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For all parties involved, which of the following financial instruments is not an example, Exams of Financial Economics

SUNY UlsterFinancial Economics

The treasurer of Company A expects to receive a cash inflow of $15,000,000 in 90 days. The treasurer expects short-term interest rates to fall during the next 90 days. In order to hedge against this risk, the treasurer decides to use an FRA that expires in 90 days and is based on 90-day LIBOR. The FRA is quoted at 5 percent. At expiration, LIBOR is 4.5 percent. Assume that the notional principal on the contract is $15,000,000

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Reading 68
1. For all parties involved, which of the following financial instruments is not an example of a forward
commitment?
A. Swap.
B. Call option.
C. Futures contract.
2. The main risk faced by an individual who enters into a forward contract to buy the S&P 500 Index is that:
A. the market may rise.
B. the market may fall.
C. market volatility may rise.
3. Which of the following statements is most accurate?
A. Forward contracts are marked to market daily.
B. Futures contracts have more default risk than forward contracts.
C. Forward contracts require that both parties to the transaction have a high degree of credit-worthiness.
4. Which of the following statements is least accurate?
A. Futures contracts are easier to offset than forward contracts.
B. Forward contracts are generally more liquid than futures contracts.
C. Forward contracts are easier to tailor to specific needs than futures contracts.
5. A swap is best characterized as a:
A. series of forward contracts.
B. derivative contract that has not gained widespread popularity.
C. single fixed payment in exchange for a single floating payment_
6. Which of the following is most representative of forward contracts and contingent claims?
Forward Contracts Contingent Claims
A. Premium paid at inception Premium paid at inception
B. Premium paid at inception No premium paid at inception
C. No premium paid at inception Premium paid at inception
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Partial preview of the text

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Reading 68

  1. For all parties involved, which of the following financial instruments is not an example of a forward commitment? A. Swap. B. Call option. C. Futures contract.
  2. The main risk faced by an individual who enters into a forward contract to buy the S&P 500 Index is that: A. the market may rise. B. the market may fall. C. market volatility may rise.
  3. Which of the following statements is most accurate? A. Forward contracts are marked to market daily. B. Futures contracts have more default risk than forward contracts. C. Forward contracts require that both parties to the transaction have a high degree of credit-worthiness.
  4. Which of the following statements is least accurate? A. Futures contracts are easier to offset than forward contracts. B. Forward contracts are generally more liquid than futures contracts. C. Forward contracts are easier to tailor to specific needs than futures contracts.
  5. A swap is best characterized as a: A. series of forward contracts. B. derivative contract that has not gained widespread popularity. C. single fixed payment in exchange for a single floating payment_
  6. Which of the following is most representative of forward contracts and contingent claims?

Forward Contracts Contingent Claims

A. Premium paid at inception Premium paid at inception B. Premium paid at inception No premium paid at inception C. No premium paid at inception Premium paid at inception

  1. For the long position, the most likely advantage of contingent claims over forward commitments is that contingent claims: A. are easier to offset than forward commitments. B. have lower default risk than forward commitments. C. permit gains while protecting against losses.
  2. For derivative contracts, the notional principal is best described as: A. the amount of the underlying asset covered by the contract. B. a measure of the actual payments made and received in the contract. C. tending to underestimate the actual payments made and received in the contract.
  3. By volume, the most widely used group of derivatives is the one with contracts written on which of the following types of underlying assets? A. Financial. B. Commodities. C. Energy-related.
  4. Which of the following is least likely to be a purpose served by derivative markets? A. Arbitrage. B. Price discovery. C. Risk management.
  5. The most likely reason derivative markets have flourished is that: A. derivatives are easy to understand and use. B. derivatives have relatively low transaction costs. C. the pricing of derivatives is relatively straightforward.
  6. A private transaction in which one party agrees to make a single fixed payment in the future and another party agrees to make a single floating payment in the future is best characterized as a(n): A. futures contract. B. forward contract. C. over-the-counter contingent claim.
  7. A public, standardized transaction that constitutes a commitment between two parties to transfer the underlying asset at a future date at a price agreed upon now is best characterized as a(n): A. swap. B. futures contract. C. exchange-traded contingent claim.

