Question 1

Which of the following statements is true of forward contracts?
A)A forward contract has three parties: buyer,seller,exchange.
B)There is no default risk in a forward contract.
C)A forward contract is customizable and traded over-the-counter.
D)A forward contract may be unilaterally revoked by the parties to the contract.

Accepted Answer

A forward contract is customizable, meaning the terms can be tailored to the specific needs of the parties involved. It is also traded over-the-counter, meaning it is not traded on a formal exchange. Choice A is incorrect because there is no exchange involved in a forward contract. Choice B is incorrect because there is a risk of default by either party. Choice D is incorrect because a forward contract is a binding agreement and cannot be unilaterally revoked by either party.

Question 2

Which of the following statements about forwards is false?
A)No payment is typically made at inception of a forward contract.
B)A forward contract may be settled in cash at maturity.
C)A futures contract is like a forward contract that is exchange-traded.
D)The payoff at maturity from a long forward contract is always non-negative (either positive or zero).

Accepted Answer

The payoff from a long forward contract can be negative, positive, or zero, depending on the spot price at maturity relative to the forward price agreed upon at inception. If the spot price is lower than the forward price, the payoff will be negative for the holder of a long position.

Question 3

Which option gives the right to sell an asset at any time prior to or at maturity?
A)European call.
B)American call.
C)American put.
D)European put.

Accepted Answer

American put options give the holder the right to sell an asset at a specified price at any time up to and including the expiration date. European options, whether calls or puts, only allow exercise at maturity, and American calls allow buying an asset at any time up to expiration.

Question 4

Consider hedging an exposure with (i)a futures contract,or (ii)an option with a strike price close to the futures price.The hedge with the futures contract
A)Has more cashflow uncertainty.
B)Has no upfront cost.
C)Has non-negative payoffs.
D)Has more cashflows.

Accepted Answer

Hedging with a futures contract has no upfront cost, but it involves more cashflow uncertainty compared to hedging with an option. Therefore, option hedging with a strike price close to the futures price may not be as effective as futures hedging in terms of non-negative payoffs, but it provides more certainty in cashflow.

Question 5

How many options does a callable,convertible bond contain?
A)0
B)1
C)2
D)3

Accepted Answer

There are two options: (a)the issuer holds a call on the bond,and (b)the buyer has the right to convert the bond into equity.One may extend the idea and say that there is an additional option-the option to default held by the issuer of the convertible.If such a response is provided,then the correct answer would be 3 options,i.e. ,answer (d).

Question 6

A US-based exporter anticipated receiving €100 million in six months,and took a short forward position,locking-in an exchange rate of $1.38/€.If after six months,at maturity,the exporter calculates that she has made a profit of $2 million from the hedging strategy,the spot exchange rate at maturity must be
A)$ 0.50/€.
B)$ 1.36/€
C)$1.40/€
D)$ 2.00/€

Accepted Answer

To calculate the expected spot exchange rate at maturity, we need to first calculate the forward exchange rate the exporter locked-in:

Forward exchange rate = $1.38/€

Profit from hedging strategy = $2 million

Amount received in euros = €100 million

Profit in euros = $2 million * (1/1.38€/$) = €1.449 million

Total amount received in euros = €100 million + €1.449 million = €101.449 million

Expected spot exchange rate = $/€ = ($101.449 million/€100 million) = $1.01449/€

Therefore, the expected spot exchange rate at maturity must be $1.01449/€ or approximately $1.36/€. The correct answer is B.

Question 7

An embedded option is one where the security contains features that are option-like.Which of the following is not an example of a security with an embedded option?
A)Callable bond.
B)Convertible bond.
C)Mortgages in the US.
D)Preferred stock.

Accepted Answer

Preferred stock does not inherently contain an embedded option like callable bonds, convertible bonds, or US mortgages, which often include features allowing for early repayment or conversion into other securities.

Question 8

A forward contract may be used for
A)Hedging price exposure at a future date.
B)Speculating on price.
C)Locking-in a price for a future transaction.
D)All of the above.

