Deck 20: An Introduction to Derivative Markets and Securities

Question 1

The initial value of a future contract is the price agreed upon in the contract.

Answer 1

False

Question 2

The price at which the stock can be acquired or sold is the exercise price.

Answer 2

True

Question 3

A cash or spot contract is an agreement for the immediate delivery of an asset such as the purchase of stock on the NYSE.

Answer 3

True

Question 4

A futures contract eliminates uncertainty about the future spot price that an individual can expect to pay for an asset at the time of delivery.

Question 5

An option to sell an asset is referred to as a call, whereas an option to buy an asset is called a put.

Question 6

A futures contract is an agreement between a trader and the clearinghouse of the exchange for delivery of an asset in the future.

Question 7

Investment costs are generally higher in the derivative markets than in the corresponding cash markets.

Question 8

Forward and future contracts, as well as options, are types of derivative securities.

Question 9

A primary function of futures markets is to allow investors to transfer risk.

Question 10

Investors buy call options because they expect the price of the underlying stock to increase before the expiration of the option.

Question 11

The minimum value of an option is zero.

Question 12

Forward contracts are traded over-the-counter and are generally not standardized.

Question 13

If an investor wants to acquire the right to buy or sell an asset, but not the obligation to do it, the best instrument is an option rather than a futures contract.

Question 14

The forward market has low liquidity relative to the futures market.

Question 15

A call option is in the money if the current market price is above the strike price.

Question 16

The futures market is a dealer market where all the details of the transactions are negotiated.

Question 17

All features of a forward contract are standardized, except for price and number of contracts.

Question 18

An option buyer must exercise the option on or before the expiration date.

Question 19

A put option is in the money if the current market price is above the strike price.

Question 20

Futures contracts are slower to absorb new information than forward contracts.

Question 21

The minimum amount that must be maintained in an account is called the maintenance margin.

Question 22

The CBOE brought numerous innovations to the option market, which of the following is not such an innovation?

A)Creation of a central marketplace
B)Creation of a non-liquid secondary option market
C)Introduction of a Clearing Corporation
D)Standardization of all expiration dates
E)Standardization of all exercise prices

Question 23

Forward contracts do not require an upfront premium.

Question 24

In the valuation of an option contract, the following statements apply except

A)The value of an option increases with its maturity.
B)There is a negative relationship between the market interest rate and the value of a call option.
C)The value of a call option is negatively related to its exercise price.
D)The value of a call option is positively related to the volatility of the underlying asset.
E)The value of a call option is positively related to the price of the underlying stock.

Question 25

The price at which a futures contract is set at the end of the day is the

A)Stock price.
B)Strike price.
C)Maintenance price.
D)Settlement price.
E)Parity price.

Question 26

The payoffs to both long and short position in the forward contact are symmetric around the contract price.

Question 27

Derivative instruments exist because

A)They help shift risk from risk-averse investors to risk-takers.
B)They help in forming prices.
C)They have lower investment costs.
D)Choices a and b
E)All of the above

Question 28

Futures differ from forward contracts because

A)Futures have more liquidity risk.
B)Futures have more credit risk.
C)Futures have more maturity risk.
D)All of the above
E)None of the above

Question 29

Which of the following factors is not considered in the valuation of call and put options?

A)Current stock price
B)Exercise price
C)Market interest rate
D)Volatility of underlying stock price
E)none of the above (that is, all are factors which should be considered in the valuation of call and put options)

Question 30

Which of the following is not a factor needed to calculate the value of an American call option?

A)The price of the underlying stock.
B)The exercise price.
C)The price of an equivalent put option.
D)The volatility of the underlying stock.
E)The interest rate.

Question 31

Which of the following statements is a true definition of an in-the-money option?

A)A call option in which the stock price exceeds the exercise price.
B)A call option in which the exercise price exceeds the stock price.
C)A put option in which the stock price exceeds the exercise price.
D)An index option in which the exercise price exceeds the stock price.
E)A call option in which the call premium exceeds the stock price.

Question 32

The payoffs diagrams to both long and short positions in a forward contract are asymmetrical around the contract price.

Question 33

In the forward market both parties are required to post collateral or margin.

Question 34

There are a number of differences between forward and futures contracts. Which of the following statements is false?

A)Futures have less liquidity risk than forward contracts.
B)Futures have less credit risk than forward contracts.
C)Futures have more default risk than forward contracts.
D)In futures, the exchange becomes the counterparty to all transactions.
E)None of the above (that is, all statements are true)

Question 35

Which of the following statements is true?

