Futures and Options Test Bank
Course Introduction
This course provides an in-depth exploration of the derivatives market, focusing on the principles and practical applications of futures and options. Students will learn how these financial instruments function for hedging, speculating, and arbitrage, as well as how to value and trade them using various pricing models and strategies. Key topics include the structure of futures and options markets, contract specifications, margin requirements, mark-to-market processes, pricing theories such as the Black-Scholes model, and risk management techniques. Case studies and real-world examples illustrate how businesses, investors, and financial institutions use futures and options to achieve their financial objectives.
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 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
Q2) The price of a stock on February 1 is $124. A trader sells 200 put options on the stock with a strike price of $120 when the option price is $5. The options are exercised when the stock price is $110. The trader's net profit or loss is
A) Gain of $1,000
B) Loss of $2,000
C) Loss of $2,800
D) Loss of $1,000
Answer: D
Q3) Which of the following best describes a central counterparty
A) It is a trader that works for an exchange
B) It stands between two parties in the over-the-counter market
C) It is a trader that works for a bank
D) It helps facilitate futures trades
Answer: B
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Chapter 2: Futures Markets and Central Counterparties
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Q1) Which of the following are cash settled
A) All futures contracts
B) All option contracts
C) Futures on commodities
D) Futures on stock indices
Answer: D
Q2) A company enters into a short futures contract to sell 50,000 units of a commodity for 70 cents per unit. The initial margin is $4,000 and the maintenance margin is $3,000. What is the futures price per unit above which there will be a margin call?
A) 78 cents
B) 76 cents
C) 74 cents
D) 72 cents
Answer: D
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4
Chapter 3: Hedging Strategies Using Futures
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Q1) Which of the following is necessary for tailing a hedge?
A) Comparing the size in units of the position being hedged with the size in units of the futures contract
B) Comparing the value of the position being hedged with the value of one futures contract
C) Comparing the futures price of the asset being hedged to its forward price
D) None of the above
Answer: B
Q2) 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
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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) An interest rate is 12% per annum with semiannual compounding. What is the equivalent rate with quarterly compounding?
A) 11.83%
B) 11.66%
C) 11.77%
D) 11.92%
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) A short forward contract that was negotiated some time ago will expire in three months and has a delivery price of $40. The current forward price for three-month forward contract is $42. The three month risk-free interest rate (with continuous compounding) is 8%. What is the value of the short forward contract?
A) +$2.00
B) $2.00
C) +$1.96
D) $1.96
Q2) Which of the following is NOT true?
A) Gold and silver are investment assets
B) Investment assets are held by significant numbers of investors for investment purposes
C) Investment assets are never held for consumption
D) The forward price of an investment asset can be obtained from the spot price, interest rates and the income paid on the asset
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Chapter 6: Interest Rate Futures
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Q1) 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
Q2) A company invests $1,000 in a five-year zero-coupon bond and $4,000 in a ten-year zero-coupon bond. What is the duration of the portfolio?
A) 6 years
B) 7 years
C) 8 years
D) 9 years
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8
Chapter 7: Swaps
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Q1) 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
Q2) 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
Q3) A floating-for-fixed 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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Chapter 8: Securitization and the Credit Crisis of 2007
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Q1) Which of the following describes a subprime mortgage?
A) The rate of interest is less than the prime rate of interest
B) The loan-to-value ratio is below average
C) The life of the mortgage is less than 25 years
D) The credit risk is high
Q2) What are teaser rates
A) Interest rates that appear lower than they are
B) Interest rates that depend on LIBOR
C) Interest rates on mortgages with a very long amortization period
D) Interest rates that apply only for the first two or three years
Q3) Which of the following describes a waterfall?
A) A distribution of cash flows to tranches with priority given to tranche with the highest rating
B) A distribution of cash flows to tranches in proportion to their outstanding principals
C) A distribution of losses to tranches so that tranches bear losses in proportion to their outstanding principals
D) None of the above
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Chapter 9: Mechanics of Options Markets
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Q1) Which of the following describes a long position in an option?
