Which of the following is the situation in which large portion of majority is borrowed from

broker of investor? (Marks: 1)

3.
Which of the following contracts involves future exchange of assets at a specified price?
(Marks: 1)
4.
Which of the following units guarantees that all buying and selling will be made by traders?
(Marks: 1)
5.
Which of the following is an example of derivative securities? (Marks: 0)

Standardized futures contracts exist for all of the following underlying assets except which of
the following?

Which of the following does the most to reduce default risk for futures contracts? Marking to
market

Using futures contracts to transfer price risk is known as which of the following? Hedging

Which of the following is best described as selling a synthetic asset and simultaneously
buying the actual asset? Arbitrage

1. If the US dollar weakens against the pound sterling, will UK exporters and importers
suffer or benefit?

UK exporters to US UK importers from US

A Benefit Benefit
B Suffer Suffer
C Benefit Suffer
D Suffer Benefit

2. Pechora Co is a German business that has purchased goods from a supplier, Kama Co,
which is based in the USA. Pechora Co has been invoiced in euros and payment is to be
made 30 days after the purchase. During this 30-day period, the euro strengthened
against the US$.

Assuming neither Pechora Co nor Kama Co hedge against currency risk, what would be
the currency gain or loss for each party as a result of this transaction?

Pechora Kama
A No gain or loss Gain
B Gain No gain or loss
C No gain or loss Loss
D Loss No gain or loss

1
3. Sirius plc is a UK business that has recently purchased machinery from a Bulgarian
exporter. The company has been invoiced in £ sterling and the terms of sale include
payment within sixty days. During this payment period, the £ sterling weakened against
the Bulgarian lev.

If neither Sirius plc nor the Bulgarian exporter hedge against foreign exchange risk,
what would be the foreign exchange gain or loss arising from this transaction for Sirius
plc and for the Bulgarian exporter?

Sirius plc Bulgarian exporter

A No gain or loss Gain
B Gain No gain or loss
C No gain or loss Loss
D Loss No gain or loss

4. The current euro / US dollar exchange rate is €1 : $2. ABC Co, a Eurozone company,
makes a $1,000 sale to a US customer on credit. By the time the customer pays, the
Euro has strengthened by 20%.

What will the Euro receipt be?

A €416.67
B €2,400
C €600
D €400

5. The current spot rate for the Dollar /Euro is $/€ 2.0000 +/- 0.003. The dollar is quoted at
a 0.2c premium for the forward rate.

What will a $2,000 receipt be translated to at the forward rate?

A €4,002
B €999.5
C €998
D €4,008

2
II. Types of Foreign Currency Risk

6. Exporters Co is concerned that the cash received from overseas sales will not be as
expected due to exchange rate movements.

What type of risk is this?

A Translation risk
B Economic risk
C Interest rate risk
D Transaction risk

7. ‘There is a risk that the value of our foreign currency-denominated assets and liabilities
will change when we prepare our accounts.’

To which risk does the above statement refer?

A Translation risk
B Economic risk
C Transaction risk
D Interest rate risk

8. The spot rate of exchange is £1 = $1·4400. Annual interest rates are 4% in the UK and
10% in the USA.

The three-month forward rate of exchange should be:

A £1 = $1·4616
B £1 = $1·5264
C £1 = $1·5231
D £1 = $1·4614.

9. The home currency of ACB Co is the dollar ($) and it trades with a company in a
foreign country whose home currency is the Dinar. The following information is
available:

Home country Foreign country

Spot rate 20.00 Dinar per $
Interest rate 3% per year 7% per year
Inflation rate 2% per year 5% per year

What is the six-month forward exchange rate?

A 20·39 Dinar per $

B 20·30 Dinar per $
C 20·59 Dinar per $
D 20·78 Dinar per $

10. The following exchange rates of £ sterling against the Singapore dollar have been
quoted in a financial newspaper:

Spot £1 = Singapore $2·3820

Three months’ forward £1 = Singapore $2·3540

3
 The interest rate in Singapore is 6% per year for a three-month deposit or borrowing.
What is the annual interest rate for a three-month deposit or borrowing in the UK?

A 2·71%
B 7·26%
C 8·71%
D 10·83%
11. Interest rate parity theory generally holds true in practice. However it suffers from
several limitations.

Which of the following is not a limitation of interest rate parity theory?