Accepted Answer

A forward contract can be used for all three purposes - hedging, speculating, and locking-in a price. Hedging involves taking a position to offset potential losses from adverse price movements, while speculating involves taking a position to profit from expected price movements. Locking-in a price involves fixing the price at which a transaction will occur in the future, providing certainty and reducing uncertainty over future prices.

Question 9

A forward contract is struck at a forward price of $40.At maturity the spot price of the asset is $45.The short forward position earns the following payoff:
A)$5
B)-$5
C)$45
D)-$45

Accepted Answer

The short forward position has agreed to sell the asset at a price of $40 in the forward contract. However, at maturity, the spot price of the asset is $45, which means the short position has to sell the asset at a lower price than the market price. Therefore, the short position incurs a loss of $5, which is the payoff for the short forward position. The answer is option B, which indicates a payoff of -$5.

Question 10

A derivative security derives its value from an "underlying" security that is
A)Any other security.
B)Other securities that are not derivatives.
C)Securities that are related to the "underlying" security.
D)None of the above.

Accepted Answer

The answer of A derivative security derives its value from...

Question 11

Which class of derivatives have been blamed most widely for causing the financial crisis of 2008?
A)Equity derivatives.
B)Interest-rate derivatives.
C)Foreign exchange derivatives.
D)Credit derivatives.

Accepted Answer

Credit derivatives, specifically mortgage-backed securities and collateralized debt obligations (CDOs), were heavily involved in the subprime mortgage crisis that led to the global financial crisis of 2008. These complex securities were often improperly rated and packaged, leading to significant losses for investors and institutions holding them.

Question 12

Which of the following statements is true of the value of European (E)options,American (A)options,and Bermudan (B)options?
A) $A > B > E$
B) $A > E > B$
C) $E > A > B$
D) $B > A > E$

Accepted Answer

American options, which can be exercised at any time before expiration, are generally the most valuable. Bermudan options, which can be exercised at specific times before expiration, are next. European options, which can only be exercised at expiration, are the least valuable.

Question 13

Which class of derivatives accounts for the largest dollar share in the world market in terms of notional amount outstanding?
A)Equity derivatives.
B)Interest-rate derivatives.
C)Foreign exchange derivatives.
D)Credit derivatives.

Accepted Answer

Interest-rate derivatives account for the largest dollar share in the world market in terms of notional amount outstanding, followed by foreign exchange derivatives and credit derivatives. Equity derivatives come in fourth in terms of notional amount outstanding.

Question 14

State which of these statements is false.
A)A futures contract is traded on an exchange.
B)A futures contract involves counterparty credit risk.
C)A futures contract is fully customizable.
D)A futures contract may be reversed unilaterally.

Accepted Answer

Futures contracts are standardized and not fully customizable, unlike forward contracts which can be tailored to the needs of the parties involved.

Question 15

At maturity of the forward contract,the following is true of the spot price and delivery price locked-in using the forward contract:
A)The spot price is greater than the delivery price.
B)The spot price is less than the delivery price.
C)The spot price is equal to the delivery price.
D)The spot price can be greater,equal to,or less than the delivery price.

Accepted Answer

At the maturity of a forward contract, the spot price—the current market price of the underlying asset—can indeed be greater than, equal to, or less than the delivery price agreed upon in the forward contract. This variability depends on market conditions and changes in the value of the underlying asset over the life of the contract.

Question 16

An investor enters into a forward contract to buy 4,000 barrels of oil in three months at $80 a barrel.At the maturity of the contract,the spot price of oil is $65 a barrel.The investor's payoff (gain/loss)from the forward contract is
A)A gain of $60,000
B)A loss of $60,000
C)A gain of $260,000
D)A loss of $260,000

Accepted Answer

The investor agreed to buy oil at $80 a barrel but the spot price at maturity is $65 a barrel, meaning they are paying $15 more per barrel than the market price. For 4,000 barrels, this results in a loss of 4,000 * $15 = $60,000.

