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Economics of Money, Banking, and Financial Markets 6e (Mishkin)

Chapter 13 Risk Management with Financial Derivatives

13.1 Hedging

1) Financial derivatives include ________.


A) stocks
B) bonds
C) futures
D) foreign exchange
Answer: C
Diff: 1 Type: MC
Skill: Recall
Objective: 13.1 Define a hedge, a long position, and a short position

2) Financial derivatives include ________.


A) stocks
B) bonds
C) forward contracts
D) foreign exchange
Answer: C
Diff: 1 Type: MC
Skill: Recall
Objective: 13.1 Define a hedge, a long position, and a short position

3) A contract that requires the investor to buy securities on a future date is called a ________.
A) short position
B) long position
C) hedge
D) cross
Answer: B
Diff: 1 Type: MC
Skill: Recall
Objective: 13.1 Define a hedge, a long position, and a short position

4) A contract that requires the investor to sell securities on a future date is called a ________.
A) short position
B) long position
C) hedge
D) micro hedge
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 13.1 Define a hedge, a long position, and a short position

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5) A long position requires that the investor ________.
A) sell securities in the future
B) buy securities in the future
C) hedge in the future
D) close out his position in the future
Answer: B
Diff: 1 Type: MC
Skill: Recall
Objective: 13.1 Define a hedge, a long position, and a short position

6) A short position requires that the investor ________.


A) sell securities in the future
B) buy securities in the future
C) hedge in the future
D) close out his position in the future
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 13.1 Define a hedge, a long position, and a short position

7) Explain the terms hedge, long position and short position in the context of managing
financial institutions' risk.
Answer: Hedging is the act of engaging in a financial transaction that reduces or eliminates
risk. When a financial institution has bought an asset, it is said to have taken a long position,
and this exposes the institution to risk if the returns on the asset are uncertain. On the other
hand, if it has sold an asset that it has agreed to deliver to another party at a future date, it is
said to have taken a short position and this can also expose the institution to risk.
Diff: 1 Type: ES
Skill: Recall
Objective: 13.1 Define a hedge, a long position, and a short position

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13.2 Forward Contracts and Markets

1) Forward contracts do not suffer from the problem of ________.


A) a lack of liquidity
B) a lack of flexibility
C) the difficulty of finding a counterparty
D) default risk
Answer: B
Diff: 1 Type: MC
Skill: Recall
Objective: 13.2 Define a forward contract and summarize its advantages and disadvantages

2) What are the pros and cons of forward contracts?


Answer: The advantage of forward contracts is that they can be as flexible as the parties
involved want them to be. This means that an institution may be able to hedge completely the
interest-rate risk for the exact security it is holding in its portfolio.
There are two disadvantages of forward contracts. First, it may be very hard for an institution to
find another party which is called counterparty to make the contract with. The second problem
with forward contracts is that they are subject to default risk. The presence of default risk in
forward contracts means that parties to these contracts must check each other out to be sure that
the counterparty is both financially sound and likely to be honest and live up to its contractual
obligations.
Diff: 2 Type: ES
Skill: Recall
Objective: 13.2 Define a forward contract and summarize its advantages and disadvantages

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13.3 Financial Futures Contracts and Markets

1) Futures contracts are regularly traded on the ________.


A) Montreal Exchange
B) Toronto Stock Exchange
C) American Stock Exchange
D) Chicago Board of Options Exchange
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

2) If you buy in March a bond future contract for 115 that matures on June 30 of the same year,
and at the maturity date the same future sells for 110, you have a ________ of $________.
A) loss; 5000
B) loss; 5
C) profit; 5000
D) profit; 5
Answer: A
Diff: 2 Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

3) If you buy in February a bond future contract for 120 that matures on June 30 of the same
year, and at the maturity date the same future sells for 110, you have a ________ of
$________.
A) loss; 10000
B) loss; 10
C) profit; 10000
D) profit; 10
Answer: A
Diff: 2 Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

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4) If you buy in March a bond future contract for 97 that matures on June 30 of the same year,
and at the maturity date the same future sells for 93, you have a ________ of $________.
A) loss; 4000
B) loss; 4
C) profit; 4000
D) profit; 4
Answer: A
Diff: 2 Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

