Futures and Options
Textbook Exam Questions
Course Introduction
This course offers an in-depth exploration of futures and options, two of the most widely used derivative instruments in financial markets. Students will examine the structure and functioning of futures and options markets, learning about contract specifications, trading mechanisms, and the economic roles of these derivatives in hedging, arbitrage, and speculation. The course covers pricing models, valuation techniques, and risk management strategies, including the use of margin and collateral. Through real-world examples and case studies, students gain practical skills in analyzing derivative positions and understanding the implications of leverage, volatility, and market behavior on derivative instruments.
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 is NOT true
A) A call option gives the holder the right to buy an asset by a certain date for a certain price
B) A put option gives the holder the right to sell an asset by a certain date for a certain price
C) The holder of a call or put option must exercise the right to sell or buy an asset
D) The holder of a forward contract is obligated to buy or sell an asset
Answer: C
Q2) An investor sells a futures contract an asset when the futures price is $1,500. Each contract is on 100 units of the asset. The contract is closed out when the futures price is $1,540. Which of the following is true
A) The investor has made a gain of $4,000
B) The investor has made a loss of $4,000
C) The investor has made a gain of $2,000
D) The investor has made a loss of $2,000
Answer: B
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3
Chapter 2: Futures Markets and Central Counterparties
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Q1) 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
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) On March 1 a commodity's spot price is $60 and its August futures price is $59. On July 1 the spot price is $64 and the August futures price is $63.50. A company entered into futures contracts on March 1 to hedge its purchase of the commodity on July 1. It closed out its position on July 1. What is the effective price (after taking account of hedging) paid by the company?
A) $59.50
B) $60.50
C) $61.50
D) $63.50
Answer: A
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 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
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) At what interest rate does a government borrow in its own currency?
A) Treasury rate
B) LIBOR
C) LIBID
D) Repo rate
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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 a consumption asset?
A) The S&P 500 index
B) The Canadian dollar
C) Copper
D) IBM stock
Q3) 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
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Chapter 6: Interest Rate Futures
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Q1) 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.
Q2) A trader enters into a long position in one Eurodollar futures contract. How much does the trader gain when the futures price quote increases by 6 basis points?
A) $6
B) $150?C. $60
C) $60
D) $600
Q3) 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
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8
Chapter 7: Swaps
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Q1) 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
Q2) Which of the following describes the way a LIBOR-in-arrears swap differs from a plain vanilla interest rate swap?
A) Interest is paid at the beginning of the accrual period in a LIBOR-in-arrears swap
B) Interest is paid at the end of the accrual period in a LIBOR-in-arrears swap
C) No floating interest is paid until the end of the life of the swap in a LIBOR-in-arrears swap, but fixed payments are made throughout the life of the swap
D) Neither floating nor fixed payments are made until the end of the life of the swap
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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 94.5% (rated AAA), mezzanine 0.1% (rated BBB), and equity 5% (rated C) . The portfolios of subprime mortgages have the same default rates. An ABS CDO is then created from the mezzanine tranches. Which of the following is true?
A) The ABS CDO tranches should have similar ratings ranging from AAA to C
B) The ABS CDO tranches should all be rated BBB
C) The ABS CDO tranches should all be rated C
D) The ABS CDO tranches are almost worthless because the mezzanine tranches are so thin
Q2) 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
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Page 10
Chapter 9: Mechanics of Options Markets
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Q1) A trader buys a call and sells a put with the same strike price and maturity date. What is the position equivalent to?
A) A long forward
B) A short forward
C) Buying the asset
D) None of the above
Q2) 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
Q3) Which of the following are true for CBOE stock options?
A) There are no margin requirements
B) The initial margin and maintenance margin are determined by formulas and are equal
C) The initial margin and maintenance margin are determined by formulas and are different
D) The maintenance margin is usually about 75% of the initial margin
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Chapter 10: Properties of Stock Options
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Q1) 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
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) When the time to maturity increases with all else remaining the same, which of the following is true?
A) European options always increase in value
B) The value of European options either stays the same or increases
C) There is no effect on European option values
D) European options are liable to increase or decrease in value
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Page 12
Chapter 11: Trading Strategies Involving Options
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Q1) 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
Q2) 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
Q3) Six-month call options with strike prices of $35 and $40 cost $6 and $4, respectively.
What is the maximum gain when a bull spread is created by trading a total of 200 options?
A) $100
B) $200
C) $300
D) $400
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Page 13
Chapter 12: Introduction to Binomial Trees
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Q1) When moving from valuing an option on a non-dividend paying stock to an option on a currency which of the following is true?
A) The risk-free rate is replaced by the excess of the domestic risk-free rate over the foreign risk-free rate in all calculations
B) The formula for u changes
C) The risk-free rate be replaced by the excess of the domestic risk-free rate over the foreign risk-free rate for discounting
D) The risk-free rate be replaced by the excess of the domestic risk-free rate over the foreign risk-free rate when p is calculated
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) A stock price is 20, 22, 19, 21, 24, and 24 on six successive Fridays. Which of the following is closest to the volatility per annum estimated from this data?
A) 50%
B) 60%
C) 70%
D) 80%
Q2) 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
Q3) 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
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Chapter 14: Employee Stock Options
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Q1) What term is used to describe losses shareholders experience because the interests of managers are not aligned with their own?
