Financial Markets and Institutions
Practice Exam
Course Introduction
This course offers an in-depth exploration of financial markets and institutions, examining their crucial roles in the global economy. Students will learn about the structure, functions, and types of financial markets, including money markets, capital markets, and derivatives markets, as well as the key financial institutions such as commercial banks, investment banks, insurance companies, and regulatory agencies. The course covers topics such as interest rate determination, risk management, financial instruments, market efficiency, and the regulatory environment, equipping students with a comprehensive understanding of how financial systems facilitate economic growth, allocate resources, and manage risks.
Recommended Textbook
Introduction to Derivatives and Risk Management 8th Edition by Don M. Chance
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Chapter 1: Introduction
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Sample Questions
Q1) Options,forwards,swaps,and futures are financial assets.
A)True
B)False
Answer: False
Q2) The market value of the derivatives contracts worldwide totals
A)less than a trillion dollars
B)in the hundreds of trillion dollars
C)over a trillion dollars but less than a hundred trillion
D)over quadrillion dollars
E)none of the above
Answer: C
Q3) Which of the following markets is/are said to provide price discovery?
A)futures
B)forwards
C)options
D)a and b
E)b and c
Answer: D
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Chapter 2: Structure of Options Markets
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Sample Questions
Q1) The Put and Call Brokers and Dealers Association created the first organized options exchange.
A)True
B)False
Answer: False
Q2) Option traders incur which of the following types of costs?
A)margin requirements
B)taxes
C)stock trading commissions
D)a and b
E)a,b and c
Answer: E
Q3) A put option in which the stock price is $60 and the exercise price is $65 is said to be A)in-the-money
B)out-of-the-money
C)at-the-money
D)exercisable
E)none of the above
Answer: A
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Page 4
Chapter 3: Principles of Option Pricing
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Sample Questions
Q1) Even if there are no dividends on the stock,American put-call parity will not be the same as European put-call parity.
A)True
B)False
Answer: True
Q2) If one portfolio always provides a return at least as high as another portfolio,then that portfolio will have a price no less than that of the other portfolio.
A)True
B)False
Answer: True
Q3) Holding everything else constant,call options are more expensive in periods of high interest rates.
A)True
B)False
Answer: True
Q4) At expiration the call price must converge to the stock price.
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) In a one-period binomial model with Su = 49.5,Sd = 40.5,p = 0.8,r = 0.06,S = 45 and X = 50,what is a European put worth?
A)2.17
B)0.50
C)9.50
D)5.00
E)none of the above
Q2) What would be the call's price if the stock goes down?
A)8.00
B)3.60
C)0.00
D)9.00
E)none of the above
Q3) The values of u and d are which of the following?
A)the return on the stock if it goes up and down,respectively
B)the inverse of the ratio of the up and down probabilities,respectively,and the risk-free rate
C)the normal probabilities of up and down movements,respectively
D)one plus the return on the stock if it goes up and down,respectively
E)none of the above
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Chapter 5: Option Pricing Models: the
Black-Scholes-Merton Model
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Sample Questions
Q1) The time to expiration of an option is based on a 360-day year.
A)True
B)False
Q2) The values of N(d<sub>1</sub>)and N(d<sub>2</sub>)are called risk neutral probabilities.
A)True
B)False
Q3) Since dividends could trigger an early exercise of an American call,the Black-Scholes-Merton dividend adjustment will provide the correct price of an American call.
A)True
B)False
Q4) What happens when the volatility is zero in the Black-Scholes-Merton model?
A)the option price converges to either zero or the lower bound
B)the option price converges to the intrinsic value
C)the option automatically expires out of the money
D)the gamma and delta converge
E)none of the above
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Chapter 6: Basic Option Strategies
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Sample Questions
Q1) What is the breakeven stock price at expiration on the transaction described in problem 1?
A)$32.89
B)$30.00
C)$27.11
D)$32.15
E)there is no breakeven
Q2) Buying a put is the mirror image of buying a call.
A)True
B)False
Q3) Which of the following is equivalent to a synthetic call?
A)a long stock and a short put position
B)a long put and a long stock position
C)a long put and a short risk-free bond position
D)a long stock and a short risk-free bond position
E)none of the above
Q4) The profit from a covered call is the profit from a long stock plus the profit from a long call.
A)True
B)False
Page 8
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Chapter 7: Advanced Option Strategies
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Sample Questions
Q1) Suppose you closed the spread 60 days later.What will be the profit if the stock price is still at $50?
A)$41
B)$198
C)$302
D)$102
E)none of the above
For questions 7 and 8,suppose an investor expects the stock price to remain at about $50 and decides to execute a butterfly spread using the June calls.
Q2) Early exercise is a disadvantage in which of the following transactions?
A)short box spread
B)put bear spread
C)long strip (2 puts and 1 call)
D)long strap (2 calls and 1 put)
E)none of the above
Q3) A call money spread that is closed prior to expiration has lower losses but higher profits for each stock price than if held to expiration.
A)True
B)False
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Page 9
Chapter 8: The Structure of Forward and Futures Markets
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Sample Questions
Q1) A futures contract covers 5000 pounds with a minimum price change of $0.01 is sold for $31.60 per pound.If the initial margin is $2,525 and the maintenance margin is $1,000,at what price would there be a margin call?
A)31.91
B)32.11
C)31.29
D)31.09
E)31.80
Q2) Where did the U.S.futures market originate?
A)Chicago
B)Kansas
C)New York
D)Minneapolis
E)none of the above
Q3) Variation margin is which of the following?