5) If you buy in February a bond future contract for 125 that matures on June 30 of the same
year, and at the maturity date the same future sells for 105, you have a ________ of
$________.
A) loss; 20000
B) loss; 20
C) profit; 20000
D) profit; 20
Answer: A
Diff: 2 Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

6) If you buy in March a bond future contract for 125 that matures on June 30 of the same year,
and at the maturity date the same future sells for 135, you have a ________ of $________.
A) loss; 10000
B) loss; 10
C) profit; 10000
D) profit; 10
Answer: C
Diff: 2 Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

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7) If you buy in March a bond future contract for 110 that matures on June 30 of the same year,
and at the maturity date the same future sells for 125, you have a ________ of $________.
A) loss; 15000
B) loss; 15
C) profit; 15000
D) profit; 15
Answer: C
Diff: 2 Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

8) If you buy in March a bond future contract for 150 that matures on June 30 of the same year,
and on the maturity date the same future sells for 170, you have a ________ of $________.
A) loss; 20000
B) loss; 20
C) profit; 20000
D) profit; 20
Answer: C
Diff: 2 Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

9) If you sell in March a bond future contract for 115 that matures on June 30 of the same year,
and at the maturity date the same future sells for 110, you have a ________ of $________.
A) loss; 5000
B) loss; 5
C) profit; 5000
D) profit; 5
Answer: C
Diff: 2 Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

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10) If you sell in February a bond future contract for 120 that matures on June 30 of the same
year, and at the maturity date the same future sells for 110, you have a ________ of
$________.
A) loss; 10000
B) loss; 10
C) profit; 10000
D) profit; 10
Answer: C
Diff: 2 Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

11) If you sell in March a bond future contract for 97 that matures on June 30 of the same year,
and at the maturity date the same future sells for 93, you have a ________ of $________.
A) loss; 4000
B) loss; 4
C) profit; 4000
D) profit; 4
Answer: C
Diff: 2 Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

12) If you sell in February a bond future contract for 125 that matures on June 30 of the same
year, and at the maturity date the same future sells for 105, you have a ________ of
$________.
A) loss; 20000
B) loss; 20
C) profit; 20000
D) profit; 20
Answer: C
Diff: 2 Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

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13) If you sell in March a bond future contract for 125 that matures on June 30 of the same
year, and at the maturity date the same future sells for 135, you have a ________ of
$________.
A) loss; 10000
B) loss; 10
C) profit; 10000
D) profit; 10
Answer: A
Diff: 2 Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

14) If you sell in March a bond future contract for 110 that matures on June 30 of the same
year, and at the maturity date the same future sells for 125, you have a ________ of
$________.
A) loss; 15000
B) loss; 15
C) profit; 15000
D) profit; 15
Answer: A
Diff: 2 Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

15) If you sell in March a bond future contract for 150 that matures on June 30 of the same
year, and on the maturity date the same future sells for 170, you have a ________ of
$________.
A) loss; 20000
B) loss; 20
C) profit; 20000
D) profit; 20
Answer: A
Diff: 2 Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

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16) By selling short a futures contract of $100,000 at a price of 115, you are agreeing to deliver
________.
A) $100,000 face value securities for $115,000
B) $115,000 face value securities for $110,000
C) $100,000 face value securities for $100,000
D) $115,000 face value securities for $115,000
Answer: A
Diff: 1 Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

17) By selling short a futures contract of $100,000 at a price of 96, you are agreeing to deliver
________.
A) $100,000 face value securities for $104,167
B) $96000 face value securities for $100,000
C) $100,000 face value securities for $96000
D) 100,000 face value securities for $100,000
Answer: C
Diff: 1 Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

18) By buying a long $100,000 futures contract for 115, you agree to pay ________.
A) $100,000 for $115,000 face value bonds
B) $115,000 for $100,000 face value bonds
C) $86956 for $100,000 face value bonds
D) $86956 for $115,000 face value bonds
Answer: B
Diff: 1 Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

19) If you sold a short contract on financial futures, you hope interest rates ________.
A) rise
B) fall
C) are stable
D) fluctuate
Answer: A
Diff: 1 Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

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20) If you bought a long contract on financial futures, you hope that interest rates ________.