Reading 70

  1. A. In February, Dave Parsons purchased a June futures contract on the NASDAQ 100 Index. He decides to close out his position in April. Describe how he would do so. B. Peggy Smith is a futures trader. In early August, she took a short position in an S&P 500 Index futures contract expiring in September. After a week, she decides to close out her position. Describe how she would do so.
  2. A gold futures contract requires the long trader to buy 100 troy ounces of gold. The initial margin requirement is $2,000, and the maintenance margin requirement is $1,500. A. Matthew Evans goes long one June gold futures contract at the futures price of $320 per troy ounce. When could Evans receive a maintenance margin call? B. Chris Tosca sells one August gold futures contract at a futures price of $323 per ounce. When could Tosca receive a maintenance margin call?
  3. A copper futures contract requires the long trader to buy 25,000 lbs of copper. A trader buys one November copper futures contract at a price of $0.75/lb. Theoretically, what is the maximum loss this trader could have? Another trader sells one November copper futures contract. Theoretically, what is the maximum loss this trader with a short position could have?
  4. Consider a hypothetical futures contract in which the current price is $212. The initial margin requirement is $10, and the maintenance margin requirement is $8. You go long 20 contracts and meet all margin calls but do not withdraw any excess margin. A. When could there be a margin call? B. Complete the table below and explain any funds deposited. Assume that the contract is purchased at the settlement price of that day so there is no mark-to-market profit or loss on the day of purchase.

Beginning Funds Futures Price Ending Day Balance Deposited Price Change Gain/Loss Balance

0 212 1 211 2 214 3 209 4 210 5 204 6 202 C. How much are your total gains or losses by the end of Day 6?

  1. Sarah Moore has taken a short position in one Chicago Board of Trade Treasury bond futures contract with a face value of $100,000 at the price of 96 6/32. The initial margin requirement is $2,700, and the maintenance margin requirement is $2,000. Moore would meet all margin calls but would not withdraw any excess margin. A. Complete the table below and provide an explanation of any funds deposited. Assume that the contract is purchased at the settlement price of that day, so there is no mark-to-market profit or loss on the day of purchase.

Beginning Funds Futures Price Ending Day Balance Deposited Price Change Gain/Loss Balance 0 96- 1 96- 2 97- 3 97- 4 97- 5 98- 6 97- B. How much are Moore's total gains or losses by the end of Day 6?

  1. A. The IMM index price in yesterday's newspaper for a September Eurodollar futures contract is 95.23. What is the actual price of this contract? B. The IMM index price in today's newspaper for the contract mentioned above is 95.25. How much is the change in the actual futures price of the contract since the previous day?
  2. Consider the following statements about a futures clearinghouse: Statement 1: "A clearinghouse in futures contracts allows for the offsetting of contracts prior to delivery." Statement 2: "A clearinghouse in futures contracts collects initial margin (performance bands) from bath the long and short sides in the contract." Are the statements most likely correct or incorrect? A. Both statements are correct. B. Statement 1 is incorrect, but Statement 2 is correct. C. Statement 1 is correct, but Statement 2 is incorrect.
  3. A trader enters into a short position of 20 futures contracts at an initial futures price of $85.00. Initial margin, per contract, is $7.50. Maintenance margin, per contract, is $7.00. Each contract is for one unit of the underlying asset. Over the next three days, the contract settles at $86.00, $84.25, and $85.50, respectively. Assuming the trader does not withdraw any funds from his/her margin account during the period, but does post variation margin sufficient to meet any maintenance margin calls, the balance in the margin account will be: A. $140.00 at initiation and $150.00 at settlement on Day 3.

