Question 1

Which of the following best describes a central clearing party?
A) It is a trader that works for an exchange
B) It stands between two parties in the over-the-counter market
C) It is a trader that works for a bank
D) It helps facilitate futures trades

Accepted Answer

A central clearing party (CCP)is a clearing house that stands between two parties in the over-the-counter market.It serves the same purpose as an exchange clearing house.

Question 2

A company knows it will have to pay a certain amount of a foreign currency to one of its suppliers in the future. Which of the following is true?
A) A forward contract can be used to lock in the exchange rate
B) A forward contract will always give a better outcome than an option
C) An option will always give a better outcome than a forward contract
D) An option can be used to lock in the exchange rate

Accepted Answer

A forward contract can be used to lock in the exchange rate for the future payment, thus mitigating the risk of currency fluctuation. Options, on the other hand, give the buyer the right but not the obligation to buy or sell the foreign currency at a set price, which may or may not be beneficial depending on the direction of currency movement. However, an option can still be used as a hedging tool in certain situations. Option B and C are incorrect as there is no definitive answer on which instrument will always give a better outcome as it depends on the market conditions and individual hedging objectives.

Question 3

A trader has a portfolio worth $5 million that mirrors the performance of a stock index. The stock index is currently 1,250. Futures contract trade on the index with one contract being on 250 times the index. To remove market risk from the portfolio the trader should
A) Buy 16 contracts
B) Sell 16 contracts
C) Buy 20 contracts
D) Sell 20 contracts

Accepted Answer

Since one futures contract is on 250 times the index, to match the portfolio of $5 million the trader needs 5,000,000 / 1,250 * 250 = 20 contracts. To remove market risk, the trader should take an opposite position in the futures market, which means selling 20 contracts.

Question 4

A one-year forward contract is an agreement where
A) One side has the right to buy an asset for a certain price in one year's time
B) One side has the obligation to buy an asset for a certain price in one year's time
C) One side has the obligation to buy an asset for a certain price at some time during the next year
D) One side has the obligation to buy an asset for the market price in one year's time

Accepted Answer

In a one-year forward contract, one side (the buyer) agrees to buy an asset at a certain price in one year's time, while the other side (the seller) has the obligation to sell the asset at that price. Therefore, the correct choice is B.

Question 5

Which of the following best describes the term "spot price"?
A) The price for immediate delivery
B) The price for delivery at a future time
C) The price of an asset that has been damaged
D) The price of renting an asset

Accepted Answer

The spot price refers to the price for immediate delivery of a particular asset or commodity, without any contracts or agreements in place for future delivery. It is the current market price at a given point in time.

Question 6

The price of a stock on July 1 is $57. A trader buys 100 call options on the stock with a strike price of $60 when the option price is $2. The options are exercised when the stock price is $65. The trader's net profit is
A) $700
B) $500
C) $300
D) $600

Accepted Answer

The payoff from the options is 100×(65-60)or $500.The cost of the options is 2×100 or $200.The net profit is therefore 500−200 or $300.

Question 7

Which of the following is NOT true?
A) When a CBOE call option on IBM is exercised, IBM issues more stock
B) An American option can be exercised at any time during its life
C) An call option will always be exercised at maturity if the underlying asset price is greater than the strike price
D) A put option will always be exercised at maturity if the strike price is greater than the underlying asset price

Accepted Answer

When an IBM call option is exercised the option seller must buy shares in the market to sell to the option buyer.IBM is not involved in any way.

Question 8

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

Accepted Answer

When the stock price is $20 the two call options provide no payoff.The put option provides a payoff of 30−20 or $10.The total cost of the options is 2×3+ 4 or $10.The stock price in D,$20,is therefore the breakeven stock price below which the position is profitable because it is the price for which the cost of the options equals the payoff.

Question 9

Which of the following is NOT true?
A) A call option gives the holder the right to buy an asset by a certain date for a certain price
B) A put option gives the holder the right to sell an asset by a certain date for a certain price
C) The holder of a call or put option must exercise the right to sell or buy an asset
D) The holder of a forward contract is obligated to buy or sell an asset

Accepted Answer

The holder of a call or put option has the right but not the obligation to exercise the right to sell or buy an asset. It is entirely up to the holder to decide whether or not they want to exercise their option.

Question 10

Which of the following describes European options?
A) Sold in Europe
B) Priced in Euros
C) Exercisable only at maturity
D) Calls (there are no puts)

Accepted Answer

European options are exercisable only at maturity, as opposed to American options which can be exercised at any point until maturity. The other choices are incorrect; European options can be sold or priced in any currency, and both calls and puts can be European options.

Question 11

The price of a stock on February 1 is $124. A trader sells 200 put options on the stock with a strike price of $120 when the option price is $5. The options are exercised when the stock price is $110. The trader's net profit or loss is
A) Gain of $1,000
B) Loss of $2,000
C) Loss of $2,800
D) Loss of $1,000

Accepted Answer

The payoff that must be made on the options is 200×(120−110)or $2000.The amount received for the options is 5×200 or $1000.The net loss is therefore 2000−1000 or $1000.

