Financial Markets and Institutions
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Course Introduction
This course provides an in-depth exploration of the structure, functions, and roles of financial markets and institutions within the global economy. Students will examine various types of financial markets including money, capital, derivatives, and foreign exchange markets and analyze the critical functions they serve in facilitating liquidity, price discovery, and capital allocation. The course also delves into the operation of key financial institutions such as commercial banks, investment banks, insurance companies, and pension funds, highlighting how these entities manage risk and contribute to economic growth. Regulatory frameworks, financial innovations, and the impact of globalization on financial systems are also discussed, giving students a comprehensive understanding of how markets and institutions interact to support economic development.
Recommended Textbook
Fundamentals of Futures and Options Markets Global Edition 8th Edition by John Hull
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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 company knows it will have to pay a certain amount of a foreign currency to one of its suppliers in the future.Which of the following is true?
A)A forward contract can be used to lock in the exchange rate
B)A forward contract will always give a better outcome than an option
C)An option will always give a better outcome than a forward contract
D)An option can be used to lock in the exchange rate
Answer: A
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3
Chapter 2: Mechanics of Futures Markets
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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) Margin accounts have the effect of
A)Reducing the risk of one party regretting the deal and backing out
B)Ensuring funds are available to pay traders when they make a profit
C)Reducing systemic risk due to collapse of futures markets
D)All of the above
Answer: D
Q3) 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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Page 4
Chapter 3: Hedging Strategies Using Futures
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Q1) Which of the following does NOT describe beta?
A)A measure of the sensitivity of the return on an asset to the return on an index
B)The slope of the best fit line when the return on an asset is regressed against the return on the market
C)The hedge ratio necessary to remove market risk from a portfolio
D)Measures correlation between futures prices and spot prices
Answer: D
Q2) Which of the following increases basis risk?
A)A large difference between the futures prices when the hedge is put in place and when it is closed out
B)Dissimilarity between the underlying asset of the futures contract and the hedger's exposure
C)A reduction in the time between the date when the futures contract is closed and its delivery month
D)None of the above
Answer: B
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Chapter 4: Interest Rates
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Q1) The zero curve is downward 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) 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
Q3) 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
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Chapter 5: Determination of Forward and Futures Prices
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Q1) Which of the following is a consumption asset?
A)The S&P 500 index
B)The Canadian dollar
C)Copper
D)IBM stock
Q2) 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
Q3) Which of the following describes the way the futures 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 futures 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 futures prices
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Chapter 6: Interest Rate Futures
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Q1) 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
Q2) Which of the following is NOT true about duration?
A)It equals the years-to-maturity for a zero coupon bond
B)It equals the weighted average of payment times for a bond.where weights are proportional to the present value of payments
C)Equals the weighted average of individual bond durations for a portfolio.where weights are proportional to the present value of bond prices
D)The prices of two bonds with the same duration change by the same percentage amount when interest rate move up by 100 basis points
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Chapter 7: Swaps
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Q1) Which of the following describes an interest rate swap?
A)The exchange of a fixed rate bond for a floating rate bond
B)A portfolio of forward rate agreements
C)An agreement to exchange interest at a fixed rate for interest at a floating rate
D)All of the above
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
Q3) 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
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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 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
Q3) Which of the following is NOT true?
A)The bonus structure at banks can lead to short-term horizons for decision making
B)Securitization involves the transfer of risk
C)The term "agency costs" describes the situation where the incentives of two parties in a business relationship are not perfectly aligned
D)Correlations decrease in stressed market conditions
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Chapter 9: Mechanics of Options Markets
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Q1) An investor has exchange-traded put options to sell 100 shares for $20.There is a $1 cash dividend.Which of the following is then the position of the investor?
A)The investor has put options to sell 100 shares for $20
B)The investor has put options to sell 100 shares for $19
C)The investor has put options to sell 105 shares for $19
D)The investor has put options to sell 105 shares for $19.05
Q2) 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
Q3) When a six-month option is purchased
A)The price must be paid in full
B)Up to 25% of the option price can be borrowed using a margin account
C)Up to 50% of the option price can be borrowed using a margin account
D)Up to 75% of the option price can be borrowed using a margin account
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Chapter 10: Properties of Stock Options
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Q1) When dividends 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
Q2) Which of the following is true?
A)An American call option on a stock should never be exercised early
B)An American call option on a stock should never be exercised early when no dividends are expected
C)There is always some chance that an American call option on a stock will be exercised early
D)There is always some chance that an American call option on a stock will be exercised early when no dividends are expected
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) 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
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 12: Introduction to Binomial Trees
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Q1) If the volatility of a stock is 20% per annum and a risk-free rate is 5% per annum,which of the following is closest to the Cox,Ross,Rubinstein parameter p for a tree with a three-month time step?
A)0.50
B)0.54
C)0.58
D)0.62
Q2) What is the value of each option? The risk-free interest rate is 2% per annum with continuous compounding.
