Financial Economics
Question Bank
Course Introduction
Financial Economics explores the principles and applications of economic theory to the financial markets and institutions. The course covers the valuation of assets, such as stocks and bonds, and examines how financial markets function, the behavior of investors, and the role of risk and return in investment decisions. Key topics include portfolio theory, asset pricing models, market efficiency, and the impact of financial regulation. Students will gain an understanding of how economic concepts underpin financial strategies and policies, equipping them with the analytical tools needed to evaluate financial decisions in both personal and professional contexts.
Recommended Textbook Options Futures and Other Derivatives 9th Edition by
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Page 2
John C. Hull
Chapter 1: Introduction
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Q1) Which of the following is NOT true
A)When a CBOE call option on IBM is exercised, IBM issues more stock
B)An American option can be exercised at any time during its life
C)An call option will always be exercised at maturity if the underlying asset price is greater than the strike price
D)A put option will always be exercised at maturity if the strike price is greater than the underlying asset price.
Answer: A
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
Q3) 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
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Chapter 2: Mechanics of Futures Markets
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Q1) Which entity in the United States takes primary responsibility for regulating futures market?
A)Federal Reserve Board
B)Commodities Futures Trading Commission (CFTC)
C)Security and Exchange Commission (SEC)
D)US Treasury
Answer: B
Q2) One futures contract is traded where both the long and short parties are closing out existing positions.What is the resultant change in the open interest?
A)No change
B)Decrease by one
C)Decrease by two
D)Increase by one
Answer: B
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Chapter 3: Hedging Strategies Using Futures
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Q1) Which of the following is necessary for tailing a hedge?
A)Comparing the size in units of the position being hedged with the size in units of the futures contract
B)Comparing the value of the position being hedged with the value of one futures contract
C)Comparing the futures price of the asset being hedged to its forward price
D)None of the above
Answer: B
Q2) Which of the following is a reason for hedging a portfolio with an index futures?
A)The investor believes the stocks in the portfolio will perform better than the market but is uncertain about the future performance of the market
B)The investor believes the stocks in the portfolio will perform better than the market and the market is expected to do well
C)The portfolio is not well diversified and so its return is uncertain
D)All of the above
Answer: A
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Chapter 4: Interest Rates
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Q1) 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%
Q2) The yield curve is flat at 6% per annum.What is the value of an FRA where the holder receives interest at the rate of 8% per annum for a six-month period on a principal of $1,000 starting in two years? All rates are compounded semiannually.
A)$9.12
B)$9.02
C)$8.88
D)$8.63
Q3) Which of the following is true of the fed funds rate
A)It is the same as the Treasury rate
B)It is an overnight interbank rate
C)It is a rate for which collateral is posted
D)It is a type of repo rate
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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) 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) 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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Chapter 6: Interest Rate Futures
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Q1) 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
Q2) 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
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Chapter 7: Swaps
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Q1) A semi-annual pay interest rate swap where the fixed rate is 5.00% (with semi-annual compounding)has a remaining life of nine months.The six-month LIBOR rate observed three months ago was 4.85% with semi-annual compounding.Today's three and nine month LIBOR rates are 5.3% and 5.8% (continuously compounded)respectively.From this it can be calculated that the forward LIBOR rate for the period between three- and nine-months is 6.14% with semi-annual compounding.If the swap has a principal value of $15,000,000,what is the value of the swap to the party receiving a fixed rate of interest?
A)$74,250
B)-$70,760
C)-$11,250
D)$103,790
Q2) Which of the following is a typical bid-offer spread on the swap rate for a plain vanilla interest rate swap?
A)3 basis points
B)8 basis points
C)13 basis points
D)18 basis points
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Chapter 8: Securitization and the Credit Crisis of 2007
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Q1) AIG lost money because
A)It bought tranches created from mortgages
B)It invested heavily in real estate
C)It invested heavily in the stock market
D)It insured AAA tranches of ABS CDOs
Q2) In 2008 the TED spread reached a high of
A)About 150 basis points
B)About 250 basis points
C)About 450 basis points
D)About 550 basis points
Q3) What,as a percent of tranche principal,are losses on the mezzanine tranche of the ABS CDO
A)50%
B)60%
C)80%
D)100%
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Chapter 9: OIS Discounting, Credit Issues, and Funding Costs
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Q1) Which of the following describes a 3-month overnight indexed swap (OIS)?
