profit?
A) When the stock price is below $60
B) When the stock price is below $64
C) When the stock price is below $54
D) When the stock price is below $50
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Page 11
Chapter 10: Properties of Stock Options
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Q1) The price of a European call option on a 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. A dividend of $1 is expected in six months. What is the price of a one-year European put option on the stock with a strike price of $50?
A) $8.97
B) $6.97
C) $3.06
D) $1.12
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 is correct?
A) A diagonal spread can be created by buying a call and selling a put when the strike prices are the same and the times to maturity are different
B) A diagonal spread can be created by buying a put and selling a call when the strike prices are the same and the times to maturity are different
C) A diagonal spread can be created by buying a call and selling a call when the strike prices are different and the times to maturity are different
D) A diagonal spread can be created by buying a call and selling a call when the strike prices are the same and the times to maturity are different
Q2) A trader creates a long butterfly spread from options with strike prices $60, $65, and $70 by trading a total of 400 options. The options are worth $11, $14, and $18. What is the maximum net gain (after the cost of the options is taken into account)?
A) $100
B) $200
C) $300
D) $400
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13
Chapter 12: Introduction to Binomial Trees
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Q1) Which of the following describes how American options can be valued using a binomial tree?
A) Check whether early exercise is optimal at all nodes where the option is in-the-money
B) Check whether early exercise is optimal at the final nodes
C) Check whether early exercise is optimal at the penultimate nodes and the final nodes
D) None of the above
Q2) The current price of a non-dividend paying stock is $30. Use a two-step tree to value a European put option on the stock with a strike price of $32 that expires in 6 months. Each step is 3 months, the risk free rate is 8%, and u = 1.1 and d = 0.9.
A) $2.24
B) $2.44
C) $2.64
D) $2.84
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Chapter 13: Valuing Stock Options: the Bsm Model
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Q1) A stock provides an expected return of 10% per year and has a volatility of 20% per year. What is the continuously compounded expected return in one year?
A) 6%
B) 8%
C) 10%
D) 12%
Q2) When the Black-Scholes-Merton and binomial tree models are used to value an option on a non-dividend-paying stock, which of the following is true?
A) The binomial tree price converges to a price slightly above the Black-Scholes-Merton price as the number of time steps is increased
B) The binomial tree price converges to a price slightly below the Black-Scholes-Merton price as the number of time steps is increased
C) Either A or B can be true
D) The binomial tree price converges to the Black-Scholes-Merton price as the number of time steps is increased
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Chapter 14: Employee Stock Options
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Q1) What term is used to describe losses shareholders experience because the interests of managers are not aligned with their own?
A) Agency costs
B) Backdating scandals
C) Dilution
D) Income statement expense
Q2) 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.
Q3) 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
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Page 16
Chapter 15: Options on Stock Indices and Currencies
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Q1) A portfolio manager in charge of a portfolio worth $10 million is concerned that the market might decline rapidly during the next six months and would like to use options on an index to provide protection against the portfolio falling below $9.5 million. The index is currently standing at 500 and each contract is on 100 times the index. What should the strike price of options on the index be the portfolio has a beta of 0.5? Assume that the risk-free rate is 10% per annum and the dividend yield on both the portfolio and the index is 2% per annum.
A) 400
B) 410
C) 420
D) 430
Q2) Which of the following is NOT true about a range forward contract?
A) It ensures that the exchange rate for a future transaction will lie between two values
B) It can be structured so that it costs nothing to set up
C) It is constructed from two options and a forward contract
D) It can be used to hedge either a future inflow or a future outflow of a foreign currency
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Chapter 16: Futures Options and Blacks Model
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Q1) Which of the following is true?
A) A futures option is settled daily
B) A futures-style option is settled daily
C) Both a futures option and a futures-style option are settled daily
D) Neither a futures option nor a futures-style option is settled daily
Q2) 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
Q3) Which of the following is true about a futures option and a spot option on the same underlying asset with an identical strike price and expiration date?
A) A European call spot option and an American call futures option are equivalent
B) An American call spot option and a European call futures option are equivalent
C) A European put spot option and European put futures option are equivalent
D) An American put spot option and American put futures option are equivalent
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18
Chapter 17: The Greek Letters
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Q1) A call option on a stock has a delta of 0.3. A trader has sold 1,000 options. What position should the trader take to hedge the position?
A) Sell 300 shares
B) Buy 300 shares
C) Sell 700 shares
D) Buy 700 shares
Q2) Which of the following could NOT be a delta-neutral portfolio?
