Financial Markets and Institutions
Final Exam Questions
Course Introduction
This course provides an in-depth exploration of the structure, functions, and impact of financial markets and institutions within the global economy. Students will study key financial intermediaries such as banks, insurance companies, and investment firms, as well as the roles of primary and secondary markets. Topics include the operation of money and capital markets, the determination of interest rates, risk and return dynamics, regulatory frameworks, and contemporary issues affecting financial systems. Emphasis is placed on understanding how financial markets contribute to economic growth and stability, alongside the challenges posed by globalization, innovation, and financial crises.
Recommended Textbook
Fundamentals of Futures and Options Markets 9th Edition by John C. Hull
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2
Chapter 1: Introduction
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Q1) Which of the following describes European options?
A) Sold in Europe
B) Priced in Euros
C) Exercisable only at maturity
D) Calls (there are no puts)
Answer: C
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
Q3) 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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Page 3
Chapter 2: Futures Markets and Central Counterparties
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Q1) Which of the following is true
A) Both forward and futures contracts are traded on exchanges.
B) Forward contracts are traded on exchanges, but futures contracts are not.
C) Futures contracts are traded on exchanges, but forward contracts are not.
D) Neither futures contracts nor forward contracts are traded on exchanges.
Answer: C
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 silver mining company has used futures markets to hedge the price it will receive for everything it will produce over the next 5 years. Which of the following is true?
A) It is liable to experience liquidity problems if the price of silver falls dramatically
B) It is liable to experience liquidity problems if the price of silver rises dramatically
C) It is liable to experience liquidity problems if the price of silver rises dramatically or falls dramatically
D) The operation of futures markets protects it from liquidity problems
Answer: B
Q2) Which of the following best describes the capital asset pricing model?
A) Determines the amount of capital that is needed in particular situations
B) Is used to determine the price of futures contracts
C) Relates the return on an asset to the return on a stock index
D) Is used to determine the volatility of a stock index
Answer: C
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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 two-year zero rate is 6% and the three year zero rate is 6.5%. What is the forward rate for the third year? All rates are continuously compounded.
A) 6.75%
B) 7.0%
C) 7.25%
D) 7.5%
Q3) Prior to the credit crisis that started in 2007 which of the following was the proxy used by derivatives traders for the risk-free rate
A) The Treasury rate
B) The LIBOR rate
C) The repo rate
D) The overnight indexed swap rate
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6
Chapter 5: Determination of Forward and Futures Prices
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Q1) Which of the following is true for a consumption commodity?
A) There is no limit to how high or low the futures price can be, except that the futures price cannot be negative
B) There is a lower limit to the futures price but no upper limit
C) There is an upper limit to the futures price but no lower limit, except that the futures price cannot be negative
D) The futures price can be determined with reasonable accuracy from the spot price and interest rates
Q2) 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) Duration matching immunizes a portfolio against
A) Any parallel shift in the yield curve
B) All shifts in the yield curve
C) Changes in the steepness of the yield curve
D) Small parallel shifts in the yield curve
Q2) Which of the following is true?
A) The futures rates calculated from a Eurodollar futures quote are always less than the corresponding forward rate
B) The futures rates calculated from a Eurodollar futures quote are always greater than the corresponding forward rate
C) The futures rates calculated from a Eurodollar futures quote should equal the corresponding forward rate
D) The futures rates calculated from a Eurodollar futures quote are sometimes greater than and sometimes less than the corresponding forward rate
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Chapter 7: Swaps
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Q1) 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
Q2) A company can invest funds for five years at LIBOR minus 30 basis points. The five-year swap rate is 3%. What fixed rate of interest can the company earn by using the swap?