A Government controls on capital markets

B Controls on currency trading
C Intervention in foreign exchange markets
D Future inflation rates are only estimates

12. What does purchasing power parity refers to?

A A situation where two businesses have equal available funds to spend.

B Inflation in different locations is the same.
C Prices are the same to different customers in an economy.
D Exchange rate movements will absorb inflation differences.

13. What is the impact of a fall in a country’s exchange rate?

1 Exports will be given a stimulus

2 The rate of domestic inflation will rise

A 1 only
B 2 only
C Both 1 and 2
D Neither 1 nor 2

14. What is the purpose of hedging?

A To protect a profit already made from having undertaken a risky position

B To make a profit by accepting risk
C To reduce or eliminate exposure to risk
D To reduce costs.

15. What does the term ‘matching’ refer to?

A The coupling of two simple financial instruments to create a more complex one.
B The mechanism whereby a company balances its foreign currency inflows and
outflows.
C The adjustment of credit terms between companies
D Contracts not yet offset by futures contracts or fulfilled by delivery.

16. ABC plc has to pay a Germany supplier 90,000 euros in three months’ time. The
company’s finance director wishes to avoid exchange rate exposure, and is looking at
four options.

4
 1. Do nothing for three months and then buy euros at the spot rate
2. Pay in full now, buying euros at today’s spot rate
3. Buy euros now, put them on deposit for three months, and pay the debt with these
euro plus accumulated interest
4. Arrange a forward exchange contract to buy the euros in three months’ time

Which of these options would provide cover against the exchange rate exposure that
ABC plc would otherwise suffer?

A 4 only
B 3 and 4 only
C 2, 3 and 4 only
D 1, 2,3 and 4

17. Consider the following statements concerning currency risk:

1. Leading and lagging is a method of hedging transaction exposure.

2. Matching receipts and payments is a method of hedging translation exposure.

Which of the above statements is/are true?

Statement 1 Statement 2
A True True
B True False
C False True
D False False

18. A large multinational business wishes to manage its currency risk. It has been suggested
that:

1. Matching receipts and payments can be used to manage translation risk.

2. Matching assets and liabilities can be used to manage economic risk.

Which ONE of the following combinations (true/false) concerning the above statements
is correct?

Statement 1 Statement 2
A True True
B True False
C False True
D False False

19. A business uses each of the hedging methods described below to protect against a
particular type of foreign exchange risk:

Hedging method used Type of foreign exchange risk

1. Matching receipts and payments Transaction risk
2. Matching assets and liabilities Economic risk
3. Leading and lagging Translation risk

Which of the hedging methods described above are suitable for their intended purpose?

A 1 and 2
B 1 and 3
C 1, 2 and 3

5
 D 2 and 3

22. A business uses the hedging methods outlined below to protect itself against the
particular types of foreign exchange risk against which they are matched.

Hedging method Type of risk

Forward exchange contracts Transaction risk
Matching receipts and payments Economic risk
Buying or selling domestic currency Translation risk

Which one of the following combinations best describes the suitability of the three
hedging methods for their intended purpose?

Suitability of hedging method for the type of risk identified

Forward exchange Matching receipts and Buying or selling in
contracts payments domestic currency
A Yes No Yes
B Yes No No
C No Yes Yes
D No No Yes

23. Which is true of forward contracts?

1 They fix the rate for a future transaction.

2 They are a binding contract.
3 They are flexible once agreed.
4 They are traded openly.

A 1, 2 and 4 only
B 1, 2, 3 and 4
C 1 and 2 only
D 2 only

24. In comparison to forward contracts, which of the following are true in the relation to
futures contracts?

1 They are more expensive.

2 They are only available in a small amount of currencies.
3 They are less flexible.
4 They are probably an imprecise match for the underlying transaction.

A 1, 2 and 4 only
B 2 and 4 only
C 1 and 3 only
D 1, 2, 3 and 4

25. A UK company expects to receive €200,000 in three months’ time for goods sold to a
German customer and wishes to hedge the currency risk by taking out a forward
contract. The following rates have been quoted:

Spot rate 3 months forward

Euro per £ 1.4925 – 1.4985 1.4890 – 1.4897

If the forward contract is taken out, what are the sterling receipts for the UK company?

