Risk Management in Finance
Pre-Test Questions
Course Introduction
Risk Management in Finance explores the principles and practices used to identify, assess, and mitigate the various risks faced by financial institutions and investors. The course covers topics such as market risk, credit risk, operational risk, and liquidity risk, emphasizing tools and techniques like value-at-risk (VaR), stress testing, and derivatives hedging. Students learn to analyze the impact of risk on financial decision-making and develop strategies to manage and control exposure in dynamic markets. Case studies and real-world examples are used to illustrate the practical applications of risk management within the global financial system.
Recommended Textbook
Introduction to Derivatives and Risk Management 9th Edition by Don M. Chance
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Chapter 1: Introduction
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Sample Questions
Q1) Which of the following contracts obligates a buyer to buy or sell something at a later date?
A) call
B) futures
C) cap
D) put
E) swaption
Answer: B
Q2) Which of the following statements is not true about the law of one price
A) investors prefer more wealth to less
B) investments that offer the same return in all states must pay the risk-free rate
C) if two investment opportunities offer equivalent outcomes, they must have the same price
D) investors are risk neutral
E) none of the above
Answer: D
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Chapter 2: Structure of Options Markets
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Sample Questions
Q1) All of the following are forms of options except
A) convertible bonds
B) callable bonds
C) warrants
D) mutual funds
E) none of the above
Answer: D
Q2) The exercise price is also called the striking price.
A)True
B)False Answer: True
Q3) Most investors close their positions by exercising their options.
A)True
B)False Answer: False
Q4) The AT&T October puts are an option series.
A)True
B)False Answer: False
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Chapter 3: Principles of Option Pricing
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Sample Questions
Q1) Which of the following inequalities correctly states the relationship between the difference in the prices of two European calls that differ only by exercise price
A) (X<sub>2?</sub> - X<sub>1</sub>)(1 + r)<sup>-T</sup>
C<sub>e</sub>(S<sub>0</sub>,T,X<sub>1</sub>)C<sub>e</sub>(S<sub>0</sub>,T,X<sub>2</sub>)
B) (X<sub>2?</sub> - X<sub>1</sub>) C<sub>e</sub>(S<sub>0</sub>,T,X<sub>2</sub>) - C<sub>e</sub>(S<sub>0</sub>,T,X<sub>1</sub>)
C) (X<sub>2</sub> - X<sub>1</sub>)(1 + r)<sup>-T</sup>
C<sub>e</sub>(S<sub>0</sub>,T,X<sub>1</sub>) + C<sub>e</sub>(S<sub>0</sub>,T,X<sub>2</sub>)
D) (X<sub>2?</sub> - X<sub>1</sub>) C<sub>e</sub>(S<sub>0</sub>,T,X<sub>1</sub>) - C<sub>e</sub>(S<sub>0</sub>,T,X<sub>2</sub>)
E) none of the above
Answer: A
Q2) Selling short a risk-free bond is equivalent to borrowing.
A)True
B)False
Answer: True
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Chapter 4: Option Pricing Models: The Binomial Model
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Sample Questions
Q1) In a multiperiod binomial model, an arbitrage profit cannot be earned until the option expires.
A)True
B)False
Q2) In a recombining binomial model with n periods, the number of outcomes is n + 1.
A)True
B)False
Q3) 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
Q4) The binomial model will give a higher price for an American call on a stock that pays no dividends than if that call is European.
A)True
B)False
Q5) If there is one period remaining and no possibility of the option expiring in-the-money, the hedge ratio will be zero.
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) An option's gamma represents the risk of the delta changing.
A)True
B)False
Q2) The values of N(d<sub>1</sub>) and N(d<sub>2</sub>) are called risk neutral probabilities.
A)True
B)False
Q3) Which of the following assumptions of the Black-Scholes-Merton model is not correct?
A) the stock volatility is constant
B) the stock return follows a normal distribution
C) there are no transaction costs
D) there are no taxes
E) none of the above
Q4) The time to expiration of an option is based on a 360-day year.
A)True
B)False
Q5) 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) An advantage of using a put over a short sale is that the short sale requires an uptick or zero-plus tick while a put does not.
A)True
B)False
Q2) The difference in profit from an actual put and a synthetic put is
A) X
B) S<sub>T</sub> - X
C) X - S<sub>T</sub>
D) S<sub>T</sub> + X(1 + r)<sup>-T</sup>
E) none of the above
Q3) Which of the following investors may be obligated to buy stock?
A) covered call writer
B) call buyer
C) put writer
D) protective put buyer
E) none of the above
Q4) The profit from a covered call is the profit from a long stock plus the profit from a long call.
A)True
B)False
Page 8
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Chapter 7: Advanced Option Strategies
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Sample Questions
Q1) The delta of a straddle would be the call delta plus the put delta.
A)True
B)False
Q2) There are three breakeven stock prices in a butterfly spread.
A)True
B)False
Q3) A call bear spread is a strategy for investors who expect stock prices to increase.
A)True
B)False
Q4) "Like the butterfly spread, the calendar spread is one in which the underlying instrument's ___________ is the major factor in its performance." The best word for the blank is which of the following?
A) volatility
B) expected rate of return
C) beta
D) correlation with the benchmark index
E) skewness
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Chapter 8: Structure of Forward and Futures Markets
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Sample Questions
Q1) Most forward contracts are closed by
A) delivery
B) offset
C) exercise
D) default
E) none of the above
Q2) Forward contracts are regulated by the Commodity Forward Trading Commission.
A)True
B)False
Q3) A limit move is when a futures price reaches its all time high or low price.
