Question 1

When would an option hedge be better than a futures or forward hedge?

Accepted Answer

The answer of When would an option hedge be better...

Question 2

How does a futures or option clearinghouse assist traders?

Accepted Answer

The answer of How does a futures or option clearinghouse...

Question 3

FNMA has direct holdings of 30-year fixed-rate mortgages financed by three- to five-year agency securities sold to the public.
What kind of interest rate swap could FNMA use to limit their interest rate risk? Explain.

Accepted Answer

The answer of FNMA has direct holdings of 30-year fixed-rate...

Question 4

A bank has made a risky loan to a midsize consumer goods manufacturer. With the weaker economy,the borrower is expected to have trouble repaying the loan. The bank decides to purchase a digital default option. Which one of the following payout patterns does a digital option provide?

Accepted Answer

A digital default option provides a fixed payout in the event of a default on the underlying credit, typically the par on the loan or bond. This means that if the borrower is unable to repay the loan, the bank holding the option will receive a payout equal to the original loan amount. This provides the bank with a form of insurance against the risk of default, helping to mitigate the potential losses associated with the risky loan.

Question 5

Two competing fully electronic derivatives markets in the United States are

Accepted Answer

CME Globex and Eurex are two well-established and highly respected electronic derivatives markets in the United States. They offer a wide range of products, including futures and options on various asset classes, and have global reach, making them attractive options for traders and investors around the world. The other options listed either do not exclusively focus on derivatives trading or are not as prominent in the derivatives market.

Question 6

A stock is priced at $27. An American call option on this stock with a $25 strike must be worth at least how much? Numerically show why.

Accepted Answer

The answer of A stock is priced at $27. An...

Question 7

Refer to the Listed Stock Option Price Quote from February and assume it is now January:

Based on the option quote,the June put should cost
I. more than $477.
II. more than $665.
III. more than the March and June 60 calls.
IV. more than the March 60 call but no more than the June 60 call.

Accepted Answer

Based on the option quote, the June put has a strike price of 60 and a premium of 12.90.

I. The June put should cost more than $477 because the premium of 12.90 would have to be multiplied by 100 (the number of shares per options contract) and added to the strike price of 60 to get a breakeven price of $672.90, which is higher than $477.

II. The June put should cost more than $665 because the breakeven price calculated in part (I) is already higher than $665.

III. The March and June 60 calls have premiums of 6.40 and 7.60, respectively, which are lower than the premium of the June put. Therefore, the June put should cost more than the March and June 60 calls.

IV. The March 60 call has a premium of 8.50, which is lower than the premium of the June put. The June 60 call has a premium of 7.60, which is also lower than the premium of the June put. Therefore, the June put should cost more than the March 60 call but no more than the June 60 call.

Overall, the correct choices are I, II, and III, but not IV.

Question 8

Your firm enters into a swap agreement with a notional principal of $40 million wherein the firm pays a fixed rate of interest of 5.50 percent and receives a variable rate of interest equal to LIBOR plus 150 basis points. If LIBOR is currently 3.75 percent,the NET amount your firm will receive (+)or pay (−)on the next transaction date is

Accepted Answer

The answer of Your firm enters into a swap agreement...

Question 9

Refer to the Listed Stock Option Price Quote from February and assume it is now January:

If you buy the March put and don't exercise before contract maturity,you will make a profit if the stock price at maturity ________ from today's price.

Accepted Answer

According to the option quote, the March put has a strike price of 57.50 and a premium of 3.30. To breakeven on this trade, the stock price would need to decrease by the premium paid, plus the strike price, or $60.80.

To make a profit on the trade, the stock price would need to decrease below the breakeven point. The current stock price listed in the quote is 59.89. To calculate the percentage decrease required to make a profit:

(60.80-59.89)/59.89  x 100 = 1.51%

Therefore, the stock price would need to decrease by more than 1.51%, which is only possible with answer choice C (a decrease of more than 3.94%).

Question 10

What determines the success or failure of an exchange-traded derivative contract? Why were currency and interest rate futures introduced in the early and late 1970s,respectively?

Accepted Answer

The answer of What determines the success or failure of...

Question 11

A bank lender is concerned about the creditworthiness of one of its major borrowers. The bank is considering using a swap to reduce its credit exposure to this customer. Which type of swap would best meet this need?

Accepted Answer

A Credit default swap (CDS) would best meet the bank lender's needs, as it is specifically designed to transfer credit risk. By purchasing a CDS from a counterparty, the bank can receive protection against the risk of default by the borrower. This can reduce the bank's credit exposure to the borrower and potentially lower the capital reserves required for the loan. Interest rate swaps, currency swaps, equity-linked swaps, and DIF swaps are not specifically designed to address credit risk.

Question 12

Refer to the Listed Stock Option Price Quote from February and assume it is now January:

Based on the option quote,the March call should cost

Accepted Answer

The option quote shows the March call price for $0.225, which is less than $225. Since the question asks for what it should cost now in January, assuming no other changes, we can assume that the price will still be less than $225. Therefore, the correct choice is D, less than $225.