A) 2.4%
B) 2.7%
C) 3.0%
D) 3.3%
Q3) A floating for floating currency swap is equivalent to
A) Two interest rate swaps, one in each currency
B) A fixed-for-fixed currency swap and one interest rate swap
C) A fixed-for-fixed currency swap and two interest rate swaps, one in each currency
D) None of the above
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9
Chapter 8: Securitization and the Credit Crisis of 2007
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Q1) Suppose that ABSs are created from portfolios of subprime mortgages with the following allocation of the principal to tranches: senior 80%, mezzanine 10%, and equity 10%. (The portfolios of subprime mortgages have the same default rates.) An ABS CDO is then created from the mezzanine tranches with the same allocation of principal. Losses on the mortgage portfolio prove to be 16%. What, as a percent of tranche principal, are losses on the senior tranche of the ABS CDO
A) 50%
B) 60%
C) 80%
D) 100%
Q2) Which of the following describes the S&P/Case-Shiller index?
A) A stock market index
B) An index of interest rates on mortgages
C) An index of house prices
D) An index showing the dollar amount of mortgages granted each month
Q3) In 2008 the LIBOR-OIS spread reached a high of
A) 164 basis points
B) 264 basis points
C) 364 basis points
D) 464 basis points
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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 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
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 short position in an option?
A) A position in an option lasting less than one month
B) A position in an option lasting less than three months
C) A position in an option lasting less than six months
D) A position where an option has been sold
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11
Chapter 10: Properties of Stock Options
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Q1) The price of a stock, which pays no dividends, is $30 and the strike price of a one year European call option on the stock is $25. The risk-free rate is 4% (continuously compounded). Which of the following is a lower bound for the option such that there are arbitrage opportunities if the price is below the lower bound and no arbitrage opportunities if it is above the lower bound?
A) $5.00
B) $5.98
C) $4.98
D) $3.98
Q2) 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
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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) 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
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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13
Chapter 12: Introduction to Binomial Trees
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Q1) Which of the following are NOT true
A) Risk-neutral valuation and no-arbitrage arguments give the same option prices
B) Risk-neutral valuation involves assuming that the expected return is the risk-free rate and then discounting expected payoffs at the risk-free rate
C) A hedge set up to value an option does not need to be changed
D) All of the above
Q2) 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
Q3) In a binomial tree created to value an option on a stock, what is the expected return on the option?
A) Zero
B) The return required by the market
C) The risk-free rate
D) It is impossible to know without more information
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Page 14
Chapter 13: Valuing Stock Options: the Bsm Model
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Q1) Which of the following is NOT true?
A) Risk-neutral valuation assumes that investors are risk neutral
B) Options can be valued based on the assumption that investors are risk neutral
C) In risk-neutral valuation the expected return on all investment assets is set equal to the risk-free rate
D) In risk-neutral valuation the risk-free rate is used to discount expected cash flows
Q2) Which of the following is a way of extending the Black-Scholes-Merton formula to value a European call option on a stock paying a single dividend?
A) Reduce the maturity of the option so that it equals the time of the dividend
B) Subtract the dividend from the stock price
C) Add the dividend to the stock price
D) Subtract the present value of the dividend from the stock price
Q3) Which of the following is measured by the VIX index
A) Implied volatilities for stock options trading on the CBOE
B) Historical volatilities for stock options trading on CBOE
C) Implied volatilities for options trading on the S&P 500 index
D) Historical volatilities for options trading on the S&P 500 index
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Chapter 14: 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 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
Q3) Employee stock options are particularly popular with start ups because
A) They encourage employees to work hard
B) The start up cannot afford to pay high salaries
C) The risk associated with the company's success is shared with employees.
D) All of the above
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Page 16
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 is the same as 100 call options to buy one unit of currency A with currency B at a strike price of 1.25?
A) 100 call options to buy one unit of currency B with currency A at a strike price of 0.8
B) 125 call options to buy one unit of currency B with currency A at a strike price of 0.8
C) 100 put options to sell one unit of currency B for currency A at a strike price of 0.8
D) 125 put options to sell one unit of currency B for currency A at a strike price of 0.8
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Chapter 16: Futures Options and Blacks Model
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Q1) Which of the following is true when the futures price exceeds the spot price?