6
 A £133,467
B £134,003
C £134,255
D £134,318

26. Polaris plc, a UK-based business, has recently exported antique furniture to a US
customer and is due to be paid $500,000 in three months’ time. To hedge against foreign
exchange risk, Polaris plc has entered into a forward contract to sell $500,000 in three
months’ time. The relevant exchange rates are as follows:

Spot £1 = $1·5535 – 1·5595

Three months’ forward 0·30 – 0·25 cents premium

How much will Polaris plc receive in £ sterling at the end of three months?

A £321,130
B £321,234
C £322,373
D £322,477

27. Gydan plc, a UK business, is due to receive €500,000 in four months’ time for goods
supplied to a French customer. The company has decided to use a money market hedge
to manage currency risk. The following information concerning borrowing rates is
available:

Country Borrowing rate per annum

France 9%
UK 6%

The spot rate is £1 = €1·4490 – 1·4520

Using the money market approach, what is the £ sterling value of the amount that
Gydan Co will have to borrow now in order to match the receipt?

A £315,920
B £335,015
C £334,323
D £337,601

28. A UK based company, which has no surplus cash, is due to pay Euro 2,125,000 to a
company in Germany in three months time and wants to hedge the payment using
money markets.

The current spot rate is Euro 1·2230–1·2270 per £ sterling. The annual interest rates
available to the company in the UK and in Germany are as follows:

Country Borrow Lend

UK 5.72% 3.64%
Germany 4.52% 2.84%

What would it cost the company in UK£ if it hedges its Euro exposure?

A £1,786,190
B £1,780,367
C £1,749,953

7
 D £1,744,248

29. Which of the following is true?

A As the majority of futures contracts are never taken to delivery a futures contract
is not legally binding
B The quantity in a futures contract is agreed between the buyer and seller
C Delivery dates on futures contracts are specified by the futures exchange and not
by the buyer and seller
D The margin requirement is a purchase cost of a future.

30. Consider the following two statements:

1. One form of hedging is where an investor buys shares in one market and sells
them immediately in another to profit from price differences between the two
markets.
2. One form of financial derivative is a preference share of a business.

Which one of the following combinations relating to the above statements is correct?

Statement 1 Statement 2
A True True
B True False
C False True
D False False

31. Consider the following statements concerning derivatives.

1. Futures contracts may not be traded on an organised exchange

2. Forward contracts may be traded on an organised exchange

Which one of the following combinations (true/false) concerning the above statements
is correct?

Statement 1 Statement 2
A True True
B True False
C False True
D False False

32. Consider the following two statements concerning futures contracts.

1. A futures contract is negotiated between a buyer and seller and can be tailored to
the buyer’s particular requirements.
2. A futures contract can be traded on a futures exchange.

Which of the following combinations (true/false) is correct?

Statement 1 Statement 2
A True True
B True False
C False True
D False False

8
33. Consider the following statements concerning futures contracts.

1. Futures contracts are tailor-made for the needs of the client

2. Futures contracts can be traded on a futures exchange
3. A short position on a futures contract can be closed by buying an equal number of
the contracts for the same settlement date.
4. A long position on a futures contract can be closed by buying an equal number of
contracts for the same settlement date.

Which two of the above statements are correct?

A 1 and 3
B 1 and 4
C 2 and 3
D 2 and 4

34. Consider the following statements concerning financial options.

1. A European-style option gives the holder the right to exercise the option at any
time up to and including its expiry date.
2. An in-the-money option has a more favourable strike price for the option writer
than the current market price of the underlying item.

Which one of the following combinations (true/false) concerning the above statements
is correct?

Statement 1 Statement 2
A True True
B True False
C False True
D False False

35. Consider the following statements concerning options.

1. An out of-the-money call option has an intrinsic value of zero.

2. An American-style option can be exercised at any time up to, and including, the
expiry date.
Which one of the following combinations (true/false) relating to the above statements is
correct?

Statement 1 Statement 2
A True True
B True False
C False True
D False False

36. The following statements have been made concerning options.

1. An out-of-the-money option has an intrinsic value of zero.

2. An American-style option can only be exercised on the expiry date of the option.
3. When an option is used to hedge currency risk, the option will be exercised only if
the market price of the underlying item is less favourable than the option strike
price.
4. An employee share option is a form of put option.

Which TWO of the above statements are correct?

