Corporate Finance
Midterm Exam
Course Introduction
Corporate Finance explores the fundamental principles and practices governing the financial management of corporations. The course covers key topics such as capital budgeting, capital structure, dividend policy, working capital management, and financial risk management. Students will examine the roles of financial markets and institutions, learn how to analyze investment opportunities, and understand strategies to maximize shareholder value. Emphasis is placed on both theoretical concepts and practical applications, equipping students with the analytical tools needed for effective corporate financial decision-making in a dynamic business environment.
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 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
Q2) 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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3
Chapter 2: Mechanics of Futures Markets
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Q1) The frequency with which margin accounts are adjusted for gains and losses is A) Daily
B) Weekly
C) Monthly
D) Quarterly Answer: A
Q2) You sell one December futures contracts when the futures price is $1,010 per unit. Each contract is on 100 units and the initial margin per contract that you provide is $2,000. The maintenance margin per contract is $1,500. During the next day the futures price rises to $1,012 per unit. What is the balance of your margin account at the end of the day?
A) $1,800
B) $3,300
C) $2,200
D) $3,700
Answer: A
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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) On March 1 the price of a commodity is $1,000 and the December futures price is $1,015. On November 1 the price is $980 and the December futures price is $981. A producer of the commodity entered into a December futures contracts on March 1 to hedge the sale of the commodity on November 1. It closed out its position on November 1. What is the effective price (after taking account of hedging) received by the company for the commodity?
A) $1,016
B) $1,001
C) $981
D) $1,014
Answer: D
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Page 5
Chapter 4: Interest Rates
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Q1) The zero curve is upward 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
Q2) 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.
Q3) 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
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Chapter 5: Determination of Forward and Futures Prices
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Q1) 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
Q2) Which of the following is NOT true?
A) Gold and silver are investment assets
B) Investment assets are held by significant numbers of investors for investment purposes
C) Investment assets are never held for consumption
D) The forward price of an investment asset can be obtained from the spot price, interest rates and the income paid on the asset
Q3) Which of the following is a consumption asset?
A) The S&P 500 index
B) The Canadian dollar
C) Copper
D) IBM stock
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Page 7
Chapter 6: Interest Rate Futures
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Q1) A trader uses 3-month Eurodollar futures to lock in a rate on $5 million for six months. How many contracts are required?
A) 5
B) 10
C) 15
D) 20
Q2) 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
Q3) 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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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 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
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Chapter 8: Securitization and the Credit Crisis of 2007
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Q1) Which of the following tends to lead to an increase in house prices?
A) An increase in interest rates
B) Regulators specifying a maximum level for the loan-to-value ratio on mortgages
C) Banks reducing the minimum FICO score that borrowers are required to have
D) An increase in foreclosures
Q2) Which of the following were introduced before the credit crisis that started in 2007?
A) Basel II
B) Dodd-Frank
C) Basel III
D) Requirements for living wills
Q3) Which of the following describes regulatory arbitrage?
A) Finding a way of reducing capital requirements without changing the risks being taken
B) Buying products that are not subject to regulation
C) Shorting products that are not subject to regulation
D) Trading with the government
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Chapter 9: Mechanics of Options Markets
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Q1) Which of the following describes a difference between a warrant and an exchange-traded stock option?
A) In a warrant issue, someone has guaranteed the performance of the option seller in the event that the option is exercised
B) The number of warrants is fixed whereas the number of exchange-traded options in existence depends on trading
C) Exchange-traded stock options have a strike price
D) Warrants cannot be traded after they have been purchased
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
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11
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) Interest rates are zero. A European call with a strike price of $50 and a maturity of one year is worth $6. A European put with a strike price of $50 and a maturity of one year is worth $7. The current stock price is $49. Which of the following is true?
A) The call price is high relative to the put price
B) The put price is high relative to the call price
C) Both the call and put must be mispriced
D) None of the above
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Chapter 11: Trading Strategies Involving Options
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Q1) Which of the following is true of a box spread?