A) rise
B) fall
C) are stable
D) fluctuate
Answer: B
Diff: 1 Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

21) If you sold a short futures contract, you will hope that bond prices ________.
A) rise
B) fall
C) are stable
D) fluctuate
Answer: B
Diff: 1 Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

22) The elimination of riskless profit opportunities in the futures market is referred to as
________.
A) speculation
B) hedging
C) arbitrage
D) open interest
Answer: C
Diff: 1 Type: MC
Skill: Recall
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

23) When a financial institution hedges the interest-rate risk for a specific asset, the hedge is
called a ________.
A) macro hedge
B) micro hedge
C) cross hedge
D) futures hedge
Answer: B
Diff: 2 Type: MC
Skill: Recall
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

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24) When the financial institution is hedging interest-rate risk on its overall portfolio, then the
hedge is a ________.
A) macro hedge
B) micro hedge
C) cross hedge
D) futures hedge
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

25) The number of contracts outstanding in a particular financial future is the ________.
A) demand coefficient
B) open interest
C) index level
D) outstanding balance
Answer: B
Diff: 1 Type: MC
Skill: Recall
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

26) The advantage of forward contracts over futures contracts is that forward contracts
________.
A) are standardized
B) have lower default risk
C) are more flexible
D) have higher default risk
Answer: C
Diff: 1 Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

27) Futures markets have grown rapidly because futures ________.


A) are standardized
B) have higher default risk
C) are illiquid
D) are more flexible
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

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28) Futures differ from forwards because they are ________.
A) used to hedge portfolios
B) used to hedge individual securities
C) used in both financial and foreign exchange markets
D) standardized contracts
Answer: D
Diff: 2 Type: MC
Skill: Recall
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

29) Futures differ from forwards because they are ________.


A) used to hedge portfolios
B) used to hedge individual securities
C) used in both financial and foreign exchange markets
D) traded on an exchange
Answer: D
Diff: 2 Type: MC
Skill: Recall
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

30) Which of the following features of futures contracts were not designed to increase
liquidity?
A) Standardized contracts
B) Traded up until maturity
C) Not tied to one specific type of bond
D) Marked to market daily
Answer: D
Diff: 3 Type: MC
Skill: Recall
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

31) Which of the following features of futures contracts were not designed to increase
liquidity?
A) Standardized contracts
B) Traded up until maturity
C) Not tied to one specific type of bond
D) Can be closed with off setting trade
Answer: D
Diff: 3 Type: MC
Skill: Recall
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

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32) If a firm is due to be paid in euros in two months, to hedge against exchange rate risk the
firm should ________.
A) sell foreign exchange futures short
B) buy foreign exchange futures long
C) stay out of the exchange futures market
D) buy foreign exchange forward contracts long
Answer: A
Diff: 2 Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

33) If a firm must pay for goods it has ordered with foreign currency, it can hedge its foreign
exchange rate risk by ________.
A) selling foreign exchange futures short
B) buying foreign exchange futures long
C) staying out of the exchange futures market
D) selling foreign exchange forward contracts short
Answer: B
Diff: 2 Type: MC
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

34) What is an interest-rate futures contract? How does it differ from an interest-rate forward
contract?
Answer: An interest-rate futures contract is similar to an interest-rate forward contract in that it
specifies that a financial instrument must be delivered by one party to another on a stated future
date. However it differs from an interest-rate forward contract in several ways that overcome
some of the liquidity and default problems of forward contracts.
Diff: 1 Type: ES
Skill: Recall
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

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35) Explain using an example the statement that "at the expiration date of a futures contract, the
price of the contract is the same as the price of the underlying asset to be delivered."
Answer: Consider what happens on the expiration date of a June contract at the end of June
when the price of the underlying $100,000 face value Canadian bond is 110 ($110,000). If the
futures contract sells bellow 110, say at 109, a trader can buy the contract for $109,000 and
take delivery of the bond and immediately sell it for $110,000, thereby earning a quick profit of
$1000. That means that everyone will try to buy the contract and this will drive its price up to
110. If the price is 111 instead everyone will try to sell the contract at $111,000 and buy it from
the market to deliver at $110,000. Thus everyone will try to sell and this will drive the price
down to 110.
Diff: 3 Type: ES
Skill: Applied
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

36) Where are financial futures traded? Describe that market.


