Financial Markets and Institutions
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Course Introduction
This course provides a comprehensive overview of financial markets and institutions, focusing on their structure, functions, and roles within the global economy. Topics include the various types of financial markets such as money, bond, stock, and derivatives markets as well as the main financial institutions, including commercial banks, investment firms, and insurance companies. The course examines how these entities facilitate the flow of funds, manage risk, and contribute to economic growth. Students will explore regulatory frameworks, recent trends in financial technology, and the impact of monetary policy on financial markets, equipping them with a solid foundation for understanding the complexities of modern financial systems.
Recommended Textbook
Fundamentals of Futures and Options Markets 9th Edition by John C. Hull
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Chapter 1: Introduction
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Q1) Which of the following is true about a long forward contract
A) The contract becomes more valuable as the price of the asset declines
B) The contract becomes more valuable as the price of the asset rises
C) The contract is worth zero if the price of the asset declines after the contract has been entered into
D) The contract is worth zero if the price of the asset rises after the contract has been entered into
Answer: B
Q2) A short forward contract on an asset plus a long position in a European call option on the asset with a strike price equal to the forward price is equivalent to
A) A short position in a call option
B) A short position in a put option
C) A long position in a put option
D) None of the above
Answer: C
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Chapter 2: Futures Markets and Central Counterparties
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Q1) Which of the following best describes central clearing parties
A) Help market participants to value derivative transactions
B) Must be used for all OTC derivative transactions
C) Are used for futures transactions
D) Perform a similar function to exchange clearing houses
Answer: D
Q2) 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
Q3) Clearing houses are
A) Never used in futures markets and sometimes used in OTC markets
B) Used in OTC markets, but not in futures markets
C) Sometimes used in both futures markets and OTC markets
D) Always used in both futures markets and OTC markets
Answer: C
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Page 4
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) Which of the following is true?
A) Hedging can always be done more easily by a company's shareholders than by the company itself
B) If all companies in an industry hedge, a company in the industry can sometimes reduce its risk by choosing not to hedge
C) If all companies in an industry do not hedge, a company in the industry can reduce its risk by hedging
D) If all companies in an industry do not hedge, a company is liable increase its risk by hedging
Answer: D
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Page 5
Chapter 4: Interest Rates
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Q1) The compounding frequency for an interest rate defines
A) The frequency with which interest is paid
B) A unit of measurement for the interest rate
C) The relationship between the annual interest rate and the monthly interest rate
D) None of the above
Q2) Under liquidity preference theory, which of the following is always true?
A) The forward rate is higher than the spot rate when both have the same maturity.
B) Forward rates are unbiased predictors of expected future spot rates.
C) The spot rate for a certain maturity is higher than the par yield for that maturity.
D) Forward rates are higher than expected future spot rates.
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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Chapter 5: Determination of Forward and Futures Prices
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Q1) Which of the following describes a known dividend yield on a stock?
A) The size of the dividend payments each year is known
B) Dividends per year as a percentage of today's stock price are known
C) Dividends per year as a percentage of the stock price at the time when dividends are paid are known
D) Dividends will yield a certain return to a person buying the stock today
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
Q3) Which of the following describes the way the forward price of a foreign currency is quoted?
A) The number of U.S. dollars per unit of the foreign currency
B) The number of the foreign currency per U.S. dollar
C) Some forward prices are always quoted as the number of U.S. dollars per unit of the foreign currency and some are always quoted the other way round
D) There are no quotation conventions for forward prices
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Chapter 6: Interest Rate Futures
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Q1) How much is a basis point?
A) 1.0%
B) 0.1%
C) 0.01%
D) 0.001%
Q2) The most recent settlement bond futures price is 103.5. Which of the following four bonds is cheapest to deliver?
A) Quoted bond price = 110; conversion factor = 1.0400.
B) Quoted bond price = 160; conversion factor = 1.5200.