A) It is a package consisting of a bull spread and a bear spread
B) It involves two call options and two put options
C) It has a known value at maturity
D) All of the above
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) What is a description of the trading strategy where an investor sells a 3-month call option and buys a one-year call option, where both options have a strike price of $100 and the underlying stock price is $75?
A) Neutral Calendar Spread
B) Bullish Calendar Spread
C) Bearish Calendar Spread
D) None of the above
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13
Chapter 12: Introduction to Binomial Trees
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Q1) Which of the following is true for a call option on a stock worth $50?
A) As a stock's expected return increases the price of the option increases
B) As a stock's expected return increases the price of the option decreases
C) As a stock's expected return increases the price of the option might increase or decrease
D) As a stock's expected return increases the price of the option on the stock stays the same
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. What is the risk-neutral probability of that the stock price will be $36?
A) 0.6
B) 0.5
C) 0.4
D) 0.3
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14
Chapter 13: Valuing Stock Options: the Bsm Model
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Q1) 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%
Q2) 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%
Q3) The volatility of a stock is 18% per year. What is the volatility per month?
A) 1.5%
B) 3.0%
C) 5.2%
D) None of the above
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Chapter 14: Employee Stock Options
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Q1) Which of the following was true about employee stock options between 1996 and 2004?
A) The options never had any affect on a company's financial statements
B) The value of options which were at-the-money when issued had to be expensed on the income statement
C) The value of options which were at-the-money when issued had to be reported in the notes to the financial statements
D) Options which were at-the-money when issued did not affect a company's financial statements
Q2) 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
Q3) Which of the following defines the vesting period?
A) The period during which employee stock options can be exercised
B) The period during which the options are issued
C) The period during which the strike price of the options equals the stock price
D) The period during which employee stock options cannot be exercised
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Page 16
Chapter 15: Options on Stock Indices and Currencies
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Q1) For a European call option on a currency, the exchange rate is 1.0000, the strike price is 0.9100, the time to maturity is one year, the domestic risk-free rate is 5% per annum, and the foreign risk-free rate is 3% per annum. How low can the option price be without there being an arbitrage opportunity?
A) 0.1048
B) 0.0900
C) 0.1344
D) 0.1211
Q2) For a European put option on an index, the index level is 1,000, the strike price is 1050, the time to maturity is six months, the risk-free rate is 4% per annum, and the dividend yield on the index is 2% per annum. How low can the option price be without there being an arbitrage opportunity?
A) $50.00
B) $43.11
C) $29.21
D) $39.16
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Chapter 16: Futures Options
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Q1) When Black's model used to value a European option on the spot price of an asset, which of the following is NOT true?
A) It is necessary to know the futures or forward price for a contract maturing at the same time as the option
B) It is not necessary to estimate income on the underlying asset
C) It is not necessary to know the risk-free rate
D) The underlying asset can be an investment or a consumption asset
Q2) Consider a European one-year call futures option and a European one-year put futures options when the futures price equals the strike price. Which of the following is true?
A) The call futures option is worth more than the put futures option
B) The put futures option is worth more than the call futures option
C) The call futures option is sometimes worth more and sometimes worth less than the put futures option
D) The call futures option is worth the same as the put futures option
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Chapter 17: The Greek Letters
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Q1) When the interest rate is zero which of the following is true for a delta-neutral portfolio with a positive gamma?
A) As gamma increases theta becomes more positive
B) As gamma decreases theta declines
C) Theta is zero
D) As gamma increases theta becomes more negative
Q2) A trader uses a stop-loss strategy to hedge a short position in a three-month call option with a strike price of 0.7000 on an exchange rate. The current exchange rate is 0.6950 and value of the option is 0.1. The trader covers the option when the exchange rate reaches 0.7005 and uncovers (i.e., assumes a naked position) if the exchange rate falls to 0.6995. Which of the following is NOT true?