Answer: Financial futures contracts are traded on organized exchanges such as the Chicago
Board of Trade, the Chicago Mercantile Exchange, the Montreal Exchange, the London
International Financial Futures Exchange etc. These futures exchanges are highly competitive
with one another, and each organization tries to design contracts and set rules that will increase
the amount of futures trading on its exchange. The exchanges are also regulated to ensure that
prices in the market are not manipulated.
Diff: 1 Type: ES
Skill: Recall
Objective: 13.3 Summarize the differences between a forward contract and a financial futures
contract

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13.4 Stock Index Futures

1) If you buy in April a stock index future contract on the S&P 500 index at the price of 1000
points that matures on June 30 of the same year and on the maturity date the S&P 500 Index is
at 900, you have a ________ of $________.
A) loss; 25000
B) loss; 100
C) profit; 25000
D) profit; 100
Answer: A
Diff: 2 Type: MC
Skill: Applied
Objective: 13.4 Define and explain a stock index future

2) If you buy in April a stock index future contract on the S&P 500 index at the price of 800
points that matures on June 30 of the same year and on the maturity date the S&P 500 Index is
at 795, you have a ________ of $________.
A) loss; 1250
B) loss; 5
C) profit; 1250
D) profit; 5
Answer: A
Diff: 2 Type: MC
Skill: Applied
Objective: 13.4 Define and explain a stock index future

3) If you buy in April a stock index future contract on the S&P 500 index at the price of 1200
points that matures on June 30 of the same year and on the maturity date the S&P 500 Index is
at 1000, you have a ________ of $________.
A) loss; 50000
B) loss; 200
C) profit; 50000
D) profit; 200
Answer: A
Diff: 2 Type: MC
Skill: Applied
Objective: 13.4 Define and explain a stock index future

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4) If you buy in April a stock index future contract on the S&P 500 index at the price of 1050
points that matures on June 30 of the same year and on the maturity date the S&P 500 Index is
at 1047, you have a ________ of $________.
A) loss; 750
B) loss; 3
C) profit; 750
D) profit; 3
Answer: A
Diff: 2 Type: MC
Skill: Applied
Objective: 13.4 Define and explain a stock index future

5) If you sell in April a stock index future contract on the S&P 500 index at the price of 1000
points that matures on June 30 of the same year and on the maturity date the S&P 500 Index is
at 900, you have a ________ of $________.
A) loss; 25000
B) loss; 100
C) profit; 25000
D) profit; 100
Answer: C
Diff: 2 Type: MC
Skill: Applied
Objective: 13.4 Define and explain a stock index future

6) If you sell in April a stock index future contract on the S&P 500 index at the price of 800
points that matures on June 30 of the same year and on the maturity date the S&P 500 Index is
at 795, you have a ________ of $________.
A) loss; 1250
B) loss; 5
C) profit; 1250
D) profit; 5
Answer: C
Diff: 2 Type: MC
Skill: Applied
Objective: 13.4 Define and explain a stock index future

7) If you sell in April a stock index future contract on the S&P 500 index at the price of 1200
points that matures on June 30 of the same year and on the maturity date the S&P 500 Index is
at 1000, you have a ________ of $________.
A) loss; 50000
B) loss; 200
C) profit; 50000
D) profit; 200
Answer: C
Diff: 2 Type: MC
Skill: Applied
Objective: 13.4 Define and explain a stock index future
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8) If you sell in April a stock index future contract on the S&P 500 index at the price of 1050
points that matures on June 30 of the same year and on the maturity date the S&P 500 Index is
at 1047, you have a ________ of $________.
A) loss; 750
B) loss; 3
C) profit; 750
D) profit; 3
Answer: C
Diff: 2 Type: MC
Skill: Applied
Objective: 13.4 Define and explain a stock index future

9) The risk that occurs because stock prices fluctuate is called ________.
A) stock market risk
B) reinvestment risk
C) interest rate risk
D) default risk
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 13.4 Define and explain a stock index future

10) Who would be most likely to buy a long stock index future?
A) A mutual fund manager who believes the market will rise
B) A mutual fund manager who believes the market will fall
C) A mutual fund manager who believes the market will be stable
D) A mutual fund manager who does not believe in hedging
Answer: A
Diff: 2 Type: MC
Skill: Applied
Objective: 13.4 Define and explain a stock index future

