Deck 14: An Introduction to Derivative Markets and Securities

Question 1

An option to sell an asset is referred to as a call, whereas an option to buy an asset is called a put.

Answer 1

False

Question 2

The forward market has low liquidity relative to the futures market.

Answer 2

True

Question 3

Investment costs are generally higher in the derivative markets than in the corresponding cash markets.

Answer 3

False

Question 4

A futures contract is an agreement between a trader and the clearinghouse of the exchange for delivery of an asset in the future.

Question 5

If an investor wants to acquire the right to buy or sell an asset, but not the obligation to do it, the best instrument is an option rather than a futures contract.

Question 6

Futures contracts are slower to absorb new information than forward contracts.

Question 7

The minimum value of an option is zero.

Question 8

The initial value of a future contract is the price agreed upon in the contract.

Question 9

A primary function of futures markets is to allow investors to transfer risk.

Question 10

All features of a forward contract are standardized, except for price and number of contracts.

Question 11

Forward contracts are traded over-the-counter and are generally not standardized.

Question 12

A cash or spot contract is an agreement for the immediate delivery of an asset, such as the purchase of stock on the NYSE.

Question 13

The price at which the stock can be acquired or sold is the exercise price.

Question 14

Investors buy call options because they expect the price of the underlying stock to increase before the expiration of the option.

Question 15

A put option is in the money if the current market price is above the strike price.

Question 16

A call option is in the money if the current market price is above the strike price.

Question 17

A futures contract eliminates uncertainty about the future spot price that an individual can expect to pay for an asset at the time of delivery.

Question 18

Forward and future contracts, as well as options, are types of derivative securities.

Question 19

An option buyer must exercise the option on or before the expiration date.

Question 20

The futures market is a dealer market in which all the details of the transactions are negotiated.

Question 21

The payoffs to both the long and short position in the forward contact are symmetric around the contract price.

Question 22

There are a number of differences between forward and futures contracts. Which of the following statements is FALSE?

A) Futures have less liquidity risk than forward contracts.
B) Futures have less credit risk than forward contracts.
C) Futures have more default risk than forward contracts.
D) In futures, the exchange becomes the counterparty to all transactions.
E) Futures have standardized terms of agreement.

Question 23

Derivative instruments exist because

A) they help shift risk from risk-averse investors to risk-takers.
B) they help in forming prices.
C) they have lower investment costs.
D) allow investors to hedge portfolio risk.
E) All of these are correct.

Question 24

A forward contract gives its holder the option to conduct a transaction involving another security or commodity.

Question 25

The payoffs diagrams to both long and short positions in a forward contract are asymmetrical around the contract price.

Question 26

The option premium is the price the call buyer will pay to the option seller if the option is exercised

Question 27

Forward contracts do not require an upfront premium.

Question 28

Which of the following statements is FALSE?

A) Derivatives help shift risk from risk-adverse investors to risk-takers.
B) Derivatives assist in forming cash prices.
C) Derivatives provide additional information to the market.
D) In many cases, the investment in derivatives (both commissions and required investment) is more than in the cash market.
E) Some derivatives trade hypothetical underlying assets.

Question 29

Which of the following is NOT a factor needed to calculate the value of an American call option?

A) price of the underlying stock
B) exercise price
C) price of an equivalent put option
D) volatility of the underlying stock
E) interest rate

Question 30

Which of the following statements is a true definition of an in-the-money option?

A) a call option in which the stock price exceeds the exercise price
B) a call option in which the exercise price exceeds the stock price
C) a put option in which the stock price exceeds the exercise price
D) an index option in which the exercise price exceeds the stock price
E) a call option in which the call premium exceeds the stock price

Question 31

The minimum amount that must be maintained in an account is called the maintenance margin.

Question 32

In the forward market, both parties are required to post collateral or margin.

Question 33

Forward contracts are much easier to unwind than futures contracts due to the standardization of the contracts.

Question 34

The value of a call option just prior to expiration is (where V is the underlying asset's market price and X is the option's exercise price)

A) max [0, V - X].
B) max [0, X - V].
C) min [0, V - X].
D) min [0, X - V].
E) max [0, V > X].

Question 35

The CBOE brought numerous innovations to the option market. Which of the following is NOT such an innovation?

