Financial Engineering
Pre-Test Questions
Course Introduction
Financial Engineering is an interdisciplinary field that applies mathematical tools, statistical techniques, and computational methodologies to solve complex problems in finance. This course covers the development and application of quantitative models for pricing, hedging, and risk management of financial instruments and derivatives. Students will explore topics such as financial markets, portfolio optimization, derivative pricing, stochastic calculus, and risk modeling, along with practical approaches in computational finance. The course is designed to equip students with the analytical skills and technical expertise needed for careers in investment banking, risk management, asset management, and financial technology.
Recommended Textbook
Introduction to Derivatives and Risk Management 8th Edition by Don M. Chance
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Study
Chapter 1: Introduction
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Sample Questions
Q1) The theoretical fair value is the only value an asset can have.
A)True
B)False
Answer: False
Q2) Which of the following contracts obligates a buyer to buy or sell something at a later date?
A)call
B)futures
C)cap
D)put
E)swaption
Answer: B
Q3) The law of one price states that the price of an asset cannot change.
A)True
B)False
Answer: False
Q4) Derivatives permit investors to manage their risk more efficiently.
A)True
B)False
Answer: True
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Chapter 2: Structure of Options Markets
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Sample Questions
Q1) The bid price is the price paid to buy an option from a market maker.
A)True
B)False
Answer: False
Q2) The Options Clearing Corporation guarantees the obligations of traders on options exchanges.
A)True
B)False
Answer: True
Q3) Offsetting an over-the-counter option contract cancels both contracts.
A)True
B)False
Answer: False
Q4) Exercise limits are restrictions on the number of options that can be exercised by an investor in a given day or series of days.
A)True
B)False
Answer: True
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Page 4
Chapter 3: Principles of Option Pricing
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Sample Questions
Q1) What is the time value of the December 105 put?
A)1.30
B)8.30
C)0.00
D)7.00
E)none of the above
Answer: A
Q2) An American call on a non-dividend paying stock will be worth more than a European call on that same stock.
A)True
B)False Answer: False
Q3) A stock is equivalent to a long call,short put and long risk-free bond.
A)True
B)False
Answer: True
Q4) The time value of a call is greatest when the stock price is very high.
A)True
B)False
Answer: False
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Chapter 4: Option Pricing Models: the Binomial Model
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Sample Questions
Q1) If the stock price adjusted for dividends at a continuous rate follows the up and down parameters,the binomial tree will recombine.
A)True
B)False
Q2) Which of the following statements about the binomial model is incorrect?
A)it converges to the Black-Scholes-Merton model
B)it can accommodate early exercise
C)it allows only two stock prices at expiration
D)it can be extended to a large number of time periods
E)none of the above
Q3) In the binomial model,if an option has no chance of expiring out-of-the-money,the hedge ratio will be
A)0.5
B)infinite
C)1
D)0
E)none of the above
Q4) In a recombining binomial model with n periods,the number of outcomes is n + 1.
A)True
B)False
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Chapter 5: Option Pricing Models: the
Black-Scholes-Merton Model
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Sample Questions
Q1) Which of the following statements about the volatility is not true?
A)the implied volatility often differs across options with different exercise prices
B)the implied volatility equals the historical volatility if the option is correctly priced
C)the implied volatility is determined by trial and error
D)the implied volatility is nearly linearly related to the option price
E)none of the above
Q2) If the simple return on a Treasury bill is 8.5 percent,the risk-free rate in the Black-Scholes-Merton model is
A)8.77 percent
B)8.93 percent
C)8.55 percent
D)8.20 percent
E)none of the above
Q3) The time to expiration of an option is based on a 360-day year.
A)True
B)False
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Chapter 6: Basic Option Strategies
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Sample Questions
Q1) Which of the following investors may be obligated to buy stock?
A)covered call writer
B)call buyer
C)put writer
D)protective put buyer
E)none of the above
Q2) What is the breakeven stock price at expiration for the transaction described in problem 6?
A)$27.11
B)$30.00
C)$32.89
D)$29.89
E)none of the above
Q3) Which of the following statements is true about closing a long call position prior to expiration relative to holding it to expiration?
A)the profit is greater at all stock prices
B)the profit is greater only at low stock prices
C)the profit is greater only at high stock prices
D)the range of possible profits is greater
E)none of the above are true
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Chapter 7: Advanced Option Strategies
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Sample Questions
Q1) What will be the profit if the spread is held 90 days and the stock price is $45?
A)$36
B)$20
C)$558
D)-$20
E)none of the above
Q2) In a calendar spread the time value of the nearby option will decay more rapidly.
A)True
B)False
Q3) To truly gain from a straddle,an investor must have a better estimate of volatility than everyone else.
A)True
B)False
Q4) An investor who holds a strap (2 calls and 1 put)believes the market is more likely to go up than down.
A)True
B)False
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Chapter 8: The Structure of Forward and Futures Markets
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Sample Questions
Q1) The earliest financial futures contracts were futures on foreign currencies.
A)True
B)False
Q2) The daily settlement procedure is a major difference between futures contracts and forward contracts.
A)True
B)False
Q3) Which of the following is the most actively traded U.S.futures contract?