Reading 71

  1. A. Calculate the payoff at expiration for a call option on the S&P 100 stock index in which the underlying price is 579.32 at expiration, the multiplier is 100, and the exercise price is i. 450. ii. 650. B. Calculate the payoff at expiration for a put option on the S&P 100 in which the underlying is at 579.32 at expiration, the multiplier is 100, and the exercise price is: i. 450. ii. 650.
  2. A. Calculate the payoff at expiration for a call option on a bond in which the underlying is at $0.95 per $1 par at expiration, the contract is on $100,000 face value bonds, and the exercise price is: i. $0.85. ii. $1.15. B. Calculate the payoff at expiration for a put option on a bond in which the underlying is at $0.95 per $1 par at expiration, the contract is on $100,000 face value bonds, and the exercise price is: i. $0.85. ii. $1.15.
  3. A. Calculate the payoff at expiration for a call option on an interest rate in which the underlying is a 180-day interest rate at 6.53 percent at expiration, the notional principal is $10 million, and the exercise price is: i. 5 percent. ii. 8 percent. B. Calculate the payoff at expiration for a put option on an interest rate in which the underlying is a 180-day interest rate at 6.53 percent at expiration, the notional principal is $10 million, and the exercise price is: i. 5 percent. ii. 8 percent.
  4. A. Calculate the payoff at expiration for a call option on the British pound in which the underlying is at $1. at expiration, the options are on 125,000 British pounds, and the exercise price is: i. $1.35. ii. $1.55. B. Calculate the payoff at expiration for a put option on the British pound where the underlying is at $1.438 at expiration, the options are on 125,000 British pounds, and the exercise price is: i. $1.35. II. $1.55.
  1. A. Calculate the payoff at expiration for a call option on a futures contract in which the underlying is at 1136.76 at expiration, the options are on a futures contract for $1,000, and the exercise price is: i. 1130. ii. 1140. B. Calculate the payoff at expiration for a put option on a futures contract in which the underlying is at 1136.76 at expiration, the options are on a futures contract for $1,000, and the exercise price is: i. 1130. ii. 1140.
  2. Consider a stock index option that expires in 75 days. The stock index is currently at 1240.89 and makes no cash payments during the life of the option. Assume that the stock index has a multiplier of 1. The risk-free rate is 3 percent. A. Calculate the lowest and highest possible prices for European-style call options on the above stock index with exercise prices of: . 1225. 11. 1255. B. Calculate the lowest and highest possible prices for European-style put options on the above stock index with exercise prices of: i. 1225. ii. 1255.
  3. A. Consider American-style call and put options on a bond. The options expire in 60 days. The bond is currently at $1.05 per $1 par and makes no cash payments during the life of the option. The risk-free rate is 5.5 percent. Assume that the contract is on $1 face value bonds. Calculate the lowest and highest possible prices for the calls and puts with exercise prices of: i. $0.95. ii. $1.10. B. Consider European-style call and put options on a bond. The options expire in 60 days. The bond is currently at $1.05 per $1 par and makes no cash payments during the life of the option. The risk-free rate is 5.5 percent. Assume that the contract is on $1 face value bonds. Calculate the lowest and highest possible prices for the calls and puts with exercise prices of: i. $0.95. ii. $1.10.
  1. A put option with an exercise price of 75 will expire in 73 days. No cash payments will be made by the underlying asset over the life of the option. If the underlying asset is at 70 and the risk-free rate of return is 5. percent, the lower bounds for an American put option and a European put option, respectively, are closest to:

Lower bound for American Lower bound for European call option call option

A. 4.27 4. B. 4.27 5. C. 5.00 4.

  1. Compare an American call with a strike of 50 which expires in 90 days to an American call on the same underlying asset which has a strike of 60 and expires in 120 days. The underlying asset is selling at 55. Consider the following statements: Statement 1: "The 50 strike call is in-the-money and the 60 strike call is out-of-the-money." Statement 2: "The time value of the 60 strike call, as a proportion of the 60 strike call's premium, exceeds the time value of the 50 strike call as a proportion of the 50 strike call's premium." Are the statements most likely correct or incorrect? A. Both statements are correct. B. Statement 1 is incorrect, but Statement 2 is correct. C. Statement 1 is correct, but Statement 2 is incorrect. www.cfainstitute.orgitoolkit—Your online preparation resource
  2. Marla Johnson priced both a put and a call on Alpha Numero using standard option pricing software. To use the program, Johnson entered the strike price of the options, the price of the underlying asset, an estimate of the risk-free rate, the time to expiration of the option, and an estimate of the volatility of the returns of the underlying asset into her computer. Both prices calculated by the software program were substantially above the actual market values observed in that day's exchange trading. Which of the following is the most likely explanation? The value Johnson entered into the program for the: A. estimate of volatility was too low. B. estimate of volatility was too high. C. time to expiration of the options was too low.
  3. A call with a strike price of $40 is available on a stock currently trading for $35. The call expires in one year and the risk-free rate of return is 10%. The lower bound on this call's value: A. is zero. B. is $5 if the call is American-style. C. is $1.36 if the call is European-style.
  1. An investor writes a call option priced at $3 with an exercise price of $100 on a stock that he owns. The investor paid $85 for the stock. If at expiration of the call option the stock price has risen to $110, the profit for the investor's position would be closest to: A. $3. B. $12. C. $18.
  2. If an investor paid $5 for a put option with an exercise price of $60 that is in-the-money $2, the price of the underlying is closest to: A. $53. B. $58. C. $62.
  3. An investor paid $10 for an option that is currently in-the-money $5. If the underlying is priced at $90, which of the following best describes that option? A. Call option with an exercise price of $80. B. Put option with an exercise price of $95. C. Call option with an exercise price of $95.
  4. Assume the probability of bankruptcy for the underlying asset is high. Compared to the price of an American put option on the same underlying asset, the price of an equivalent European put option will most likely be: A. lower. B. higher. C. the same because the probability of bankruptcy does not affect pricing.
  1. An asset manager wishes to reduce her exposure to small-cap stocks and increase her exposure to fixed-income securities. She seeks to do so using an equity swap. She agrees to pay a dealer the return on a small-cap index and the dealer agrees to pay the manager a fixed rate of 5.5 percent. For each of the scenarios listed below, calculate the overall payment six months later and indicate which party makes the payment. Assume that payments are made semiannually (180 days per period) and there are 365 days in each year. The notional principal is $50 million. A. The value of the small-cap index starts off at 234.10 and six months later is at 238.41. B. The value of the small-cap index starts off at 234.10 and six months later is at 241.27.
  2. An asset manager wishes to reduce his exposure to fixed-income securities and increase his exposure to large-cap stocks. He seeks to do so using an equity swap. He agrees to pay a dealer a fixed rate of 4.5 percent, and the dealer agrees to pay the manager the return on a large-cap index. For each of the scenarios listed below, calculate the overall payment six months later and indicate which party makes it. Assume that payments are made semiannually (180 days per period) and there are 365 days in a year. The notional principal is $25 million. A. The value of the large-cap index starts off at 578.50 and six months later is at 622.54. B. The value of the large-cap index starts off at 578.50 and six months later is at 581.35.
  3. The party agreeing to make the fixed-rate payment might also be required to make the variable payment in: A. an equity swap but not an interest rate swap. B. an interest rate swap but not an equity swap. C. both an equity swap and an interest rate swap.
  4. The formula for calculating the payoff at expiration of a forward rate agreement (FRA) is:

( Underlying rate at expiration - Forward contract rate () Days in underlying rate 360 )

Notional principal Days in underlying rate

1 + Underlying rate at expiration( )

Use the above formula to solve for the payment at expiration for an investor who went long a 3 X 9 FRA with a notional principal of $10,000,000 where the 180-day LIBOR rate at expiration is 4.80 percent and the forward contract rate was set at 5.20 percent. A. –$588,235. B. –$19,531. C. $19,493.

