Investment Analysis
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Course Introduction
Investment Analysis examines the fundamental principles and analytical tools used to evaluate investment opportunities and make informed investment decisions. The course covers topics such as financial markets and instruments, risk and return analysis, portfolio theory, asset valuation, and investment strategies. Students learn to assess equities, fixed income securities, mutual funds, and alternative investments, as well as utilize quantitative techniques for portfolio construction and performance evaluation. Case studies and real-world applications help develop critical thinking and practical skills essential for careers in finance, asset management, and investment banking.
Recommended Textbook Fundamentals of Futures and Options Markets 8th Edition by John C. Hull
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Page 2
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) A one-year call option on a stock with a strike price of $30 costs $3; a one-year put option on the stock with a strike price of $30 costs $4. Suppose that a trader buys two call options and one put option. The breakeven stock price below which the trader makes a profit is
A) $25
B) $28
C) $26
D) $20
Answer: D
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3
Chapter 2: Mechanics of Futures Markets
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Q1) A limit order
A) Is an order to trade up to a certain number of futures contracts at a certain price
B) Is an order that can be executed at a specified price or one more favorable to the investor
C) Is an order that must be executed within a specified period of time
D) None of the above
Answer: B
Q2) A speculator takes a long position in a futures contract on a commodity on November 1, 2012 to hedge an exposure on March 1, 2013. The initial futures price is $60. On December 31, 2012 the futures price is $61. On March 1, 2013 it is $64. The contract is closed out on March 1, 2013. What gain is recognized in the accounting year January 1 to December 31, 2013? Each contract is on 1000 units of the commodity.
A) $0
B) $1,000
C) $3,000
D) $4,000
Answer: C
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Chapter 3: Hedging Strategies Using Futures
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Q1) 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
Q2) The basis is defined as spot minus futures. A trader is hedging the sale of an asset with a short futures position. The basis increases unexpectedly. Which of the following is true?
A) The hedger's position improves
B) The hedger's position worsens
C) The hedger's position sometimes worsens and sometimes improves
D) The hedger's position stays the same
Answer: A
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Chapter 4: Interest Rates
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Q1) 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
Q2) The compounding frequency for an interest rate defines
A) The frequency with which interest is paid
B) A unit of measurement for the interest rate
C) The relationship between the annual interest rate and the monthly interest rate
D) None of the above
Q3) 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%
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Chapter 5: Determination of Forward and Futures Prices
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Q1) 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
Q2) 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 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) It is May 1. The quoted price of a bond with a 30/360 day count and 12% per annum coupon in the United States is 105. It has a face value of 100 and pays coupons on April 1 and October 1. What is the cash price?
A) 106.00
B) 106.02
C) 105.98
D) 106.04
Q3) What is the quoted discount rate on a money market instrument?
A) The interest rate earned as a percentage of the final face value of a bond
B) The interest rate earned as a percentage of the initial price of a bond
C) The interest rate earned as a percentage of the average price of a bond
D) The risk-free rate used to calculate the present value of future cash flows from a bond
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Chapter 7: Swaps
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Q1) A semi-annual pay interest rate swap where the fixed rate is 5.00% (with semi-annual compounding) has a remaining life of nine months. The six-month LIBOR rate observed three months ago was 4.85% with semi-annual compounding. Today's three and nine month LIBOR rates are 5.3% and 5.8% (continuously compounded) respectively. From this it can be calculated that the forward LIBOR rate for the period between three- and nine-months is 6.14% with semi-annual compounding. If the swap has a principal value of $15,000,000, what is the value of the swap to the party receiving a fixed rate of interest?
A) $74,250
B) -$70,760
C) -$11,250
D) $103,790
Q2) Which of the following describes the five-year swap rate?
A) The fixed rate of interest which a swap market maker is prepared to pay in exchange for LIBOR on a 5-year swap
B) The fixed rate of interest which a swap market maker is prepared to receive in exchange for LIBOR on a 5-year swap
C) The average of A and B
D) The higher of A and B
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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 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 mezzanine tranche of the ABS CDO?
