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business
options futures and other derivatives

Questions and Answers of Options Futures And Other Derivatives

5. Which of the following is a limit to arbitrage?A. Clearinghouses restrict the transactions that can be arbitraged.B. Pricing models do not show whether to buy or sell the derivative.C. It may not
4. An investor who requires no premium to compensate for the assumption of risk is said to be which of the following?A. Risk seeking B. Risk averse C. Risk neutral
3. Which of the following best describes how derivatives are priced?A. A hedge portfolio is used that eliminates arbitrage opportunities.B. The payoff of the underlying is adjusted downward by the
2. What most likely happens when an arbitrage opportunity exists?A. Investors trade quickly and prices adjust to eliminate the opportunity.B. Risk premiums increase to compensate traders for the
1. Which of the following best describes an arbitrage opportunity? It is an opportunity to:A. earn a risk premium in the short run.B. buy an asset at less than its fundamental value.C. make a profit
2. Which of the following does not represent a benefit of holding an asset?A. The convenience yield B. An optimistic expected outlook for the asset C. Dividends if the asset is a stock or interest if
1. Which of the following factors does not affect the spot price of an asset that has no interim costs or benefits?A. The time value of money B. The risk aversion of investors C. The price recently
• How does American option pricing differ from European option pricing?
• How are the prices and values of European options determined?
• How are the prices and values of swaps determined?
• How are futures contracts priced differently from forward contracts?
• How are the prices and values of forward contracts determined?
• How are derivatives priced using the principle of arbitrage?
• How does the pricing of the underlying asset affect the pricing of derivatives?
• explain under which circumstances the values of European and American options differ?
• explain how the value of an option is determined using a one-period binomial model;
• explain put–call–forward parity for European options;
• explain put–call parity for European options;
• identify the factors that determine the value of an option and explain how each factor affects the value of an option;
• explain the exercise value, time value, and moneyness of an option;
• explain how the value of a European option is determined at expiration;
• distinguish between the value and price of swaps;
• explain how swap contracts are similar to but different from a series of forward contracts;
• explain why forward and futures prices differ;
• define a forward rate agreement and describe its uses;
• describe monetary and nonmonetary benefits and costs associated with holding the underlying asset and explain how they affect the value and price of a forward contract;
• explain how the value and price of a forward contract are determined at expiration, during the life of the contract, and at initiation;
• distinguish between value and price of forward and futures contracts;
• explain how the concepts of arbitrage, replication, and risk neutrality are used in pricing derivatives;
15. Arbitrage opportunities exist when:A. two identical assets or derivatives sell for different prices.B. combinations of the underlying asset and a derivative earn the risk-free rate.C.
14. The law of one price is best described as:A. the true fundamental value of an asset.B. earning a risk-free profit without committing any capital.C. two assets that will produce the same cash
13. Which of the following is most likely to be a destabilizing consequence of speculation using derivatives?A. Increased defaults by speculators and creditors B. Market price swings resulting from
12. Which of the following characteristics is least likely to be a benefit associated with using derivatives?A. More effective management of risk B. Payoffs similar to those associated with the
11. Compared with the underlying spot market, derivative markets are more likely to have:A. greater liquidity.B. higher transaction costs.C. higher capital requirements.
10. A credit derivative is a derivative contract in which the:A. clearinghouse provides a credit guarantee to both the buyer and the seller.B. seller provides protection to the buyer against the
9. Which of the following derivatives is least likely to have a value of zero at initiation of the contract?A. Futures B. Options C. Forwards
8. Forward commitments subject to default are:A. forwards and futures.B. futures and interest rate swaps.C. interest rate swaps and forwards.
7. An interest rate swap is a derivative contract in which:A. two parties agree to exchange a series of cash flows.B. the credit seller provides protection to the credit buyer.C. the buyer has the
6. Which of the following derivatives provide payoffs that are non-linearly related to the payoffs of the underlying?A. Options B. Forwards C. Interest rate swaps
5. In contrast to contingent claims, forward commitments provide the:A. right to buy or sell the underlying asset in the future.B. obligation to buy or sell the underlying asset in the future.C.
4. Which of the following derivatives is classified as a contingent claim?A. Futures contracts B. Interest rate swaps C. Credit default swaps
3. Exchange-traded derivatives are:A. largely unregulated.B. traded through an informal network.C. guaranteed by a clearinghouse against default.
2. Compared with exchange-traded derivatives, over-the-counter derivatives would most likely be described as:A. standardized.B. less transparent.C. more transparent.
1. A derivative is best described as a financial instrument that derives its performance by:A. passing through the returns of the underlying.B. replicating the performance of the underlying.C.
4. Which of the following ways best describes how arbitrage contributes to market efficiency?A. Arbitrage penalizes those who trade too rapidly.B. Arbitrage equalizes the risks taken by all market
3. Which of the following accurately defines arbitrage?A. An opportunity to make a profit at no risk B. An opportunity to make a profit at no risk and with the investment of no capital C. An
2. When an arbitrage opportunity exists, what happens in the market?A. The combined actions of all arbitrageurs force the prices to converge.B. The combined actions of arbitrageurs result in a
1. Which of the following is a result of arbitrage?A. The law of one price B. The law of similar prices C. The law of limited profitability
3. Which of the following responds to the criticism that derivatives can be destabilizing to the underlying market?A. Market crashes and panics have occurred since long before derivatives existed.B.
2. Which of the following pieces of information is not conveyed by at least one type of derivative?A. The volatility of the underlying.B. The most widely used strategy of the underlying.C. The price
1. Which of the following is not an advantage of derivative markets?A. They are less volatile than spot markets.B. They facilitate the allocation of risk in the market.C. They incur lower transaction