9
 A 1 and 2
B 1 and 3
C 2 and 4
D 3 and 4

37. Which of the following measures will allow a UK company to enjoy the benefits of a
favourable change in exchange rates for their euro receivables contract while protecting
them from unfavourable exchange rate movements?

A A forward exchange contract

B A put option for euros
C A call option for euros
D A money market hedge

38. The following European-style options are held at their expiry date by an investor:

1. A call option of 20,000 shares in Peterhouse plc with an exercise price of 860p.
The market price of the shares at the expiry date is 880p.
2. A put option of £600,000 in exchange for euros at a strike rate of £1 = €1·5. The
exchange rate at the expiry date is £1 = €1·45.

Which one of the above combinations (exercise/lapse) concerning the options should be
undertaken by the investor?

Option 1 Option 2
A Exercise Exercise
B Exercise Lapse
C Lapse Exercise
D Lapse Lapse

39. Musat plc holds the following OTC options at their expiry date:

1. A put option on dollars at an exchange rate of £1 = $1·92. The exchange rate is £1

= $1·95 at the expiry date of the option.
2. A call option on 5,000 ordinary shares in Spitzer plc at an exercise price of 575p.
The share price is 562p at the expiry date of the option.

Which of the above options should be exercised and which should be allowed to lapse
at their expiry date?

Put option Call option

A Exercise Exercise
B Lapse Exercise
C Exercise Lapse
D Lapse Lapse

40. A US company has just purchased goods from a UK supplier for £500,000. Payment is
due in three months’ time and the US company wishes to hedge its exposure to
exchange rate risk. The following ways of dealing with the exchange rate risk have been
suggested:

1. Buy sterling futures now and sell sterling futures in three months’ time
2. Buy sterling call options now.
3. Sell sterling futures now and buy sterling futures in three months’ time

10
 4. Buy sterling put options now

Which two of the above suggestions would provide a hedge against exchange rate risk?

A 1 and 2
B 1 and 3
C 2 and 3
D 3 and 4

41. A UK business expects to receive euros in five months’ time. Assume that the business
wishes to hedge against exchange rate risk.

Which one of the following methods should be employed?

A Take out a forward contract to sell euros in five months’ time

B Take out a forward contract to buy euros in five months’ time
C Buy euros now at the prevailing spot rate
D Take out a call option on euros.

42. A company based in Farland (with the Splot as its currency) is expecting its US
customer to pay $1,000,000 in 3 month’s time and wants to hedge this transaction using
currency options.

What is the option they require?

1 A Splot put option purchased in America

2 A US dollar put option purchased in Farland
3 A Splot call option purchased in America
4 A US dollar call option purchased in Farland.

A 2 or 3 only
B 2 only
C 1 or 4 only
D 4 only

43. A UK company has just provided a service to a US company for $750,000. Settlement is
due in two months’ time and the UK company wants to hedge the risk of a fall in the
value of the US dollar over the next two months. The following methods of hedging this
risk have been suggested:

1. Buy sterling put options now

2. Buy sterling futures now
3. Buy sterling call options now
4. Sell sterling futures now

Which two of the above suggestions would provide a hedge against the exchange rate
risk?

A 1 and 3
B 1 and 4
C 2 and 3
D 2 and 4

11
44. Wetterstein Inc, a US-based company, expects to receive €800,000 in two months’ time
for consultancy services provided to the Spanish government. It wishes to be certain of
the amount to be received and will use the derivatives market to achieve this.

Which one of the following actions should the company take NOW to hedge the risk?

A Buy euro futures

B Buy US dollar options
C Sell euro futures
D Sell US dollar futures

45. Three derivatives that may be used to manage financial risk are as follows:

1. Futures contracts
2. Forward contracts
3. Swaps

Which of the above may be traded on an organised exchange?

A 1 only
B 1 and 2
C 2 only
D 2 and 3

46. Consider the following statements concerning currency risk hedges:

1. A currency swap may be used to hedge for a longer period than that offered by
forward exchange contracts.
2. A futures contract can be customised to fit the particular needs of the client.

Which one of the following combinations (true/false) concerning the above statements
is correct?

Statement 1 Statement 2
A True True
B True False
C False True
D False False

1. Which is the best definition of basis risk?

A Interest rates on deposits and on loans are revised at different times.

