Deck 12: Financial Derivatives

Question 1

Forward contracts exist because both buyers and sellers inherently dislike uncertainty.

Answer 1

True

Question 2

A call is an option to sell an underlying asset at a predetermined strike price.

Answer 2

False

Question 3

Options are most often written on commodities.

Answer 3

False

Question 4

In a forward contract, one party usually has an incentive to break the agreement.

Question 5

Financial derivatives used for speculation essentially limit the losses from investments.

Question 6

As the market prices and the price stated in a futures contract diverge, the incentive to default decreases.

Question 7

Investors engage in hedging in order to limit losses.

Question 8

As the market price and the price stated in a futures contract diverge, the incentive to default increases.

Question 9

Credit Default Swaps are a special form of swap akin to an insurance policy on bonds.

Question 10

An individual's assets will also include rented property.

Question 11

Futures exchanges require traders to have margin accounts in order to insure that traders do not renege on their trade.

Question 12

A put is an option to sell an underlying asset at a predetermined strike price.

Question 13

The purchaser of an option can never lose more than the premium paid.

Question 14

Futures are a standardized form of forward contracts developed by the Chicago Board of Trade among others.

Question 15

Swaps can be used to hedge but cannot be used to speculate.

Question 16

The price of a financial derivative is a function of supply and demand for the derivative.

Question 17

Financial derivatives are not considered to be financial instruments.

Question 18

A margin account is an account in which a futures trader deposits cash equal to the value of the futures contract.

Question 19

In a forward contract, the buyer and the seller agree today on the price of an asset to be purchased and delivered in the future.

Question 20

To lock in the price that it will have to pay for an asset in the future, a business should sell a futures contract.

Question 21

A swap is an exchange of one asset for another on a predetermined, one time basis.

Question 22

One of the limitations of a forward contract is that:

A) it is very difficult to frame and understand the agreement.
B) the seller cannot be sure of the amount she will receive on settlement date.
C) it is costly to find a willing counterparty.
D) the prices in the forward market are highly volatile.

Question 23

A farmer and a sugar factory enter into a futures contract requiring the delivery of 4,000 tons of sugarcane to the buyer in June at a price of $30 per ton. Suppose the futures contracts for sugarcane increases to $35 per bushel the day after the farmer and the sugar factory enter into their futures contract. If the contract was settled under these conditions, the farmer will have:

A) lost $5.
B) lost $20,000.
C) gained $5.
D) gained $20,000.

Question 24

Which of the following is NOT a major problem with forward contracts?

A) It is often costly/difficult to find a willing counterparty.
B) The market for forward contracts is illiquid as they are not easily sold to other parties.
C) The market is highly regulated.
D) One party usually has an incentive to break the agreement.

Question 25

A swap holder usually pays a premium to the issuer based on the expiration date.

Question 26

An option that can be exercised on or before its maturity is known as a(n)

A) American option.
B) barrier option.
C) European option.
D) Swiss option.

Question 27

The payoff for issuing an option is known as a put.

Question 28

An option that must be exercised on the pre-determined maturity date is known as a(n)

A) American option.
B) barrier option.
C) European option.
D) Swiss option.

Question 29

In order to prevent traders from reneging on futures contracts, exchanges require traders to maintain _____.

A) micro accounts
B) savings accounts
C) credit accounts
D) margin accounts

Question 30

Return volatility is

A) the statistical dispersion of financial returns on an investment.
B) the probability that a swap will increase in value.
C) the probability that a swaption will lose its value.
D) none of the above

Question 31

Futures contracts avoid the difficulties of forward contracts by:

A) efficiently linking buyers and sellers.
B) controlling the price of the commodity being traded.
C) allowing speculators to make a profit on futures contracts.
D) covering any losses incurred by buyers and sellers on the contract.

Question 32

The difficulties associated with forward contracts can be eliminated by:

A) mandating a minimum amount to be paid by the buyer.
B) developing standardized weights, definitions, and expiration dates.
C) reducing the possibility of hedging and speculation.
D) reducing the liquidity of the forwards market.

Question 33

Which of the following is NOT a type of derivative?

A) futures
B) options
C) forwards
D) all are derivatives

Question 34

A wholesale firm agrees to deliver 2 tons of fertilizer to Ronald, a farmer, one month from today at a price of $110 per ton. This is an example of a(n)

A) swap.
B) futures contract.
C) forward contract.
D) option.

Question 35

Which of the following is considered to be a derivative?

A) Bonds
B) Mutual funds
C) Swaps
D) Equities

Question 36

A farmer growing cocoa beans enters into a contract with a chocolate factory. According to the contract, the chocolate factory will buy a ton of cocoa beans from the farmer at the price of $2,200 per ton next month. A day after the contract is signed the price of cocoa beans falls to $2,000 per ton. If the farmer and the chocolate factory go ahead with the contract:

A) the farmer will have lost $200.
B) the chocolate factory will have lost $200.
C) the farmer will have lost $2,000.
D) the chocolate factory will have lost $2,200.

Question 37

An interest rate swap would buffer the bank against rising interest rates while protecting the finance company from lower ones.

Question 38

A swaption is a financial derivative that is a combination of a swap and an option.

Question 39

Which of the following markets is least liquid?

A) The currency market
B) The bond market
C) The forwards market
D) The stock market

Question 40

Swaps can be used to hedge but cannot be used to speculate.

Question 41

Which of the following is true of a financial derivative?

A) The price of a derivative is independent of its supply in the market.
B) Derivatives can be used to multiply gains or losses from an asset.
C) Derivatives are not traded on exchanges and so cannot be regulated.
D) Derivatives can also be traded without any underlying asset.

Question 42

What is a swap?

Question 43

What is the difference between a European option and an American option?

Question 44

What is a financial derivative?

Question 45

At the beginning of March 2012, Brian told Chris that he is thinking of buying some shares of Ford motors from him at the end of the month at $12/share. Chris agreed to this proposal and wrote a contract to sell shares to Brian at a price of $12/share. The current market price is $10/share. At the end of the month, the share price was $11/share, so Brian chose not to buy the shares from Chris. This is an example of:

A) a forward contract.
B) an option.
C) a future contract.
D) a swap.

Question 46

How do exchanges obviate the difficulties associated with forward contracts?

Question 47

Why were standardized forward contracts introduced?

Question 48

Explain how speculation makes hedging possible.
.

Question 49

Differentiate between options and swaps.

Question 50

Sam owns a call option on a stock and on the expiration date the stock price exceeds the strike price in the option contract, so Sam will:

A) let the option expire without exercising the option.
B) exercise the option and buy the stock at the strike price and hold it in his portfolio.
C) exercise the option and buy the stock at the strike price and immediately resell it at the market price.
D) buy the stock at the market price and then exercise the option by selling the stock at the strike price.

Question 51

What is a credit default swap (CDS)?

Question 52

How do futures contracts avoid the difficulties with forward contracts?

Question 53

Which of the following does NOT determine the premium paid by the option holder to the option issuer?

A) interest rates
B) the expiration date
C) the strike price
D) the volume of the asset traded