11) If you buy a futures contract on the S&P 500 Index at a price of 450 and the index rises to
500, you will ________.
A) lose $12500
B) gain $12500
C) lose $50
D) gain $50
Answer: B
Diff: 2 Type: MC
Skill: Applied
Objective: 13.4 Define and explain a stock index future

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12) if you sell a futures contract on the S&P 500 Index at a price of 450 and the index rises to
500, you will ________.
A) lose $12500
B) gain $12500
C) lose $50
D) gain $50
Answer: A
Diff: 2 Type: MC
Skill: Applied
Objective: 13.4 Define and explain a stock index future

13) Which of the following is a likely reason for a money market fund manager to sell a stock
index future short?
A) He believes the market will rise.
B) He wants to lock in current prices.
C) He wants to increase stock market risk.
D) He believes the market will be unchanged.
Answer: D
Diff: 2 Type: MC
Skill: Applied
Objective: 13.4 Define and explain a stock index future

14) If a money manager believes stock prices will fall and knows that a block of funds will be
received in the future, then he should ________.
A) sell stock index futures short
B) buy stock index futures long
C) stay out of the futures market
D) borrow and buy securities now
Answer: A
Diff: 3 Type: MC
Skill: Applied
Objective: 13.4 Define and explain a stock index future

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13.5 Options

1) Options are contracts that give the purchasers the ________.


A) option to buy or sell an underlying asset
B) the obligation to buy or sell an underlying asset
C) the right to hold an underlying asset
D) the right to switch payment streams
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

2) The price specified in an option contract at which the holder can buy or sell the underlying
asset is called the ________.
A) premium
B) call
C) strike price
D) put
Answer: C
Diff: 1 Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

3) The price specified in an option contract at which the holder can buy or sell the underlying
asset is called the ________.
A) premium
B) interest rate
C) exercise price
D) call
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

4) The seller of an option has the ________.


A) right to buy or sell the underlying asset
B) the obligation to buy or sell the underlying asset
C) ability to reduce transaction risk
D) right to exchange one payment stream for another
Answer: B
Diff: 2 Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
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5) The seller of an option has the ________ to buy or sell the underlying asset, while the
purchaser of an option has the ________ to buy or sell the asset.
A) obligation; right
B) right; obligation
C) obligation; obligation
D) right; right
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

6) An option that can be exercised at any time up to maturity is called a(n) ________.
A) swap
B) stock option
C) European option
D) American option
Answer: D
Diff: 2 Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

7) An option that can be exercised only at maturity is called a(n) ________.


A) swap
B) stock option
C) European option
D) American option
Answer: C
Diff: 2 Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

8) Options on individual stocks are referred to as ________.


A) stock options
B) futures options
C) American options
D) individual options
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

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9) Options on futures contracts are referred to as ________.
A) stock options
B) futures options
C) American options
D) individual options
Answer: B
Diff: 2 Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

10) An option that gives the owner the right to buy a financial instrument at the exercise price
within a specified period of time is a(n) ________.
A) call option
B) put option
C) American option
D) European option
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

11) A call option gives the owner ________.


A) the right to sell the underlying security
B) the obligation to sell the underlying security
C) the right to buy the underlying security
D) the obligation to buy the underlying security
Answer: C
Diff: 2 Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

12) A call option gives the seller ________.


A) the right to sell the underlying security
B) the obligation to sell the underlying security
C) the right to buy the underlying security
D) the obligation to buy the underlying security
Answer: B
Diff: 2 Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

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13) A put option gives the owner ________.
A) the right to sell the underlying security
B) the obligation to sell the underlying security
C) the right to buy the underlying security
D) the obligation to buy the underlying security
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

14) A put option gives the seller ________.


