Deck 11: Derivatives Markets

Question 1

A depository institution can guarantee its costs of funds by selling Eurodollar futures.

Answer 1

True

Question 2

Options premiums vary directly with the maturity of the option.

Answer 2

True

Question 3

The price sensitivity rule assists the hedger by estimating the number of futures contracts to trade.

Answer 3

True

Question 4

Basis risk involves the risk that the price of futures contracts will not vary in exactly the same way as the price of the item being hedged.

Question 5

Margin risk involves the chance that initial margin requirements will be raised.

Question 6

Hedgers always buy futures contracts.

Question 7

Margin requirements relate to the amount of cash down payment or equity one must have deposited before participating in any trade.

Question 8

Futures markets involve more standardized contracts compared to forward markets.

Question 9

Writing calls can generate potentially unlimited losses.

Question 10

A swap entails buying and selling a futures contract at the same time.

Question 11

A pension fund manager can protect his/her recent price gains by buying stock index futures contracts.

Question 12

Interest rate swap dealers bring together counterparties willing to trade but never take positions in swap contracts themselves.

Question 13

Most forward market contracts are settled before delivery.

Question 14

The open interest is the number of outstanding contracts.

Question 15

A futures contract involves a hedger (risk averter) and a speculator (risk taker).

Question 16

The financial futures hedger loses when futures contracts are marked to market.

Question 17

A hedger always owns the financial contract or is producing the commodity.

Question 18

Cross-hedgers have to accept some basis risk.

Question 19

A savings and loan with interest rate-sensitive liabilities and interest rate insensitive assets (i.e., negative GAP) might swap future fixed rate interest payments for variable rate interest payments.

Question 20

The Chicago Board Options Exchange is the primary regulator of options contracts.

Question 21

At least one of two counterparties in a forward contract must be a speculator.

Question 22

In a forward contract one party to the contract deals with

A) the futures exchange.
B) the stock exchange.
C) the counter-party of the forward contract.
D) the opposite swap party.
E) the hedger.

Question 23

An agreement between a business and a large money center bank to sell 10 million dollars of T-Bills in sixty days is called a

A) a call option.
B) a forward contract.
C) a put option.
D) a long futures position.

Question 24

What is the relationship between spot market prices and forward market prices of a good or financial asset?

A) Spot prices represent expected forward prices.
B) Forward prices are always higher than spot prices.
C) Spot prices are always higher than forward prices.
D) Forward prices are expected future spot prices.

Question 25

Which of the following is not a derivative security?

A) a call option on a stock index
B) a futures contract
C) an interest rate swap
D) a repurchase agreement
E) All of the above are derivative securities.

Question 26

If a corporation wanted to guarantee its long-term costs of financing an investment project, it could

A) sell T-bill futures for when the funds were needed.
B) buy T-bill futures for when the funds were needed.
C) sell T-bond futures for when the funds were needed.
D) buy T-bond futures for when the funds were needed.

Question 27

A hedger in the financial futures market

A) seeks a position in the spot market to offset the price risk, which exists in the futures market.
B) will purchase financial futures if holding financial assets in the spot market.
C) seeks to offset the price risk in its spot market position with the equal but opposite price risk of the futures position.
D) will always short financial futures to create a perfect hedge.

Question 28

A portfolio manager plans to buy three-month T-bills with the total face value of $1,000,000 in one month. The current price for three-month T-bills is $988,520. What is the fair forward price if the current effective annual risk-free rate over one month is 4%?

A) $950,500
B) $985,236
C) $988,520
D) $991,815
E) $1,028,061

Question 29

The writer of a call option on stock benefits if the underlying stock price decrease or if the volatility of the stock's price decreases.

Question 30

A hedger in the financial futures market

A) usually buys futures contracts.
B) usually sells futures contracts.
C) either buys or sells so that underlying asset gains/losses are directly related to futures contract gains/losses.
D) either buys or sells so that underlying asset gains/losses are inversely related to futures contract gains/losses.

Question 31

Futures contracts differ from forward contracts in that

A) futures contracts are between the individual hedger and speculator.
B) futures contracts are personalized, unique contracts; forwards are standardized.
C) futures contracts are marked to market daily with changes in value added to or subtracted from the accounts of the buyer and the seller.
D) forward contracts always require a margin deposit.
E) all of the above

Question 32

Which one of the following statements is true?

A) Derivative securities are used to minimize or eliminate an investor's or a firm's exposure to various types of risk that they may be exposed to.
B) Derivatives are financial securities which are based upon or derived from existing securities.
C) Risk to an investor or a firm can be caused by interest rate changes or foreign exchange rate changes, commodity prices or stock prices.
D) all of the above

Question 33

Speculators intentionally assume price risk.

Question 34

The forward price for an asset is

A) equal to the face value of the asset.
B) always higher than the current price of the asset.
C) the price that makes the forward contract have zero net present value.
D) adjusted downward to incorporate storage costs.
E) both c and d

Question 35

Futures contracts differ from forward contracts in all of the following ways except:

A) Forward contracts involve an intermediary or exchange.
B) Futures contracts are standardized; forward contracts are not.
C) Futures markets are more formal than forward markets.
D) Delivery is made most often in forward contracts.

