Options and Futures Markets
Exam Practice Tests
Course Introduction
This course provides an in-depth exploration of options and futures markets, focusing on their structure, pricing, and strategic uses in risk management and speculative investment. Students will learn the characteristics and functions of various derivative instruments, including calls, puts, forwards, and futures contracts. Key topics include arbitrage relationships, hedging strategies, valuation models such as Black-Scholes and binomial trees, and the impact of market dynamics on derivative pricing. Through theoretical analysis and practical examples, the course equips students with the foundational and analytical skills necessary to navigate the complexities of modern derivatives markets.
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) The theoretical fair value is the only value an asset can have.
A)True
B)False Answer: False
Q2) Speculation is equivalent to gambling.
A)True
B)False Answer: False
Q3) A market in which the price equals the true economic value
A)is risk-free
B)has high expected returns
C)is organized
D)is efficient
E)all of the above
Answer: D
Q4) Most derivative contracts terminate with delivery of the underlying asset.
A)True
B)False Answer: False
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Chapter 2: Structure of Options Markets
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Sample Questions
Q1) An order that specifies a maximum price to pay if buying is a
A)stop order
B)market order
C)limit order
D)all or none order
E)none of the above
Answer: C
Q2) The number of option contracts outstanding at any given time is called the open interest.
A)True
B)False
Answer: True
Q3) An investor who exercises a call option on an index must
A)accept the cash difference between the index and the exercise price
B)purchase all of the stocks in the index in their appropriate proportions from the writer
C)immediately buy a put option to offset the call option
D)immediately write another call option to offset
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) The difference between a Treasury bill's face value and its price is called the A)time value
B)discount
C)coupon rate
D)bid
E)none of the above
Answer: B
Q2) Transactions to exploit pricing errors in the put-call parity relationship are called conversions and reversals.
A)True
B)False
Answer: True
Q3) The maximum value of a call is the stock price.
A)True
B)False
Answer: True
Q4) A stock is equivalent to a long call,short put and long risk-free bond.
A)True
B)False
Answer: True
Page 5
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Chapter 4: Option Pricing Models: the Binomial Model
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Sample Questions
Q1) What is the theoretical value of the call?
A)8.00
B)4.39
C)5.15
D)5.36
E)none of the above
Q2) When pricing a put with the binomial model,the up and down probabilities are reversed.
A)True
B)False
Q3) In a recombining binomial model with n periods,the number of outcomes is n + 1.
A)True
B)False
Q4) A portfolio that combines the underlying stock and a short position in an option is called
A)a risk arbitrage portfolio
B)a hedge portfolio
C)a ratio portfolio
D)a two-state portfolio
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) If we now assume that the stock pays a dividend at a known constant rate of 3.5 percent,what stock price should we use in the model? (Due to differences in rounding your calculations may be slightly different."none of the above" should be selected only if your answer is different by more than 10 cents. )
A)22.60
B)19.65
C)23.00
D)21.99
E)none of the above
Q2) What is the reason for executing a gamma hedge?
A)the volatility can change
B)the stock price can make a large move
C)the stock price moves are too small for a delta hedge to work
D)there is no true risk-free rate
E)none of the above
Q3) The implied volatilities of a call and a put with the same terms should be the same.
A)True
B)False
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Chapter 6: Basic Option Strategies
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Sample Questions
Q1) A covered call with a higher exercise price has a higher breakeven.
A)True
B)False
Q2) 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
Q3) Which of the following is the breakeven for a protective put?
A)X + S<sub>0</sub> - P
B)P + S<sub>0</sub>
C)X - S<sub>T</sub>
D)X - S<sub>0</sub> - P
E)none of the above
Q4) In the context of insurance,protective put buyers who choose lower exercise prices are using higher deductibles.
A)True
B)False
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Chapter 7: Advanced Option Strategies
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Sample Questions
Q1) A strap is a less expensive bullish strategy than a straddle.
A)True
B)False
Q2) What will the straddle cost?
A)$145
B)$690
C)$971
D)$413
E)none of the above
Q3) The payoffs form a straddle are more like the payoffs from a money spread than a calendar spread.
A)True
B)False
Q4) What is the maximum loss on the spread?
A)$500
B)$698
C)$198
D)$802
E)none of the above
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Chapter 8: The Structure of Forward and Futures Markets
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Q1) Because futures markets do not have designated market makers,there is no such thing as a bid-ask spread.
A)True
B)False
Q2) Many futures contracts specify that there are several grades of a commodity that are acceptable for delivery.
A)True
B)False
Q3) One party to a futures transaction does not bear the risk that the other party will default.
A)True
B)False
Q4) Margin in a futures transaction differs from margin in a stock transaction because A)stock transactions are much smaller
B)delivery occurs immediately in a stock transaction
C)no money is borrowed in a futures transaction
D)futures are much more volatile
E)none of the above
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Chapter 9: Principles of Pricing Forwards, Futures, and Options on Futures
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Q1) Why is the initial value of a futures contract zero?