A)S&P 500 Index
B)crude oil
C)Treasury bonds
D)Wheat
E)none of the above
Q4) The trading procedure on the floor of the futures exchange is referred to as
A)against actuals
B)open interest
C)open outcry
D)index participation
E)none of the above
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Chapter 9: Principles of Pricing Forwards, Futures, and Options on Futures
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Sample Questions
Q1) If one buys an asset,sells a futures,and holds the position until expiration,it is equivalent to selling the asset at the original futures price.
A)True
B)False
Q2) Suppose you sell a three-month forward contract at $35.One month later,new forward contracts are selling for $30.The risk-free rate is 10 percent.What is the value of your contract?
A)$4.96
B)$5.00
C)$4.92
D)$4.55
E)none of the above
Q3) A synthetic put option on futures could be constructed by buying a call option on futures and selling the futures.
A)True
B)False
Q4) Interest-rate parity is a cost-of-carry model.
A)True
B)False
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Chapter 10: Futures Arbitrage Strategies
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Sample Questions
Q1) The wild card option exists because of the difference in the closing times of the spot and futures markets for Treasury bills.
A)True
B)False
Q2) It is important to identify the cheapest bond to deliver because it is the one the futures contract is priced off of.
A)True
B)False
Q3) If a stock index futures is at 455 and the pricing model says it should be at 458,an arbitrageur should buy the futures and sell short the stock.
A)True
B)False
Q4) Suppose the number of days between two coupon payment dates is 181,the number of days since the last coupon payment is 100,the annual coupon rate is 8 percent and the par value is $100,000,then the accrued interest is $2,210.
A)True
B)False
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Page 12
Chapter 11: Forward and Futures Hedging, Spread, and Target Strategies
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Sample Questions
Q1) A firm that expects to borrow in the future would use a short hedge to protect against interest rate changes.
A)True
B)False
Q2) The relationship between the spot yield and the yield implied by the futures price is called
A)the yield beta
B)the price sensitivity
C)the tail
D)the hedge ratio
E)none of the above
Q3) A hedge reduces risk because the futures price is less volatile than the spot price.
A)True
B)False
Q4) The risk of the basis is usually less than the risk of the spot position.
A)True
B)False
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Chapter 12: Swaps
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Sample Questions
Q1) The most basic and common type of swap is called
A)basis swap
B)plain vanilla swap
C)plain paper swap
D)commercial swap
E)bond swap
Q2) Currency swap volume is greater than equity swap volume.
A)True
B)False
Q3) The fixed rates on a currency swap are the same as the fixed rates on plain vanilla interest rate swaps in the respective currencies.
A)True
B)False
Q4) A currency swap with no notional principal can be used to synthetically convert a bond issued in one currency into a bond issued in another currency.
A)True
B)False
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Chapter 13: Interest Rate Forwards and Options
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Sample Questions
Q1) Which of the following strategies replicates a long position in an FRA?
A)long a long term Eurodollar time deposit and short a short-term Eurodollar time deposit
B)long a Eurodollar futures and short a Eurodollar option
C)long a Eurodollar option on a futures
D)short a long-term Treasury bond futures and short a short-term Treasury bond futures
E)long a receiver swaption
Q2) FRAs,and caps and floors are guaranteed against default.
A)True
B)False
Q3) Which of the following best describes an interest rate cap?
A)a cash-and-carry hedge
B)a series of forward contracts
C)a series of interest rate calls
D)a call option spread
E)none of the above
Q4) Payer swaptions can be used to convert callable to non-callable debt.
A)True
B)False
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Chapter 14: Advanced Derivatives and Strategies
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Sample Questions
Q1) In a weather derivative,the number of days times the average temperature above 65 degrees Fahrenheit is called
A)temperature day count
B)day-temps
C)cooling degree days
D)temp-days
E)heating degree days
Q2) Portfolio insurance using stock and T-bills is less expensive than using stock and puts.
A)True
B)False
Q3) Asian options are also called
A)average price options
B)Pacific options
C)installment options
D)no-regrets options
E)none of the above
Q4) The cost of portfolio insurance is the return foregone if the market moves up.
A)True
B)False
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Chapter 15: Financial Risk Management Techniques and Applications
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Sample Questions
Q1) The equity of a company with leverage is a put option on the assets.
A)True
B)False
Q2) The Monte Carlo simulation method of estimating Value at Risk is one of the most flexible methods because it permits the user to assume any probability distribution.
A)True
B)False
Q3) Stress testing allows a firm to see how its portfolio will behave under extremely rare but favorable conditions.
A)True
B)False
Q4) Value at Risk estimates for portfolios must take into account the correlations among the various assets and liabilities in a portfolio.
A)True
B)False
Q5) Legal risk is the risk that the government will declare derivatives illegal. A)True
B)False
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Chapter 16: Managing Risk in an Organization
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Sample Questions
Q1) "Independent risk management" means which of the following?
A)that risk management of a firm is independent of its overall corporate policy decisions
B)that the risk management function is provided by an outside consulting firm
C)that the risk manager cannot be influenced by the traders
D)that the risk manager is independent of the firm's senior managers
E)none of the above
Q2) Orange County lost $1.6 billion doing what?
A)betting that interest rates would remain stable
B)buying Treasury bond futures
C)selling Eurodollar futures
D)buying short- and intermediate-term bonds on margin
E)trading money market options
Q3) Barings lost $1.2 billion because of what?
A)a failure of risk controls in one of its foreign offices
B)model risk in their VAR models
C)fraudulent transactions
D)regulators shut it down because of poor risk management
E)speculating on German interest rates
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