Question 36

If you forecast that interest rates are likely to decrease over the next several years, you might sell a T-bond futures contract or buy an interest rate cap to take advantage of your expectations.

Question 37

An investor planning to buy IBM stock in 30 days can protect himself against price risk by

A) selling an IBM put option that matures in 30 days
B) buying an IBM call option that matures in 30 days
C) selling an IBM call option that matures in 30 days
D) buying an IBM put option that matures in 30 days
E) selling IBM stock short

Question 38

The purchase of U.S. Treasury bonds for immediate delivery is a _______ market transaction.

A) stock
B) spot
C) futures
D) forward
E) swap

Question 39

If the exercise price is greater than the current stock price, the call option is out-of-the- money but the put option is in-the-money.

Question 40

A non-standardized agreement that is negotiated between a buyer and seller to exchange an asset for cash at some future date, with the price set today is called a future agreement.

Question 41

A portfolio manager is concerned that the expected drop in interest rates is going to lower the yield on the $1,000,000 of T-Bill she plans to buy in 3 months. She can hedge this potential interest rate risk by

A) taking a short position in 3-month T-bill futures.
B) taking a long position in 3-month T-bill futures.
C) buying a call option on 3-month T-bill futures.
D) buying a put option on 3-month T-bill futures.
E) Either b or c would work.

Question 42

An agreement with the futures exchange to buy is a ______ position; to sell, a ________ position.

A) spot; futures
B) high; low
C) long; short
D) short; long
E) wide; narrow

Question 43

You manage a stock portfolio worth $3,000,000 that has a beta of 1.25. In order to hedge the portfolio, you decide to trade S&P 500 futures contracts. Each contract is worth $250 per index point. How many contracts do you need to buy or sell if the S&P 500 index is currently at 1,500?

A) sell 10 contracts
B) buy 10 contracts
C) sell 8 contracts
D) buy 8 contracts
E) buy 20 contracts

Question 44

A speculator sells one 10-year T-note futures contract for $100,000 of face value of T- notes at 98'14. Three month later, the contract expires at 101'10.5. How much did the speculator gain (lose)?

A) $2,965
B) ($2,965)
C) $2,891
D) ($2,891)
E) $328

Question 45

A farmer growing wheat is in wheat and may hedge by _ wheat futures.

A) short; long
B) short; selling
C) long; buying
D) long; selling

Question 46

An insurance company can invest funds which are coming to the company in the future at today's interest rates by

A) selling calls on financial futures.
B) buying puts on financial futures.
C) buying financial futures.
D) selling financial futures.
E) taking no action.

Question 47

Daily changes in futures prices means one party (hedger or speculator) has gained while another lost money on the contract. How are the exchanges able to keep the "daily" loser in the contract and prevent default?

A) by the threat of bankruptcy
B) by daily margin calls if needed
C) by loans
D) by guarantees by third parties

Question 48

The lowest amount of funds required to maintain a positions in a futures contract is called a(n) _______ margin.

A) initial
B) maintenance
C) minimum
D) enforced
E) futures

Question 49

Who will lose if the price of an underlying asset falls?

A) the seller of a futures contract
B) the buyer of a put
C) the writer of a call
D) the buyer of a futures contract
E) both b and c

Question 50

The price sensitivity rule

A) determines the number of futures contracts to trade.
B) states that a hedging futures position must have the same sensitivity to interest rate changes as the asset or portfolio whose value is being hedged.
C) requires determining the relative price variability of a futures contract and underlying assets given a change in interest rates.
D) all of the above.

Question 51

A speculator sold one 10-year T-note futures contract for $100,000 of face value of T- notes at 99'04.5. He posted a $2,500 margin on his account. The contract's closing price at the end of the day is 98'24. What is the amount of funds on the speculator's account after marking-to-market?

A) $2,500
B) $3,305
C) $2,891
D) $3,500
E) $2,109

Question 52

Which is NOT a function of the CFTC?

A) to approve new futures contracts
B) to monitor enforcement of exchange rules
C) to make sure traders maintain their margin level
D) to investigate violations of laws

Question 53

A five-member federal regulatory commission which serves as the primary regulator of the futures market is the

A) Chicago Mercantile Exchange.
B) Federal Commodity Futures Commission.
C) Commodity Futures Trading Commission.
D) Chicago Board of Trade.

Question 54

A small commercial bank with rate sensitive assets greater than rate sensitive liabilities sells T-bill futures. The bank is

A) speculating.
B) hedging.
C) neither hedging nor speculating.
D) both hedging and speculating.

Question 55

First National Bank recently purchased a T-bill futures contract to hedge a risk position at the bank. If the price of the futures contract is increasing,

A) First National is "gaining."
B) First National is "losing."
C) First National is neither "gaining" nor "losing."
D) First National's risk exposure is increasing.
E) both b and d

Question 56

A(n) margin is deposited before entering into the futures contract; thereafter, the balance cannot fall below a(n) _______ margin.