A)A fixed rate is exchanged for the overnight rate every day for three months
B)LIBOR is exchanged for the overnight rate every day for three months
C)The arithmetic average of overnight rates is exchanged for a fixed rate at the end of three months
D)The geometric average of overnight rates is exchanged for a fixed rate at the end of three months
Q2) Since the credit crisis that started in 2007 which of the following have derivatives traders used as the risk-free discount rate for collateralized transactions
A)The Treasury rate
B)The LIBOR rate
C)The repo rate
D)The overnight indexed swap rate
Q3) When a bank's borrowing rate goes up,which of the following is true
A)DVA increases so that the bank's profit goes down
B)DVA increases so that the bank's profit goes up
C)DVA declines so that the bank's profit goes down
D)DVA declines so that the bank's profit goes up
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Chapter 10: Mechanics of Options Markets
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Q1) 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
Q2) Which of the following is an example of an option series?
A)All calls on a certain stock
B)All calls with a particular strike price on a certain stock
C)All calls with a particular time to maturity on a certain stock
D)All calls with a particular time to maturity and strike price on a certain stock
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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Chapter 11: Properties of Stock Options
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Q1) Which of the following can be used to create a long position in a European put option on a stock?
A)Buy a call option on the stock and buy the stock
B)Buy a call on the stock and short the stock
C)Sell a call option on the stock and buy the stock
D)Sell a call option on the stock and sell the stock
Q2) When the time to maturity increases with all else remaining the same,which of the following is true?
A)European options always increase in value
B)The value of European options either stays the same or increases
C)There is no effect on European option values
D)European options are liable to increase or 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 had to exercise it immediately or not at all
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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Chapter 12: Trading Strategies Involving Options
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Q1) How can a strip trading strategy be created?
A)Buy one call and one put with the same strike price and same expiration date
B)Buy one call and one put with different strike prices and same expiration date
C)Buy one call and two puts with the same strike price and expiration date
D)Buy two calls and one put with the same strike price and expiration date
Q2) What is the number of different option series used in creating a butterfly spread?
Q3) Which of the following creates a bear 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
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Chapter 13: Binomial Trees
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Q1) Which of the following describes delta?
A)The ratio of the option price to the stock price
B)The ratio of the stock price to the option price
C)The ratio of a change in the option price to the corresponding change in the stock price
D)The ratio of a change in the stock price to the corresponding change in the option price
Q2) 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
Q3) A stock is expected to return 10% when the risk-free rate is 4%.What is the correct discount rate to use for the expected payoff on an option in the real world?
A)4%
B)10%
C)More than 10%
D)It could be more or less than 10%
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Chapter 14: Wiener Processes and Itos Lemma
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Q1) A stock price is $20.It has an expected return of 12% and a volatility of 25%.What is the standard deviation of the change in the price in one day.(For this question assume that there are 365 days in the year.)
A)$0.20
B)$0.23
C)$0.26
D)$0.29
Q2) A stock price is $20.It has an expected return of 12% and a volatility of 25%.What is the stock price that has a 2.5% chance of being exceeded in one day? (For this question assume that there are 365 days in the year.)
A)$20.41
B)$20.51
C)$20.61
D)$20.71
Q3) If a = 2 and b =3 what is the expected value after 3 years?
A)12
B)14
C)16
D)18
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Page 16
Chapter 15: The Black-Scholes-Merton Model
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Q1) 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%
Q2) What does N(x)denote?
A)The area under a normal distribution from zero to x
B)The area under a normal distribution up to x
C)The area under a normal distribution beyond x
D)The area under the normal distribution between -x and x
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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Chapter 16: Employee Stock Options
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Q1) When an employee leaves the company which of the following is usually true?
A)All outstanding employee stock options are forfeited
B)Out-of the money employee stock options are forfeited
C)All options which have vested are forfeited
D)All options are retained
Q2) 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
Q3) A company surprises the market with an announcement that it has granted stock options to senior executives.The options are exercised four years later.When does dilution take place?
A)Dilution takes place when the options are exercised
B)Dilution takes place on the announcement date
C)Dilution takes place gradually over the four years
D)There is no dilution
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Chapter 17: Options on Stock Indices and Currencies
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Q1) What should the strike price of options on the index be the portfolio has a beta of 1?
A)425
B)450
C)475
D)500
Q2) What position is required if the portfolio has a beta of 0.5?
A)Short 200 contracts
B)Long 200 contracts
C)Short 100 contracts
D)Long 100 contracts
Q3) 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 there are no dividends.
