Risk Management
Chapter Exam Questions
Course Introduction
Risk Management is a course that introduces students to the principles and practices of identifying, analyzing, and managing risks within various organizational contexts. The course covers key concepts such as risk identification, qualitative and quantitative risk assessments, risk control strategies, and the development of risk management plans. Students will explore risk management frameworks and standards, learn to evaluate the potential impact of different types of risks such as financial, operational, legal, and strategic risks and apply tools for risk mitigation. Through case studies and practical exercises, students gain insights into the decision-making processes that help organizations minimize potential losses and seize opportunities in a dynamic environment.
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) 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
Q2) A one-year forward contract is an agreement where
A) One side has the right to buy an asset for a certain price in one year's time.
B) One side has the obligation to buy an asset for a certain price in one year's time.
C) One side has the obligation to buy an asset for a certain price at some time during the next year.
D) One side has the obligation to buy an asset for the market price in one year's time.
Answer: B
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Chapter 2: Futures Markets and Central Counterparties
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Q1) Clearing houses are
A) Never used in futures markets and sometimes used in OTC markets
B) Used in OTC markets, but not in futures markets
C) Sometimes used in both futures markets and OTC markets
D) Always used in both futures markets and OTC markets
Answer: C
Q2) With bilateral clearing, the number of agreements between four dealers, who trade with each other, is
A) 12
B) 1
C) 6
D) 2
Answer: C
Q3) Margin accounts have the effect of
A) Reducing the risk of one party regretting the deal and backing out
B) Ensuring funds are available to pay traders when they make a profit
C) Reducing systemic risk due to collapse of futures markets
D) All of the above
Answer: D
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Page 4
Chapter 3: Hedging Strategies Using Futures
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Q1) On March 1 the price of a commodity is $1,000 and the December futures price is $1,015. On November 1 the price is $980 and the December futures price is $981. A producer of the commodity entered into a December futures contracts on March 1 to hedge the sale of the commodity on November 1. It closed out its position on November 1. What is the effective price (after taking account of hedging) received by the company for the commodity?
A) $1,016
B) $1,001
C) $981
D) $1,014
Answer: D
Q2) Which of the following best describes "stack and roll"?
A) Creates long-term hedges from short term futures contracts
B) Can avoid losses on futures contracts by entering into further futures contracts
C) Involves buying a futures contract with one maturity and selling a futures contract with a different maturity
D) Involves two different exposures simultaneously
Answer: A
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Chapter 4: Interest Rates
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Q1) At what interest rate does a government borrow in its own currency?
A) Treasury rate
B) LIBOR
C) LIBID
D) Repo rate
Q2) The six month and one-year rates are 3% and 4% per annum with semiannual compounding. Which of the following is closest to the one-year par yield expressed with semiannual compounding?
A) 3.99%
B) 3.98%
C) 3.97%
D) 3.96%
Q3) A repo rate is
A) An uncollateralized rate
B) A rate where the credit risk is relative high
C) The rate implicit in a transaction where securities are sold and bought back at a higher price
D) None of the above
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6
Chapter 5: Determination of Forward and Futures Prices
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Q1) As inventories of a commodity decline, which of the following is true?
A) The one-year futures price as a percentage of the spot price increases
B) The one-year futures price as a percentage of the spot price decreases
C) The one-year futures price as a percentage of the spot price stays the same
D) Any of the above can happen
Q2) 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
Q3) 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) 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
Q2) In the U.S. what is the longest maturity for 3-month Eurodollar futures contracts?
A)2 years
B)5 years
C)10 years
D)20 years
Q3) Which of following is applicable to corporate bonds in the United States?
A) Actual/360
B) Actual/Actual
C) 30/360
D) Actual/365
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Chapter 7: Swaps
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Q1) 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
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 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 the his or her income
D) None of the above
Q3) 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
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Chapter 9: Mechanics of Options Markets
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Q1) An investor has exchange-traded put options to sell 100 shares for $20. There is 25% stock dividend. Which of the following is the position of the investor after the stock dividend?
A) Put options to sell 100 shares for $20
B) Put options to sell 75 shares for $25
C) Put options to sell 125 shares for $15
D) Put options to sell 125 shares for $16
Q2) Which of the following describes a difference between a warrant and an exchange-traded stock option?
A) In a warrant issue, someone has guaranteed the performance of the option seller in the event that the option is exercised
B) The number of warrants is fixed whereas the number of exchange-traded options in existence depends on trading
C) Exchange-traded stock options have a strike price
D) Warrants cannot be traded after they have been purchased
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11
Chapter 10: Properties of Stock Options
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Q1) Interest rates are zero. A European call with a strike price of $50 and a maturity of one year is worth $6. A European put with a strike price of $50 and a maturity of one year is worth $7. The current stock price is $49. Which of the following is true?
A) The call price is high relative to the put price
B) The put price is high relative to the call price
C) Both the call and put must be mispriced
D) None of the above
Q2) When the strike price 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
Q3) 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
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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) 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 gain (after the cost of the options is taken into account)?
A) $100
B) $200
C) $300
D) $400
Q3) Which of the following creates a bear spread?
A) Buy a low strike price call and sell a high strike price call
B) Buy a high strike price call and sell a low strike price call
C) Buy a low strike price call and sell a high strike price put
D) Buy a low strike price put and sell a high strike price call
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Page 13
Chapter 12: Introduction to Binomial Trees
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Q1) The current price of a non-dividend paying stock is $30. Use a two-step tree to value a European put option on the stock with a strike price of $32 that expires in 6 months. Each step is 3 months, the risk free rate is 8%, and u = 1.1 and d = 0.9.