C) Quoted bond price = 131; conversion factor = 1.2500.
D) Quoted bond price = 143; conversion factor = 1.3500.
Q3) In the U.S. what is the longest maturity for 3-month Eurodollar futures contracts?
A)2 years
B)5 years
C)10 years
D)20 years
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Chapter 7: Swaps
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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 tehe end of three months
Q2) Since the 2008 credit crisis
A) LIBOR has replaced OIS as the discount rate for non-collateralized swaps
B) OIS has replaced LIBOR as the discount rate, but only for non-collateralized swaps
C) LIBOR has replaced OIS as the discount rate for collateralized swaps
D) OIS has replaced LIBOR as the discount rate for swaps
Q3) Which of the following is true for an interest rate swap?
A) A swap is usually worth close to zero when it is first negotiated
B) Each forward rate agreement underlying a swap is worth close to zero when the swap is first entered into
C) Comparative advantage is a valid reason for entering into the swap
D) None of the above
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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) 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 is true of a non-recourse mortgage?
A) The house buyer, if unable to make payments, can lose all possessions
B) The house buyer has an American style put option on the house
C) The house buyer has a European style put option on the house
D) The lender is less likely to lose money on the mortgage
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Chapter 9: Mechanics of Options Markets
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Q1) Which of the following is true?
A) A long call is the same as a short put
B) A short call is the same as a long put
C) A call on a stock plus a stock the same as a put
D) None of the above
Q2) 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
Q3) 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
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Chapter 10: Properties of Stock Options
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Q1) The price of a European call option on a 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. A dividend of $1 is expected in six months. What is the price of a one-year European put option on the stock with a strike price of $50?
A) $8.97
B) $6.97
C) $3.06
D) $1.12
Q2) When the strike price 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) When the interest rate is 5% per annum with continuous compounding, which of the following creates a $1000 principal protected note?
A) A one-year zero-coupon bond plus a one-year call option worth about $59
B) A one-year zero-coupon bond plus a one-year call option worth about $49
C) A one-year zero-coupon bond plus a one-year call option worth about $39
D) A one-year zero-coupon bond plus a one-year call option worth about $29
Q2) 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
Q3) How can a strangle 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
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Chapter 12: Introduction to Binomial Trees
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Q1) The current price of a non-dividend paying stock is $30. Use a two-step tree to value a European call 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% per annum with continuous compounding. What si the option price when u = 1.1 and d = 0.9.
A) $1.29
B) $1.49
C) $1.69
D) $1.89
Q2) The current price of a non-dividend-paying stock is $40. Over the next year it is expected to rise to $42 or fall to $37. An investor buys put options with a strike price of $41. Which of the following is necessary to hedge the position?
A) Buy 0.2 shares for each option purchased
B) Sell 0.2 shares for each option purchased
C) Buy 0.8 shares for each option purchased
D) Sell 0.8 shares for each option purchased
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Chapter 13: Valuing Stock Options: the Bsm Model
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Q1) What was the original Black-Scholes-Merton model designed to value?
A) A European option on a stock providing no dividends
B) A European or American option on a stock providing no dividends
C) A European option on any stock
D) A European or American option on any stock
Q2) When the non-dividend paying stock price is $20, the strike price is $20, the risk-free rate is 5%, the volatility is 20% and the time to maturity is 3 months which of the following is the price of a European put option on the stock
A) 19.7N(-0.1)-20N(-0.2)
B) 20N(-0.1)-20N(-0.2)
C) 19.7N(-0.2)-20N(-0.1)
D) 20N(-0.2)-20N(-0.1)
Q3) Which of the following is a definition of volatility
A) The standard deviation of the return, measured with continuous compounding, in one year
B) The variance of the return, measured with continuous compounding, in one year
C) The standard deviation of the stock price in one year
D) The variance of the stock price in one year
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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) 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 15: Options on Stock Indices and Currencies
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Q1) A portfolio manager in charge of a portfolio worth $10 million is concerned that the market might decline rapidly during the next six months and would like to use options on an index to provide protection against the portfolio falling below $9.5 million. The index is currently standing at 500 and each contract is on 100 times the index. 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
Q2) 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
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Chapter 16: Futures Options and Blacks Model
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Q1) What is the cash settlement if a call 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
Q2) 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
Q3) What is the value of a European call futures option where the futures price is 50, the strike price is 50, the risk-free rate is 5%, the volatility is 20% and the time to maturity is three months?