A) Agency costs
B) Backdating scandals
C) Dilution
D) Income statement expense
Q2) 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
Q3) Which of the following was true after 2005?
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
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Page 16
Chapter 15: Options on Stock Indices and Currencies
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Q1) Suppose that the domestic risk free rate is r and dividend yield on an index is q. How should the put-call parity formula for options on a non-dividend-paying stock be changed to provide a put-call parity formula for options on a stock index? Assume the options last T years.
A) The stock price is replaced by the value of the index multiplied by exp(qT)
B) The stock price is replaced by the value of the index multiplied by exp(rT)
C) The stock price is replaced by the value of the index multiplied by exp(-qT)
D) The stock price is replaced by the value of the index multiplied by exp(-rT)
Q2) Which of the following describes what a company should do to create a range forward contract in order to hedge foreign currency that will be paid?
A) Buy a put and sell a call on the currency with the strike price of the put higher than that of the call
B) Buy a put and sell a call on the currency with the strike price of the put lower than that of the call
C) Buy a call and sell a put on the currency with the strike price of the put higher than that of the call
D) Buy a call and sell a put on the currency with the strike price of the put lower than that of the call
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Page 17
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) 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
Q3) 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
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18
Chapter 17: The Greek Letters
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Q1) The gamma of a delta-neutral portfolio is 500. What is the impact of a jump of $3 in the price of the underlying asset?
A) A gain of $2,250
B) A loss of $2,250
C) A gain of $750
D) A loss of $750
Q2) 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
Q3) A portfolio of derivatives on a stock has a delta of 2400 and a gamma of -10. An option on the stock with a delta of 0.5 and a gamma of 0.04 can be traded. What position in the option is necessary to make the portfolio gamma neutral?
A) Long position in 250 options
B) Short position in 250 options
C) Long position in 20 options
D) Short position in 20 options
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19
Chapter 18: Binomial Trees in Practice
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Q1) 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
Q2) 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, u?
A) 1.34
B) 1.29
C) 1.09
D) 1.19
Q3) 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
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Chapter 19: Volatility Smiles
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Q1) The implied volatilities for strike prices of 1.1 and 1.2 when the time to maturity is 6 months are 20% and 22%. The implied volatilities for strike prices of 1.1 and 1.2 when the time to maturity is 1 year are 18.8% and 20.2%. Using linear interpolation, what is the implied volatility for a strike price of 1.12 and a time to maturity of 10 months?
A) 19.24%
B) 19.52%
C) 20.48%
D) 19.96%
Q2) 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
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Chapter 20: Value at Risk and Expected Shortfall
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Q1) 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
Q2) Which of the following is a definition of the covariance between X and Y?
A) Correlation between X and Y times variance of X times variance of Y
B) Variance of X times the variance of Y
C) Correlation between X and Y divided by the product of the standard deviation of X and the standard deviation of Y
D) Correlation between X and Y times standard deviation of X times standard deviation of Y
Q3) Which of the following is true?
A) The quadratic model approximates daily changes in using delta and gamma
B) The quadratic model approximates daily changes using delta, but not gamma
C) The quadratic model approximates daily changes using gamma, but not delta
D) None of the above
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Page 22
Chapter 21: Interest Rate Options
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Q1) In a cap with quarterly reset dates, the cap rate is 3.5% per annum and the notional principal is $1 million. Suppose that the LIBOR rate is 4.0% per annum for a particular 3-month period. What is the approximate payoff at the end of the 3 months?
A) $10,000
B) $5,000
C) $2,500
D) $1,250
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) 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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23
Chapter 22: Exotic Options and Other Nonstandard Products
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Q1) When can Bermudan options be exercised?
A) Any time during the life of the options
B) Any time after a certain date up to the end of the life of the life
C) Any time before a certain date or at the end of the option's life
D) On dates specified at the start of the option
Q2) A fixed lookback put option pays off which of the following
A) The amount by which the final stock price exceeds the minimum stock price
B) The amount by which the maximum stock price exceeds the final stock price
C) The amount by which the strike price exceeds the minimum stock price
D) The amount by which the maximum stock price exceeds the strike price
Q3) 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)
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Page 24
Chapter 23: Credit Derivatives
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Q1) Which of the following is true of a synthetic CDO?
A) It is created from portfolios of bonds
B) It is created from portfolios of CDSs
C) It references a standard portfolio of bonds
D) None of the above
Q2) 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
Q3) What is the number of companies underlying the iTraxx index?
A) 50
B) 75
C) 100
D) 125
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Chapter 24: Weather, Energy, and Insurance Derivatives
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Q1) On a certain day the highest temperature is 77 degrees and the lowest temperature is 61 degrees. What is the day's CDD?
A) 5
B) 12
C) 4
D) 0
Q2) Which of the following are least likely to use weather derivatives?
A) Energy producers
B) Food and drink manufacturers
C) Companies in the leisure industry
D) Automobile manufacturers
Q3) Which of the following might we expect to be the result of global warming?
A) An decrease in observed CDDs
B) An increase in observed CDDs
C) An increase in observed HDDs
D) None of the above
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