Question 17

Which of the following statements is true when comparing the payoffs at maturity of a long forward contract with a long position in a call option,assuming the strike price of the option is the same as the delivery price in the forward contract?
A)The maximum (i.e. ,best-case)payoff of the forward contract exceeds that of the option.
B)The minimum (i.e. ,worst-case)payoff of the forward contract exceeds that of the option.
C)The minimum payoff of the option exceeds that of the forward contract.
D)The maximum payoff of the option exceeds that of the forward contract.

Accepted Answer

The option provides the holder with the right but not the obligation to buy the underlying asset at the strike price. Therefore, if the asset's price at maturity is less than the strike price, the minimum payoff of the option is zero, whereas the minimum payoff of the forward contract is negative. Hence, the minimum payoff of the option exceeds that of the forward contract, making choice C the correct answer.

Question 18

The following is not a point of difference between futures and forwards.
A)The futures payoff depends on the spot price of the asset at contract maturity.
B)Futures are traded on an exchange.
C)Futures have standardized terms.
D)Default risk in a futures contract is borne by the exchange.

Accepted Answer

This is not a point of difference between futures and forwards because the same is true for forwards as well. The payoff of a forward contract also depends on the spot price of the asset at the contract maturity.

Question 19

Which of the following securities is not a derivative?
A)Call option on a stock.
B)A bond issued by a BBB-rated corporate firm.
C)Put option on a currency.
D)A futures contract on oil.

Accepted Answer

A bond is not a derivative as it represents a direct investment in the underlying asset. A call option, put option, and futures contract are derivatives as their value is derived from the underlying asset, such as a stock, currency, or commodity.

Question 20

An option gives the buyer
A)The right but not the obligation to undertake the trade specified in the contract at maturity.
B)The obligation but not the right to undertake the trade specified in the contract at maturity.
C)The right to cancel the contract at any time prior to maturity.
D)The same obligation as in a forward contract.

Accepted Answer

An option contract gives the buyer the right but not the obligation to undertake the trade specified in the contract at maturity. This means that the buyer has the choice to exercise their option and buy or sell the underlying asset at the agreed price, but they are not required to do so. This is in contrast to a forward contract, where both parties are obligated to follow through with the trade at maturity. Option buyers pay a fee or premium for this right, and the seller (or writer) of the option is obligated to sell or buy the underlying asset if the buyer decides to exercise their option.

Quiz 1: Overview

Which of the following statements is true of forward contracts?

Which of the following statements about forwards is false?

Which option gives the right to sell an asset at any time prior to or at maturity?

Consider hedging an exposure with (i) a futures contract,or (ii) an option with a strike price close to the futures price.The hedge with the futures contract

How many options does a callable,convertible bond contain?

An embedded option is one where the security contains features that are option-like.Which of the following is not an example of a security with an embedded option?

A forward contract may be used for

A forward contract is struck at a forward price of $40.At maturity the spot price of the asset is $45.The short forward position earns the following payoff:

A derivative security derives its value from an "underlying" security that is

Which class of derivatives have been blamed most widely for causing the financial crisis of 2008?

Which of the following statements is true of the value of European (E) options,American (A) options,and Bermudan (B) options?

Which class of derivatives accounts for the largest dollar share in the world market in terms of notional amount outstanding?

State which of these statements is false.

At maturity of the forward contract,the following is true of the spot price and delivery price locked-in using the forward contract:

An investor enters into a forward contract to buy 4,000 barrels of oil in three months at $80 a barrel.At the maturity of the contract,the spot price of oil is $65 a barrel.The investor's payoff (gain/loss) from the forward contract is

Which of the following statements is true when comparing the payoffs at maturity of a long forward contract with a long position in a call option,assuming the strike price of the option is the same as the delivery price in the forward contract?

The following is not a point of difference between futures and forwards.

Which of the following securities is not a derivative?

An option gives the buyer