  1. Agrawal Telecom is considering issuing $10,000,000 of 6.75% fixed-coupon bonds to finance an expansion. Alternatively, Agrawal could borrow the funds in the Eurodollar market using a series of six-month LIBOR contracts. A swap contract matching the maturity of the 6.75% coupon bonds is available. The swap uses six-month LIBOR as the floating-rate component. Identify the interest rate swap that Agrawal should use to convert the Eurodollar borrowing to the equivalent of issuing fixed-income bonds. A. Agrawal would use a pay-fixed, receive-floating interest rate swap. B. Agrawal would use a pay-floating, receive-fixed interest rate swap. C. Agrawal would use a total return equity payer swaption to evaluate the two borrowing options.
  2. Determine the upcoming payments on a swap with a notional principal of $5,000,000 in which the fixed-rate payer makes semiannual fixed payments of 8% and the counterparty makes floating-rate payments at Euribor. The Euribor rate at the last settlement period was 7.25%. The fixed-rate payments are made on the basis of 180 days in the settlement period and 365 days in a year. The floating-rate payments use a 180/360 day convention. A. The net payment is $16,010 from the fixed-rate payer to the floating-rate payer. B. The net payment is $18,750 from the fixed-rate payer to the floating-rate payer. C. The net payment is $18,750 from the floating-rate payer to the fixed-rate payer.
  3. A portfolio manager entered into a swap with a dealer. The swap's notional principal is $100 million, payments are to be made semiannually, and the swap allows netting of payments. The dealer agrees to pay a fixed annual rate of 4 percent while the asset manager agrees to pay the return on a stock index. The index value at initiation of the swap is 280. If the value of the stock index six months after initiation of the swap is 250, the payment from the dealer to the asset manager would be closest to: A. $2 million. B. $9 million. C. $13 million.

C. Determine the following: i. The maximum profit to the buyer (maximum loss to the seller). ii. The maximum loss to the buyer (maximum profit to the seller). D. Determine the breakeven price of the underlying at expiration.

  1. Suppose you believe that the price of a particular underlying, currently selling at $99, will decrease considerably in the next six months. You decide to purchase a put option expiring in six months on this underlying. The put option has an exercise price of $95 and sells for $5. A. Determine the profit for you under the following outcomes for the price of the underlying six months from now: i. $100. ii. $95. iii. $93. iv. $90. v. $85. B. Determine the breakeven price of the underlying at expiration. Check that your answer is consistent with the solution to Part A of this problem. C. i. What is the maximum profit that you can have? ii. At what expiration price of the underlying would this profit be realized?
  2. You simultaneously purchase an underlying priced at $77 and write a call option on it with an exercise price of $80 and selling at $6. A. What is the term commonly used for the position that you have taken? B. Determine the value at expiration and the profit for your strategy under the following outcomes: i. The price of the underlying at expiration is $70. ii. The price of the underlying at expiration is $75. iii. The price of the underlying at expiration is $80. iv. The price of the underlying at expiration is $85. C. Determine the following: i. The maximum profit. ii. The maximum loss. iii. The expiration price of the underlying at which you would realize the maximum profit. iv. The expiration price of the underlying at which you would incur the maximum loss. D. Determine the breakeven price at expiration.
  1. Suppose you simultaneously purchase an underlying priced at $71 and a put option on it, with an exercise price of $75 and selling at $3. A. What is the term commonly used for the position that you have taken? B. Determine the value at expiration and the profit for your strategy under the following outcomes: i. The price of the underlying at expiration is $70. ii. The price of the underlying at expiration is $75. iii. The price of the underlying at expiration is $80. iv. The price of the underlying at expiration is $85. v. The price of the underlying at expiration is $90. C. Determine the following: i. The maximum profit. ii. The maximum loss. iii. The expiration price of the underlying at which you would incur the maximum loss. D. Determine the breakeven price at expiration.
  2. The recent price per share of Dragon Vacations, Inc. is $50 per share. Calls with exactly six months left to expiration are available on Dragon with strikes of $45, $50, and $55. The prices of the calls are $8.75, $6.00, and $4.00, respectively. Assume that each call contract is for 100 shares of stock and that at initiation of the strategy the investor purchases 100 shares of Dragon at the current market price. Further assume that the investor will close out the strategy in six months when the options expire, including the sale of any stock not delivered against exercise of a call, whether the stock price goes up or goes down. If the closing price of Dragon stock in six months is exactly $60, the profit to a covered call using the $50 strike call is closest to: A. $400. B. $600. C. $1,600.
  3. The recent price per share of Win Big, Inc. is €50 per share. Verna Hillsborough buys 100 shares at €50. To protect against a fall in price, Hillsborough buys one put, covering 100 shares of Win Big, with a strike price of €40. The put premium is €1 per share. If Win Big closes at €45 per share at the expiration of the put and Hillsborough sells her shares at €45, Hillsborough's profit from the stay/put is closest to: A. —€1,100. B. —€600. C. €900.