2. Which of the following statements is true about contingent claims?A. Either party can default to the other.B. The payoffs are linearly related to the performance of the underlying.C. The most the
1. Which of the following is not a forward commitment?A. An agreement to take out a loan at a future date at a specific rate B. An offer of employment that must be accepted or rejected in two weeks
3. A credit derivative is which of the following?A. A derivative in which the premium is obtained on credit B. A derivative in which the payoff is borrowed by the seller C. A derivative in which the
2. Which of the following is not a characteristic of a call option on a stock?A. A guarantee that the stock will increase B. A specified date on which the right to buy expires C. A fixed price at
1. An option provides which of the following?A. Either the right to buy or the right to sell an underlying B. The right to buy and sell, with the choice made at expiration C. The obligation to buy or
3. Which of the following occurs in the daily settlement of futures contracts?A. Initial margin deposits are refunded to the two parties.B. Gains and losses are reported to other market
2. Which of the following distinguishes forwards from swaps?A. Forwards are OTC instruments, whereas swaps are exchange traded.B. Forwards are regulated as futures, whereas swaps are regulated as
1. Which of the following characterizes forward contracts and swaps but not futures?A. They are customized.B. They are subject to daily price limits.C. Their payoffs are received on a daily basis.
4. Which of the following statements most accurately describes exchange-traded derivatives relative to over-the-counter derivatives? Exchange-traded derivatives are more likely to have:A. greater
3. Market makers earn a profit in both exchange and over-the-counter derivatives markets by:A. charging a commission on each trade.B. a combination of commissions and markups.C. buying at one price,
2. Which of the following characteristics is associated with over-the-counter derivatives?A. Trading occurs in a central location.B. They are more regulated than exchange-listed derivatives.C. They
1. Which of the following characteristics is not associated with exchange-traded derivatives?A. Margin or performance bonds are required.B. The exchange guarantees all payments in the event of
3. Which of the following statements about derivatives is not true?A. They are created in the spot market.B. They are used in the practice of risk management.C. They take their values from the value
2. Which of the following is not a characteristic of a derivative?A. An underlying B. A low degree of leverage C. Two parties—a buyer and a seller
1. Which of the following is the best example of a derivative?A. A global equity mutual fund B. A non-callable government bond C. A contract to purchase Apple Computer at a fixed price
• What is arbitrage and what role does it play in a well-functioning financial market?
• What are some criticisms of derivatives and to what extent are they well founded?
• What are the benefits of derivatives?
• What are credit derivatives and what are the various types of credit derivatives?
• What are call and put options and how do they differ from forwards, futures, and swaps?
• What are swaps?
• What are forward and futures contracts? In what ways are they alike and in what ways are they different?
• What is the distinction between a forward commitment and a contingent claim?
• What purposes do derivatives serve for financial market participants?
• What are the defining characteristics of derivatives?
• explain arbitrage and the role it plays in determining prices and promoting market efficiency?
• describe purposes of, and controversies related to, derivative markets;
• define forward contracts, futures contracts, options (calls and puts), swaps, and credit derivatives and compare their basic characteristics;
• contrast forward commitments with contingent claims;
• define a derivative and distinguish between exchange-traded and over-the-counter derivatives;
Suppose that the spot price, 6-month futures price, and 12-month futures price for wheat are 250, 260, and 270 cents per bushel, respectively. Suppose that the price of wheat follows the process in
A driver entering into a car lease agreement can obtain the right to buy the car in 4 years for $10,000. The current value of the car is $30,000. The value of the car, S, is expected to follow the
A company can buy an option for the delivery of 1 million units of a commodity in 3 years at $25 per unit. The 3-year futures price is $24. The risk-free interest rate is 5% per annum with continuous
The correlation between a company's gross revenue and the market index is 0.2. The excess return of the market over the risk-free rate is 6% and the volatility of the market index is 18%. What is the
Derive a relationship between the convenience yield of a commodity and its market price of risk. P-968
Consider a commodity with constant volatility and an expected growth rate that is a function solely of time. Show that, in the traditional risk-neutral world, In St~ (In F(T)-loT.'T] where Sy is the
Explain the difference between the net present value approach and the risk-neutral valuation approach for valuing a new capital investment opportunity. What are the advantages of the risk-neutral
How is the tree in Figure 33.2 modified if the 1- and 2-year futures prices are $21 and $22 instead of $22 and $23, respectively. How does this affect the value of the American option in Example
An insurance company’s losses of a particular type are to a reasonable approximation normally distributed with a mean of $150 million and a standard deviation of $50 million.(Assume no difference
Consider two bonds that have the same coupon, time to maturity, and price. One is a B-rated corporate bond. The other is a CAT bond. An analysis based on historical data shows that the expected
Explain how CAT bonds work. P-968
Explain how a 5 x 8 option contract for May 2009 on electricity with daily exercise works. Explain how a 5 x 8 option contract for May 2009 on electricity with monthly exercise works. Which is worth
How can an energy producer use derivatives markets to hedge risks? P-968
What are the characteristics of an energy source where the price has a very high volatility and a very high rate of mean reversion? Give an example of such an energy source. P-968
Would you expect the volatility of the 1-year forward price of oil to be greater than or less than the volatility of the spot price? Explain your answer. P-968
Suppose that you have 50 years of temperature data at your disposal. Explain carefully the analyses you would carry out to value a forward contract on the cumulative CDD for a particular month. P-968
"HDD and CDD can be regarded as payoffs from options on temperature." Explain this statement. P-968
Why is the historical data approach appropriate for pricing a weather derivatives contract and a CAT bond? P-968
Why is the price of electricity more volatile than that of other energy sources? P-968

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