Trading Strategies
Final Exam
Course Introduction
This course provides a comprehensive overview of trading strategies employed in financial markets, with a focus on both theoretical foundations and practical application. Students will explore various short-term and long-term strategies including technical analysis, fundamental analysis, algorithmic trading, market making, and arbitrage while considering market microstructure, risk management, transaction costs, and behavioral biases. Case studies and hands-on simulations offer real-world context, helping students to develop, test, and evaluate trading strategies using historical and real-time data. By the end of the course, students will be equipped with the tools and knowledge required to construct and implement effective trading plans across diverse asset classes.
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) 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 above which the trader makes a profit is
A) $35
B) $40
C) $30
D) $36
Answer: A
Q2) The price of a stock on February 1 is $84. A trader buys 200 put options on the stock with a strike price of $90 when the option price is $10. The options are exercised when the stock price is $85. The trader's net profit or loss is
A) Loss of $1,000
B) Loss of $2,000
C) Gain of $200
D) Gain of $1000
Answer: A
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Chapter 2: Mechanics of Futures Markets
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Q1) Which of the following is true?
A) Both forward and futures contracts are traded on exchanges
B) Forward contracts are traded on exchanges, but futures contracts are not
C) Futures contracts are traded on exchanges, but forward contracts are not
D) Neither futures contracts nor forward contracts are traded on exchanges
Answer: C
Q2) 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
Q3) In the corn futures contract a number of different types of corn can be delivered (with price adjustments specified by the exchange) and there are a number of different delivery locations. Which of the following is true?
A) This flexibility tends increase the futures price
B) This flexibility tends decrease the futures price
C) This flexibility may increase and may decrease the futures price
D) This flexibility has no effect on the futures price
Answer: B
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Chapter 3: Hedging Strategies Using Futures
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Q1) Which of the following is true?
A) Gold producers should always hedge the price they will receive for their production of gold over the next three years
B) Gold producers should always hedge the price they will receive for their production of gold over the next one year
C) The hedging strategies of a gold producer should depend on whether it shareholders want exposure to the price of gold
D) Gold producers can hedge by buying gold in the forward market
Answer: C
Q2) Which of the following does NOT describe beta?
A) A measure of the sensitivity of the return on an asset to the return on an index
B) The slope of the best fit line when the return on an asset is regressed against the return on the market
C) The hedge ratio necessary to remove market risk from a portfolio
D) Measures correlation between futures prices and spot prices
Answer: D
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Chapter 4: Interest Rates
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Q1) An interest rate is 12% per annum with semiannual compounding. What is the equivalent rate with quarterly compounding?
A) 11.83%
B) 11.66%
C) 11.77%
D) 11.92%
Q2) An interest rate is 6% per annum with annual compounding. What is the equivalent rate with continuous compounding?
A) 5.79%
B) 6.21%
C) 5.83%
D) 6.18%
Q3) The six-month zero rate is 8% per annum with semiannual compounding. The price of a one-year bond that provides a coupon of 6% per annum semiannually is 97. What is the one-year continuously compounded zero rate?
A) 8.02%
B) 8.52%
C) 9.02%
D) 9.52%
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Page 6
Chapter 5: Determination of Forward and Futures Prices
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Q1) What should a trader do when the one-year forward price of an asset is too low? Assume that the asset provides no income.
A) The trader should borrow the price of the asset, buy one unit of the asset and enter into a short forward contract to sell the asset in one year
B) The trader should borrow the price of the asset, buy one unit of the asset and enter into a long forward contract to buy the asset in one year
C) The trader should short the asset, invest the proceeds of the short sale at the risk-free rate, enter into a short forward contract to sell the asset in one year
D) The trader should short the asset, invest the proceeds of the short sale at the risk-free rate, enter into a long forward contract to buy the asset in one year
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
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Chapter 6: Interest Rate Futures
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Q1) The time-to-maturity of a Eurodollars futures contract is 4 years, and the time-to-maturity of the rate underlying the futures contract is 4.25 years. The standard deviation of the change in the short term interest rate, = 0.011. What is the difference between the futures and the forward interest rate?
A) 0.105%
B) 0.103%
C) 0.098%
D) 0.093%
Q2) It is May 1. The quoted price of a bond with an Actual/Actual (in period) 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
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8
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) When LIBOR is used as the discount rate
A) The value of a swap is worth zero immediately after a coupon payment
B) The value of a swap is worth zero immediately before a coupon payment
C) The value of the floating rate bond underlying a swap is worth par immediately after a coupon payment
D) The value of the floating rate bond underlying a swap is worth par immediately before a coupon payment
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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 94.5% (rated AAA), mezzanine 0.1% (rated BBB), and equity 5% (ratedC). The portfolios of subprime mortgages have the same default rates. An ABS CDO is then created from the mezzanine tranches. Which of the following is true?
