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231-0106

231-0106

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Question Paper
Financial Risk Management-I (231)\u2013January 2006
Section A : Basic Concepts (30 Marks)
\u2022 \u2022
This section consists of questions with serial number 1 - 30.
\u2022 \u2022
Answer all questions.
\u2022 \u2022
Each question carries one mark.
\u2022 Maximum time for answering Section A is 30 Minutes.
1.
As per FASB 133, the accounting treatment accorded to a Foreign currency hedge is that

(a) The changes are included in current income
(b) The changes are included in current net income
(c) The changes are included in other comprehensive income
(d) The changes are included in comprehensive net income
(e) The changes are included in earnings.

< Answer
>
2.

Zydus Ltd. stock is priced at Rs.30 with a standard deviation of 30%. The risk-free rate is 5%. There are put and call options available at exercise prices of Rs.30 and a time to expiration of six months. The call is priced at Rs.2.89 and the put costs Rs.2.15. There are no dividends on the stock and the options are European. An investor constructed a covered call. What is the breakeven stock price at expiration?

(a) Rs.27.11
(b) Rs.29.89
(c) Rs.30.00
(d) Rs.32.89
(e) Rs.35.66.
< Answer
>
3.
Consider two put options differing only by exercise price. The one with the higher exercise price has

(a) The lower breakeven and lower profit potential
(b) The lower breakeven and greater profit potential
(c) The higher breakeven and greater profit potential
(d) The higher breakeven and lower profit potential
(e) The greater premium and lower profit potential.

< Answer
>
4.
Which of the following statements istrue about closing a long call position prior to expiration relative
to holding it to expiration?

(a) The profit is greater at all stock prices
(b) The profit is greater only at low stock prices
(c) The profit is greater only at high stock prices
(d) The range of possible profits is greater
(e) Profit is lower at all stock prices.

< Answer
>
5.
Early exercise imposes a risk to all but one of the following transactions.
(a) A short call
(b) A short put
(c) A protective put
(d) An uncovered call
(e) A covered call.
< Answer
>
6.
Which of the following participant of derivative market perform a valuable economic function by
feeding information and analysis into the derivative markets?
(a) Arbitrageurs
(b) Financial institutions
(c) Speculators
(d) Banks
(e) Hedgers.
< Answer
>
7.

Ignoring transactions costs, whether the futures price is at a discount or premium to the spot price, equilibrium non-arbitrage conditions imply that at the futures delivery date the futures price and the spot price will be equal. This result is referred to as the

< Answer
>
(a) Convergence principle
(b) Delivery parity
(c) Expected futures price
(d) Futures contract settlement
(e) Arbitrage pricing.
8.
Which of the following statements ist rue about the purchase of a protective put at a higher exercise
price relative to a lower exercise price?

(a) The breakeven is lower
(b) The maximum loss is greater
(c) The insurance is less costly
(d) The insurance is more costly
(e) The put option with lower exercise price is more valuable.

< Answer
>
9.
Which of the following statements is/aret rue regarding Coffee Future Exchange India Limited
(COFEI)?
I.
It aims at providing a hedging opportunity against price risk to all those within and outside coffee

industry.
II. COFEI permits trading in twelve contracts simultaneously covering 24 months forward.
III. The clearing house is an entity separate from COFEI.

(a) Only (I) above
(b) Only (II) above
(c) Only (III) above
(d) Both (I) and (III) above
(e) Both (II) and (III) above.
< Answer
>
10.What will be the optimal stock index futures hedge ratio if the portfolio is worth $2,400,000, the beta is
1.15 and the S&P 500 futures price is 450.70 with a multiplier of 500.
(a) 10.65
(b) 12.25
(c) 15.84
(d) 6123.80
(e) 5325.05.
< Answer
>
11.Though a cross currency hedge has somewhat higher risk than an ordinary hedge, it will reduce risk if
which of the following occurs?

(a) Futures prices are more volatile than spot prices
(b) The spot and futures contracts are correctly priced at the onset
(c) Spot and futures prices are positively correlated
(d) Futures prices are less volatile than spot prices
(e) Spot and future prices are negatively correlated.