A)True
B)False
Q4) 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
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Chapter 9: Principles of Pricing Forwards, Futures and Options on Futures
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Sample Questions
Q1) The daily settlement brings the value of a futures contract back to zero.
A)True
B)False
Q2) The Black formula prices an option on an instrument with a positive cost of carry.
A)True
B)False
Q3) Determine the appropriate price of a European put on a futures if the call is worth $6.55, the continuously compounded risk-free rate is 5.6 percent, the futures price is $80, the exercise price is $75, and the expiration is in three months.
A) $12.56
B) $0.54
C) $11.48
D) $1.62
E) none of the above
Q4) The futures price of a non-storable asset is determined by the cost of carry.
A)True
B)False
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Chapter 10: Futures Arbitrage Strategies
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Sample Questions
Q1) The implied repo rate on a spread is the implicit return on a risk-free spread transaction.
A)True
B)False
Q2) The implied repo rate is similar to the
A) internal rate of return
B) cost of hedging
C) yield on the futures contract
D) all of the above
E) none of the above
Q3) Which of the following is not a risk of program trading?
A) the stocks cannot be simultaneously sold at expiration
B) fractional contracts cannot be purchased or sold
C) the dividends are not certain
D) the stocks cannot be purchased simultaneously
E) none of the above
Q4) Transaction costs in program trading are so small that they are not much of a factor.
A)True
B)False
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Chapter 11: Forward and Futures Hedging, Spread, and Target Strategies
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Sample Questions
Q1) Hedging can be viewed as a form of speculation, inasmuch as it involves taking a position that something bad will happen.
A)True
B)False
Q2) Based on the minimum variance hedge ratio approach, what is the optimal number of futures contracts to deploy, given the following information. The correlation coefficient between changes in the underlying instrument's price and changes in the futures contract price is 0.95, the standard deviation of the changes in the underlying position's value is 300%, and the standard deviation of the changes in the futures contract's price is 11.4%.
A) long 35 futures contracts
B) long 25 futures contracts
C) long 15 futures contracts
D) short 25 futures contracts
E) short 15 futures contracts
Q3) If the target beta exceeds the underlying's beta, then the manager will go long the futures contract.
A)True
B)False
13
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Chapter 12: Swaps
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Sample Questions
Q1) Find the approximate upcoming net payment on an equity swap in which party A pays the return on stock index 1 and party B pays the return on stock index 2. The notional amount is $25 million. Stock index 1 starts the period at 1500 and goes up to 1600 at the end of the period. Stock index 2 starts the period at 3500 and goes up to 3300 at the end of the period.
A) The party paying index 1 pays about $238,000
B) The party paying index 2 pays about $238,000
C) The party paying index 2 pays about $3.095 million
D) The party paying index 1 pays about $25 million
E) The party paying index 1 pays about $3.095 million
Q2) Find the fixed rate on a plain vanilla interest rate swap with payments every 180 days (assume a 360-day year) for one year. The prices of Eurodollar zero coupon bonds are 0.9756 (180 days) and 0.9434 (360 days).
A) 5.9 percent
B) 5 percent
C) 6 percent
D) 5.5 percent
E) 2.95 percent
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Chapter 13: Interest Rate Forwards and Options
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Q1) An FRA in which the rate is not set according to rates in the market is called
A) a short FRA
B) a long FRA
C) an off-market FRA
D) a hedged FRA
E) an FRA spread
Q2) Payer swaptions can be used to convert callable to non-callable debt.
A)True
B)False
Q3) The fixed rate on an FRA expiring in 30 days on 180-day LIBOR with the 30-day rate being 5 percent and the 210 day rate being 6 percent is
A) 6 percent
B) 6.14 percent
C) 5 percent
D) 5.5 percent
E) 5.15 percent
Q4) An interest rate payer swaption is more like an interest rate put than an interest rate call.
A)True
B)False
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Chapter 14: Advanced Derivatives and Strategies
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Sample Questions
Q1) An option to buy an option is called a compound option.
A)True
B)False
Q2) The cost of a break forward contract is a result of the possibility of having a negative value at expiration.
A)True
B)False
Q3) A contingent-pay option allows the holder to decide at expiration if he or she wants to pay for it.
A)True
B)False
Q4) What is the minimum value of the insured portfolio?
A) $16,672,344
B) $12,500,000
C) $12,091,709
D) $12,244,898
E) $13,375,000
Q5) A PO is a security promising a stream of common stock dividend payments.
A)True
B)False
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Chapter 15: Financial Risk Management Techniques and Appplications
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Sample Questions
Q1) If a firm holds a position in an option, it can delta and gamma hedge the position by adding a position in another option.
A)True
B)False
Q2) Which of the following best describes the delta normal method?
A) a method of managing a delta hedge to assure a low gamma
B) the historical method when the distribution is normal
C) the Monte Carlo method when price changes are normally distributed
D) the analytical method applied to options
E) a method of measuring changes in an option's delta
Q3) Which of the following instruments could be used to execute a delta, gamma and vega hedge?
A) a swap
B) an option
C) a futures
D) an FRA
E) none of the above
Q4) Potential credit risk is encountered by only one party at a time in a swap.
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) Enterprise risk management includes all of the following except
A) a process in which a firm seeks to controls all of its risks in a centralized, integrated manner
B) seeks to manage traditional financial risks, such as interest rate and foreign currency risks
C) seeks to manage risk of product obsolescence risk
D) seeks also to manage nontraditional financial risks, such as insurable risks
E) all of the above
Q3) There are two distinct groups of specialists at derivatives dealer institutions, sales personnel and traders.
A)True
B)False
Q4) End users typically invest more resources in their derivatives operations than do dealers.
A)True
B)False
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