A) The ABS CDO tranches should have similar ratings ranging from AAA to C
B) The ABS CDO tranches should all be rated BBB
C) The ABS CDO tranches should all be rated C
D) The ABS CDO tranches are almost worthless because the mezzanine tranches are so thin
Q2) Which of the following tends to lead to an increase in house prices?
A) An increase in interest rates
B) Regulators specifying a maximum level for the loan-to-value ratio on mortgages
C) Banks reducing the minimum FICO score that borrowers are required to have
D) An increase in foreclosures
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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 short position in an option?
A) A position in an option lasting less than one month
B) A position in an option lasting less than three months
C) A position in an option lasting less than six months
D) A position where an option has been sold
Q3) Which of the following is an example of an option series?
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
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Chapter 10: Properties of Stock Options
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Q1) When the stock 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
Q2) The price of a European call option on a non-dividend-paying stock with a strike price of $50 is $6. The stock price is $51, the continuously compounded risk-free rate (all maturities) is 6% and the time to maturity is one year. What is the price of a one-year European put option on the stock with a strike price of $50?
A) $9.91
B) $7.00
C) $6.00
D) $2.09
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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Page 12
Chapter 11: Trading Strategies Involving Options
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Q1) 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
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
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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 $40. Over the next year it is expected to rise to $42 or fall to $37. An investor buys put options with a strike price of $41. Which of the following is necessary to hedge the position?
A) Buy 0.2 shares for each option purchased
B) Sell 0.2 shares for each option purchased
C) Buy 0.8 shares for each option purchased
D) Sell 0.8 shares for each option purchased
Q2) The current price of a non-dividend-paying stock is $40. Over the next year it is expected to rise to $42 or fall to $37. An investor buys put options with a strike price of $41. What is the value of each option? The risk-free interest rate is 2% per annum with continuous compounding.
A) $3.93
B) $2.93
C) $1.93
D) $0.93
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Chapter 13: Valuing Stock Options: the Bsm Model
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Q1) The risk-free rate is 5% and the expected return on a non-dividend-paying stock is 12%. Which of the following is a way of valuing a derivative?
A) Assume that the expected growth rate for the stock price is 17% and discount the expected payoff at 12%
B) Assuming that the expected growth rate for the stock price is 5% and discounting the expected payoff at 12%
C) Assuming that the expected growth rate for the stock price is 5% and discounting the expected payoff at 5%
D) Assuming that the expected growth rate for the stock price is 12% and discounting the expected payoff at 5%
Q2) When there are two dividends on a stock, Black's approximation sets the value of an American call option equal to which of the following?
A) The value of a European option maturing just before the first dividend
B) The value of a European option maturing just before the second (final) dividend
C) The greater of the values in A and B
D) The greater of the value in B and the value assuming no early exercise
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Chapter 14: Employee Stock Options
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Q1) When a CEO has employee stock options, he or she is in theory motivated to do which of the following?
A) Take more risk
B) Take less risk
C) Buy some of the company's stock
D) None of the above
Q2) 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
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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Chapter 15: Options on Stock Indices and Currencies
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Q1) A portfolio manager in charge of a portfolio worth $10 million is concerned that the market might decline rapidly during the next six months and would like to use options on an index to provide protection against the portfolio falling below $9.5 million. The index is currently standing at 500 and each contract is on 100 times the index. What position is required if the portfolio has a beta of 0.5?
A) Short 200 contracts
B) Long 200 contracts
C) Short 100 contracts
D) Long 100 contracts
Q2) 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
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Page 17
Chapter 16: Futures Options
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Q1) When Black's model used to value a European option on the spot price of an asset, which of the following is NOT true?
A) It is necessary to know the futures or forward price for a contract maturing at the same time as the option
B) It is not necessary to estimate income on the underlying asset
C) It is not necessary to know the risk-free rate
D) The underlying asset can be an investment or a consumption asset
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) 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
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Chapter 17: The Greek Letters
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Q1) A trader uses a stop-loss strategy to hedge a short position in a three-month call option with a strike price of 0.7000 on an exchange rate. The current exchange rate is 0.6950 and value of the option is 0.1. The trader covers the option when the exchange rate reaches 0.7005 and uncovers (i.e., assumes a naked position) if the exchange rate falls to 0.6995. Which of the following is NOT true?