A) $2.24
B) $2.44
C) $2.64
D) $2.84
Q2) 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. What is the risk-neutral probability of that the stock price will be $36?
A) 0.6
B) 0.5
C) 0.4
D) 0.3
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14
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 volatility of a stock is 18% per year. What is the volatility per month?
A) 1.5%
B) 3.0%
C) 5.2%
D) None of the above
Q3) A stock price is $100. Volatility is estimated to be 20% per year. What is an estimate of the standard deviation of the change in the stock price in one week?
A) $0.38
B) $2.77
C) $3.02
D) $0.76
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15
Chapter 14: Employee Stock Options
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Q1) Which of the following is NOT usually true about employee stock options?
A) There is a vesting period
B) They can be sold to other employees
C) They are often at-the-money when issued
D) Their value is currently a charge to the income statement
Q2) Which of the following strategies makes no sense?
A) An employee exercises stock options early and sells the stock. No dividends are expected
B) An employee exercises stock options early and keeps the stock. No dividends are expected
C) An employee exercises stock options early and sells the stock. Dividends are expected
D) An employee exercises stock options early and keeps the stock. Dividends are expected.
Q3) Which of the following ensures that managers are rewarded only when a company performs better than its competitors?
A) A constant strike price for executive stock options
B) A strike price that increases with time
C) A strike price that changes in line with an index of stock prices
D) A strike price that is tied to reported profit
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Page 16
Chapter 15: Options on Stock Indices and Currencies
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Q1) What is the same as 100 call options to buy one unit of currency A with currency B at a strike price of 1.25?
A) 100 call options to buy one unit of currency B with currency A at a strike price of 0.8
B) 125 call options to buy one unit of currency B with currency A at a strike price of 0.8
C) 100 put options to sell one unit of currency B for currency A at a strike price of 0.8
D) 125 put options to sell one unit of currency B for currency A at a strike price of 0.8
Q2) 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)
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17
Chapter 16: Futures Options and Blacks Model
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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 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
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 value of a six-month put option with a strike price of 37 cents?
A) 3.00 cents
B) 2.91 cents
C) 1.16 cents
D) 1.20 cents
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18
Chapter 17: The Greek Letters
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Q1) What does rho 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) 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
Q3) 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
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Chapter 18: Binomial Trees in Practice
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Q1) When the stock price is 20 and the present value of dividends is 2, which of the following is the recommended way of constructing a tree?
A) Draw a tree for an initial stock price of 20 and subtract the present value of future dividends at each node
B) Draw a tree for an initial stock price of 22 and subtract the present value of future dividends at each node
C) Draw a tree with an initial stock price of 18 and add the present value of future dividends at each node
D) Draw a tree with an initial stock price of 18 and add 2 at each node
Q2) What is the recommended way of making interest rates 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
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20
Chapter 19: Volatility Smiles
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Q1) The daily percentage change in an exchange rate is compared to a normal distribution with the same mean and standard deviation. Which of the following is true
A) Both small and large exchange rate moves are more likely than with the normal distribution
B) Small exchange rate moves are less likely and large exchange rate moves are more likely than with the normal distribution
C) Large exchange rate moves are less likely and small exchange rate moves are more likely than with the normal distribution
D) Both small and large exchange rate moves are less likely than with the normal distribution
Q2) Which of the following is true when the tails of a future stock price distribution are compared with those of a lognormal distribution with the same mean and standard deviation?
A) The left tail and right tail are thinner
B) The left tail is thinner and the right tail is fatter
C) The right tail is thinner and the left tail is fatter
D) Both tails are fatter
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Chapter 20: Value at Risk and Expected Shortfall
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Q1) 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
Q2) 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
Q3) 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
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22
Chapter 21: Interest Rate Options
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Q1) 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
Q2) Which of the following is true?
A) A swaption that gives the holder the right to pay fixed is equivalent to a call option on a bond
B) A swaption that gives the holder the right to pay fixed is equivalent to a put option on a bond
C) A swaption that gives the holder the right to pay fixed is equivalent to a put option on one bond combined with a call option on another bond
D) None of the above
Q3) In put-call parity for caps and floors, which of the following is true?
A) Long cap plus long floor equals swap
B) Long cap plus swap equals short floor
C) Long cap equals long floor plus swap
D) Long cap minus long floor equals swaption
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23
Chapter 22: Exotic Options and Other Nonstandard Products
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Q1) 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
Q2) Which of the following is equivalent to a short position in a European put 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 a tranche spread is 55 basis points and the fixed coupon is 60 basis points, which of the following happens when a trader buys protection?
A) The trader pays an estimate of the present value of 5 basis points per year and then pays 55 basis points per year
B) The trader pays an estimate of the present value of 5 basis points per year and then pays 60 basis points per year
C) The trader receives an estimate of the present value of 5 basis points per year and then pays 55 basis points per year
D) The trader receives an estimate of the present value of 5 basis points per year and then pays 60 basis points per year
Q2) A CDS with a number of reference entities provides a payoff when any of the reference entities defaults. What is a name for this CDS?
A) Binary CDS
B) Add-up Basket CDS
C) First-to-Default CDS
D) n-to-Default CDS
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Chapter 24: Weather, Energy, and Insurance Derivatives
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Q1) 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
Q2) 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
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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