Trading Strategies
Practice Questions
Course Introduction
This course explores the principles and practices behind successful trading strategies in financial markets. Students will examine a variety of approaches including technical analysis, fundamental analysis, quantitative strategies, and algorithmic trading. Emphasis is placed on risk management, market psychology, backtesting, and the evaluation of trading performance. Through real-world case studies and simulations, participants will gain practical skills in formulating, executing, and refining trading strategies tailored to different asset classes and market conditions.
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) The price of a stock on February 1 is $48. A trader sells 200 put options on the stock with a strike price of $40 when the option price is $2. The options are exercised when the stock price is $39. The trader's net profit or loss is
A) Loss of $800
B) Loss of $200
C) Gain of $200
D) Loss of $900
Answer: C
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Chapter 2: Futures Markets and Central Counterparties
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Q1) Which entity in the United States takes primary responsibility for regulating futures market?
A) Federal Reserve Board
B) Commodities Futures Trading Commission (CFTC)
C) Security and Exchange Commission (SEC)
D) US Treasury
Answer: B
Q2) 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
Q3) The frequency with which margin accounts are adjusted for gains and losses is
A) Daily
B) Weekly
C) Monthly
D) Quarterly
Answer: A
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Page 4
Chapter 3: Hedging Strategies Using Futures
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Q1) 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
Q2) A company will buy 1000 units of a certain commodity in one year. It decides to hedge 80% of its exposure using futures contracts. Spot price and futures price are currently $100 and $90. The one year futures price of the commodity is $90. If the spot price and the futures price in one year turn out to be $112 and $110, respectively. What is the average price paid for the commodity?
A) $92
B) $96
C) $102
D) $106
Answer: B
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Chapter 4: Interest Rates
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Q1) The zero curve is downward sloping. Define X as the 1-year par yield, Y as the 1-year zero rate and Z as the forward rate for the period between 1 and 1.5 year. Which of the following is true?
A) X is less than Y which is less than Z
B) Y is less than X which is less than Z
C) X is less than Z which is less than Y
D) Z is less than Y which is less than X
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) 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%
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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) 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
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Chapter 6: Interest Rate Futures
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Q1) How much is a basis point?
A) 1.0%
B) 0.1%
C) 0.01%
D) 0.001%
Q2) Which of the following day count conventions applies to a US Treasury bond?
A) Actual/360
B) Actual/Actual (in period)
C) 30/360
D) Actual/365
Q3) The modified duration of a bond portfolio worth $1 million is 5 years. By approximately how much does the value of the portfolio change if all yields increase by 5 basis points?
A) Increase of $2,500
B) Decrease of $2,500
C) Increase of $25,000
D) Decrease of $25,000
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8
Chapter 7: Swaps
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Q1) Which of the following is true for the party paying fixed in an interest rate swap?
A) There is more credit risk when the yield curve is upward sloping than when it is downward sloping
B) There is more credit risk when the yield curve is downward sloping than when it is upward sloping
C) The credit exposure increases when interest rates decline
D) There is no credit exposure providing a financial institution is used as the intermediary
Q2) A fixed-for-fixed currency swap
A) Is equivalent to a portfolio of FRAs
B) Is equivalent to a long position in one bond and a short position in another bond
C) Is worth the same whether or not principals are exchanged
D) Involves no exchange of principals at the beginning of its life
Q3) Which of the following is usually true
A) OIS rates are less than the corresponding LIBOR rates
B) OIS rates are greater than corresponding LIBOR rates
C) OIS rates are sometimes greater and sometimes less than LIBOR rates
D) OIS rates are equivalent to one-day LIBOR rates
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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 describes a waterfall?
A) A distribution of cash flows to tranches with priority given to tranche with the highest rating
B) A distribution of cash flows to tranches in proportion to their outstanding principals
C) A distribution of losses to tranches so that tranches bear losses in proportion to their outstanding principals
D) None of the above
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Page 10
Chapter 9: Mechanics of Options Markets
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Q1) Which of the following is an example of an option class?