A) The exchange rate trading might cost nothing so that the trader gains 0.1 for each option sold
B) The exchange rate trading might cost considerably more than 0.1 for each option sold so that the trader loses money
C) The present value of the gain or loss from the exchange rate trading should be about 0.1 on average for each option sold
D) The hedge works reasonably well
Q2) What does gamma 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) How many nodes are there at the end of a Cox-Ross-Rubinstein five-step binomial tree?
A) 4
B) 5
C) 6
D) 7
Q2) When we move from assuming no dividends to assuming a constant dividend yield, which of the following is true for a Cox, Ross, Rubinstein tree?
A) The parameters u and p change
B) p changes but u does not
C) u changes but p does not
D) Neither p nor u changes
Q3) What is the recommended way of making volatility 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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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?
A) The volatility skew for equities is much more pronounced now than it was in 1985
B) The volatility skew for equities has a positive gradient
C) The volatility skew for equities is consistent with the Black-Scholes-Merton model
D) The volatility skew for equities is similar to that for foreign currencies
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Chapter 20: Value at Risk
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Q1) An investor has $2,000 invested in stock A and $5,000 in stock B. The daily volatilities of A and B are 1.5% and 1% respectively and the coefficient of correlation is 0.8. What is the one day 99% VaR? (Note that N(-2.33)=0.01)
A) $177
B) $135
C) $215
D) $331
Q2) Which was the minimum capital requirement for market risk in the 1996 BIS Amendment?
A) At least 3 times the 10-day VaR with a 99% confidence level
B) At least 3 times 7-day VaR with a 97% confidence level
C) At least 2 times 5-day VaR with a 95% confidence level
D) 1-day VaR with a 99% confidence level
Q3) If the volatility for a portfolio is 20% per year, what is the volatility per quarter?
A) 20%
B) 10%
C) 5%
D) 2%
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Chapter 21: Interest Rate Options
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Q1) Which of the following is assumed to be lognormal when a swap option is valued?
A) A future bond price
B) A future swap rate
C) A future short-term rate
D) A future bond yield
Q2) 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
Q3) In a floor with semiannual reset dates, the floor rate is 3.5% per annum and the notional principal is $1 million. Suppose that the LIBOR rate is 3% per annum for a particular 6-month period. What is the approximate payoff at the end of the 6 months?
A) $10,000
B) $5,000
C) $2,500
D) $1,250
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23
Chapter 22: Exotic Options and Other Nonstandard Products
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Q1) Which of the following is the payoff from an average strike put option?
A) The excess of the strike price over the average stock price, if positive
B) The excess of the final stock price over the average stock price, if positive
C) The excess of the average stock price over the strike price, if positive
D) The excess of the average stock price over the final stock price, if positive
Q2) Which of the following would be referred to as an equity swap?
A) An exchange of the return from an equity index for a fixed rate of interest
B) An exchange of a long position in one stock for a long position in another stock
C) An exchange of a short position in one stock for a short position in another stock
D) None of the above
Q3) When can Bermudan options be exercised?
A) Any time during the life of the options
B) Any time after a certain date up to the end of the life
C) Any time before a certain date or at the end of the option's life
D) On dates specified at the start of the option
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Page 24
Chapter 23: Credit Derivatives
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Q1) In a one-year forward contract on a CDS that will last five years, what usually happens if there is a default during the first year?
A) There is a payoff to the forward protection buyer at the time of default
B) There is a payoff to the forward protection buyer at the end of one year
C) There is a payoff to the forward protection buyer at the end of six years
D) The contract ceases to exist
Q2) Which of the following is the most popular life for a credit default swap?
A) 1 year
B) 3 years
C) 5 years
D) 10 years
Q3) Which of the following is usually used to define the recovery rate of a bond?
A) The value of the bond immediately after default as a percent of its face value
B) The value of the bond immediately after default as a percent of the sum of the bond's face value and accrued interest
C) The amount finally realized by a bondholder as a percent of face value
D) The amount finally realized by a bondholder as a percent of the sum of the bond's face value and accrued interest
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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 the period during which a "5 times 8" contract provides electricity?
A) From 11pm to 7am on five successive days
B) From 8am to 4pm on five successive days
C) For any 5 hours of a day on 8 successive days
D) For any 8 hours of a day in five successive days
Q3) Which of the following is the basis for calculating HDD and CDD?
A) The average temperature during the day
B) The average of the highest and lowest temperature during the day
C) The temperature at 12 noon during the day
D) None of the above
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