A) creation of a central marketplace
B) creation of a non-liquid secondary option market
C) introduction of a Clearing Corporation
D) standardization of all expiration dates
E) standardization of all exercise prices

Question 36

You own a stock that has risen from $10 per share to $32 per share. You wish to delay taking the profit, but you are troubled about the short-run behavior of the stock market. An effective action on your part would be to

A) buy a put option on the stock.
B) write a call option on the stock.
C) purchase an index option.
D) purchase an interest rate option.
E) write a put option on the stock.

Question 37

Which of the following factors is NOTconsidered in the valuation of call and put options?

A) current stock price
B) exercise price
C) market interest rate
D) volatility of underlying stock price
E) the option trading market

Question 38

Futures differ from forward contracts because

A) futures have more liquidity risk.
B) futures have more credit risk.
C) futures have more maturity risk.
D) futures do not require collateral.
E) None of these are correct.

Question 39

The price at which a futures contract is set at the end of the day is the

A) stock price.
B) strike price.
C) maintenance price.
D) settlement price.
E) parity price.

Question 40

Which of the following statements is TRUE?

A) The buyer of a futures contract is said to be long futures.
B) The buyer of a futures contract is said to be long futures.
C) The seller of a futures contract is said to be long futures.
D) The buyer of a futures contract is said to be short futures.
E) The buyer of a futures contract is unwinding a long position.

Question 41

A call option differs from a put option in that

A) a call option obliges the investor to purchase a given number of shares in a specific common stock at a set price; a put obliges the investor to sell a certain number of shares in a common stock at a set price.
B) both give the investor the opportunity to participate in stock market dealings without the risk of actual stock ownership.
C) a call option gives the investor the right to purchase a given number of shares of a specified stock at a set price; a put option gives the investor the right to sell a given number of shares of a stock at a set price.
D) a put option has risk because leverage is not as great as with a call.
E) All of these are correct.

Question 42

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
On the last day of October, Bruce Springsteen is considering the purchase of 100 shares of Olivia Corporation common stock selling at $37 1/2 per share and is considering an Olivia option.

Refer to Exhibit 14.1. If Bruce decides to buy a March call option with an exercise price of 35, what is his dollar gain (loss) if he closes his position when the stock is selling at 43 1/2?

A) $225.00 loss
B) $350.00 loss
C) $225.00 gain
D) $350.00 gain
E) $850.00 gain

Question 43

The value of a put option at expiration is

A) max [0, S(T) - X].
B) max [0, X - S(T)].
C) min [0, X - S(T)].
D) X

Question 44

The price paid for the option contract is referred to as the

A) forward price.
B) exercise price.
C) striking price.
D) option premium.
E) call price.

Question 45

A call option in which the stock price is higher than the exercise price is said to be

A) at-the-money.
B) in-the-money.
C) before-the-money.
D) out-of-the-money.
E) above-the-money.

Question 46

Which of the following statements is a true definition of an out-of-the-money option?

A) a call option in which the stock price exceeds the exercise price
B) a call option in which the exercise price exceeds the stock price
C) a call option in which the exercise price exceeds the stock price
D) a put option in which the exercise price exceeds the stock price
E) a call option in which the call premium exceeds the stock price

Question 47

Futures contracts are similar to forward contracts in that they both

A) have volatile price movements and strong interest from buyers and sellers.
B) give the holder the option to make a transaction in the future.
C) have similar liquidity.
D) have similar credit risk.
E) trade on the same exchange.

Question 48

An expiration date payoff and profit diagram for forward positions illustrates

A) gains and losses are usually small.
B) the payoffs to both long and short positions in the forward contract are asymmetrical around the contract price.
C) forward contracts are zero-sum games.
D) long positions benefit from falling prices.
E) short positions benefit from rising prices.

Question 49

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
On the last day of October, Bruce Springsteen is considering the purchase of 100 shares of Olivia Corporation common stock selling at $37 1/2 per share and is considering an Olivia option.

Refer to Exhibit 14.1. If Bruce buys a March put option with an exercise price of 40, what is his dollar gain (loss) if he closes his position when the stock is selling at 43 1/2?

A) $825.00 loss
B) $475.00 loss
C) $350.00 loss
D) $25.00 loss
E) $50.00 gain

Question 50

A stock currently sells for $15 per share. A put option on the stock with an exercise price of $20 currently sells for $6.50. The put option is

A) at-the-money.
B) in-the-money.
C) out-of-the-money.
D) at breakeven.
E) above-the-money.