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
Q2) 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
Q3) Which of the following must post margin?
A) The seller of an option
B) The buyer of an option
C) The seller and the buyer of an option
D) Neither the seller nor the buyer of an option
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11
Chapter 10: Properties of Stock Options
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Q1) A European call and a European put on a stock have the same strike price and time to maturity. At 10:00am on a certain day, the price of the call is $3 and the price of the put is $4. At 10:01am news reaches the market that has no effect on the stock price or interest rates, but increases volatilities. As a result the price of the call changes to $4.50. Which of the following is correct?
A) The put price increases to $6.00
B) The put price decreases to $2.00
C) The put price increases to $5.50
D) It is possible that there is no effect on the price
Q2) 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
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Chapter 11: Trading Strategies Involving Options
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Q1) 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 loss (after the cost of the options is taken into account)?
A) $100
B) $200
C) $300
D) $400
Q2) Six-month call options with strike prices of $35 and $40 cost $6 and $4, respectively. What is the maximum gain when a bull spread is created by trading a total of 200 options?
A) $100
B) $200
C) $300
D) $400
Q3) 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
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Page 13
Chapter 12: Introduction to Binomial Trees
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Q1) Which of the following describes delta?
A) The ratio of the option price to the stock price
B) The ratio of the stock price to the option price
C) The ratio of a change in the option price to the corresponding change in the stock price
D) The ratio of a change in the stock price to the corresponding change in the option price
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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Chapter 13: Valuing Stock Options: the Bsm Model
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Q1) A stock provides an expected return of 10% per year and has a volatility of 20% per year. What is the continuously compounded expected return in one year?
A) 6%
B) 8%
C) 10%
D) 12%
Q2) When the non-dividend paying stock price is $20, the strike price is $20, the risk-free rate is 6%, the volatility is 20% and the time to maturity is 3 months which of the following is the price of a European call option on the stock
A) 20N(0.1)-19.7N(0.2)
B) 20N(0.2)-19.7N(0.1)
C) 19.7N(0.2)-20N(0.1)
D) 19.7N(0.1)-20N(0.2)
Q3) What was the original Black-Scholes-Merton model designed to value?
A) A European option on a stock providing no dividends
B) A European or American option on a stock providing no dividends
C) A European option on any stock
D) A European or American option on any stock
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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 was true about employee stock options prior to 1995?
A) The options never had any affect on a company's financial statements
B) The value of options which were at-the-money when issued had to be expensed on the income statement
C) The value of options which were at-the-money when issued had to be reported in the notes to the financial statements
D) Options which were at-the-money when issued did not affect a company's financial statements
Q3) 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
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Page 16
Chapter 15: Options on Stock Indices and Currencies
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Q1) A binomial tree with three-month time steps is used to value a currency option. The domestic and foreign risk-free rates are 4% and 6% respectively. The volatility of the exchange rate is 12%. What is the probability of an up movement?
A) 0.4435
B) 0.5267
C) 0.5565
D) 0.5771
Q2) What is the size of one option contract on the S&P 500?
A) 250 times the index
B) 100 times the index
C) 50 times the index
D) 25 times the index
Q3) The domestic risk-free rate is 3%. The foreign risk-free rate is 5%. What is the risk-neutral growth rate of the exchange rate?
A) +2%
B) -2%
C) +5%
D) +3%
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Chapter 16: Futures Options and Blacks Model
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Q1) 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
Q2) Which of the following is true for a September futures option?
A) The expiration month of option is September
B) The option was first traded in September
C) The delivery month of the underlying futures contract is September
D) September is the first month when the option can be exercised
Q3) 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
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Chapter 17: The Greek Letters
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Q1) The gamma of a delta-neutral portfolio is 500. What is the impact of a jump of $3 in the price of the underlying asset?
A) A gain of $2,250
B) A loss of $2,250
C) A gain of $750
D) A loss of $750
Q2) Which of the following is NOT true about gamma?