A) The exchange rate trading might cost nothing so that the trader gains 0.1 for each option sold
B) The exchange rate trading might cost considerably more than 0.1 for each option sold so that the trader loses money
C) The present value of the gain or loss from the exchange rate trading should be about 0.1 on average for each option sold
D) The hedge works reasonably well
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Chapter 18: Binomial Trees in Practice
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Q1) Which of the following is true for u in a Cox-Ross-Rubinstein binomial tree?
A) It depends on the interest rate and the volatility
B) It depends on the volatility but not the interest rate
C) It depends on the interest rate but not the volatility
D) It depends on neither the interest rate nor the volatility
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
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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Page 20
Chapter 19: Volatility Smiles
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Q1) Which of the following is true when the tails of a future foreign currency distribution are compared with those of a lognormal distribution with the same mean and standard deviation?
A) The left tail and right tail are thinner
B) The left tail is thinner and the right tail is fatter
C) The right tail is thinner and the left tail is fatter
D) Both tails are fatter
Q2) What does the shape of the volatility smile reveal about put options on equity?
A) Options close-to-the-money have the lowest implied volatility
B) Options deep-in-the-money have a relatively high implied volatility
C) Options deep-out-of-the-money have a relatively high implied volatility
D) All of the above
Q3) Which of the following is true for European call and put options?
A) If they have the same strike price, they have the same implied volatility
B) If they have the same time to maturity, they have the same implied volatility
C) If they have the same strike price and time to maturity, they have the same implied volatility
D) None of the above
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Chapter 20: Value at Risk
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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) Which of the following is true when delta, but not gamma, is used in calculating VaR for option positions?
A) VaR for a long call is too low and VaR for a long put is too low
B) VaR for a long call is too low and VaR for a long put is too high
C) VaR for a long call is too high and VaR for a long put is too low
D) VaR for a long call is too high and VaR for a long put is too high
Q3) Which of the following is true?
A) The quadratic model approximates daily changes in using delta and gamma
B) The quadratic model approximates daily changes using delta, but not gamma
C) The quadratic model approximates daily changes using gamma, but not delta
D) None of the above
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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) A floating-rate lender 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
Q3) 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
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Chapter 22: Exotic Options and Other Nonstandard Products
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Q1) A binary option pays of $100 if a stock price is greater than its current value in three months. The risk-free rate is 3% and the volatility is 40%. Which of the following is its value?
A) 99.25N(-0.1375)
B) 99.25N(0.1375)
C) 99.25N(-0.0625)
D) 99.25N(0.0625)
Q2) Which of the following is equivalent to a short position in a European put option?
A) A short position in a cash-or-nothing put option plus a long position in an asset-or-nothing put option
B) A long position in an asset-or-nothing put option plus a long position in a cash-or-nothing put option
C) A long position in an asset-or-nothing call option plus a long position in a cash-or-nothing call option
D) A long position in an asset-or-nothing call option plus a short position in a cash-or-nothing call option
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Chapter 23: Credit Derivatives
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Q1) If the CDS spread for a regular 5-year CDS is 120 basis points, what is the CDS spread for a 5-year binary CDS on the same underlying reference entity? Assume a recovery rate of 40%.
A) 48 basis points
B) 72 basis points
C) 200 basis points
D) 300 basis points
Q2) Which of the following is usually used to define the recovery rate of a bond?
A) The value of the bond immediately after default as a percent of its face value
B) The value of the bond immediately after default as a percent of the sum of the bond's face value and accrued interest
C) The amount finally realized by a bondholder as a percent of face value
D) The amount finally realized by a bondholder as a percent of the sum of the bond's face value and accrued interest
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25
Chapter 24: Weather, Energy, and Insurance Derivatives
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Q1) Where are oil, gas, and electricity derivatives traded?
A) On exchanges and the OTC market
B) On exchanges, but not on the OTC market
C) On the OTC market, but not on exchanges
D) Oil is traded in both markets, but the other two are traded only in the OTC market
Q2) Which of the following describes a CAT bond?
A) Has a great deal of systematic risk
B) Has very little systematic risk
C) Has a moderate amount of systematic risk
D) Has negative systematic risk
Q3) 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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