A) the right to sell the underlying security
B) the obligation to sell the underlying security
C) the right to buy the underlying security
D) the obligation to buy the underlying security
Answer: D
Diff: 2 Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

15) The main disadvantage of futures contracts as compared to options on futures contracts is
that futures ________.
A) remove the possibility of gains
B) increase the transactions cost
C) are not as effective a hedge
D) do not remove the possibility of losses
Answer: A
Diff: 3 Type: MC
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

16) All other things held constant, premiums on put options will increase when the ________.
A) exercise price falls
B) volatility of the underlying asset falls
C) term to maturity increases
D) term to maturity decreases
Answer: C
Diff: 3 Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

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Copyright 2017 Pearson Canada, Inc.
17) An option that gives the owner the tight to sell a financial instrument at the exercise price
within a specified period of time is a(n) ________.
A) call option
B) put option
C) American option
D) European option
Answer: B
Diff: 2 Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

18) If a bank manager wants to protect the bank against losses that would be incurred on its
portfolio of treasury securities should interest rates rise, he could ________.
A) buy put options on financial futures
B) buy call options on financial futures
C) sell put options on financial futures
D) sell call options on financial futures
Answer: A
Diff: 2 Type: MC
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

19) If you buy a European call option on Canada bonds with a strike price of 115 assuming that
the premium is $0, and on the maturity date the market price of Canada bonds is 110, you will
________ the option and potentially make a profit of $________.
A) not exercise; 5000
B) not exercise; 5
C) exercise; 5000
D) exercise; 5
Answer: A
Diff: 3 Type: MC
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

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Copyright 2017 Pearson Canada, Inc.
20) If you buy a European call option on Canada bonds with a strike price of 120 assuming that
the premium is $0, and on the maturity date the market price of Canada bonds is 117, you will
________ the option and potentially make a profit of $________.
A) not exercise; 3000
B) not exercise; 3
C) exercise; 3000
D) exercise; 3
Answer: A
Diff: 3 Type: MC
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

21) If you buy a European call option on Canada bonds with a strike price of 110 assuming that
the premium is $0, and on the maturity date the market price of Canada bonds is 103, you will
________ the option and potentially make a profit of $________.
A) not exercise; 7000
B) not exercise; 7
C) exercise; 7000
D) exercise; 7
Answer: A
Diff: 3 Type: MC
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

22) If you buy a European call option on Canada bonds with a strike price of 115 assuming that
the premium is $0, and on the maturity date the market price of Canada bonds is 120, you will
________ the option in order to make a profit of $________.
A) not exercise; 5000
B) not exercise; 5
C) exercise; 5000
D) exercise; 5
Answer: C
Diff: 3 Type: MC
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

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Copyright 2017 Pearson Canada, Inc.
23) If you buy a European call option on Canada bonds with a strike price of 120 assuming that
the premium is $0, and on the maturity date the market price of Canada bonds is 123, you will
________ the option in order to make a profit of $________.
A) not exercise; 3000
B) not exercise; 3
C) exercise; 3000
D) exercise; 3
Answer: C
Diff: 3 Type: MC
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

24) If you buy a European call option on Canada bonds with a strike price of 110 assuming that
the premium is $0, and on the maturity date the market price of Canada bonds is 117, you will
________ the option in order to make a profit of $________.
A) not exercise; 7000
B) not exercise; 7
C) exercise; 7000
D) exercise; 7
Answer: C
Diff: 3 Type: MC
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

25) If you buy an option to buy Canada futures at 115, and at expiration the market price is 110,
________.
A) the call will be exercised
B) the put will be exercised
C) the call will not be exercised
D) the put will not be exercised
Answer: C
Diff: 3 Type: MC
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

25
Copyright 2017 Pearson Canada, Inc.
26) if you buy an option to sell Canada futures at 115, and at expiration the market price is 110,
________.
A) the call will be exercised
B) the put will be exercised
C) the call will not be exercised
D) the put will not be exercised
Answer: B
Diff: 3 Type: MC
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

27) if you buy an option to buy Canada futures at 110, and at expiration the market price is 115,
________.
A) the call will be exercised
B) the put will be exercised
C) the call will not be exercised
D) the put will not be exercised
Answer: A
Diff: 3 Type: MC
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

28) If you buy an option to sell Canada futures at 110, and at expiration the market price is 115,
________.
A) the call will be exercised
B) the put will be exercised
C) the call will not be exercised
D) the put will not be exercised
Answer: D
Diff: 3 Type: MC
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

