Corporate Finance
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Course Introduction
Corporate Finance explores the fundamental principles and strategies involved in the financial management of corporations. The course covers key topics such as capital budgeting, risk analysis, cost of capital, capital structure, dividend policy, and working capital management. Students will learn how financial managers make investment and financing decisions that maximize firm value while considering factors like risk, market conditions, and ethical implications. Through case studies and financial modeling exercises, participants will develop analytical skills necessary to evaluate corporate financial performance and to understand the impact of financial decisions on overall business 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) A speculator can choose between buying 100 shares of a stock for $40 per share and buying 1000 European call options on the stock with a strike price of $45 for $4 per option. For second alternative to give a better outcome at the option maturity, the stock price must be above
A) $45
B) $46
C) $55
D) $50
Answer: D
Q2) A one-year forward contract is an agreement where
A) One side has the right to buy an asset for a certain price in one year's time
B) One side has the obligation to buy an asset for a certain price in one year's time
C) One side has the obligation to buy an asset for a certain price at some time during the next year
D) One side has the obligation to buy an asset for the market price in one year's time
Answer: B
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3
Chapter 2: Mechanics of Futures Markets
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Q1) In the corn futures contract a number of different types of corn can be delivered (with price adjustments specified by the exchange) and there are a number of different delivery locations. Which of the following is true?
A) This flexibility tends increase the futures price
B) This flexibility tends decrease the futures price
C) This flexibility may increase and may decrease the futures price
D) This flexibility has no effect on the futures price
Answer: B
Q2) 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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4
Chapter 3: Hedging Strategies Using Futures
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Q1) 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
Q2) Which of the following describes tailing the hedge?
A) A strategy where the hedge position is increased at the end of the life of the hedge
B) A strategy where the hedge position is increased at the end of the life of the futures contract
C) A more exact calculation of the hedge ratio when forward contracts are used for hedging
D) None of the above
Answer: D
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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) Since the credit crisis that started in 2007 which of the following have derivatives traders started to use as the risk-free rate for some transactions?
A) The Treasury rate
B) The LIBOR rate
C) The repo rate
D) The overnight indexed swap rate
Q3) At what interest rate does a government borrow in its own currency?
A) Treasury rate
B) LIBOR
C) LIBID
D) Repo rate
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6
Chapter 5: Determination of Forward and Futures Prices
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Q1) Which of the following is NOT a reason why a short position in a stock is closed out?
A) The investor with the short position chooses to close out the position
B) The lender of the shares issues instructions to close out the position
C) The broker is no longer able to borrow shares from other clients
D) The investor does not maintain margins required on his/her margin account
Q2) Which of the following is true?
A) The convenience yield is always positive or zero
B) The convenience yield is always positive for an investment asset
C) The convenience yield is always negative for a consumption asset
D) The convenience yield measures the average return earned by holding futures contracts
Q3) The spot price of an asset is positively correlated with the market. Which of the following would you expect to be true?
A) The forward price equals the expected future spot price
B) The forward price is greater than the expected future spot price
C) The forward price is less than the expected future spot price
D) The forward price is sometimes greater and sometimes less than the expected future spot price
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Chapter 6: Interest Rate Futures
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Q1) What is the quoted discount rate on a money market instrument?
A) The interest rate earned as a percentage of the final face value of a bond
B) The interest rate earned as a percentage of the initial price of a bond
C) The interest rate earned as a percentage of the average price of a bond
D) The risk-free rate used to calculate the present value of future cash flows from a bond
Q2) How much is a basis point?
A) 1.0%
B) 0.1%
C) 0.01%
D) 0.001%
Q3) It is May 1. The quoted price of a bond with a 30/360 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
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Chapter 7: Swaps
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Q1) Which of the following describes the five-year swap rate?
A) The fixed rate of interest which a swap market maker is prepared to pay in exchange for LIBOR on a 5-year swap
B) The fixed rate of interest which a swap market maker is prepared to receive in exchange for LIBOR on a 5-year swap
C) The average of A and B
D) The higher of A and B
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 floating for floating 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
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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% (ratedC). 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) In which of the following cases is an asset NOT considered constructively sold?
A) The owner shorts the asset
B) The owner buys an in-the-money put option on the asset
C) The owner shorts a forward contract on the asset
D) The owner shorts a futures contract on the stock
Q2) An investor has exchange-traded put options to sell 100 shares for $20. There is a 2 for 1 stock split. Which of the following is the position of the investor after the stock split?
A) Put options to sell 100 shares for $20
B) Put options to sell 100 shares for $10
C) Put options to sell 200 shares for $10
D) Put options to sell 200 shares for $20
Q3) 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
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11
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) A European call and a European put on a stock have the same strike price and time to maturity. At 10:00am on a certain day, the price of the call is $3 and the price of the put is $4. At 10:01am news reaches the market that has no effect on the stock price or interest rates, but increases volatilities. As a result the price of the call changes to $4.50.
Which of the following is correct?
A) The put price increases to $6.00
B) The put price decreases to $2.00
C) The put price increases to $5.50
D) It is possible that there is no effect on the price
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Chapter 11: Trading Strategies Involving Options
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Q1) 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
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
Q3) 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
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Page 13
Chapter 12: Introduction to Binomial Trees
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Q1) 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. Which of the following hedges the position?
A) Buy 0.6 shares for each call option sold
B) Buy 0.4 shares for each call option sold
C) Short 0.6 shares for each call option sold
D) Short 0.4 shares for each call option sold
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 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
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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15
Chapter 14: Employee Stock Options
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Q1) Which of the following strategies makes no sense?