B Interest rates on deposits and loans move by different amounts.
C Interest rates move.
D The bank base rate might move with a knock on effect to other interest rates.

2. If a business benefits from gap exposure what does this mean?

A The timing of interest rate movements on deposits and loans means it has made a
profit
B The timing of interest rate movements on deposits and loans means it has made a
loss
C The interest rates reduce between deciding a loan is needed and signing for that
loan.
D The inefficiencies between two markets means arbitrage gains are possible.

12
3. Which of the following explain the shape and movement of a yield curve?

1 Expectations theory
2 Liquidity preference theory
3 Market segmentation theory

A 1 and 2 only
B 2 and 3 only
C 1 and 3 only
D 1, 2 and 3 only

4. A yield curve shows

A the relationship between liquidity and bond interest rates

B the relationship between time to maturity and bond interest rates
C the relationship between risk and bond interest rates
D the relationship between bond interest rates and bond prices

5. Consider the following statements concerning forward rate agreements (FRAs):

1. FRAs cannot be tailored to the specific requirements of a customer.

2. FRAs are binding agreements that must be settled at the settlement date.
3. FRAs do not require any payments or receipts until the settlement date.
4. FRAs can be resold in the secondary market.

Which of the above statements are correct?

A 1 and 2
B 1, 2 and 4
C 2 and 3
D 2, 3 and 4

6. A company plans to take out a $50 million loan in six months’ time and wishes to fix
the interest rate for a 12-month period. The company wants to use a forward rate
agreement to hedge the interest rate risk and the following rates have been quoted by a
bank:

Bid % Offer %
6 v 12 5.65 5.60
6 v 18 5.70 5.64

LIBOR is 5·5% at the fixing date and the company can borrow at 45 basis points above
this figure.

What rate of interest will the company pay to, or receive from, the bank as a result of
the forward rate agreement?

A 0·15% paid to bank

B 0·20% paid to bank
C 0·25% received from bank
D 0·31% received from bank

13
7. Indus plc wishes to fix the interest rate for a six-month period on a £20 million loan that
it plans to take out in three months’ time. The company decides to use a forward rate
agreement (FRA) to hedge the interest rate risk and a bank quotes the following rates:

Bid Offer
3v6 6.60 6.56
3v9 6.65 6.61

The company can borrow at 60 basis points above LIBOR and, at the fixing date, the
relevant LIBOR is 6·4%.

What is the amount of interest (in percentage terms) that the company will pay to, or
receive from, the bank as a result of the forward rate agreement?

A 0·20% paid to bank

B 0·25% paid to bank
C 0·35% received from bank
D 0·39% received from bank

8. LIBOR rates are quoted as follows for FRAs.

2v5 3.37% – 3.32%

3v5 3.45% – 3.39%

A company can borrow at 65 basis points over LIBOR. In order to stabilise its finance
costs, it wants to fix the interest rate for a three-month borrowing starting in two
months’ time.

What is the effective rate of interest that the company will fix its loan?

A 4·10%
B 4·04%
C 4·02%
D 3·97%

9. Consider the following statements concerning financial options.

1 An interest rate cap is a series of lenders’ options on a notional loan.

2 An American-style option may be exercised before the expiry date of the option.

Which of the following combinations (true/false) concerning the above statements is

correct?

Statement 1 Statement 2
A True True
B True False
C False True
D False False

10. Consider the following statements concerning financial derivatives.

1. Interest rate swaps are a form of over-the-counter derivative.
2. A European-style option will give the right to buy or sell at any time up to and
including the expiry date.

14
 Which ONE of the following combinations (true/false) is correct?

Statement 1 Statement 2
A True True
B True False
C False True
D False False

11. In relation to hedging interest rate risk, which of the following statements is correct?

A The flexible nature of interest rate futures means that they can always be matched
with a specific interest rate exposure
B Interest rate options carry an obligation to the holder to complete the contract at
maturity
C Forward rate agreements are the interest rate equivalent of forward exchange
contracts
D Matching is where a balance is maintained between fixed rate and floating rate
debt

12. Which of the following is true of exchange traded interest rate options?

1 They maintain access to upside risk whilst limiting the downside to the premium.
2 They can be sold if not needed.
3 They are expensive.
4 They are tailored to an investor’s needs.