A) 50%
B) 60%
C) 80%
D) 100%
Q2) Which of the following would be described by the term "liar loan"?
A) A situation where the lender concealed information from the borrower
B) A situation where the lender lied to the borrower about the interest rate
C) A situation where the borrower lied about his or her income
D) None of the above
Q3) 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
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Chapter 9: Mechanics of Options Markets
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Q1) Which of the following is an example of an option class?
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
Q2) In which of the following cases is an asset NOT considered constructively sold?
A) The owner shorts the asset
B) The owner buys an in-the-money put option on the asset
C) The owner shorts a forward contract on the asset
D) The owner shorts a futures contract on the stock
Q3) Which of the following is NOT traded by the CBOE?
A) Weeklys
B) Monthlys
C) Binary options
D) DOOM options
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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 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) 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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Chapter 11: Trading Strategies Involving Options
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Q1) 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
Q2) A stock price is currently $23. A reverse (i.e., short) butterfly spread is created from options with strike prices of $20, $25, and $30. Which of the following is true?
A) The gain when the stock price is greater that $30 is less than the gain when the stock price is less than $20
B) The gain when the stock price is greater that $30 is greater than the gain when the stock price is less than $20
C) The gain when the stock price is greater that $30 is the same as the gain when the stock price is less than $20
D) It is incorrect to assume that there is always a gain when the stock price is greater than $30 or less than $20
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13
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. What is the value of each call option?
A) $1.6
B) $2.0
C) $2.4
D) $3.0
Q2) The current price of a non-dividend paying stock is $50. Use a two-step tree to value an American put option on the stock with a strike price of $48 that expires in 12 months. Each step is 6 months, the risk free rate is 5% per annum, and the volatility is 20%. Which of the following is the option price?
A) $1.95
B) $2.00
C) $2.05
D) $2.10
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14
Chapter 13: Valuing Stock Options: the Bsm Model
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Q1) Which of the following is assumed by the Black-Scholes-Merton model?
A) The return from the stock in a short period of time is lognormal
B) The stock price at a future time is lognormal
C) The stock price at a future time is normal
D) None of the above
Q2) The original Black-Scholes and Merton papers on stock option pricing were published in which year?
A) 1983
B) 1984
C) 1974
D) 1973
Q3) When the non-dividend paying stock price is $20, the strike price is $20, the risk-free rate is 6%, the volatility is 20% and the time to maturity is 3 months, which of the following is the price of a European call option on the stock?
A) 20N(0.1)-19.7N(0.2)
B) 20N(0.2)-19.7N(0.1)
C) 19.7N(0.2)-20N(0.1)
D) 19.7N(0.1)-20N(0.2)
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Chapter 14: Employee Stock Options
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Q1) 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
Q2) 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
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Chapter 15: Options on Stock Indices and Currencies
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Q1) 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
Q2) A binomial tree with three-month time steps is used to value a currency option. The domestic and foreign risk-free rates are 4% and 6% respectively. The volatility of the exchange rate is 12%. What is the probability of an up movement?
A) 0.4435
B) 0.5267
C) 0.5565
D) 0.5771
Q3) What should the continuous dividend yield be replaced by when options on an exchange rate are valued using the formula for an option of a stock paying a continuous dividend yield?
A) The domestic risk-free rate
B) The foreign risk-free rate
C) The foreign risk-free rate minus the domestic risk-free rate
D) None of the above
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Page 17
Chapter 16: Futures Options
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Q1) What is the growth rate of an index futures price in the risk-neutral world?
A) The excess of the risk-free rate over the dividend yield
B) The risk-free rate
C) The dividend yield on the index
D) Zero
Q2) 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
Q3) 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
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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) A call option on a non-dividend-paying stock has a strike price of $30 and a time to maturity of six months. The risk-free rate is 4% and the volatility is 25%. The stock price is $28. What is the delta of the option?