A)$3.93
B)$2.93
C)$1.93
D)$0.93
Q3) Which of the following is NOT true in a risk-neutral world?
A)The expected return on a call option is independent of its strike price
B)Investors expect higher returns to compensate for higher risk
C)The expected return on a stock is the risk-free rate
D)The discount rate used for the expected payoff on an option is the risk-free rate
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Chapter 13: Valuing Stock Options: The BSM Model
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Q1) 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
Q2) What is the number of trading days in a year usually assumed for equities?
A)365
B)252
C)262
D)272
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Chapter 14: Employee Stock Options
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Q1) Which of the following hypotheses is supported by empirical research?
A)The grant date for executive stock options tends to be when the stock price is high
B)The grant date for executive stock options tends to be when the stock price is low
C)The grant date for executive stock options tends to be after a growth spurt in the stock price
D)The is no relationship between the timing of grants and the stock price
Q2) 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
Q3) Which of the following is true about employee stock options after they have been issued?
A)They have to be revalued every year
B)They have to be revalued every quarter
C)They have to be revalued every day like other derivatives
D)They never have to be revalued
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Chapter 15: Options on Stock Indices and Currencies
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Q1) A European at-the-money call option on a currency has four years until maturity.The exchange rate volatility is 10%,the domestic risk-free rate is 2% and the foreign risk-free rate is 5%.The current exchange rate is 1.2000.What is the value of the option?
A)0.98N(0.25)-1.11(0.05)
B)0.98N(-0.3)-1.11N(-0.5)
C)0.98N(-0.5)-1.11N(-0.7)
D)0.98N(0.10)-1.11N(0.06)
Q2) 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 the dividend yield on both the portfolio and the index is 2% per annum.
A)400
B)410
C)420
D)430
Q3) 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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Page 17
Chapter 16: Futures Options
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Q1) 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
Q2) 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
Q3) 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
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Chapter 17: The Greek Letters
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Q1) What does vega 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) 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
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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Chapter 18: Binomial Trees in Practice
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Q1) 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
Q2) How many different paths are there through a Cox-Ross-Rubinstein tree with four-steps?
A)5
B)9
C)12
D)16
Q3) What is the recommended way of making volatility a function of time in a Cox,Ross,Rubinstein tree?
A)Make u a function of time
B)Make p a function of time
C)Make u and p a function of time
D)Make the lengths of the time steps unequal
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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) 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
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Q1) Which of the following is true of the historical simulation method for calculating VaR?
A)It fits historical data on the behavior of variables to a normal distribution
B)It fits historical data on the behavior of variables to a lognormal distribution
C)It assumes that what will happen in the future is a random sample from what has happened in the past
D)It uses Monte Carlo simulation to create random future scenarios
Q2) Which of the following is true when 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
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Chapter 21: Interest Rate Options
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Q1) 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
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) Which of the following is true?
A)A puttable bond allows the lender to ask for the principal to be repaid early
B)A puttable bond allows the borrower to repay the principal early
C)A puttable bond is a bond with an embedded stock option
D)None of the above
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Chapter 22: Exotic Options and Other Nonstandard Products
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Q1) 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
Q2) An Asian option is a term used to describe which of the following?
A)An option where the payoff depends on whether a barrier is hit
B)An option where the payoff depends on the average value of a variable over a period of time
C)An option that trades on an exchange in the Far East
D)Any option with a nonstandard payoff
Q3) A PO is a "principal only" MBS and an IO is an "interest only" MBS.As prepayments increase which of the following happens?
A)Both the PO and IO become more valuable
B)The PO becomes more valuable and the IO becomes less valuable
C)The PO becomes less valuable and the IO becomes more valuable
D)Both the PO and IO become less valuable
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Chapter 23: Credit Derivatives
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Q1) Which of the following is the most popular life for a credit default swap?
A)1 year
B)3 years
C)5 years
D)10 years
Q2) Which of the following happens when the default correlation of the companies underlying a CDO increases?
A)The value of the senior tranche and the equity tranche to the protection buyer both increase
B)The value of the senior tranche and the equity tranche to the protection buyer both decrease
C)The value of the senior tranche to the protection buyer decreases and the value of the equity tranche to the protection buyer increases
D)The value of the senior tranche to the protection buyer increases and the value of the equity tranche to the protection buyer decreases
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Chapter 24: Weather, Energy, and Insurance Derivatives
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Q1) What is the day's CDD?
A)5
B)12
C)4
D)0
Q2) What is the day's HDD?
A)5
B)12
C)4
D)0
Q3) An August CDD weather option is offered on the cumulative monthly CDD at an Atlanta weather station.An investor has a long call with a strike price of 375 and a short call with a strike price of 400.The payment is $10,000 per degree day.What is the maximum payoff?
A)$500,000
B)$250,000
C)$100,000
D)$50,000
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