Question 1

What is speculation?

Accepted Answer

Speculation is purposefully taking on an identified risk with a view to making a profit.For instance,one can take a gamble that the exchange rate will move in his/her favour by entering into a forward exchange agreement.For example,a party could bet that the US dollar will weaken against the Canadian dollar.If the US$ weakens during the period,the speculator will make a profit,but if the US$ strengthens in the period,the speculator will lose money.

Question 2

What is an option?
A)A contract that gives the holder the right to sell an instrument at a pre-specified price.
B)A contract that is derived from some other underlying quantity,index,asset or event.
C)A contract that gives the holder the right to acquire an instrument at a pre-specified price.
D)A contract that gives the holder the right to buy or sell something at a specified price.

Accepted Answer

An option is a contract that gives the holder the right, but not the obligation, to buy or sell something (usually an underlying asset or instrument) at a specified price (strike price) before or at a specific date (expiration date). This definition matches with option (D) as it includes both buying and selling options. Option (A) only refers to selling, option (B) mentions derivation, and option (C) only talks about acquiring.

Question 3

Which statement is correct about accounting for financial instruments?
A)All financial instruments are accounted for at fair value through profit or loss.
B)All are accounted for in accordance to their economic substance.
C)All financial instruments are accounted for at amortized cost.
D)All financial instruments are accounted for at fair value through OCI.

Accepted Answer

Financial instruments are accounted for according to their economic substance rather than their legal form. This principle ensures that the financial statements reflect the underlying transactions' true nature and economic realities. Options A, C, and D are incorrect because not all financial instruments are accounted for in the same way; the accounting treatment depends on the classification of the financial instrument, which can vary.

Question 4

Which of the following is correct about financial instruments?
A)Accounting for financial instruments has been consistent.
B)There is no economic substance to financial instruments.
C)They may be used in support of innovations designed to circumvent accounting standards.
D)All financial instruments are accounted for at fair value.

Accepted Answer

Financial instruments can indeed be used in innovative ways, sometimes with the intention of circumventing accounting standards. This can involve structuring transactions in a manner that achieves certain financial reporting outcomes without necessarily reflecting the underlying economic reality.

Question 5

What is a "forward"?
A)A contract in which two parties agree to exchange cash flows (e.g.interest cash flows).
B)A contract in which one party commits upfront to buy or sell commonly traded items at a defined price and maturity date.
C)A contract in which one party commits upfront to buy or sell something at a defined price at a defined future date.
D)A contact that gives the right,but not the obligation,to buy a share at a specified price over a specified period of time.

Accepted Answer

A forward is a contract in which one party commits upfront to buy or sell something at a defined price at a defined future date, without the obligation to trade. This distinguishes it from an option (answer D) where one has the right to buy/sell but not obligation, and from an interest rate swap (answer A) where two parties exchange cash flows on a predetermined basis. Answer B describes a futures contract which is similar to a forward but is standardized and trades on an exchange.

Question 6

Which of the following is an example of a "forward"?
A)Right to buy 100 shares of CIBC over the next 5 years.
B)Commitment to buy 100 barrels of oil next month at $125/barrel.
C)Commitment to buy $100,000 US dollars in 120 days at US$=1.10.
D)Pay interest at prime +3% in exchange for receiving interest at 5%.

Accepted Answer

The answer of Which of the following is an example...

Question 7

What is a "swap"?
A)A contract in which two parties agree to exchange cash flows (e.g.interest cash flows).
B)A contract in which one party commits upfront to buy or sell commonly traded items at a defined price and maturity date.
C)A contract in which one party commits upfront to buy or sell something at a defined price at a defined future date.
D)A contact that gives the right,but not the obligation,to buy a share at a specified price over a specified period of time.

Accepted Answer

A swap is a contract in which two parties agree to exchange cash flows, such as interest cash flows. The swap can involve two types of cash flows: fixed and floating. The fixed cash flow is predetermined and agreed upon in advance, while the floating cash flow is based on an underlying reference rate that changes over time. Swaps are commonly used to manage interest rate risk or currency risk.

Question 8

What is a "put" option?
A)A contract that gives the holder the right to sell an instrument at a pre-specified price.
B)A contract that is derived from some other underlying quantity,index,asset or event.
C)A contract that gives the holder the right to acquire an instrument at a pre-specified price.
D)A contract that gives the holder the right to buy or sell something at a specified price.

Accepted Answer

A "put" option is a contract that gives the holder the right, but not the obligation, to sell an underlying asset (such as a stock, commodity, or currency) at a pre-specified price, within a certain time period. This is different from a "call" option, which gives the holder the right to buy an asset at a pre-specified price.

Question 9

Contrast options with warrants.

Accepted Answer

The answer of Contrast options with warrants....

Question 10

Which of the following is an example of a "future"?
A)Right to buy 100 shares of CIBC over the next 5 years.
B)Commitment to buy 100 barrels of oil next month at $125/barrel.
C)Commitment to buy $100,000 US dollars in 120 days at US$=1.10.
D)Pay interest at prime +3% in exchange for receiving interest at 5%.

Accepted Answer

A future is a standardized contract to buy or sell a specific quantity of a commodity or financial instrument at a predetermined price at a specified time in the future. Option B describes such a contract for oil.

