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Hull: Options, Futures, and other Derivatives, Ninth Edition

Chapter 21: Basic Numerical Procedures


Multiple Choice Test Bank: Questions
1. How many nodes are there at the end of a Cox-Ross-Rubinstein five-step
binomial tree?
A. 4
B. 5
C. 6
D. 7
2. Which of the following cannot be estimated from a single binomial tree?
A. delta
B. gamma
C. theta
D. vega
3. Which of the following is true for u in a Cox-Ross-Rubinstein binomial tree?
A. It depends on the interest rate and the volatility
B. It depends on the volatility but not the interest rate
C. It depends on the interest rate but not the volatility
D. It depends on neither the interest rate nor the volatility
4. How many different paths are there through a Cox-Ross-Rubinstein tree with
four-steps?
A. 5
B. 9
C. 12
D. 16
5. When we move from assuming no dividends to assuming a constant dividend
yield, which of the following is true for a Cox, Ross, Rubinstein tree?
A. The parameters u and p change
B. p changes but u does not
C. u changes but p does not
D. Neither p nor u changes
6. When the stock price is 20 and the present value of dividends is 2, which of
the following is the recommended way of constructing a tree?
A. Draw a tree for an initial stock price of 20 and subtract the present
value of future dividends at each node
B. Draw a tree for an initial stock price of 22 and subtract the present
value of future dividends at each node
C. Draw a tree with an initial stock price of 18 and add the present value
of future dividends at each node
D. Draw a tree with an initial stock price of 18 and add 2 at each node

7. What is the recommended way of making interest rates a function of time in

a Cox, Ross, Rubinstein tree?


A. Make u a function of time
B. Make p a function of time
C. Make u and p a function of time
D. Make the lengths of the time steps unequal
8. What is the recommended way of making volatility a function of time in a
Cox, Ross, Rubinstein tree?
A. Make u a function of time
B. Make p a function of time
C. Make u and p a function of time
D. Make the lengths of the time steps unequal
9. A binomial tree prices an American option at $3.12 and the corresponding
European option at $3.04. The Black-Scholes price of the European option is
$2.98. What is the control variate price of the American option?
A. $3.06
B. $3.18
C. $2.90
D. $3.08
10.The chapter discusses an alternative to the Cox, Ross, Rubinstein tree. In this
alternative, which of the following are true:
A. The relationship between u and d is: u=1/d
B. The relationship between u and d is: u-1=1-d
C. The probabilities on the tree are all 0.5
D. None of the above
11.Which of the following cannot be valued by Monte Carlo simulation
A. European options
B. American options
C. Asian options (i.e., options on the average stock price)
D. An option which provides a payoff of $100 if the stock price is greater
than the strike price at maturity
12.Which of the following is true?
A. The implicit finite difference method relates prices at one node to three
prices at nodes at a later time
B. The implicit finite difference method relates prices at one node to three
prices at nodes at an earlier time
C. The implicit finite difference method relates prices at one node to three
prices at nodes at the same time
D. None of the above

13.Which of the following is true?


A. The implicit finite difference method is equivalent to using a trinomial
tree

B. The explicit finite difference method is equivalent to using a trinomial


tree
C. Both methods are equivalent to using a trinomial tree
D. Neither method is equivalent to using a trinomial tree
14.The standard deviation of the values of an option calculated using 10,000
Monte Carlo trials is 4.5. The average of the values is 20. What is the
standard error of this as an estimate of the option price?
A. 4.5
B. 0.45
C. 0.045
D. 0.0045
15.The values of a stock price at the end of the second time step are $80, $100,
$125. The corresponding values of an option are $0, $5, and $20 respectively.
What is an estimate of gamma?
A. 0.136
B. 0.146
C. 0.156
D. 0.166
16.What is the difference between valuing an American and a European option
using a tree?
A. The value of u is higher for American options
B. The value of u is lower for American options
C. The time steps for American options are not equal
D. It is necessary to do two calculations at nodes where the option is in
the money
17.A European option on a stock with a known dollar dividend is valued by
setting the stock price variable equal to the stock price minus the present
value of the dividend in the Black-Scholes-Merton formula. A second price can
be obtained using the tree building procedure in the chapter. Which of the
following is true when a very large number of time steps are used in the tree?
A. The first price is higher than the second price
B. The first price is lower than the second price
C. The first price is sometimes higher and sometimes lower than the
second price
D. The two prices are almost exactly the same
18.Which of the following is possible in a modified Cox, Ross, Rubinstein binomial
tree?
A. The interest rate and volatility can both be functions of time
B. The interest rate or the volatility can be a function of time, but not
both
C. The interest rate can be a function of time but the volatility cannot
D. The interest rate and volatility must be constant

19.Which of the following describes the way that the parameters in a binomial
tree are chosen?
A. The expected return during each time step is the risk-free rate
B. The standard deviation of the return in each time step is, for small time
steps, almost exactly equal to the volatility per annum times the
square root of the length of the time step in years
C. The tree recombines
D. All of the above
20.Which of the following can be valued without using a numerical procedure
such as a binomial tree?
A. American put options on a non-dividend paying stock
B. American call options on a non-dividend paying tock
C. American call options on a currency
D. American put options on futures