29) The main advantage of using options on futures contracts rather than the futures contracts
themselves is that ________.
A) interest rate risk is controlled while preserving the possibility of gains
B) interest rate risk is controlled, while removing the possibility of losses
C) interest rate risk is not controlled, but the possibility of gains is preserved
D) interest rate risk is not controlled, but the possibility of gains is lost
Answer: A
Diff: 3 Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
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30) The main reason to buy an option on a futures contract rather than buying the futures
contract is ________.
A) to reduce transaction cost
B) to preserve the possibility for gains
C) to limit losses
D) to remove the possibility for gains
Answer: B
Diff: 3 Type: MC
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

31) All other things held constant, premiums on call options will increase when the ________.
A) exercise price falls
B) volatility of the underlying asset falls
C) term to maturity decreases
D) futures price increases
Answer: A
Diff: 3 Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

32) An increase in the volatility of the underlying asset, all other things held constant, will
________ the option premium.
A) increase
B) decrease
C) increase or decrease
D) Not enough information is given.
Answer: A
Diff: 3 Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

33) An increase in the exercise price, all other things held constant, will ________ the premium
on call options.
A) increase
B) decrease
C) increase or decrease
D) Not enough information is given.
Answer: B
Diff: 3 Type: MC
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options
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Copyright 2017 Pearson Canada, Inc.
34) What are options? What are their differences from futures contracts?
Answer: Options are contracts that give the purchaser the option, or right, to buy or sell the
underlying asset at a specified price, called the exercise price or strike price, within a specific
time period called the term to expiration. The seller, sometimes called the writer, of the option
is obligated to buy or sell the asset to the purchaser if the owner of the option exercises the right
to sell or buy. Because the right to buy or sell an asset at a specified price has value, the owner
of an option is willing to pay an amount for it called premium. There are two types of option
contracts: American options can be exercised at any time up to the expiration date of the
contract, and European options can be exercised only on the expiration date.
Diff: 2 Type: ES
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

35) Why have options on financial futures become the most widely traded option contracts?
Answer: Option contracts are more likely to be written on financial futures than on underlying
financial instruments such as bonds. As we know, at the expiration date, the price of the futures
contract and of the deliverable debt instrument will be the same because of arbitrage. So it
would seem that investors would be indifferent about having the option written on the asset or
on the futures contract. However, financial futures contracts have been so well designed that
their markets are often more liquid than the markets in the underlying assets. Investors would
rather have the option written on the more liquid instrument, in this case the futures contract.
Diff: 3 Type: ES
Skill: Recall
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

36) What is the value of a call option at expiration? Use an appropriate graph to show the profit
and loses of the buyer and seller of a call option.
Answer: The value of a call option at expiration, or intrinsic value is given by: C = max (0, S -
X). The net profit for the buyer is equal to C - . Students must use a graph similar to Figure
13-1 on page 325 of the text to explain the profit and loses of the buyer and the seller of a call
option.
Diff: 3 Type: ES
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

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Copyright 2017 Pearson Canada, Inc.
37) What is the value of a put option at expiration? Use an appropriate graph to show the profit
and loses of the buyer and seller of a put option.
Answer: The value of a put option at expiration, or intrinsic value is given by: P = max (X - S,
0). The net profit for the buyer is equal to P - . Students must use a graph similar to Figure 13-
2 on page 326 of the text to explain the profit and loses of the buyer and the seller of a put
option.
Diff: 3 Type: ES
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

38) Use an appropriate graph to show the profits and losses for the buyer of a call option and
the buyer of a futures contract, when the price of the future and the exercise price of the option
is 115 and the premium is equal to $2000.
Answer: Students should use a graph similar to Figure 13-3 on page 328 of the text and show
the profit and loss of from the options and futures contract bought at 115.
Diff: 3 Type: ES
Skill: Applied
Objective: 13.5 Identify the different types of options contracts, and summarize the three
conclusions regarding call and put options

13.6 Swaps

1) A financial contract that obligates one party to exchange a set of payments it owns for
another set of payments owned by another party is called a ________.
A) cross hedge
B) cross call option
C) cross put option
D) swap
Answer: D
Diff: 1 Type: MC
Skill: Recall
Objective: 13.6 Define a swap-and summarize the advantages and disadvantages of interest-rate
swaps

2) A swap that involves the exchange of a set of payments in one currency for a set of payments
in another currency is a(n) ________.
A) interest rate swap
B) currency swap
C) swaption
D) national swap
Answer: B
Diff: 1 Type: MC
Skill: Recall
Objective: 13.6 Define a swap-and summarize the advantages and disadvantages of interest-rate
swaps