Question 11

What is a derivative and what are two reasons why parties would enter into a derivative contract?

Accepted Answer

The answer of What is a derivative and what are...

Question 12

Indicate whether the following statements are true or false with respect to characteristics of stock options.

Accepted Answer

The answer of Indicate whether the following statements are true...

Question 13

Which of the following is correct regarding a call option?
A)The intrinsic value of a call option is the greater of zero and (K- S),the difference between the market price and the strike price.
B)The time value of an option reflects the probability that the future market price of the underlying instrument will not exceed the strike price.
C)The time value decreases with the length of time to expiration and the volatility of the underlying instrument (such as the share price).
D)The time value is always positive until the option expires,so the total value of an unexpired option is always greater than the intrinsic value.

Accepted Answer

The time value of an option is indeed always positive until the option expires, reflecting the potential for the option to gain in value. This means the total value of an option (intrinsic value plus time value) is always greater than just its intrinsic value before expiration.

Question 14

What is hedging?

Accepted Answer

The answer of What is hedging?...

Question 15

What is a "future"?
A)A contract in which two parties agree to exchange cash flows (e.g.interest cash flows).
B)A contract in which one party commits upfront to buy or sell commonly traded items at a defined price and maturity date.
C)A contract in which one party commits upfront to buy or sell something at a defined price at a defined future date.
D)A contact that gives the right,but not the obligation,to buy a share at a specified price over a specified period of time.

Accepted Answer

A future is a contract in which one party commits upfront to buy or sell commonly traded items (such as commodities, currencies, or financial instruments) at a defined price and maturity date. It is different from an option (answer D) because a future contract obligates both parties to fulfill the terms of the contract, whereas an option gives the holder the right but not the obligation to buy or sell the underlying asset. Choices A and C are similar to futures, but they refer specifically to contracts involving cash flows or non-standardized assets.

Question 16

Which of the following is an example of a "swap"?
A)Right to buy 100 shares of CIBC over the next 5 years.
B)Commitment to buy 100 barrels of oil next month at $125/barrel.
C)Commitment to buy $100,000 US dollars in 4 months at US$=1.10.
D)Pay interest at prime +3% in exchange for receiving interest at 5%.

Accepted Answer

A swap involves exchanging one set of cash flows for another. Option A is an option contract, option B is a futures contract, and option C is a forward contract. Option D involves exchanging different interest rate payments, making it the only example of a swap among the choices given.

Question 17

What is a "warrant"?
A)A contract in which two parties agree to exchange cash flows (e.g.interest cash flows).
B)A contract in which one party commits upfront to buy or sell commonly traded items at a defined price and maturity date.
C)A contract in which one party commits upfront to buy or sell something at a defined price at a defined future date.
D)A contact that gives the right,but not the obligation,to buy a share at a specified price over a specified period of time.

Accepted Answer

A warrant is a financial instrument that gives the holder the right, but not the obligation, to buy a share at a specified price over a specified period of time. It is often issued by a company as a way to raise additional capital but can also be traded on exchanges like stocks.

Question 18

Describe the underlying quantity that the derivative instrument derives its value from?

Accepted Answer

The answer of Describe the underlying quantity that the derivative...

Question 19

Which of the following is an example of a "warrant"?
A)Right to buy 100 shares of CIBC at $50.00 per share over the next 5 years.
B)Commitment to buy 100 barrels of oil next month at $125/barrel.
C)Commitment to buy $100,000 US dollars in 4 months at US$=1.10.
D)Pay interest at prime +3% in exchange for receiving interest at 5%.

Accepted Answer

A warrant is a financial instrument that gives the holder the right to buy or sell an underlying asset at a predetermined price and time. In this case, the right to buy 100 shares of CIBC at $50.00 per share over the next 5 years is an example of a warrant.

Question 20

What is a "call" option?
A)A contract that gives the holder the right to sell an instrument at a pre-specified price.
B)A contract that is derived from some other underlying quantity,index,asset or event.
C)A contract that gives the holder the right to acquire an instrument at a pre-specified price.
D)A contract that gives the holder the right to buy or sell something at a specified price.

Accepted Answer

A "call" option is a contract that gives the holder the right to acquire an instrument (such as a stock or commodity) at a predetermined price, called the strike price. This option is usually exercised when the price of the underlying instrument rises above the strike price, allowing the holder to buy at a lower price and sell at a higher price, thus making a profit.

Quiz 14: Complex Financial Instruments

What is speculation?

What is an option?

Which statement is correct about accounting for financial instruments?

Which of the following is correct about financial instruments?

What is a "forward"?

Which of the following is an example of a "forward"?

What is a "swap"?

What is a "put" option?

Contrast options with warrants.

Which of the following is an example of a "future"?

What is a derivative and what are two reasons why parties would enter into a derivative contract?

Indicate whether the following statements are true or false with respect to characteristics of stock options.

Which of the following is correct regarding a call option?

What is hedging?

What is a "future"?

Which of the following is an example of a "swap"?

What is a "warrant"?

Describe the underlying quantity that the derivative instrument derives its value from?

Which of the following is an example of a "warrant"?

What is a "call" option?