Risk Management in Finance
Final Test Solutions
Course Introduction
Risk Management in Finance explores the principles, techniques, and tools used to identify, assess, and mitigate financial risks within organizations and financial institutions. The course covers key topics such as market risk, credit risk, liquidity risk, and operational risk, emphasizing both qualitative and quantitative methods for risk measurement and control. Students will learn how derivatives, portfolio diversification, and hedging strategies are employed to manage exposure to uncertainty. Real-world case studies and regulatory frameworks like Basel Accords are examined to provide practical insights into the implementation of risk management practices in the global financial landscape.
Recommended Textbook
Introduction to Derivatives and Risk Management 8th Edition by Don M. Chance
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16 Chapters
781 Verified Questions
781 Flashcards
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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) Derivatives permit investors to manage their risk more efficiently.
A)True
B)False Answer: True
Q3) A risk premium is the additional return investors expect for assuming risk.
A)True
B)False
Answer: True
Q4) 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
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Chapter 2: Structure of Options Markets
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Sample Questions
Q1) The order book official executes limit order option trades for the general public.
A)True
B)False
Answer: True
Q2) What amount must a call writer pay if a cash-settled index call is exercised?
A)difference between the index level and the exercise price
B)exercise price
C)difference between the exercise price and the index level
D)index level
E)none of the above
Answer: A
Q3) A market maker is an options trader who buys and sells options off of the exchange floor.
A)True
B)False
Answer: False
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Chapter 3: Principles of Option Pricing
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Sample Questions
Q1) Put-call parity is a relationship that can be used to provide the price of both a European put and call simultaneously.
A)True
B)False
Answer: False
Q2) If there are no dividends on a stock,which of the following statements is correct?
A)An American call will sell for more than a European call
B)A European call will sell for more than an American call
C)An American call will be immediately exercised
D)An American call and an American put will sell for the same price
E)none of the above
Answer: E
Q3) An American call on a non-dividend paying stock will be worth more than a European call on that same stock.
A)True
B)False
Answer: False
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Chapter 4: Option Pricing Models: the Binomial Model
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Sample Questions
Q1) The hedge ratio is the number of shares per call in a risk-free portfolio.
A)True
B)False
Q2) When the number of time periods in a binomial model is large,what happens to the binomial probability of an up move?
A)it approaches 1.0
B)it approaches zero
C)it fluctuates without pattern
D)it converges to 0.5
E)none of the above
Q3) The binomial option pricing formula is based on the weighted average of the next two possible values,discounted back to the present.
A)True
B)False
Q4) If the stock price adjusted for dividends at a continuous rate follows the up and down parameters,the binomial tree will recombine.
A)True
B)False
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Chapter 5: Option Pricing Models: the
Black-Scholes-Merton Model
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Sample Questions
Q1) The Black-Scholes-Merton formula requires cumulative probabilities from the lognormal distribution.
A)True
B)False
Q2) The implied volatilities of a call and a put with the same terms should be the same.
A)True
B)False
Q3) To construct a riskless hedge,the number of puts per 100 shares purchased is: (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 0.01. )
A)0.7580
B)0.2420
C)-0.2480
D)-0.6628
E)none of the above
Q4) The historical volatility is the same value as the implied volatility.
A)True
B)False
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Chapter 6: Basic Option Strategies
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Sample Questions
Q1) The profit for a long put is higher for a given stock price if the put is sold back prior to expiration.
A)True
B)False
Q2) An investor can construct a synthetic put by buying a call and selling short a stock.
A)True
B)False
Q3) Early exercise imposes a risk to all but one of the following transactions.
A)a short call
B)a short put
C)a protective put
D)an uncovered call
E)none of the above
Q4) A synthetic put is always less expensive than a synthetic call.
A)True
B)False
Q5) The breakeven for a protective put is the same as that for a covered call.
A)True
B)False
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Chapter 7: Advanced Option Strategies
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Sample Questions
Q1) Which of the following transactions can have an unlimited loss?
A)long straddle
B)calendar spread
C)butterfly spread
D)reverse box spread
E)none of the above
Q2) Suppose the investor adds a call to the long straddle,a transaction known as a strap.What will this do to the breakeven stock prices?
A)lower both the upside and downside breakevens
B)raise both the upside and downside breakevens
C)raise the upside and lower the downside breakevens
D)lower the upside and raise the downside breakevens
E)none of the above
Q3) What is the maximum profit on the spread?
A)$500
B)$802
C)$198
D)$302
E)none of the above
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Page 9
Chapter 8: The Structure of Forward and Futures Markets
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Sample Questions
Q1) Stock index futures contracts are terminated by delivery the portfolio of stocks represented by the index.
A)True
B)False
Q2) What are circuit breakers?
A)rules that stop trading when futures are about to expire
B)a system that shuts down the exchange computer during periods of abnormal volume
C)limits on the number of contracts that can be traded on high volume days
D)rules that limit the number of contracts a speculator can hold
E)none of the above
Q3) Scalping is a colorful term used to describe a futures trading style that involves aggressive,emotional trading.
A)True
B)False
Q4) Very few futures contracts are terminated in delivery of the underlying commodity or security.
