Corporate Finance
Exam Materials
Course Introduction
Corporate Finance explores the fundamental principles and strategies involved in financial decision-making within corporations. The course covers key topics such as capital structure, risk and return analysis, valuation of financial assets, capital budgeting, dividend policy, working capital management, and mergers and acquisitions. Students will learn how corporations raise capital, allocate resources, and maximize shareholder value by analyzing both theoretical frameworks and real-world case studies. Emphasis is placed on understanding financial markets, ethical considerations, and the impact of financial decisions on an organization's performance and long-term strategy.
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 best describes a central clearing party?
A) It is a trader that works for an exchange
B) It stands between two parties in the over-the-counter market
C) It is a trader that works for a bank
D) It helps facilitate futures trades
Answer: B
Q3) 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
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3
Chapter 2: Mechanics of Futures Markets
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Q1) A company enters into a long futures contract to buy 1,000 units of a commodity for $60 per unit. The initial margin is $6,000 and the maintenance margin is $4,000. What futures price will allow $2,000 to be withdrawn from the margin account?
A) $58
B) $62
C) $64
D) $66
Answer: B
Q2) Margin accounts have the effect of
A) Reducing the risk of one party regretting the deal and backing out
B) Ensuring funds are available to pay traders when they make a profit
C) Reducing systemic risk due to collapse of futures markets
D) All of the above
Answer: D
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Chapter 3: Hedging Strategies Using Futures
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Q1) Futures contracts trade with every month as a delivery month. A company is hedging the purchase of the underlying asset on June 15. Which futures contract should it use?
A) The June contract
B) The July contract
C) The May contract
D) The August contract
Answer: B
Q2) Suppose that the standard deviation of monthly changes in the price of commodity A is $2. The standard deviation of monthly changes in a futures price for a contract on commodity B (which is similar to commodity A) is $3. The correlation between the futures price and the commodity price is 0.9. What hedge ratio should be used when hedging a one month exposure to the price of commodity A?
A) 0.60
B) 0.67
C) 1.45
D) 0.90
Answer: A
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Page 5
Chapter 4: Interest Rates
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Q1) An interest rate is 6% per annum with annual compounding. What is the equivalent rate with continuous compounding?
A) 5.79%
B) 6.21%
C) 5.83%
D) 6.18%
Q2) Prior to the credit crisis that started in 2007 which of the following was the proxy used by derivatives traders for the risk-free rate?
A) The Treasury rate
B) The LIBOR rate
C) The repo rate
D) The overnight indexed swap rate
Q3) Which of the following is true of LIBOR?
A) The LIBOR rate is free of credit risk
B) A LIBOR rate is lower than the Treasury rate when the two have the same maturity
C) It is a rate used when borrowing and lending takes place between banks
D) It is subject to favorable tax treatment in the U.S.
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6
Chapter 5: Determination of Forward and Futures Prices
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Q1) What should a trader do when the one-year forward price of an asset is too low? Assume that the asset provides no income.
A) The trader should borrow the price of the asset, buy one unit of the asset and enter into a short forward contract to sell the asset in one year
B) The trader should borrow the price of the asset, buy one unit of the asset and enter into a long forward contract to buy the asset in one year
C) The trader should short the asset, invest the proceeds of the short sale at the risk-free rate, enter into a short forward contract to sell the asset in one year
D) The trader should short the asset, invest the proceeds of the short sale at the risk-free rate, enter into a long forward contract to buy the asset in one year
Q2) Which of the following describes contango?
A) The futures price is below the expected future spot price
B) The futures price is below today's spot price
C) The futures price is a declining function of the time to maturity
D) The futures price is above the expected future spot price
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Chapter 6: Interest Rate Futures
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Q1) A portfolio is worth $24,000,000. The futures price for a Treasury note futures contract is 110 and each contract is for the delivery of bonds with a face value of $100,000. On the delivery date the duration of the bond that is expected to be cheapest to deliver is 6 years and the duration of the portfolio will be 5.5 years. How many contracts are necessary for hedging the portfolio?
A) 100
B) 200
C) 300
D) 400
Q2) 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
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8
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) 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
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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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) Suppose that ABSs are created from portfolios of subprime mortgages with the following allocation of the principal to tranches: senior 85%, mezzanine 10%, and equity 5%. (The portfolios of subprime mortgages have the same default rates.) An ABS CDO is then created from the mezzanine tranches with the same allocation of principal. How high can losses on the mortgages be before the senior tranche of the ABS CDO bears losses?
A) 5.5%
B) 6.0%
C) 6.5%
D) 7.0%
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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) Consider a put option and a call option with the same strike price and time to maturity. Which of the following is true?
A) It is possible for both options to be in the money
B) It is possible for both options to be out of the money
C) One of the options must be in the money
D) One of the options must be either in the money or at the money
Q3) 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
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Chapter 10: Properties of Stock Options
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Q1) 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
Q2) When dividends increases with all else remaining the same, which of the following is true?
A) Both calls and puts increase in value
B) Both calls and puts decrease in value
C) Calls increase in value while puts decrease in value
D) Puts increase in value while calls decrease in value
Q3) Which of the following best describes the intrinsic value of an option?
A) The value it would have if the owner were forced to exercise immediately
B) The Black-Scholes-Merton price of the option
C) The lower bound for the option's price
D) The amount paid for the option
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Page 12
Chapter 11: Trading Strategies Involving Options
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Q1) Which of the following describes a protective put?