A)the futures is immediately marked-to-market
B)you do not pay anything for it
C)the basis will converge to zero
D)the expected profit is zero
E)none of the above
Q2) If the U.S.risk-free rate is 4 percent and the Swiss risk-free rate is 5 percent,a U.S.investor can earn the Swiss rate by buying Swiss francs,selling a forward or futures contract and converting back to dollars at the contract's expiration.
A)True
B)False
Q3) The dividend yield on a stock option is similar to the foreign interest rate on a foreign currency option.
A)True
B)False
Q4) A market in which the futures price is said to be unbiased is also a market in which there is a risk premium.
A)True
B)False
Page 11
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Chapter 10: Futures Arbitrage Strategies
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Sample Questions
Q1) The implied repo rate is the return on an overnight repurchase agreement.
A)True
B)False
Q2) Which of the following is not needed when calculating the implied repo rate for stock index futures?
A)futures price
B)conversion factor
C)time-to-expiration
D)spot price
E)none of the above
Q3) 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
Q4) Selling an index futures and holding an undiversified portfolio would eliminate unsystematic risk.
A)True
B)False
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Page 12
Chapter 11: Forward and Futures Hedging, Spread, and Target Strategies
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Sample Questions
Q1) Which technique can be used to compute the minimum variance hedge ratio?
A)duration analysis
B)present value
C)regression
D)all of the above
E)none of the above
Q2) The relationship between the spot yield and the yield implied by the futures price is called
A)the yield beta
B)the price sensitivity
C)the tail
D)the hedge ratio
E)none of the above
Q3) The measure of hedging effectiveness in a minimum variance hedge is the size of profit on the hedge.
A)True
B)False
Q4) A hedge that is expected to earn a net profit is called an anticipatory hedge.
A)True
B)False
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Chapter 12: Swaps
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Sample Questions
Q1) An interest rate swap is a special case of a currency swap with both currencies being the same.
A)True
B)False
Q2) Swap payments are always either fixed or floating but never both.
A)True
B)False
Q3) A currency swap with no notional principal can be used to synthetically convert a bond issued in one currency into a bond issued in another currency.
A)True
B)False
Q4) Use the information in problem 16 to find the fixed rate on an equity swap in which the stock index is at 2,000.
A)5.9 percent
B)5 percent
C)6 percent
D)2.95 percent
E)3.5 percent
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Page 14
Chapter 13: Interest Rate Forwards and Options
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Q1) 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
Q2) A payer swaption is expiring.The underlying swap has a two year maturity.Th e present value factors are 0.9259 (one year)and 0.8651 (two years).The strike rate is 7 percent.What is the value of the swaption per $1 notional principal.
A)0.0000,since it is out-of-the-money
B)1.0000
C)0.0753
D)0.0095
E)none of the above
Q3) Payer swaptions can be used to convert callable to non-callable debt. A)True
B)False
Q4) Buying an interest rate call results in a limited loss if interest rates fall.
A)True
B)False
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Chapter 14: Advanced Derivatives and Strategies
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Sample Questions
Q1) An equity forward contract is
A)a forward contract on LIBOR secured by a stock as collateral
B)a futures contract on a stock index that is not marked-to-market
C)a call option on a stock with greater downside risk than an ordinary call
D)a forward contract whose payoff is determined by a stock or index
E)none of the above
Q2) A security that is sub-divided into securities called tranches is called a A)principal-only strip
B)asian lookback option
C)range mortgage strip
D)collateralized mortgage obligation
E)none of the above
Q3) Because a chooser option enables the holder to end up with either a put or a call,it is equivalent to a straddle.
A)True
B)False
Q4) Mortgage-backed securities are widely used to make home ownership more affordable.
A)True
B)False
16
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Chapter 15: Financial Risk Management Techniques and Applications
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Sample Questions
Q1) The equity of a company with leverage is a put option on the assets.
A)True
B)False
Q2) Which of the following are types of risks faced by a derivatives dealer?
A)tax risk
B)operational risk
C)accounting risk
D)legal risk
E)none of the above
Q3) Potential credit risk is encountered by only one party at a time in a swap.
A)True
B)False
Q4) Legal risk is the risk that the government will declare derivatives illegal.
A)True
B)False
Q5) A credit default swap is an ordinary swap that is subject to default.
A)True
B)False
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Chapter 16: Managing Risk in an Organization
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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) A risk management system that controls risk within a single department is considered to be centralized.
A)True
B)False
Q3) Dealers typically have more sophisticated risk management operations than end users.
A)True
B)False
Q4) Which of the following methods is not permitted to satisfy the SEC's requirements for disclosure of derivatives activity?
A)an explanation in the chairman's letter
B)a Value-at-Risk figure
C)a sensitivity analysis
D)a table of market values and related terms
E)none of the above
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