A) A position where there is more than one year to maturity
B) A position where there is more than five years to maturity
C) A position where an option has been purchased
D) A position that has been held for a long time
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) The price of a stock is $67. A trader sells 5 put option contracts on the stock with a strike price of $70 when the option price is $4. The options are exercised when the stock price is $69. What is the trader's net profit or loss?
A) Loss of $1,500
B) Loss of $500
C) Gain of $1,500
D) Loss of $1,000
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Chapter 10: Properties of Stock Options
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Q1) When interest rates increase 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 can be used to create a long position in a European put option on a stock?
A) Buy a call option on the stock and buy the stock
B) Buy a call on the stock and short the stock
C) Sell a call option on the stock and buy the stock
D) Sell a call option on the stock and sell the stock
Q3) When volatility 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
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Chapter 11: Trading Strategies Involving Options
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Q1) A trader creates a long butterfly spread from options with strike prices $60, $65, and $70 by trading a total of 400 options. The options are worth $11, $14, and $18. What is the maximum net loss (after the cost of the options is taken into account)?
A) $100
B) $200
C) $300
D) $400
Q2) How can a straddle 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
Q3) Which of the following describes a protective put?
A) A long put option on a stock plus a long position in the stock
B) A long put option on a stock plus a short position in the stock
C) A short put option on a stock plus a short call option on the stock
D) A short put option on a stock plus a long position in the stock
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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. Over the next six months it is expected to rise to $36 or fall to $26. Assume the risk-free rate is zero. An investor sells call options with a strike price of $32. Which of the following hedges the position?
A) Buy 0.6 shares for each call option sold
B) Buy 0.4 shares for each call option sold
C) Short 0.6 shares for each call option sold
D) Short 0.4 shares for each call option sold
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 u for a tree with a three-month time step?
A) 1.05
B) 1.07
C) 1.09
D) 1.11
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Chapter 13: Valuing Stock Options: the Bsm Model
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Q1) What does N(x) denote?
A) The area under a normal distribution from zero to x
B) The area under a normal distribution up to x
C) The area under a normal distribution beyond x
D) The area under the normal distribution between -x and x
Q2) The risk-free rate is 5% and the expected return on a non-dividend-paying stock is 12%. Which of the following is a way of valuing a derivative?
A) Assume that the expected growth rate for the stock price is 17% and discount the expected payoff at 12%
B) Assuming that the expected growth rate for the stock price is 5% and discounting the expected payoff at 12%
C) Assuming that the expected growth rate for the stock price is 5% and discounting the expected payoff at 5%
D) Assuming that the expected growth rate for the stock price is 12% and discounting the expected payoff at 5%
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15
Chapter 14: Employee Stock Options
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Q1) When an employee stock option is exercised, which of the following is usually true?
A) The employee pays the market price for the shares and the company refunds the difference between the market price and the strike price
B) The company or the company's agent buys stock in the market for the employee
C) The company issues more shares and sells them to the employee for the strike price
D) The employee cannot immediately sell the shares
Q2) 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
Q3) 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
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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 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
Q2) 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)
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Chapter 16: Futures Options and Blacks Model
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Q1) Which of the following is true for a September futures option?
A) The expiration month of option is September
B) The option was first traded in September
C) The delivery month of the underlying futures contract is September
D) September is the first month when the option can be exercised
Q2) A futures price is currently 40 cents. It is expected to move up to 44 cents or down to 34 cents in the next six months. The risk-free interest rate is 6%. What is the value of a six month call option with a strike price of 39 cents?
A) 5.00 cents
B) 2.91 cents
C) 3.00 cents
D) 4.21 cents
Q3) A futures price is currently 40 cents. It is expected to move up to 44 cents or down to 34 cents in the next six months. The risk-free interest rate is 6%. What is the probability of an up movement in a risk-neutral world?
A) 0.4
B) 0.5
C) 0.72
D) 0.6
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Page 18
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 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) Which of the following is true for a call option on a non-dividend-paying stock?