A)400
B)410
C)420
D)425
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Page 19
Chapter 18: Futures Options
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Q1) Which of the following are true?
A)Futures options are usually European
B)Futures options are usually American
C)Both American and European futures options trade actively are exchanges
D)Both American and European futures options trade actively in the OTC market
Q2) What is the expected 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
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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Chapter 19: The Greek Letters
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Q1) What does rho measure?
A)The rate of change of delta with the asset price
B)The rate of change of the portfolio value with the passage of time
C)The sensitivity of a portfolio value to interest rate changes
D)None of the above
Q2) 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) 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
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Chapter 20: Volatility Smiles
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Q1) Which of the following causes a volatility smile that is a ``frown``?
A)There is a small probability of a large stock price decrease in one week
B)There is a small probability of a large stock price increase in one week
C)The outcome of a lawsuit (roughly equal chance of being favorable or unfavorable) will create a large movement up or down in one week
D)None of the above
Q2) 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
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Chapter 21: Basic Numerical Procedures
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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) Which of the following can be valued without using a numerical procedure such as a binomial tree?
A)American put options on a non-dividend paying stock
B)American call options on a non-dividend paying tock
C)American call options on a currency
D)American put options on futures
Q3) 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
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Chapter 22: Value at Risk
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Q1) Consider a position in options on a particular stock.The position has a delta of 12 and the stock price is 10.Which of the following is the approximate relation between the change in the portfolio value in one day,dP,and the return on the stock during the day,dx
A)dP=12dx
B)dP=1.2dx
C)dP=120dx
D)dP=22dx
Q2) Which of the following is true?
A)Cash flow mapping is a way of calculating the present value of cash flows
B)Cash flow mapping is used to handle interest rate exposures in the model building approach
C)Cash flow mapping is used to handle interest rate exposures in the historical simulation approach
D)None of the above
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 23: Estimating Volatilities and Correlations
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Q1) The parameters in a GARCH (1,1)model are: omega =0.000002, alpha = 0.04,and beta = 0.95.What is the reversion rate for the variance rate implied by the model
A)0.5% per day
B)1.0% per day
C)1.5% per day
D)2.0% per day
Q2) Which of the following is true when the parameter lambda equals 0.95?
A)The weight given to the most recent observation is 0.95
B)The weight given to the observation one day ago is 95% of the weight given to the observation two days ago
C)The weights given to observations add up to 0.95
D)The weights given to the observation two days ago is 95% of the weight given to the observation one day ago
Q3) How many parameters are necessary to define an EWMA model
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Chapter 24: Credit Risk
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Q1) Which of the following is true
A) Downgrade triggers are particularly valuable if they are widely used by a company's counterparties
B)Downgrade triggers become less valuable if they are widely used by a company's counterparties
C) Downgrade triggers are useless because their impact is always anticipated by the market
D) Downgrade triggers are a two-edged sword.If company A has a downgrade trigger for company B then company B has a downgrade trigger for company A
Q2) Which of the following is true of Merton's model:
A)The strike price is the market value of the debt
B)The strike price is the market value of the equity
C)The strike price is the book value of the equity
D)The strike price is the face value of the debt
Q3) Which of the following is true
A)A derivative dealer's CVA is the counterparty's DVA and vice versa
B)Collateral posted by the counterparty reduces CVA
C)Collateral posted by the dealer reduces DVA
D)All of the above
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Chapter 25: Credit Derivatives
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Q1) A portfolio of ten companies is formed.In a third-to-default swap (Circle one)
A)There is a payoff when the third default on the portfolio happens
B)There is a payoff when the first, second and third companies defaults happen
C)There is a payoff when the third, fourth, fifth tenth companies defaults happen
D)None of the above
Q2) 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%
Q3) 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
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Chapter 26: Exotic Options
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Q1) An employer has promised that it will grant employees three year options in one year's time and that the options will be at the money at the time they are granted.What describes these options?
A)Chooser options
B)Forward start options
C)Compound options
D)Shout options
Q2) Which of the following is true of a gap option
A)The strike price determining whether a payoff is made is not the same as the strike price determining the size of the payoff
B)There is a straightforward valuation formula similar to Black-Scholes-Merton
C)It describes an option where there is a cost to exercising
D)All of the above
Q3) A fixed lookback put option pays off which of the following
A)The amount by which the final stock price exceeds the minimum stock price
B)The amount by which the maximum stock price exceeds the final stock price
C)The amount by which the strike price exceeds the minimum stock price
D)The amount by which the maximum stock price exceeds the strike price
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