A) initial; maintenance
B) initial; enforced
C) net; seller's
D) safe; double
E) first; second

Question 57

Which of the following statements is NOT true?

A) A swap is like a forward contract in that it guarantees the exchange of two items of value at some future point in time.
B) Only the net interest difference is swapped in an interest rate swap.
C) Swap parties always have the same level of credit risk.
D) Unlike in a forward contract, the exact terms of exchange of the swap will vary with changes in interest rates.
E) All of the above statements are true.

Question 58

You hedged a $2,000,000 portfolio of stocks that you manage by selling eight S&P 500 futures contracts at 1,450. Each contract is worth $250 per index point. Recently, your portfolio lost 4% of its value, while the S&P 500 index declined to 1,400. What is your total (spot plus futures) gain (loss)?

A) $80,000
B) $20,000
C) ($20,000)
D) (80,000)
E) (180,000)

Question 59

Unlike hedging with futures, hedging with options

A) locks in a particular price or rate of return for a hedger.
B) exposes a hedger to a risk of large losses.
C) allows a hedger to benefit from the upside potential of his spot position.
D) is free (i.e., creating the hedge is costless)
E) both b and c

Question 60

A bank with a high positive duration GAP wishing to hedge its interest rate risk might

A) sell financial futures.
B) purchase financial futures.
C) sell puts on financial futures.
D) both a and c

Question 61

What action would the holder of a maturing call option take if an option which cost $300, had a strike price of $50, and the market value of the stock was $52?

A) let the option expire unexercised
B) exercise the option
C) request that the $300 be returned
D) none of the above

Question 62

What is the regulator that approves newly issued futures contracts?

A) The Federal Reserve
B) The SEC
C) The CFTC
D) The NYSE
ESSAY QUESTIONS

Question 63

The value of a call option _______ and the value of a put option with the same price and expiration date _______ when the spot price of an underlying increases.

A) increases; increases
B) increases; falls
C) does not change; does not change
D) falls; increases
E) falls; falls

Question 64

Suppose a stock is priced at $100 currently. You are bullish on the stock and are considering buying May calls with an exercise price of $95 and $105 respectively. The call with an exercise price $95 is priced at $8.50 and the 105 call is quoted at $2.75. Consider different price projection, what should you consider in deciding which to purchase if you do not plan on exercising prior to maturity?

Question 65

All of the following are risks associated with futures contracts except

A) margin risk.
B) basis risk.
C) default risk.
D) manipulation risk.

Question 66

A European option is an option contract that allows the holder to

A) exercise the option only on the expiration date.
B) exercise the option on or before the expiration date.
C) exercise the option before but not on the expiration date.
D) exercise the option after the expiration date.
E) none of the above.

Question 67

You speculated stock price of Cino. Co. will move toward a certain direction and decided to taken an option position of this stock to make profit. For that position, if the stock's price drops you will get a level gain no matter how huge prices decrease. However, you could go bankrupt if the stock's price rises. What is your option position?

A) Bought a call option
B) Bought a put option
C) Written a put option
D) Written a call option

Question 68

Explain how a savings and loan manager could use futures or options to hedge against the possibility that interest rates will rise.

Question 69

You have a right to buy a security at a specific price on a specific date if you _______ on this security.

A) bought a forward contract
B) sold a futures contract
C) bought a put option
D) sold a call option
E) bought a call option

Question 70

A bank which hedges its future funding costs in the T-bill futures market is

A) hedging perfectly.
B) accepting some basis risk.
C) speculating.
D) accepting some default risk in the futures position.

Question 71

A financial institution wishing to avoid higher borrowing costs would be most likely to use:

A) A short or selling hedge in futures.
B) A long or buying hedge in futures.
C) A call option on futures contracts.
D) b and c above.

Question 72

Explain how forward and futures markets differ.

Question 73

Which of the following terms is associated with futures as opposed to options?

A) exercise price
B) premium
C) marking-to-market
D) naked

Question 74

What determines whether a buyer or a seller of a derivative security is a hedger or a speculator?

Question 75

What role does the SEC have in regulating options markets? How does it differ from the role of CFTC?

Question 76

Which of the following is true about hedging using duration analysis?

A) The institution may hedge its earnings and its net worth simultaneously.
B) If market value weighted asset duration is greater than the liability counterpart, sell financial futures to "immunize."
C) If market value weighted asset duration is greater than the liability counterpart, buy financial futures to "immunize."
D) Maturity hedging provides the same hedging as duration hedging.

Question 77

A manager of a large stock portfolio has earned a respectable return by October, and would like to protect that return for the year. How might she guarantee a certain portfolio return with trades in derivative securities?

Question 78

37. The value of an option varies directly with

A) the price volatility of the underlying asset.
B) the time to expiration.
C) the level of interest rates.
D) both a and b above.
E) all of the above.