A) If the option is at the money (stock price equals strike price) it must have a delta of 0.5
B) If the strike price equals the forward price of the stock, it must have a delta of 0.5
C) If the option has a delta of 0.5, it must be out of the money
D) If the option has a delta of 0.5, it must be in of the money
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Chapter 18: Binomial Trees in Practice
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Q1) How many different paths are there through a Cox-Ross-Rubinstein tree with four-steps?
A) 5
B) 9
C) 12
D) 16
Q2) 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
Q3) How many nodes are there at the end of a Cox-Ross-Rubinstein five-step binomial tree?
A) 4
B) 5
C) 6
D) 7
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Chapter 19: Volatility Smiles
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Q1) Which of the following is NOT true?
A) A volatility surface provides more information than a single volatility smile
B) A volatility surface is used to determine the implied volatility of an option that does not trade actively
C) A volatility surface can be determined from a single volatility smile using interpolation
D) A volatility surface incorporates information about options with different maturity dates
Q2) What does the shape of the volatility smile reveal about call options on a currency?
A) Options close-to-the-money have the lowest implied volatility
B) Options deep-in-the-money have a relatively high implied volatility
C) Options deep-out-of-the-money have a relatively high implied volatility
D) All of the above
Q3) A volatility surface is a table showing the relationship between which of the following
A) Implied volatility, time to maturity, and strike price
B) Implied volatility, historical volatility, and time to maturity
C) Historical volatility, strike price, and time to maturity
D) None of the above
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Chapter 20: Value at Risk and Expected Shortfall
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Q1) Which of the following is true when delta, but not gamma, is used in calculating VaR for option positions?
A) VaR for a long call is too low and VaR for a long put is too low
B) VaR for a long call is too low and VaR for a long put is too high
C) VaR for a long call is too high and VaR for a long put is too low
D) VaR for a long call is too high and VaR for a long put is too high
Q2) Which of the following is true of the 99.9% value at risk?
A) There is 1 chance in 10 that the loss will be greater than the value of risk
B) There is 1 chance in 100 that the loss will be greater than the value of risk
C) There is 1 chance in 1000 that the loss will be greater than the value of risk
D) None of the above
Q3) What is the method of testing how often a VaR with a certain confidence level was exceeded in the past called?
A) Stress testing
B) Backtesting
C) EWMA
D) The model-building approach
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Page 22
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 swap option is valued?
A) A future bond price
B) A future swap rate
C) A future short-term rate
D) A future bond yield
Q3) Which of the following is assumed to be lognormal when a bond option is valued?
A) A future bond price
B) A future swap rate
C) A future short-term rate
D) A future bond yield
Q4) Which of the following is true?
A) A cap is a portfolio of put options on interest rates
B) A cap is a put option on a coupon-bearing bond
C) A cap is a call option on a coupon-bearing bond
D) None of the above
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Chapter 22: Exotic Options and Other Nonstandard Products
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Q1) There are two types of regular options (calls and puts). How many types of compound options are there?
A) Two
B) Four
C) Six
D) Eight
Q2) 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
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Chapter 23: Credit Derivatives
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Q1) If the CDS-bond basis is X minus Y, what are X and Y?
A) X is the CDS spread and Y is the excess of the bond yield over the swap rate
B) X is the excess of the bond yield over the swap rate and Y is the CDS spread
C) X is the CDS spread and Y is the excess of the bond yield over the Treasury rate
D) X is the excess of the bond yield over the Treasury rate and Y is the CDS spread
Q2) 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
Q3) 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
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Chapter 24: Weather, Energy, and Insurance Derivatives
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Q1) 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
Q2) Where are oil, gas, and electricity derivatives traded?
A) On exchanges and the OTC market
B) On exchanges, but not on the OTC market
C) On the OTC market , but not on exchanges
D) Oil is traded in both markets, but the other two are traded only in the OTC market
Q3) Which of the following typically has the lowest volatility?
A) Crude oil
B) Natural gas
C) Electricity in the winter
D) Electricity in the summer
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