A) Calls on futures should never be exercised early
B) Put on futures should never be exercised early
C) A call on futures is always worth at least as much as the corresponding call on spot
D) A call on spot is always worth at least as much as the corresponding call on futures
Q2) Which of the following is acquired (in addition to a cash payoff) when the holder of a put futures exercises?
A) A long position in a futures contract
B) A short position in a futures contract
C) A long position in the underlying asset
D) A short position in the underlying asset
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 17: 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) What does theta 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) The risk-free rate is 5% and the dividend yield on an index is 2%. Which of the following is the delta with respect to the index of a one-year futures on the index?
A) 0.98
B) 1.05
C) 1.03
D) 1.02
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Chapter 18: Binomial Trees in Practice
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Q1) Which of the following is possible in a modified Cox, Ross, Rubinstein binomial tree?
A) The interest rate and volatility can both be functions of time
B) The interest rate or the volatility can be a function of time, but not both
C) The interest rate can be a function of time but the volatility cannot
D) The interest rate and volatility must be constant
Q2) 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
Q3) 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
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Chapter 19: Volatility Smiles
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Q1) The daily percentage change in an exchange rate is compared to a normal distribution with the same mean and standard deviation. Which of the following is true
A) Both small and large exchange rate moves are more likely than with the normal distribution
B) Small exchange rate moves are less likely and large exchange rate moves are more likely than with the normal distribution
C) Large exchange rate moves are less likely and small exchange rate moves are more likely than with the normal distribution
D) Both small and large exchange rate moves are less likely than with the normal distribution
Q2) Which of the following is true?
A) The volatility skew for equities is much more pronounced now than it was in 1985.
B) The volatility skew for equities has a positive gradient
C) The volatility skew for equities is consistent with the Black-Scholes-Merton model.
D) The volatility skew for equities is similar to that for foreign currencies.
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Chapter 20: Value at Risk and Expected Shortfall
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Q1) If the volatility for a portfolio is 20% per year, what is the volatility per quarter?
A) 20%
B) 10%
C) 5%
D) 2%
Q2) The 10-day VaR is often assumed to be which of the following
A) The 1-day VaR multiplied by 10
B) The 1-day VaR multiplied by the square root of10
C) The 1-day VaR divided by 10
D) The 1-day VaR divided by the square root of 10
Q3) 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) 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
Q2) 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
Q3) A ten year interest rate cap has quarterly resets. How many caplets does the cap consist of?
A) 38
B) 39
C) 40
D) 41
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Chapter 22: Exotic Options and Other Nonstandard Products
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Q1) Which of the following is equivalent to a long position in a European call 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
Q2) 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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Page 24
Chapter 23: Credit Derivatives
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Q1) A CDS with a number of reference entities provides a payoff when any of the reference entities defaults. What is a name for this CDS?
A) Binary CDS
B) Add-up Basket CDS
C) First-to-Default CDS
D) n-to-Default CDS
Q2) In a one-year forward contract on a CDS that will last five years, what usually happens if there is a default during the first year?
A) There is a payoff to the forward protection buyer at the time of default
B) There is a payoff to the forward protection buyer at the end of one year
C) There is a payoff to the forward protection buyer at the end of six years
D) The contract ceases to exist
Q3) Which of the following is true about a CDS?
A) Restructuring is never a credit event
B) Restructuring is always a credit event
C) Certain types of restructuring qualify as credit events but others do not
D) Sometimes a CDS is defined so that restructuring is a credit event and sometimes it is not
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25
Chapter 24: Weather, Energy, and Insurance Derivatives
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Q1) Which of the following is NOT seasonal?
A) Spot electricity
B) Spot natural gas
C) Electricity futures prices
D) Spot price of corn
Q2) 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
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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