A) A highly positive or highly negative value of gamma indicates that a portfolio needs frequent rebalancing to stay delta neutral
B) The magnitude of gamma is a measure of the curvature of the portfolio value as a function of the underlying asset price
C) A big positive value for gamma indicates that a big movement in the asset price in either direction will lead to a loss
D) A long position in either a call or a put has a positive gamma
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Chapter 18: Binomial Trees in Practice
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Q1) A European option on a stock with known dollar dividend is valued by setting the stock price variable equal to the stock price minus the present value of the dividend in the Black-Scholes-Merton formula. A second price can be obtained using the tree building procedure in the chapter. Which of the following is true when a very large number of time steps are used in the tree?
A) The first price is higher than the second price
B) The first price is lower than the second price
C) The first price is sometimes higher and sometimes lower than the second price
D) The two prices are almost exactly the same
Q2) For an option on futures, the volatility is 35%, the time step is three months, and the risk-free rate is 5%. What is the Cox, Ross, Rubinstein parameter, u?
A) 1.34
B) 1.29
C) 1.09
D) 1.19
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Chapter 19: Volatility Smiles
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Q1) What does the shape of the volatility smile reveal about call options on a currency?
A) Options close-to-the-money have the lowest implied volatility
B) Options deep-in-the-money have a relatively high implied volatility
C) Options deep-out-of-the-money have a relatively high implied volatility
D) All of the above
Q2) Which of the following causes a volatility smile that is a ``frown``?
A) There is a small probability of a large stock price decrease in one week
B) There is a small probability of a large stock price increase in one week
C) The outcome of a lawsuit (roughly equal chance of being favorable or unfavorable) will create a large movement up or down in one week
D) None of the above
Q3) Which of the following is true when the tails of a future foreign currency 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 does EWMA stand for?
A) Equally weighted moving average
B) Equally weighted median approximation
C) Exponentially weighted moving average
D) Exponentially weighted median average
Q2) Which of the following is true of a covariance matrix?
A) The numbers on the diagonal are variances
B) The numbers on the diagonal are standard deviations
C) The numbers on the diagonal are all one
D) The numbers on the diagonal are all zero
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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Chapter 21: Interest Rate Options
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Q1) 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
Q2) 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
Q3) Which of the following is assumed to be lognormal when a bond option is valued?
A) A future bond price
B) A future swap rate
C) A future short-term rate
D) A future bond yield
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Chapter 22: Exotic Options and Other Nonstandard Products
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Q1) An Asian option is a term used to describe which of the following
A) An option where the payoff depends on whether a barrier is hit
B) An option where the payoff depends on the average value of a variable over a period of time
C) An option that trades on an exchange in the Far East
D) Any option with a nonstandard payoff
Q2) Which of the following are subject to prepayment risk?
A) Collateralized mortgage obligations
B) POs
C) IOs
D) All of the above
Q3) A binary option pays of $100 if a stock price is greater than its current value in three months. The risk-free rate is 3% and the volatility is 40%. Which of the following is its value?
A) 99.25N(-0.1375)
B) 99.25N(0.1375)
C) 99.25N(-0.0625)
D) 99.25N(0.0625)
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Chapter 23: Credit Derivatives
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Q1) A hazard rate is 1% per annum. What is the probability of a default during the first two years?
A) 2.00%
B) 2.02%
C) 1.98%
D) 1.96%
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) In the Lehman bankruptcy the payoff to people who had bought CDS protection was 91.375% of the notional principal. How was this determined?
A) By calculation of the cheapest-to-deliver bond
B) By an auction process
C) By a calculation agent
D) By Lehman's liquidators
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25
Chapter 24: Weather, Energy, and Insurance Derivatives
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Q1) On a certain day the highest temperature is 77 degrees and the lowest temperature is 61 degrees. What is the day's HDD?
A) 5
B) 12
C) 4
D) 0
Q2) Which of the following is NOT true about electricity?
A) Supply and demand for electricity are matched within 140 control areas in the US, then excess power sold to other control areas
B) The ability to sell excess power is constrained by transmission capacity
C) Electricity is a commodity that can be easily stored
D) Air conditioning is a big use of electricity
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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