A)The buyer of a futures contract is said to be long futures.
B)The seller of a futures contract is said to be short futures.
C)The seller of a futures contract is said to be long futures.
D)The buyer of a futures contract is said to be short futures.
E)Choices a and b

Question 36

The value of a call option just prior to expiration is (where V is the underlying asset's market price and X is the option's exercise price)

A)Max [0, V - X]
B)Max [0, X F- V]
C)Min [0, V - X]
D)Min [0, X - V]
E)Max [0, V > X]

Question 37

Forward contracts are much easier to unwind than futures contracts due to the standardization of the contracts.

Question 38

Which of the following statements is false?

A)Derivatives help shift risk from risk-adverse investors to risk-takers.
B)Derivatives assist in forming cash prices.
C)Derivatives provide additional information to the market.
D)In many cases, the investment in derivatives (both commissions and required investment) is more than in the cash market.
E)None of the above (that is, all are reasons)

Question 39

A forward contract gives its holder the option to conduct a transaction involving another security or commodity.

Question 40

The option premium is the price the call buyer will pay to the option seller if the option is exercised.

Question 41

The value of a put option at expiration is

A)Max [0, S(T) - X]
B)Max [0, X - S(T)]
C)Min [0, S(T) - X]
D)Min [0, X - S(T)]
E)X

Question 42

A buyer of the call option is speculating on the

A)Direction of the price movement of the underlying investment.
B)Timing of the price movement of the underlying investment.
C)Leverage that a call option creates with respect to the underlying investment.
D)All of the above.
E)None of the above.

Question 43

A call option in which the stock price is higher than the exercise price is said to be

A)At-the-money.
B)In-the-money.
C)Before-the-money.
D)Out-of-the-money.
E)Above-the-money.

Question 44

The price paid for the option contract is referred to as the

A)Forward price.
B)Exercise price.
C)Striking price.
D)Option premium.
E)Call price.

Question 45

A stock currently sells for $15 per share. A put option on the stock with an exercise price $15 currently sells for $1.50. The put option is

A)At-the-money.
B)In-the-money.
C)Out-of-the-money.
D)At breakeven.
E)None of the above.

Question 46

A stock currently sells for $15 per share. A put option on the stock with an exercise price $20 currently sells for $6.50. The put option is

A)At-the-money.
B)In-the-money.
C)Out-of-the-money.
D)At breakeven.
E)None of the above.

Question 47

The cost of carry includes all of the following except

A)Storage costs.
B)Insurance.
C)Current price.
D)Financing costs.
E)Risk free rate.

Question 48

An equity portfolio manager can neutralize the risk of falling stock prices by entering into a hedge position where the payoffs are

A)Not correlated with the existing exposure.
B)Positively correlated with the existing exposure.
C)Negatively correlated with the existing exposure.
D)Any of the above.
E)None of the above.

Question 49

A stock currently sells for $75 per share. A put option on the stock with an exercise price $70 currently sells for $0.50. The put option is

A)At-the-money.
B)In-the-money.
C)Out-of-the-money.
D)At breakeven.
E)None of the above.

Question 50

A stock currently sells for $150 per share. A call option on the stock with an exercise price $155 currently sells for $2.50. The call option is

A)At-the-money.
B)In-the-money.
C)Out-of-the-money.
D)At breakeven.
E)None of the above.

Question 51

Futures contracts are similar to forward contracts in that they both

A)Have volatile price movements and strong interest from buyers and sellers.
B)Give the holder the option to make a transaction in the future.
C)Have similar liquidity.
D)Have similar credit risk.
E)None of the above.

Question 52

Which of the following statements is a true definition of an out-of-the-money option?

A)A call option in which the stock price exceeds the exercise price.
B)A call option in which the exercise price exceeds the stock price.
C)A call option in which the exercise price exceeds the stock price.
D)A put option in which the exercise price exceeds the stock price.
E)A call option in which the call premium exceeds the stock price.

Question 53

In the two state option pricing model, which of the following does not influence the option price?

A)Past stock price
B)Up and down factors u and d
C)The risk free rate
D)The exercise price
E)Current stock price

Question 54

A vertical spread involves buying and selling call options in the same stock with

A)The same time period and exercise price.
B)The same time period but different exercise price.
C)A different time period but same exercise price.
D)A different time period and different price.
E)Quotes in different options markets.

Question 55

According to put/call parity

A)Stock price + Call Price = Put Price + Risk Free Bond Price
B)Stock price + Put Price = Call Price + Risk Free Bond Price
C)Put price + Call Price = Stock Price + Risk Free Bond Price
D)Stock price - Put Price = Call Price + Risk Free Bond Price
E)Stock price + Call Price = Put Price - Risk Free Bond Price

Question 56

Which of the following statements are true?

A)Futures contracts have less liquidity risk and credit risk than forward contracts.
B)Futures contract prices are strongly linked to the prevailing level of the underlying spot index.
C)Futures contract decrease in price, the further forward in time the delivery date is set.
D)All of the above.
E)None of the above.