Question 51

A stock currently sells for $150 per share. A call option on the stock with an exercise price of $155 currently sells for $2.50. The call option is

A) at-the-money.
B) in-the-money.
C) out-of-the-money.
D) at breakeven.
E) above-the-money.

Question 52

A stock currently sells for $15 per share. A put option on the stock with an exercise price of $15 currently sells for $1.50. The put option is

A) at-the-money.
B) in-the-money.
C) out-of-the-money.
D) at breakeven.
E) above-the-money.

Question 53

Intrinsic value represents the value

A) the seller could extract from the option if they exercised it immediately.
B) the buyer could extract from the option if they exercised it immediately.
C) seller pays for the time premium.
D) buyer pays for time premium.
E) below zero.

Question 54

A forward contract is similar to an option contract because they both

A) can provide insurance against the price of the underlying stock.
B) are paid for up front in the form of premiums.
C) are paid for at the end of the contract in the form of premiums.
D) require a future settlement payment.
E) trade on exchanges.

Question 55

Which of the following statements are TRUE?

A) Futures contracts have less liquidity risk and credit risk than forward contracts.
B) Futures contract prices are strongly linked to the prevailing level of the underlying spot index.
C) Futures contract decrease in price the further forward in time the delivery date is set.
D) Futures contracts have more liquidity risk and credit risk than forward contracts.
E) Futures contract prices are weakly linked to the prevailing level of the underlying spot index.

Question 56

A stock currently sells for $75 per share. A call option on the stock with an exercise price of $70 currently sells for $5.50. The call option is

A) at-the-money.
B) in-the-money.
C) out-of-the-money.
D) at breakeven.
E) above-the-money.

Question 57

An advantage of a forward contract over a futures contract is that

A) the terms of the contract are flexible.
B) it is more liquid.
C) it trades through a centralized market exchange.
D) it is easier to unwind due to contract homogeneity.
E) the counterparty is anonymous.

Question 58

A stock currently sells for $75 per share. A put option on the stock with an exercise price of $70 currently sells for $0.50. The put option is

A) at-the-money.
B) in-the-money.
C) out-of-the-money.
D) at breakeven.
E) above-the-money.

Question 59

A buyer of the call option is NOT speculating on the

A) direction of the price movement of the underlying investment.
B) timing of the price movement of the underlying investment.
C) leverage that a call option creates with respect to the underlying investment.
D) volatility of the price movement of the underlying investment.
E) liquidity of the underlying investment.

Question 60

Which of the following does NOT influence the option price?

A) past stock price
B) up and down factors u and d
C) risk free rate
D) exercise price
E) current stock price

Question 61

Tom Gettback buys 100 shares of Johnson Walker stock for $87.00 per share and a three-month Johnson Walker put option with an exercise price of $105.00 for $20.00. What is Tom's dollar gain/loss if at expiration the stock is selling for $105.00 per share?

A) $1000 gain
B) $200 loss
C) $1000 loss
D) $200 gain
E) $500 gain

Question 62

Assume that you purchased shares of a stock at a price of $35 per share. At this time, you purchased a put option with a $35 strike price of $3. The stock currently trades at $40. Calculate the dollar return on this option strategy.

A) $3
B) -$2
C) $2
D) -$3
E) $0

Question 63

Consider a stock that is currently trading at $10. Calculate the intrinsic value for a call option that has an exercise price of $15.

A) $25
B) -$5
C) $0
D) $20
E) $5

Question 64

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Sarah Kling bought a six-month Peppy Cola put option with an exercise price of $55 for a premium of $8.25 when Peppy was selling for $48.00 per share.
Refer to Exhibit 14.3. What is Sarah's annualized gain/loss?

A) 11.51 percent gain
B) 115.15 percent gain
C) 11.51 percent loss
D) 115.15 percent loss
E) 0 percent

Question 65

Assume that you have purchased a call option with a strike price $60 for $5. At the same time, you purchase a put option on the same stock with a strike price of $60 for $4. If the stock is currently selling for $75 per share, calculate the dollar return on this option strategy.