A) A long position in call options plus a short position in the underlying stock
B) A short position in call options plus a short position in the underlying stock
C) A long position in put options and a long position in the underlying stock
D) A long position in a put option and a long position in a call option
Q3) A portfolio of derivatives on a stock has a delta of 2400 and a gamma of -10. An option on the stock with a delta of 0.5 and a gamma of 0.04 can be traded. What position in the option is necessary to make the portfolio gamma neutral?
A) Long position in 250 options
B) Short position in 250 options
C) Long position in 20 options
D) Short position in 20 options
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Chapter 18: Binomial Trees in Practice
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Q1) Which of the following cannot be estimated from a single binomial tree?
A) delta
B) gamma
C) theta
D) vega
Q2) Which of the following describes the way that the parameters in a binomial tree are chosen?
A) The expected return during each time step is the risk-free rate
B) The standard deviation of the return in each time step is, for small time steps, almost exactly equal to the volatility per annum times the square root of the length on the time step in years
C) The tree recombines
D) All of the above
Q3) How many nodes are there at the end of a Cox-Ross-Rubinstein five-step binomial tree?
A) 4
B) 5
C) 6
D) 7
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Page 20
Chapter 19: Volatility Smiles
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Q1) Which of the following is true as time to maturity increases?
A) The volatility smile for currency options tends to become more pronounced
B) The volatility smile for currency options tends to become less pronounced
C) The volatility smile for currency options first becomes less pronounced and then becomes more pronounced
D) The volatility smile for currency options remains approximately the same
Q2) Why do traders use volatility smiles for pricing options?
A) To allow for non-lognormality of the probability distribution of future asset price
B) Because it is consistent with recent market moves
C) As a tool to reflect their views about extreme market moves
D) Because extreme market moves are always more likely than Black-Scholes-Merton assumes
Q3) Which of the following is true?
A) The volatility skew for equities is much more pronounced now than it was in 1985.
B) The volatility skew for equities has a positive gradient
C) The volatility skew for equities is consistent with the Black-Scholes-Merton model.
D) The volatility skew for equities is similar to that for foreign currencies.
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21
Chapter 20: Value at Risk and Expected Shortfall
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Q1) What is the method of testing how often a VaR with a certain confidence level was exceeded in the past called?
A) Stress testing
B) Backtesting
C) EWMA
D) The model-building approach
Q2) 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
Q3) Which was the minimum capital requirement for market risk in the 1996 BIS Amendment?
A) At least 3 times the 10-day VaR with a 99% confidence level
B) At least 3 times 7-day VaR with a 97% confidence level
C) At least 2 times 5-day VaR with a 95% confidence level
D) 1-day VaR with a 99% confidence level
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Chapter 21: Interest Rate Options
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Q1) Which of the following is assumed to be lognormal when a swap option is valued?
A) A future bond price
B) A future swap rate
C) A future short-term rate
D) A future bond yield
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) 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
Q4) Which of the following is true?
A) A puttable bond allows the lender to ask for the principal to be repaid early
B) A puttable bond allows the borrower to repay the principal early
C) A puttable bond is a bond with an embedded stock option
D) None of the above
Page 23
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Chapter 22: Exotic Options and Other Nonstandard Products
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Q1) When can Bermudan options be exercised?
A) Any time during the life of the options
B) Any time after a certain date up to the end of the life of the life
C) Any time before a certain date or at the end of the option's life
D) On dates specified at the start of the option
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 a five-year interest rate swap that can be canceled at the two year point?
A) The difference between two plain vanilla interest rate swaps
B) The difference between a plain vanilla interest rate swap and a forward start swap
C) A regular interest rate swap plus a European swap option
D) A regular interest rate swap plus a Bermudan swap option
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Page 24
Chapter 23: Credit Derivatives
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Q1) 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
Q2) In the Lehman bankruptcy the payoff to people who had bought CDS protection was 91.375% of the notional principal. How was this determined?
A) By calculation of the cheapest-to-deliver bond
B) By an auction process
C) By a calculation agent
D) By Lehman's liquidators
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25
Chapter 24: Weather, Energy, and Insurance Derivatives
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Q1) Which of the following is the average of CDD and HDD for a day?
A) The highest temperature during the day
B) The lowest temperature during the day
C) The average temperature during the day
D) None of the above
Q2) Which of the following is NOT seasonal?
A) Spot electricity
B) Spot natural gas
C) Electricity futures prices
D) Spot price of corn
Q3) Which of the following describes a typical reinsurance contract?
A) Covers a percentage of all losses by an insurance company
B) Covers all losses of the insurance company up to a certain amount
C) Covers all losses of the insurance company above a certain amount
D) Covers all losses of the insurance company between two amounts
Q4) 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
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