Question 57

You own a stock that has risen from $10 per share to $32 per share. You wish to delay taking the profit but you are troubled about the short run behavior of the stock market. An effective action on your part would be to

A)Buy a put option on the stock.
B)Write a call option on the stock.
C)Purchase an index option.
D)Utilize a bearish spread.
E)Utilize a bullish spread.

Question 58

A hedge strategy known as a collar agreement involves the simultaneous

A)Purchase of an in-the money put and purchase of an out-of-the-money call on the same underlying asset with same expiration date and market price.
B)Sale of an out-of-the money put and sale of an out-of-the-money call on the same underlying asset with same expiration date and market price.
C)Purchase of an in-the money put and purchase of an in-the-money call on the same underlying asset with same expiration date and market price.
D)Purchase of an out-of-the money put and sale of an out-of-the-money call on the same underlying asset with same expiration date and market price.
E)Sale of an in-the money put and purchase of an in-the-money call on the same underlying asset with same expiration date and market price.

Question 59

A stock currently sells for $75 per share. A call option on the stock with an exercise price $70 currently sells for $5.50. The call option is

A)At-the-money.
B)In-the-money.
C)Out-of-the-money.
D)At breakeven.
E)None of the above.

Question 60

A call option differs from a put option in that

A)a call option obliges the investor to purchase a given number of shares in a specific common stock at a set price; a put obliges the investor to sell a certain number of shares in a common stock at a set price.
B)both give the investor the opportunity to participate in stock market dealings without the risk of actual stock ownership.
C)a call option gives the investor the right to purchase a given number of shares of a specified stock at a set price; a put option gives the investor the right to sell a given number of shares of a stock at a set price.
D)a put option has risk, since leverage is not as great as with a call.
E)none of the above

Question 61

Exhibit 20.1
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
December futures on the S&P 500 stock index trade at 250 times the index value of 1187.70. Your broker requires an initial margin of 10% percent on futures contracts. The current value of the S&P 500 stock index is 1178.
Refer to Exhibit 20.1. How much must you deposit in a margin account if you wish to purchase one contract?

A)$267,232.5
B)$29,450
C)$29,692.50
D)$30,000
E)$265,050

Question 62

An expiration date payoff and profit diagram for forward positions illustrates

A)Gains and losses are usually small
B)The payoffs to both long and short positions in the forward contract are asymmetrical around the contract price
C)Forward contracts are zero-sum games
D)Long positions benefit from falling prices
E)None of the above

Question 63

A one year call option has a strike price of 50, expires in 6 months, and has a price of $4.74. If the risk free rate is 3%, and the current stock price is $45, what should the corresponding put be worth?

A)$12.74
B)$10.48
C)$5.00
D)$9.00
E)$8.30

Question 64

Derivative securities can be used

A)By investors in the same way as the underlying security
B)To modify the risk and expected return characteristics of existing investment portfolios
C)To duplicate cash flow patterns for arbitrage opportunities
D)All of the above
E)None of the above

Question 65

Exhibit 20.4
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Rick Thompson is considering the following alternatives for investing in Davis Industries which is now selling for $44 per share:
(1)Buy 500 shares, and
(2)Buy six month call options with an exercise price of 45 for $3.25 premium.
Refer to Exhibit 20.4. Assuming no commissions or taxes, what is the annualized percentage gain if the stock is at $30 in four months and the stock was purchased?

A)9.54% loss
B)95.45% loss
C)0.9545% gain
D)95.45% gain
E)9.54% gain

Question 66

A one year call option has a strike price of 70, expires in 3 months, and has a price of $7.34. If the risk free rate is 6%, and the current stock price is $62, what should the corresponding put be worth?

A)$5.34
B)$8.00
C)$10.68
D)$14.33
E)$13.33

Question 67

Exhibit 20.3
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
On the last day of October, Bruce Springsteen is considering the purchase of 100 shares of Olivia Corporation common stock selling at $37 1/2 per share and also considering an Olivia option. $$\begin{array} { l c c c c } & { \text { Calls } } && { \text { Puts } } \\\text { Price } & \text { December } & \text { March } & \text { December } & \text { March } \\\hline 35 & 33 / 4 & 5 & 11 / 4 & 2 \\40 & 21 / 2 & 31 / 2 & 41 / 2 & 43 / 4\end{array}$$

-Refer to Exhibit 20.3. If Bruce buys a March put option with an exercise price of 40, what is his dollar gain (loss) if he closes his position when the stock is selling at 43 1/2?

A)$825.00 loss
B)$475.00 loss
C)$350.00 loss
D)$25.00 loss
E)He has a gain

Question 68

An advantage of a forward contract over a futures contract is that

A)The terms of the contract are flexible
B)It is more liquid
C)It trades through a centralized market exchange
D)It is easier to unwind due to contract homogeneity
E)None of the above

Question 69

Exhibit 20.1
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
December futures on the S&P 500 stock index trade at 250 times the index value of 1187.70. Your broker requires an initial margin of 10% percent on futures contracts. The current value of the S&P 500 stock index is 1178.