Question 13

The type of swap most closely linked to the subprime mortgage crisis is the ________.

Accepted Answer

The credit default swap is the type of swap most closely linked to the subprime mortgage crisis. These swaps were used to transfer the risk of default on subprime mortgage loans to third-party investors, therefore contributing to the buildup of risky mortgage-backed securities in the financial system.

Question 14

A U.S. firm has a European subsidiary that earns euros. The subsidiary has borrowed dollars at a floating rate of interest. What kind of risk does the subsidiary have? What kind of swap could be used to limit the subsidiary's risk? Be specific.

Accepted Answer

The answer of A U.S. firm has a European subsidiary...

Question 15

A contract wherein the buyer agrees to pay a specified interest rate on a loan that will be originated at some future time is called a(n)

Accepted Answer

A forward rate agreement is a financial contract wherein the buyer agrees to pay a specified interest rate on a loan that will be originated at some future time. This agreement hedges against potential interest rate movements in the future. The other options provided, such as a futures loan, option on a futures contract, interest rate swap contract, and currency swap contract, do not accurately match the description given.

Question 16

FNMA has direct holdings of 30-year fixed-rate mortgages financed by three- to five-year agency securities sold to the public.
What kind of interest rate option could FNMA use to limit the interest rate risk? Explain how this would work. Explain how a collar could also be used.

Accepted Answer

The answer of FNMA has direct holdings of 30-year fixed-rate...

Question 17

When would a forward contract be better for hedging than a futures contract?

Accepted Answer

The answer of When would a forward contract be better...

Question 18

Using the Black-Scholes model,explain what happens to the value of a call as S,T,and σ2 change. Why is the relationship between risk and price different for options than for other securities?
1. As S increases,C (the call premium)increases because the right to buy at the fixed price E has more value as the sale price S rises.
2. As T increases,C increases and as T decreases,C decreases. The less time remaining on the option,the lower its value since there is less time during which the option right is available.
3. As σ increases,C increases.

Accepted Answer

The answer of Using the Black-Scholes model,explain what happens to...

Question 19

Buying an "at-the-money" call option and writing an "at-the-money" put option are two ways to make money when prices rise. When would each be the preferable strategy?

Accepted Answer

The answer of Buying an "at-the-money" call option and writing...

Question 20

When might an option on a futures contract be preferable to an option on the underlying instrument?

Accepted Answer

The answer of When might an option on a futures...

Quiz 10: Derivative Securities Markets

When would an option hedge be better than a futures or forward hedge?

How does a futures or option clearinghouse assist traders?

FNMA has direct holdings of 30-year fixed-rate mortgages financed by three- to five-year agency securities sold to the public. What kind of interest rate swap could FNMA use to limit their interest rate risk? Explain.

A bank has made a risky loan to a midsize consumer goods manufacturer. With the weaker economy,the borrower is expected to have trouble repaying the loan. The bank decides to purchase a digital default option. Which one of the following payout patterns does a digital option provide?

Two competing fully electronic derivatives markets in the United States are

A stock is priced at $27. An American call option on this stock with a $25 strike must be worth at least how much? Numerically show why.

Refer to the Listed Stock Option Price Quote from February and assume it is now January: Based on the option quote,the June put should cost I. more than $477. II. more than $665. III. more than the March and June 60 calls. IV. more than the March 60 call but no more than the June 60 call.

Refer to the Listed Stock Option Price Quote from February and assume it is now January: If you buy the March put and don't exercise before contract maturity,you will make a profit if the stock price at maturity ________ from today's price.

What determines the success or failure of an exchange-traded derivative contract? Why were currency and interest rate futures introduced in the early and late 1970s,respectively?

A bank lender is concerned about the creditworthiness of one of its major borrowers. The bank is considering using a swap to reduce its credit exposure to this customer. Which type of swap would best meet this need?

Refer to the Listed Stock Option Price Quote from February and assume it is now January: Based on the option quote,the March call should cost

The type of swap most closely linked to the subprime mortgage crisis is the ________.

A U.S. firm has a European subsidiary that earns euros. The subsidiary has borrowed dollars at a floating rate of interest. What kind of risk does the subsidiary have? What kind of swap could be used to limit the subsidiary's risk? Be specific.

A contract wherein the buyer agrees to pay a specified interest rate on a loan that will be originated at some future time is called a(n)

FNMA has direct holdings of 30-year fixed-rate mortgages financed by three- to five-year agency securities sold to the public. What kind of interest rate option could FNMA use to limit the interest rate risk? Explain how this would work. Explain how a collar could also be used.

When would a forward contract be better for hedging than a futures contract?

Buying an "at-the-money" call option and writing an "at-the-money" put option are two ways to make money when prices rise. When would each be the preferable strategy?

When might an option on a futures contract be preferable to an option on the underlying instrument?