A) 49.38N(0.05)-49.38N(-0.05)
B) 50N(0.05)-50N(-0.05)
C) 49.38N(0.1)-49.38N(-0.1)
D) 50N(0.1)-49.38N(-0.1)
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Chapter 17: The Greek Letters
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Q1) The delta of a call option on a non-dividend-paying stock is 0.4. What is the delta of the corresponding put option?
A) -0.4
B) 0.4
C) -0.6
D) 0.6
Q2) What does gamma 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
Q3) Vega tends to be high for which of the following
A) At-the money options
B) Out-of-the money options
C) In-the-money options
D) Options with a short time to maturity
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Chapter 18: Binomial Trees in Practice
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Q1) For an option on futures, the volatility is 35%, the time step is three months, and the risk-free rate is 5%. What is the Cox, Ross, Rubinstein parameter, p?
A) 0.52
B) 0.46
C) 0.48
D) 0.50
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) 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
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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) Which of the following is true about daily exchange rate moves?
A) Four standard deviation daily moves in an exchange rate happen less frequently than they would do if changes were normally distributed
B) Four standard deviation daily movements in an exchange rate happen more frequently than three standard deviation moves in the exchange rate
C) The frequency of six standard deviation daily movements in an exchange rate is about once every 100 years
D) None of the above
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Chapter 20: Value at Risk and Expected Shortfall
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Q1) At the end of Thursday, the estimated covariance between assets A and B is 0.0001. During Friday asset A produces a return of 3% and asset B produces a return of zero. An EWMA model with lambda equal to 0.9 is used. What is an estimate of the covariance at the end of Friday?
A) 0.000090
B) 0.000081
C) 0.000100
D) 0.000095
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 describes stressed VaR?
A) It is based on movements in market variables in stressed market conditions
B) It is VaR with a very high confidence level
C) It is VaR multiplied by a factor of 3
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 put?
A) $0
B) $1,250
C) $1,750
D) $2,500
Q3) Which of the following is assumed to be lognormal when a caplet is valued?
A) A future bond price
B) A future swap rate
C) A future short-term rate
D) A future long-term rate
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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) Which of the following is true?
A) Risk neutral default probabilities are usually much lower than real world default probabilities
B) Risk neutral default probabilities are usually much higher than real world default probabilities
C) Risk neutral and real world probabilities must be close to each other if there are to be no arbitrage opportunities
D) Risk-neutral default probabilities cannot be calculated from CDS spreads
Q2) In the Lehman bankruptcy the payoff to people who had bought CDS protection was 91.375% of the notional principal. How was this determined?
A) By calculation of the cheapest-to-deliver bond
B) By an auction process
C) By a calculation agent
D) By Lehman's liquidators
Q3) What is the number of companies underlying the CDX NA IG index?
A) 50
B) 75
C) 100
D) 125
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Page 25
Chapter 24: Weather, Energy, and Insurance Derivatives
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Q1) Which of the following is the average of CDD and HDD for a day?
A) The highest temperature during the day
B) The lowest temperature during the day
C) The average temperature during the day
D) None of the above
Q2) Which of the following is a common use of weather derivatives?
A) Hedge the volume of electricity that will be demanded by customers in the summer
B) Hedge the price of oil that must be purchased in the winter
C) Hedge the price of electricity that must be purchased in the summer
D) Hedge the price and volume of gas that must be purchased for heating in the winter
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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