< Answer
>
12.If you buy 100 shares of TTK at Rs.79, and simultaneously write a MAR 80straddle for Rs.6. The
break-even point will be
(a) Rs.76.5
(b) Rs.78
(c) Rs.79.5
(d) Rs.80.5
(e) Rs.85.
< Answer
>
13.If an investor buys a bullish vertical spread consisting of one July call of 270 with a premium of Rs.62
and a July call of 350 with a premium of Rs.12, what will be his profit or loss if spot price at expiration
is Rs.325?
(a) Rs. 5
(b) \u2013 Rs. 5
(c) \u2013 Rs. 20
(d) Rs. 20
(e) Rs.25.
< Answer
>
14.Which of the following statements is false?

(a) Minimum value of an American call option is either zero or, S0 \u2013 X
(b) Maximum value of an American call option can be the value of underlying asset (S0)
(c) If two American call options have same exercise price, the option with longer maturity date will be

worth less than the other option with shorter maturity.
(d) An American call option can never be worth less than a European call option
(e) The price difference between two American puts cannot exceed the difference in exercise prices.

< Answer
>
15.According to put-call parity, writing a put is similar to

(a) Buying a call, buying stock and lending
(b) Writing a call, buying stock and borrowing
(c) Writing a call, buying stock and lending

< Answer
>
(d) Writing a call, selling stock and borrowing
(e) Buying a call, selling stock and lending.
16.Which of the following statements is/are true?
I.
Black \u2013 Scholes model of option \u2013 pricing assumes that volatility of the underlying instrument is
constant over the entire life of the option but is continuously compounded.
II. The price prediction under Black \u2013 Scholes model focuses both the magnitude and direction of
changes.
III. According to the smile effect volatility of options deeply in the money is less than for those at the
money.
(a) Only (I) above
(b) Only (II) above
(c) Both (I) and (III) above
(d) Both (II) and (III) above
(e) Both (I) and (II) above.
< Answer
>
17.Which of the following is true about a callable swap?

(a) The fixed rate receiver has the right to terminate the swap at any time before its maturity
(b) The fixed rate payer has the right to extend the swap beyond maturity
(c) The fixed rate payer has the right to terminate the swap at any time before its maturity
(d) Both fixed rate payer and receiver have right to terminate the swap at any time before its maturity
(e) Both fixed rate payer and receiver have right to extend the swap beyond maturity.

< Answer
>
18.A swap quote for US dollar interest rate swap fixed vs. LIBOR is 10 \u2013 30 basis points over 3-year US
T-bills. This quote can be interpreted as

(a) The bid rate is 30 basis points over yields on the US Treasury Bills versus LIBOR (b) The bid rate is 20 basis points over yields on the US Treasury Bills versus LIBOR (c) The bid rate is 10 basis points over yields on the US Treasury Bills versus LIBOR (d) The ask rate is 10 basis points over yields on the US Treasury Bills versus LIBOR (e) The ask rate is 20 basis points over yields on the US Treasury Bills versus LIBOR.

< Answer
>
19.Which of the following statements is/are not true?
I.

Collectively, swap facilitators are known as \u2018Swap Banks\u2019.
II. Swap brokers share the gain from a swap arrangement.
III. Swap dealers bear the financial risk associated with a swap deal.

(a) Only (I) above
(d) Both (I) and (II) above
(b) Only (II) above
(e) Both (II) and (III) above.
(c) Only (III) above
< Answer
>
20.Assume that there are two firms X and Y in need of $100 million and \u00a350 million respectively. They can
borrow these currencies at the following interest rates:
Firms
Dollars
Sterling
Firm X
10.5%
11.8%
Firm Y
8.5%
12.5%
The quality spread differential is
(a) 0.7
(b) 1.3
(c) 2.0
(d) 2.7
(e) 3.8.
< Answer
>
21.Which of the following is not true?

(a) Delta of a call option is always positive or zero
(b) Delta of a put option is always negative or zero
(c) Rho is a measure of the sensitivity of option value to changes in spot prices
(d) Gamma is the rate of change of the delta to the price of the underlying stock
(e) Vega of all options declines as the expiration date approaches.

< Answer
>
22.A portfolio has a gamma of \u20132700. The delta and gamma of a call option are 0.65 and 0.90 respectively.
The position in call option that could lead to gamma neutral portfolio is
< Answer
>

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