A) An employee exercises stock options early and sells the stock. No dividends are expected
B) An employee exercises stock options early and keeps the stock. No dividends are expected
C) An employee exercises stock options early and sells the stock. Dividends are expected
D) An employee exercises stock options early and keeps the stock. Dividends are expected
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 increases the expected life of employee stock options?
A) An increase in the vesting period
B) An increase in employee turnover
C) A fast growth rate for the stock price
D) A tendency for employees to exercise earlier than in the past
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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) Which of the following is true when a European currency option is valued using forward exchange rates?
A) It is not necessary to know the domestic interest rate or the spot exchange rate
B) It is not necessary to know either the foreign or domestic interest rate
C) It is necessary to know the difference between the foreign and domestic interest rates but not the rates themselves
D) It is not necessary to know the foreign interest rate or the spot exchange rate
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Chapter 16: Futures Options
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Q1) Which of the following is true for a September futures option?
A) The expiration month of option is September
B) The option was first traded in September
C) The delivery month of the underlying futures contract is September
D) September is the first month when the option can be exercised
Q2) 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
Q3) What is the cash settlement if a put futures option on 50 units of the underlying asset is exercised?
A) (Current Futures Price - Strike Price) times 50
B) (Strike Price - Current Futures Price) times 50
C) (Most Recent Futures Settlement Price - Strike Price) times 50
D) (Strike Price - Most Recent Futures Settlement Price) times 50
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18
Chapter 17: The Greek Letters
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Q1) Maintaining a delta-neutral portfolio is an example of which of the following?
A) Stop-loss strategy
B) Dynamic hedging
C) Hedge and forget strategy
D) Static hedging
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) Which of the following is true?
A) The delta of a European put equals minus the delta of a European call
B) The delta of a European put equals the delta of a European call
C) The gamma of a European put equals minus the gamma of a European call
D) The gamma of a European put equals the gamma of a European call
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19
Chapter 18: Binomial Trees in Practice
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Q1) Which of the following cannot be valued by simulating paths through a tree in the way described in the chapter?
A) European options
B) American options
C) Asian options (i.e., options on the average stock price)
D) An option which provides a payoff of $100 if the stock price is greater than the strike price at maturity
Q2) When we move from assuming no dividends to assuming a constant dividend yield, which of the following is true for a Cox, Ross, Rubinstein tree?
A) The parameters u and p change
B) p changes but u does not
C) u changes but p does not
D) Neither p nor u changes
Q3) How many different paths are there through a Cox-Ross-Rubinstein tree with four-steps?
A) 5
B) 9
C) 12
D) 16
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Page 20
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) The implied volatilities for strike prices of 1.1 and 1.2 when the time to maturity is 6 months are 20% and 22%. The implied volatilities for strike prices of 1.1 and 1.2 when the time to maturity is 1 year are 18.8% and 20.2%. Using linear interpolation, what is the implied volatility for a strike price of 1.12 and a time to maturity of 10 months?
A) 19.24%
B) 19.52%
C) 20.48%
D) 19.96%
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21
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) What does EWMA stand for?
A) Equally weighted moving average
B) Equally weighted median approximation
C) Exponentially weighted moving average
D) Exponentially weighted median average
Q3) 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
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Chapter 21: Interest Rate Options
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Q1) A floating-rate borrower wants to use a collar as a hedge. Which of the following is appropriate?
A) Buy a cap and sell a floor
B) Buy a cap and buy a floor
C) Sell a cap and sell a floor
D) Sell a cap and buy a floor
Q2) 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
Q3) Which of the following is an implication of the mean reversion of interest rates?
A) Interest rates cannot become negative
B) When short-term interest rates are high they tend to move down
C) The term structure of interest rates tends to be upward sloping
D) When short-term interest rates are low they tend to stay low
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Chapter 22: Exotic Options and Other Nonstandard Products
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Q1) Which of the following describes a cliquet option?
A) An option to exchange one asset for another
B) An instrument when the holder can choose between several alternative options
C) An option on an option with predetermined strike prices for the two options
D) A series of options with rules for determining strike prices
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) As the barrier is observed more frequently, a knock out option becomes which of the following?
A) More valuable
B) Less valuable
C) There is no effect on value
D) May become more valuable or less valuable
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Page 24
Chapter 23: Credit Derivatives
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Q1) For what range of losses is the equity tranche of iTraxx (or CDX NA IG) responsible?
A) 0 to 10%
B) 0 to 7%
C) 0 to 6%
D) 0 to 3%
Q2) Which of the following best describes a total return swap?
A) It exchanges the realized return on an asset, including both income and capital gains/losses, for a return, equal to LIBOR plus a spread on the initial value of the asset
B) It exchanges the promised return on an asset, including both income and capital gains/losses, for a return equal to LIBOR plus a spread on the initial value of the asset
C) It exchanges the realized return on an asset, including income but not capital gains/losses, for a return equal to LIBOR plus a spread on the initial value of the asset
D) It exchanges the promised return on an asset, including income but not capital gains/losses, for a return equal to LIBOR plus a spread on the initial value of the asset
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25
Chapter 24: Weather, Energy, and Insurance Derivatives
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Q1) 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
Q2) Which of the following might we expect to be the result of global warming?
A) An decrease in observed CDDs
B) An increase in observed CDDs
C) An increase in observed HDDs
D) None of the above
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 are products refined from crude oil?
A) Heating oil
B) Gasoline
C) Kerosene
D) All of the above
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