A) $10
B) -$4
C) $5
D) $6
E) $15

Question 66

A stock currently trades for $25. January call options with a strike price of $30 sell for $6. The appropriate risk-free bond has a price of $30. Calculate the price of the January put option.

A) $11
B) $24
C) $19
D) $30
E) $25

Question 67

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Sarah Kling bought a six-month Peppy Cola put option with an exercise price of $55 for a premium of $8.25 when Peppy was selling for $48.00 per share.
Refer to Exhibit 14.3. If at expiration Peppy is selling for $42.00, what is Sarah's dollar gain or loss?

A) $420 gain
B) $420 loss
C) $475 loss
D) $475 gain
E) $525 gain

Question 68

Datacorp stock currently trades at $50. August call options on the stock with a strike price of $55 are priced at $5.75. October call options with a strike price of $55 are priced at $6.25. Calculate the value of the time premium between the August and October options.

A) -$0.50
B) $0
C) $0.50
D) $5
E) -$5

Question 69

Consider a stock that is currently trading at $45. Calculate the intrinsic value for a call option that has an exercise price of $35.

A) $25
B) $35
C) $0
D) -$10
E) $10

Question 70

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Sarah Kling bought a six-month Peppy Cola put option with an exercise price of $55 for a premium of $8.25 when Peppy was selling for $48.00 per share.
Refer to Exhibit 14.3. If at expiration Peppy is selling for $47.00, what is Sarah's dollar gain or loss?

A) $25 loss
B) $250 loss
C) $25 gain
D) $250 gain
E) $0

Question 71

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Rick Thompson is considering the following alternatives for investing in Davis Industries, which is now selling for $44 per share:

Refer to Exhibit 14.2. Assuming no commissions or taxes, what is the annualized percentage gain if the stock reaches $50 in four months and a call was purchased?

A) 161.54 percent gain
B) 53.85 percent gain
C) 161.54 percent loss
D) 11.11 percent gain
E) 53.85 percent loss

Question 72

A stock currently trades at $110. June put options on the stock with a strike price of $100 are priced at $5.25. Calculate the dollar return on one put contract.

A) -$525
B) $1000
C) $0
D) -$1000
E) $525

Question 73

A stock currently trades at $110. June call options on the stock with a strike price of $120 are priced at $5.75. Calculate the dollar return on one call contract.

A) -$1000
B) $1000
C) $575
D) -$575
E) $0

Question 74

Consider a stock that is currently trading at $65. Calculate the intrinsic value for a put option that has an exercise price of $55.

A) $10
B) $50
C) $55
D) -$10
E) $0

Question 75

Assume that you purchased shares of a stock at a price of $35 per share. At this time, you wrote a call option with a $35 strike and received a call price of $2. The stock currently trades at $70. Calculate the dollar return on this option strategy.

A) $25
B) -$2
C) $2
D) -$25
E) $0

Question 76

Consider a stock that is currently trading at $20. Calculate the intrinsic value for a put option that has an exercise price of $35.

A) $15
B) $55
C) $35
D) -$15
E) $0

Question 77

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Sarah Kling bought a six-month Peppy Cola put option with an exercise price of $55 for a premium of $8.25 when Peppy was selling for $48.00 per share.
Refer to Exhibit 14.3. What is Sarah's annualized gain/loss?

A) 60.60 percent gain
B) 6.06 percent loss
C) 60.60 percent loss
D) 6.06 percent gain
E) 0 percent

Question 78

Tom Gettback buys 100 shares of Johnson Walker stock for $87.00 per share and a three-month Johnson Walker put option with an exercise price of $105.00 for $20.00. What is his dollar gain if the stock is selling for $80.00 per share at expiration?

A) $200 loss
B) $700 loss
C) $200 gain
D) $700 gain
E) $900 gain

Question 79

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Rick Thompson is considering the following alternatives for investing in Davis Industries, which is now selling for $44 per share:

Refer to Exhibit 14.2. Assuming no commissions or taxes, what is the annualized percentage gain if the stock is at $30 in four months and the stock was purchased?

A) 9.54 percent loss
B) 95.45 percent loss
C) 0.9545 percent gain
D) 95.45 percent gain
E) 9.54 percent gain

Question 80

A stock currently trades at $110. June call options on the stock with a strike price of $105 are priced at $4. Calculate the arbitrage profit that you can earn.

A) $0
B) $1
C) $5
D) $4
E) $9