Question 1

The payoff values on bond options are positively linked to the changes in interest rates.

Accepted Answer

The payoff values on bond options are inversely related to changes in interest rates because as interest rates rise, bond prices fall, and vice versa, affecting the value of bond options accordingly.

Question 2

Unlike futures and forward contracts, the use of options by FIs has deceased in recent years.

Accepted Answer

The statement is incorrect. The use of options by FIs has not decreased in recent years. In fact, options are increasingly used as a risk management tool by FIs.

Question 3

FIs may increase fee income by serving as a counterparty for other entities wanting to hedge risk on their own balance sheet.

Accepted Answer

When other entities want to hedge risk on their own balance sheet, FIs can serve as counterparty and earn fee income for providing this service.

Question 4

The most a call option buyer stands to lose is the amount of the call premium paid for the option.

Accepted Answer

When purchasing a call option, the most a buyer can lose is the premium paid for the option. The potential loss is limited to this amount, as the buyer has the right but not the obligation to exercise the option.

Question 5

The maximum potential loss to a buyer of bond put options is limited to the premium paid.

Accepted Answer

The maximum potential loss to a buyer of bond put options is limited to the premium paid. This means that if the buyer's prediction of the bond's price decrease is incorrect and the option expires worthless, the buyer only loses the premium paid for the option. However, if the buyer exercises the put option and sells the bond at a lower price, the loss would be the difference between the bond's purchase price and its selling price, not just the premium paid for the option.

Question 6

Unlike futures contracts, options are traded electronically through an option dealer network known as the Options Clearing Corporation (OCC).

Accepted Answer

The Options Clearing Corporation (OCC) is not a network for trading options but rather acts as a central clearinghouse for option transactions, ensuring the fulfillment of obligations under options contracts. Options are traded on various exchanges, such as the Chicago Board Options Exchange (CBOE), and can be traded electronically or through other means, but the OCC's role is in clearing and settlement, not trading.

Question 7

Buying a call option on a bond ensures an FI that it will be able to sell the bond at a given point in time for a price at least equal to the exercise price of the option.

Accepted Answer

Buying a call option on a bond gives the holder the right, but not the obligation, to buy the bond at a specified price (the exercise price) before the option expires, not to sell it.

Question 8

When interest rates rise, writing a bond call option may cause profits to offset the loss on an FI's bonds held in the portfolio.

Accepted Answer

Writing a bond call option in a rising interest rate environment could potentially lead to the option being exercised by the bond issuer, causing the FI to lose their bonds and miss out on potential future gains. This would not offset the loss on bonds held in the portfolio.

Question 9

The profit on bond call options moves asymmetrically with interest rates.

Accepted Answer

When interest rates decrease, the profit on bond call options increases at a faster rate than when interest rates increase. This is due to the inverse relationship between bond prices and interest rates. When interest rates decrease, bond prices increase at a faster rate, which benefits the owner of the call option. On the other hand, when interest rates increase, the bond prices decrease at a slower rate, which limits the profit potential for the call option owner. Therefore, the profit on bond call options is asymmetric with interest rates.

Question 10

Selling an interest rate call option may hedge an FI when rates rise and bond prices fall.

Accepted Answer

Selling an interest rate call option exposes the seller to losses if rates rise, as the option buyer would exercise the option to benefit from higher rates. To hedge against rising rates, an FI would typically buy an interest rate call option or sell an interest rate put option.

Question 11

The trading process of options is the same as that of futures contracts.

Accepted Answer

The answer of The trading process of options is the...

Question 12

The potential gain to the seller of a bond call option is unlimited.

Accepted Answer

The potential gain to the seller of a bond call option is limited to the premium received for selling the option. The buyer of the option has the potential for unlimited gain.

Question 13

The Chicago Board Options Exchange (CBOE) was the first exchange devoted solely to the trading of options.

Accepted Answer

This is true. The CBOE was founded in 1973 and was the first exchange to specialize in trading options contracts.

Question 14

The buyer of a bond put option stands to make a profit if changes in market interest rates cause the bond price to fall below the exercise price by enough to recoup the option premium paid.

Accepted Answer

This is because the put option gives the buyer the right to sell the bond at a fixed exercise price, which becomes profitable if the market interest rates cause the bond price to decrease, as the put option holder can purchase the bond at a lower market price and immediately sell it at the higher exercise price.

Question 15

Regulators tend to discourage, and even prohibit in some cases, FIs from writing options because the upside potential is unlimited and the downside losses are potentially limited.

Accepted Answer

Regulators tend to discourage or prohibit FIs from writing options because the downside losses are potentially unlimited (especially for naked or uncovered options), while the upside potential is limited to the premium received for selling the option.

Question 16

A bond call option gives the holder the right to sell the underlying bond at a pre-specified exercise price.

Accepted Answer

A bond call option gives the issuer, not the holder, the right to call (buy back) the underlying bond at a pre-specified exercise price.

Question 17

The payoff values on bond options are directly related to the changes in interest rates.

Accepted Answer

The answer of The payoff values on bond options are...

Question 18

The potential gain to a buyer of bond call options is unlimited, even if interest rates decrease to zero.

Accepted Answer

The gain to a buyer of bond call options is limited because as interest rates decrease, the value of the bond increases, but it cannot exceed the bond's face value plus accrued interest, thus capping the potential gain.

Question 19

The payoffs on bond call options move symmetrically with changes in interest rates.

Accepted Answer

Bond call options increase in value when interest rates decrease, as the underlying bond's price increases. Conversely, they decrease in value when interest rates increase, leading to an asymmetric relationship with interest rates.

Question 20

The buyer of a bond call option stands to make a positive payoff if changes in market interest rates cause the bond price to rise above the exercise price by enough to recoup the call premium paid for the option.

Accepted Answer

This statement is true. A bond call option gives the buyer the right to purchase a bond at a specified exercise price before the option expires. If the bond price rises above the exercise price, the buyer can purchase the bond at a discount and sell it for a profit. However, the buyer must recoup the premium paid for the option before making a positive payoff.

Quiz 24: Options, Caps, Floors, and Collars