A) A long put option on a stock plus a long position in the stock
B) A long put option on a stock plus a short position in the stock
C) A short put option on a stock plus a short call option on the stock
D) A short put option on a stock plus a long position in the stock
Q2) Which of the following creates a bull 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
Q3) 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
Q4) Which of the following creates a bear spread?
A) Buy a low strike price call and sell a high strike price call
B) Buy a high strike price call and sell a low strike price call
C) Buy a low strike price call and sell a high strike price put
D) Buy a low strike price put and sell a high strike price call
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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. 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 measured by the VIX index?
A) Implied volatilities for stock options trading on the CBOE
B) Historical volatilities for stock options trading on CBOE
C) Implied volatilities for options trading on the S&P 500 index
D) Historical volatilities for options trading on the S&P 500 index
Q2) An investor has earned 2%, 12% and -10% on equity investments in successive years (annually compounded). This is equivalent to earning which of the following annually compounded rates for the three year period.
A) 1.33%
B) 1.23%
C) 1.13%
D) 0.93%
Q3) A stock price is $100. Volatility is estimated to be 20% per year. What is an estimate of the standard deviation of the change in the stock price in one week?
A) $0.38
B) $2.77
C) $3.02
D) $0.76
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15
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) When a CEO has employee stock options, he or she is in theory motivated to do which of the following?
A) Take more risk
B) Take less risk
C) Buy some of the company's stock
D) None of the above
Q3) 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
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Page 16
Chapter 15: Options on Stock Indices and Currencies
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Q1) 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
Q2) A binomial tree with one-month time steps is used to value an index option. The interest rate is 3% per annum and the dividend yield is 1% per annum. The volatility of the index is 16%. What is the probability of an up movement?
A) 0.4704
B) 0.5065
C) 0.5592
D) 0.5833
Q3) 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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17
Chapter 16: Futures Options
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Q1) 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
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) Which of the following is NOT true?
A) Black's model can be used to value an American-style option on futures
B) Black's model can be used to value a European-style option on futures
C) Black's model can be used to value a European-style option on spot
D) Black's model is widely used by practitioners
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18
Chapter 17: The Greek Letters
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Q1) 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
Q2) 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)
Q3) What does theta 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
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Page 19
Chapter 18: Binomial Trees in Practice
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Q1) The chapter discusses an alternative to the Cox, Ross, Rubinstein tree. In this alternative, which of the following are true?
A) The relationship between u and d is: u=1/d
B) The relationship between u and d is: u-1=1-d
C) The probabilities on the tree are all 0.5
D) None of the above
Q2) When the stock price is 20 and the present value of dividends is 2, which of the following is the recommended way of constructing a tree?
A) Draw a tree for an initial stock price of 20 and subtract the present value of future dividends at each node
B) Draw a tree for an initial stock price of 22 and subtract the present value of future dividends at each node
C) Draw a tree with an initial stock price of 18 and add the present value of future dividends at each node
D) Draw a tree with an initial stock price of 18 and add 2 at each node
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Chapter 19: Volatility Smiles
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Q1) 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
Q2) The daily percentage change in an exchange rate is compared to a normal distribution with the same mean and standard deviation. Which of the following is true?
A) Both small and large exchange rate moves are more likely than with the normal distribution
B) Small exchange rate moves are less likely and large exchange rate moves are more likely than with the normal distribution
C) Large exchange rate moves are less likely and small exchange rate moves are more likely than with the normal distribution
D) Both small and large exchange rate moves are less likely than with the normal distribution
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Chapter 20: Value at Risk
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Q1) At the end of Thursday, the estimated volatility of asset A is 2% per day. During Friday asset A produces a return of 3%. An EWMA model with lambda equal to 0.9 is used. What is an estimate of the volatility of asset A at the end of Friday?
A) 2.08%
B) 2.10%
C) 2.12%
D) 2.14%
Q2) 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
Q3) 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
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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 put?
A) $0
B) $1,250
C) $1,750
D) $2,500
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 a floor with semiannual reset dates, the floor rate is 3.5% per annum and the notional principal is $1 million. Suppose that the LIBOR rate is 3% per annum for a particular 6-month period. What is the approximate payoff at the end of the 6 months?
A) $10,000
B) $5,000
C) $2,500
D) $1,250
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23
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 are subject to prepayment risk?
A) Collateralized mortgage obligations
B) POs
C) IOs
D) All of the above
Q3) Which of the following would be referred to as an equity swap?
A) An exchange of the return from an equity index for a fixed rate of interest
B) An exchange of a long position in one stock for a long position in another stock
C) An exchange of a short position in one stock for a short position in another stock
D) None of the above
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Chapter 23: Credit Derivatives
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Q1) Suppose that the cumulative probability of a company defaulting by years one, two, three and four are 3%, 6.5%, 10%, and 14.5%, respectively. What is the probability of default in the fourth year conditional on no earlier default?
A) 4.5%
B) 5.0%
C) 5.5%
D) 6.0%
Q2) 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
Q3) Which of the following is true of a synthetic CDO?
A) It is created from portfolios of bonds
B) It is created from portfolios of CDSs
C) It references a standard portfolio of bonds
D) None of the above
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Chapter 24: Weather, Energy, and Insurance Derivatives
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Q1) Which of the following is NOT true about electricity?
A) Supply and demand for electricity are matched within 140 control areas in the US, then excess power sold to other control areas
B) The ability to sell excess power is constrained by transmission capacity
C) Electricity is a commodity that can be easily stored
D) Air conditioning is a big use of electricity
Q2) 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
Q3) 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
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