A)True
B)False
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Chapter 9: Principles of Pricing Forwards, Futures, and Options on Futures
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Sample Questions
Q1) Find the lower bound of a European foreign currency put if the spot rate is $3.50,the domestic interest rate is 8 percent,the foreign interest rate is 7 percent,the option expires in six months,and the exercise price is $3.75.
A)zero
B)$0.250
C)$0.366
D)$0.108
E)none of the above
Q2) Which of the following can explain a contango?
A)the interest rate exceeds the dividend yield
B)the cost of carry is negative
C)futures prices exceed forward prices
D)the market is at less than full carry
E)none of the above
Q3) The Black-Scholes-Merton formula can be used in place of the Black formula if you use the futures price for the stock price and a risk-free rate of zero.
A)True
B)False
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Chapter 10: Futures Arbitrage Strategies
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Sample Questions
Q1) The timing option results from the difference in closing times of the spot and futures market.
A)True
B)False
Q2) Compute the dollar profit or loss from borrowing the present value of $5,000,000 at one month LIBOR and lending the same amount at two month LIBOR while simultaneously selling one November Fed funds futures contract.Assume that rates on November 1 were 7 percent,there is no basis risk,and the position is unwound on November 1.Select the closest answer.
A)-$3,150
B)$0
C)$3,150
D)$940
E)-$940
Q3) The implied repo rate on a spread is the implicit return on a risk-free spread transaction.
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) A short hedge is one in which
A)the margin requirement is waived
B)the hedger is short futures
C)the hedger is short in the spot market
D)the futures price is lower than the spot price
E)none of the above
Q2) An individual who plans to take a foreign vacation could hedge the risk of converting into the foreign currency by selling foreign currency futures.
A)True
B)False
Q3) Find the profit if the investor buys a July futures at 75,sells an October futures at 78 and then reverses the July futures at 72 and the October futures at 77.
A)-3
B)-2
C)2
D)1
E)none of the above
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Page 13
Chapter 12: Swaps
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Sample Questions
Q1) The notional principal is never exchanged in an interest rate swap.
A)True
B)False
Q2) A swap involving two floating rates is called a basis swap.
A)True
B)False
Q3) For a currency swap with $10 million notional principal,the notional principal in British pounds if the exchange rate is $1.55 is (approximately)
A) 11.55 million
B) 15.5 million
C) 10 million
D) 6.45 million
E)none of the above
Q4) Currency swap volume is greater than equity swap volume.
A)True
B)False
Q5) Like interest rate and currency swaps,equity swap payments are always positive. A)True
B)False
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Chapter 13: Interest Rate Forwards and Options
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Sample Questions
Q1) Which of the following best describes an interest rate cap?
A)a cash-and-carry hedge
B)a series of forward contracts
C)a series of interest rate calls
D)a call option spread
E)none of the above
Q2) Determine the value of an interest rate call option at the maturity of a loan if the call has a strike of 12 percent,a face value of $50 million,the loan matures 90 days after the call is exercised,the call expires in 60 days,the call premium is $200,000,and LIBOR ends up at 13 percent.
A)$125,000
B)$83,333
C)$208,000
D)-$75,000
E)none of the above
Q3) Pricing an interest rate cap is done by pricing the component caplets and adding up their values.
A)True
B)False
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Chapter 14: Advanced Derivatives and Strategies
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Sample Questions
Q1) Which of the following is not a type of structured note?
A)range floater
B)inverse floater
C)diff floater
D)reverse floater
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) Which of the following statements is correct about cash-or-nothing options
A)they are subject to no credit risk
B)they must be priced by the binomial model
C)they have lower upside gains and lower downside losses than ordinary options
D)they are equivalent to short positions in asset-or-nothing options
E)none of the above
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16
Chapter 15: Financial Risk Management Techniques and Applications
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Sample Questions
Q1) Which of the following is the primary impetus for the growth in the practice of risk management?
A)faster computers
B)better pricing models
C)improved knowledge of risk management
D)tighter government regulation
E)concern over volatility
Q2) In option terms,the limited liability of corporate stockholders is
A)a forward contract
B)a call option
C)a put option
D)a protective put
E)a fiduciary call
Q3) The analytical (variance-covariance)method of estimating Value at Risk requires the assumption of a normal distribution.
A)True
B)False
Q4) Eurodollar futures are widely used to hedge gamma and vega risk.
A)True
B)False
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Chapter 16: Managing Risk in an Organization
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Sample Questions
Q1) Cash flow accounting must be used for all hedges involving cash outlays.
A)True
B)False
Q2) Which of the following organizations recommends best practices for the investment management industry?
A)PRMIA
B)Risk Standards Working Group
C)GARP
D)G-30
E)Financial Accounting Standards Board
Q3) Which of the following activities does senior management not do?
A)ensure that personnel are qualified
B)ensure that controls are in place
C)execute hedge transactions
D)establish policies
E)define roles and responsibilities
Q4) The purpose of IAS 39 is to prescribe standards for derivatives accounting for foreign currency transactions.
A)True
B)False
Page 18
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