A)the difference in margin between hedger and speculator
B)margin differences according to trading style
C)margin deposited as a result of marking-to-market
D)margin set by the variability of a futures price
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) Value is created in a futures contract with the passage of time.
A)True
B)False
Q2) American foreign currency calls will never be exercised early.
A)True
B)False
Q3) A convenience yield is an explanation for a negative cost of carry.
A)True
B)False
Q4) Which of the following best describes normal contango?
A)the spot price is less than the futures price
B)the futures price is less than the spot price
C)the expected spot price is less than the futures price
D)the cost of carry is negative
E)none of the above
Q5) A synthetic put option on futures could be constructed by buying a call option on futures and selling the futures.
A)True
B)False
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Chapter 10: Futures Arbitrage Strategies
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Sample Questions
Q1) Find the annualized implied repo rate on a T-bond arbitrage if the spot price is 112.25,the accrued interest is 1.35,the futures price is 114.75,the CF is 1.0125,the accrued interest at delivery is 0.95,and the holding period is three months.
A)1.85 percent
B)0.77 percent
C)14.77 percent
D)13.04 percent
E)2.23 percent
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) The transaction designed to exploit mispricing in the relationship between futures and spot prices is called
A)a repurchase agreement
B)a hedge
C)speculation
D)carry arbitrage
E)none of the above
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Page 12
Chapter 11: Forward and Futures Hedging, Spread, and Target Strategies
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Sample Questions
Q1) In the real-world,financial decisions are irrelevant,so there is really no reason for firms to hedge.
A)True
B)False
Q2) You hold a stock portfolio worth $15 million with a beta of 1.05.You would like to lower the beta to 0.90 using S&P 500 futures,which have a price of 460.20 and a multiplier of 250.What transaction should you do? Round off to the nearest whole contract.
A)sell 130 contracts
B)sell 9,778 contracts
C)sell 20 contracts
D)buy 50,000 contracts
E)sell 50,000 contracts
Q3) An investor who expects to purchase stock at a later date would use a short hedge to protect against stock price movements.
A)True
B)False
Q4) The basis is the ratio of the futures price to the spot price.
A)True
B)False
13
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Chapter 12: Swaps
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Sample Questions
Q1) In an index amortizing swap,the notional principal increases throughout the life of the swap.
A)True
B)False
Q2) Interest rate swap payments are made
A)on the last day of the quarter
B)on the first day of each month
C)at whatever dates are agreed upon by the counterparties
D)on the 15th of the agreed-upon months
E)on the last day of the month
Q3) A swap involving two floating rates is called a basis swap.
A)True
B)False
Q4) 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
Q5) Swap payments are always either fixed or floating but never both.
A)True
B)False
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Chapter 13: Interest Rate Forwards and Options
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Sample Questions
Q1) Buying an interest rate call results in a limited loss if interest rates fall.
A)True
B)False
Q2) A bank buys an interest rate floor in conjunction with a loan it holds that will make four semiannual payments starting six months from now.The floor has a strike of 9 percent.LIBOR at the beginning of the four payment periods is 10,11,8,and 8.6 percent.On which dates will the floor writer make a payment to the bank?
A)now and in 24 months
B)in 18 and 24 months
C)in 12 and 18 months
D)in 6,12,18 and 24 months
E)none of the above
Q3) The convention for calculating interest on an interest rate derivative is to multiply the notional principal times the payoff function times 90 over 360 or 365.
A)True
B)False
Q4) The appropriate fixed rate on an FRA is the forward rate in the term structure.
A)True
B)False
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Chapter 14: Advanced Derivatives and Strategies
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Sample Questions
Q1) The cost of portfolio insurance is the return foregone if the market moves up.
A)True
B)False
Q2) How many puts should be used to insure this portfolio?
A)122,584
B)31,397
C)62,814
D)961,538
E)32,468
Q3) A standard (Black-Scholes)European option is equivalent to a combination of a down-and-out call plus a down-and-out put.
A)True
B)False
Q4) The rate on a constant maturity swap is based on a U.S.Treasury security of a given maturity.
A)True
B)False
Q5) Large stock price moves reduce the effectiveness of portfolio insurance.
A)True
B)False
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Chapter 15: Financial Risk Management Techniques and Applications
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Sample Questions
Q1) 18.Credit derivatives are derivatives that are insured against credit losses.
A)True
B)False
Q2) Earnings at Risk is a better risk measure for a derivatives dealer than is Value at Risk.
A)True
B)False
Q3) Which of the following statements is not true about a credit spread option?
A)it is an option on the spread of a bond over a reference bond
B)its value would change with changes in investors' perceptions of a party's credit quality
C)it requires payment of a premium up front
D)it requires that the underlying bond be relatively liquid
E)none of the above
Q4) What is the reason for undertaking a gamma hedge?
A)government regulation
B)the possibility of counterparty default
C)changes in volatility
D)large movements in the underlying
E)none of the above
Chapter 16: Managing Risk in an Organization
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Sample Questions
Q1) The basic premise behind FAS 133 is that derivatives transactions must be marked to market and recorded somewhere in the financial statements.
A)True
B)False
Q2) In which of the following activities is hedge accounting prohibited?
A)hedging an overall portfolio as opposed to an individual transaction
B)using short calls to protect a long asset
C)using long puts to protect an asset
D)hedging a long position with a short futures
E)hedging a swapt with a swaption
Q3) What is the primary activity of a firm's front office?
A)risk management
B)trading
C)pricing derivative products
D)auditing
E)none of the above
Q4) Barings Bank failed due to excessive government regulation of their derivatives activities.
A)True
B)False
Page 18
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