A) N(-0.1342)
B) N(-0.1888)
C) N(-0.2034)
D) N(-0.2241)
Q3) Which of the following could NOT be a delta-neutral portfolio?
A) A long position in call options plus a short position in the underlying stock
B) A short position in call options plus a short position in the underlying stock
C) A long position in put options and a long position in the underlying stock
D) A long position in a put option and a long position in a call option
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Page 19
Chapter 18: Binomial Trees in Practice
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Q1) A European option on a stock with known dollar dividend is valued by setting the stock price variable equal to the stock price minus the present value of the dividend in the Black-Scholes-Merton formula. A second price can be obtained using the tree building procedure in the chapter. Which of the following is true when a very large number of time steps are used in the tree?
A) The first price is higher than the second price
B) The first price is lower than the second price
C) The first price is sometimes higher and sometimes lower than the second price
D) The two prices are almost exactly the same
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) Which of the following is true for u in a Cox-Ross-Rubinstein binomial tree?
A) It depends on the interest rate and the volatility
B) It depends on the volatility but not the interest rate
C) It depends on the interest rate but not the volatility
D) It depends on neither the interest rate nor the volatility
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Page 20
Chapter 19: Volatility Smiles
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Q1) Which of the following causes a volatility smile that is a "frown"?
A) There is a small probability of a large stock price decrease in one week
B) There is a small probability of a large stock price increase in one week
C) The outcome of a lawsuit (roughly equal chance of being favorable or unfavorable) will create a large movement up or down in one week
D) None of the above
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
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Q1) The gain from a project is equally likely to have any value between -$0.15 million and +$0.85 million. What is the 99% value at risk?
A) $0.145 million
B) $0.14 million
C) $0.13 million
D) $0.10 million
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) What does EWMA stand for?
A) Equally weighted moving average
B) Equally weighted median approximation
C) Exponentially weighted moving average
D) Exponentially weighted median average
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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) Which of the following is true?
A) A callable bond allows the lender to ask for the principal to be repaid early
B) A callable bond allows the borrower to repay the principal early
C) A callable bond is a bond with an embedded stock option
D) None of the above
Q3) Which of the following is an implication of the mean reversion of interest rates?
A) Interest rates cannot become negative
B) When short-term interest rates are high they tend to move down
C) The term structure of interest rates tends to be upward sloping
D) When short-term interest rates are low they tend to stay low
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Chapter 22: Exotic Options and Other Nonstandard Products
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Q1) 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
Q2) An employer has promised that it will grant employees three year options in one year's time and that the options will be at the money at the time they are granted. What describes these options?
A) Chooser options
B) Forward start options
C) Compound options
D) Shout options
Q3) 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
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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) What is the rating of the companies underlying the iTraxx index?
A) A or above
B) BBB or above
C) BB or below
D) BBB or below
Q3) A hazard rate is 1% per annum. What is the probability of a default during the first two years?
A) 2.00%
B) 2.02%
C) 1.98%
D) 1.96%
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Chapter 24: Weather, Energy, and Insurance Derivatives
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Q1) Which of the following describes the period during which a "5 times 16" contract provides electricity?
A) From 7am to 11pm on five successive days
B) From 4pm to 8am on five successive days
C) For any 5 hours of a day on 16 successive days
D) For any 16 hours of a day in five successive days
Q2) Which of the following describes a typical reinsurance contract?
A) Covers a percentage of all losses by an insurance company
B) Covers all losses of the insurance company up to a certain amount
C) Covers all losses of the insurance company above a certain amount
D) Covers all losses of the insurance company between two amounts
Q3) How can an energy producer hedge its risks?
A) Use weather derivatives for price risk and energy derivatives for volume risk
B) Use energy derivatives for price and volume risk
C) Use energy derivatives for price risk and weather derivatives for volume risk
D) Use weather derivatives for price and volume risk
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