-Refer to Exhibit 20.1. Suppose at expiration the futures contract price is 250 times the index value of 1170. Disregarding transaction costs, what is your percentage return?

A)1.87%
B)-0.68%
C)-14.90%
D)10.36%
E)None of the above

Question 70

Exhibit 20.4
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Rick Thompson is considering the following alternatives for investing in Davis Industries which is now selling for $44 per share:
(1)Buy 500 shares, and
(2)Buy six month call options with an exercise price of 45 for $3.25 premium.
Refer to Exhibit 20.4. Assuming no commissions or taxes what is the annualized percentage gain if the stock reaches $50 in four months and a call was purchased?

A)161.54% gain
B)53.85% gain
C)161.54% loss
D)11.11% gain
E)53.85% loss

Question 71

Which of the following is consistent with put-call-spot parity?

A)S + C = P + X/(1 + RFR)
B)S + P = C + X/(1 + RFR)
C)S -C = P + X/(1 + RFR)
D)S- P = C + X/(1 + RFR)
E)S = P - C + X/(1 + RFR)

Question 72

Exhibit 20.2
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
A futures contract on Treasury bond futures with a December expiration date currently trade at 103:06. The face value of a Treasury bond futures contract is $100,000. Your broker requires an initial margin of 10%.
Refer to Exhibit 20.2. Calculate the initial margin deposit.

A)$10,000
B)$10,360.50
C)$10,318.75
D)$10,230.63
E)$10,429.35

Question 73

Exhibit 20.1
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
December futures on the S&P 500 stock index trade at 250 times the index value of 1187.70. Your broker requires an initial margin of 10% percent on futures contracts. The current value of the S&P 500 stock index is 1178.

-Refer to Exhibit 20.1. Calculate the return on a cash investment in the S&P 500 stock index if the ending index value is 1170 over the same time period.

A)1.87%
B)-0.68%
C)-14.90%
D)10.36%
E)None of the above

Question 74

Holding a put option and the underlying security at the same time is an example of

A)Collar
B)Straddle
C)Income generation
D)Portfolio insurance
E)None of the above

Question 75

A one year call option has a strike price of 60, expires in 6 months, and has a price of $2.5. If the risk free rate is 7%, and the current stock price is $55, what should the corresponding put be worth?

A)$5.00
B)$4.56
C)$5.50
D)$7.08
E)$7.54

Question 76

A forward contract is similar to an option contract because they both

A)Can provide insurance against the price of the underlying stock
B)Are paid for up front in the form of premiums
C)Are paid for at the end of the contract in the form of premiums
D)Require a future settlement payment
E)None of the above

Question 77

Exhibit 20.3
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
On the last day of October, Bruce Springsteen is considering the purchase of 100 shares of Olivia Corporation common stock selling at $37 1/2 per share and also considering an Olivia option. $$\begin{array} { l c c c c } & { \text { Calls } } && { \text { Puts } } \\\text { Price } & \text { December } & \text { March } & \text { December } & \text { March } \\\hline 35 & 33 / 4 & 5 & 11 / 4 & 2 \\40 & 21 / 2 & 31 / 2 & 41 / 2 & 43 / 4\end{array}$$

-Refer to Exhibit 20.3. If Bruce decides to buy a March call option with an exercise price of 35, what is his dollar gain (loss) if he closes his position when the stock is selling at 43 1/2?

A)$225.00 loss
B)$350.00 loss
C)$225.00 gain
D)$350.00 gain
E)$850.00 gain

Question 78

Exhibit 20.2
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
A futures contract on Treasury bond futures with a December expiration date currently trade at 103:06. The face value of a Treasury bond futures contract is $100,000. Your broker requires an initial margin of 10%.
Refer to Exhibit 20.2. Calculate the current value of one contract.

A)$100,000
B)$103,600.5
C)$103,187.5
D)$102,306.3
E)$104,293.5

Question 79

Exhibit 20.2
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
A futures contract on Treasury bond futures with a December expiration date currently trade at 103:06. The face value of a Treasury bond futures contract is $100,000. Your broker requires an initial margin of 10%.

-Refer to Exhibit 20.2. If the futures contract is quoted at 105:08 at expiration calculate the percentage return.

A)1.99%
B)19.99%
C)20.62%
D)25.37%
E)-13.65%

Question 80

A one year call option has a strike price of 50, expires in 6 months, and has a price of $5.04. If the risk free rate is 5%, and the current stock price is $50, what should the corresponding put be worth?

A)$3.04
B)$4.64
C)$6.08
D)$3.83
E)$0