Question 12

A short forward contract on an asset plus a long position in a European call option on the asset with a strike price equal to the forward price is equivalent to
A) A short position in a call option
B) A short position in a put option
C) A long position in a put option
D) None of the above

Accepted Answer

The combination of a short forward contract and a long call option with a strike price equal to the forward price is known as a synthetic long call. This means the payoff at expiration will be the same as that of a long call option. In this case, the European call option is at-the-money, i.e., the strike price is equal to the forward price, and hence the premium paid is equal to zero. Therefore, the payoff will be identical to that of a long put option with the same strike price, which means this combination is equivalent to a long position in a put option.

Question 13

Which of the following is true about a long forward contract?
A) The contract becomes more valuable as the price of the asset declines
B) The contract becomes more valuable as the price of the asset rises
C) The contract is worth zero if the price of the asset declines after the contract has been entered into
D) The contract is worth zero if the price of the asset rises after the contract has been entered into

Accepted Answer

In a long forward contract, the investor has agreed to buy the underlying asset at a specified price on a future date. Therefore, if the price of the asset rises, the contract becomes more valuable because the investor can buy at a lower price and sell at a higher price. If the price of the asset declines after the contract has been entered into, the contract still maintains its value as the investor is obligated to buy the asset at the specified price, which may still be lower than the current market price. Therefore, options A, C, and D are incorrect.

Question 14

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

Accepted Answer

When the stock price is $35,the two call options provide a payoff of 2×(35−30)or $10.The put option provides no payoff.The total cost of the options is 2×3+ 4 or $10.The stock price in A,$35,is therefore the breakeven stock price above which the position is profitable because it is the price for which the cost of the options equals the payoff.

Question 15

A speculator can choose between buying 100 shares of a stock for $40 per share and buying 1000 European call options on the stock with a strike price of $45 for $4 per option. For second alternative to give a better outcome at the option maturity, the stock price must be above
A) $45
B) $46
C) $55
D) $50

Accepted Answer

When the stock price is $50 the first alternative leads to a position in the stock worth 100×50 or $5000.The second alternative leads to a payoff from the options of 1000×(50−45)or $5000.Both alternatives cost $4000.It follows that the alternatives are equally profitable when the stock price is $50.For stock prices above $50 the option alternative is more profitable.

Question 16

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

Accepted Answer

The payoff is 90−85 or $5 per option.For 200 options the payoff is therefore 5×200 or $1000.However the options cost 10×200 or $2000.There is therefore a net loss of $1000.

Question 17

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

Accepted Answer

The payoff is 40−39 or $1 per option.For 200 options the payoff is therefore 1×200 or $200.However the premium received by the trader is 2×200 or $400.The trader therefore has a net gain of $200.

Question 18

Which of the following is approximately true when size is measured in terms of the underlying principal amounts or value of the underlying assets?
A) The exchange-traded market is twice as big as the over-the-counter market
B) The over-the-counter market is twice as big as the exchange-traded market
C) The exchange-traded market is ten times as big as the over-the-counter market
D) The over-the-counter market is ten times as big as the exchange-traded market

Accepted Answer

The OTC market is about $500 trillion whereas the exchange-traded market is about $60 trillion.

Question 19

Which of the following is NOT true about call and put options?
A) An American option can be exercised at any time during its life
B) A European option can only be exercised only on the maturity date
C) Investors must pay an upfront price (the option premium) for an option contract
D) The price of a call option increases as the strike price increases

Accepted Answer

A call option is the option to buy for the strike price.As the strike price increases this option becomes less attractive and is therefore less valuable.A,B,and C are true.

Question 20

An investor sells a futures contract an asset when the futures price is $1,500. Each contract is on 100 units of the asset. The contract is closed out when the futures price is $1,540. Which of the following is true?
A) The investor has made a gain of $4,000
B) The investor has made a loss of $4,000
C) The investor has made a gain of $2,000
D) The investor has made a loss of $2,000

Accepted Answer

An investor who buys (has a long position)has a gain when a futures price increases.An investor who sells (has a short position)has a loss when a futures price increases.

Quiz 1: Introduction

Which of the following best describes a central clearing party?

A company knows it will have to pay a certain amount of a foreign currency to one of its suppliers in the future. Which of the following is true?

A trader has a portfolio worth $5 million that mirrors the performance of a stock index. The stock index is currently 1,250. Futures contract trade on the index with one contract being on 250 times the index. To remove market risk from the portfolio the trader should

A one-year forward contract is an agreement where

Which of the following best describes the term "spot price"?

The price of a stock on July 1 is $57. A trader buys 100 call options on the stock with a strike price of $60 when the option price is $2. The options are exercised when the stock price is $65. The trader's net profit is

Which of the following is NOT true?

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

Which of the following is NOT true?

Which of the following describes European options?

The price of a stock on February 1 is $124. A trader sells 200 put options on the stock with a strike price of $120 when the option price is $5. The options are exercised when the stock price is $110. The trader's net profit or loss is

A short forward contract on an asset plus a long position in a European call option on the asset with a strike price equal to the forward price is equivalent to

Which of the following is true about a long forward contract?

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 speculator can choose between buying 100 shares of a stock for $40 per share and buying 1000 European call options on the stock with a strike price of $45 for $4 per option. For second alternative to give a better outcome at the option maturity, the stock price must be above

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

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

Which of the following is approximately true when size is measured in terms of the underlying principal amounts or value of the underlying assets?

Which of the following is NOT true about call and put options?

An investor sells a futures contract an asset when the futures price is $1,500. Each contract is on 100 units of the asset. The contract is closed out when the futures price is $1,540. Which of the following is true?