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3) A swap that involves the exchange of one set of interest payments for another set of interest
payments is called a(n) ________.
A) interest rate swap
B) currency swap
C) swaption
D) national swap
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 13.6 Define a swap-and summarize the advantages and disadvantages of interest-rate
swaps

4) If Second Bank has more rate-sensitive assets than rate sensitive liabilities, it can reduce
interest rate risk with a swap which requires Second Bank to ________.
A) pay a fixed rate while receiving a floating rate
B) receive a fixed rate while paying a floating rate
C) both receive and pay a fixed rate
D) both receive and pay a floating rate
Answer: B
Diff: 3 Type: MC
Skill: Applied
Objective: 13.6 Define a swap-and summarize the advantages and disadvantages of interest-rate
swaps

5) If Second Bank has more rate-sensitive liabilities then rate-sensitive assets, it can reduce
interest rate risk with a swap which requires Second Bank to ________.
A) pay a fixed rate while receiving a floating rate
B) receive a fixed rate while paying a floating rate
C) both receive and pay a fixed rate
D) both receive and pay a floating rate
Answer: A
Diff: 2 Type: MC
Skill: Applied
Objective: 13.6 Define a swap-and summarize the advantages and disadvantages of interest-rate
swaps

6) If a bank has a gap of -$10 million, it can reduce its interest rate risk by ________.
A) paying a fixed rate on $10 million and receiving a floating rate on $10 million
B) paying a floating rate on $10 million and receiving a fixed rate on $10 million
C) selling $20 million fixed rate assets
D) buying $20 million fixed rate assets
Answer: A
Diff: 2 Type: MC
Skill: Applied
Objective: 13.6 Define a swap-and summarize the advantages and disadvantages of interest-rate
swaps

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7) One advantage of using swaps to eliminate interest-rate risk is that swaps ________.
A) are less costly than futures
B) are less costly than rearranging balance sheets
C) are more liquid than futures
D) have better accounting treatment than options
Answer: B
Diff: 2 Type: MC
Skill: Recall
Objective: 13.6 Define a swap-and summarize the advantages and disadvantages of interest-rate
swaps

8) The disadvantage of swaps is that ________.


A) they lack liquidity
B) it is easy to arrange for a counterparty
C) they do not have default risk
D) they are costly
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: 13.6 Define a swap-and summarize the advantages and disadvantages of interest-rate
swaps

9) As compared to a default on the notional principle, a default on a swap ________.


A) is more costly
B) is about as costly
C) is less costly
D) may cost more or less than default on the notional principle
Answer: C
Diff: 2 Type: MC
Skill: Recall
Objective: 13.6 Define a swap-and summarize the advantages and disadvantages of interest-rate
swaps

10) Intermediaries are active in the swap markets because ________.


A) they increase liquidity
B) they increase default risk
C) they increase search cost
D) they do not need counterparties
Answer: A
Diff: 2 Type: MC
Skill: Recall
Objective: 13.6 Define a swap-and summarize the advantages and disadvantages of interest-rate
swaps

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Copyright 2017 Pearson Canada, Inc.
13.7 Credit Derivatives

1) ________ derivatives offer payoffs on previously issued securities, but ones that bear credit
risk.
A) Credit
B) Bond
C) Note
D) Stock
Answer: A
Diff: 1 Type: MC
Skill: Recall
Objective: 13.7 Summarize the three types of credit derivatives

2) Credit options are contracts where the purchaser gains the right to receive profits that are tied
to ________.
A) the obligation to buy or sell an underlying asset
B) the price of an underlying security or to an interest rate
C) the right to hold an underlying asset
D) the right to switch payment streams
Answer: B
Diff: 1 Type: MC
Skill: Recall
Objective: 13.7 Summarize the three types of credit derivatives

3) Which credit derivative is a combination of a bond and a credit option?


A) A bond-linked note
B) A linked note
C) A credit-linked note
D) None of the above
Answer: C
Diff: 1 Type: MC
Skill: Recall
Objective: 13.7 Summarize the three types of credit derivatives

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Copyright 2017 Pearson Canada, Inc.