A 1 and 2 only
B 1 and 3 only
C 2, 3 and 4 only
D 1, 2 and 3 only

15
20. Consider the following hedging methods.

1. International diversification of operations

2. Matching receipts and payments
3. Leading and lagging
4. Forward exchange contracts

Which of the hedging methods above are suitable for hedging transaction exposure?

A 1 and 2
B 1, 2 and 3
C 2 and 3
D 2, 3 and 4

21. The following methods may be used to hedge currency risk:

1. International diversification of operations;

2. Currency swaps;
3. Leading and lagging;
4. Forward exchange contracts.

Which TWO of the above can be used to hedge currency risk arising from economic
exposure?

A 1 and 2
B 1 and 3
C 2 and 4
D 3 and 4

15-1. The process of protecting oneself against future price changes by shifting some or all of
the risk to someone else is called:

a. speculating
b. investing
c. hedging
d. gambling

15-2. People who bet on price changes in the hope of making a profit are called:

a. speculators
b. hedgers
c. investors
d. gamblers

15-3. Borrowing a security and selling it with the hope of buying it back later at a cheaper
price is called

a. leveraging.
b. short-selling.
c. investing.
d. gambling.
b.
c.
15-4. What is called the amount of cash put up by an investor, which is a fraction of the value

16
the asset?
a. Short position.
b. Long position.
c. Margin.
d. Fractional reserve.

15-5. An agreement to accept or make delivery of an asset on a particular future date at a

price struck today is called a

a. margin.
b. futures contract.
c. spot contract.
d. cash contract.

15-7. Which of the following is not common to both forward contracts and futures contracts?

a. Both deal in durable goods.

b. Both are used for hedging.
c. Both require estimates of the future by participants.
d. Both have the buyer taking future delivery of the assets in question.

15-8. An individual who expects that prices for some asset will rise is said to take a

a. long position
b. short position
c. 'worst case scenario'
d. the current spot position

15-9. The method whereby an investor assumes that futures and their spot prices move
together and then considers how to hedge depending on whether spot prices will move up or
down in the future is called

a. long position.
b. short position.
c. 'worst case scenario'.
d. the current spot position.

15-10. The differential between the spot price and the futures price is known as

a. the spread.
b. the basis.
c. the differential rate.
d. the Gap.

15-12. A Canadian importer has ordered $1,000,000 US worth of software to be delivered in

six months. The current spot exchange rate is $1.50 CAN = $1.00 US. However, the importer
fears that the Canadian dollar will depreciate to $1.55 CAN = $1.00 US in the next 6 months.
As a result, the importer purchases $1,000,000 US at today's prevailing six-month forward
rate of $1.52 CAN = $1.00 US. What is the savings to the importer from his dealings in the
forward market?

a. $30,000 US.

17
b. $30,000 CAN.
c. $50,000 CAN.
d. $20,000 CAN.

15-13. The person who takes a short position usually

a. sells an asset that he does not own with the intent of buying it back in the future at a
lower price.
b. buys an asset with the intent of selling it in the future at a higher price for profit.
c. owns the asset but sells it with the intent of buying it back at a higher price.
d. sells an asset that he does not own with the intent of buying it back in the future at a higher
price.

15-15. The right but not the obligation to buy an asset at a particular price during a stipulated
period is called a

a. Call option
b. Put option
c. Strike price
d. Long option

15-16. The right but not the obligation to sell an asset at a particular price during a stipulated
period is called a

a. Call option
b. Put option
c. Strike option
d. Long option

15-17. When an asset is selling at a strike price below its market price, it is said to be

a. in a long position.
b. selling at its exercise price.
c. in the money.
d. out of the money.

15-18. Suppose an investor buys an option for a $1000 premium on a $100,000 August T-bill
futures contract with a strike price of 120. On the expiration date, the T-bill futures contract
has a price of 115. (Recall that arbitrage will result in the spot price equalling the futures
contract price.) What is the individual likely to do?

a. He will buy the asset and make a profit of $5,000.

b. He will not buy the asset and thus suffer no loss.
c. He will buy the option but suffer a loss of $5,000.
d. He will not buy the option but he will suffer a loss of $1,000.

15-19. In question 15-18, what should be the price of the futures contract to make the
individual indifferent between buying the T-bill (exercising his option) and not exercising his
option?

a. 115
b. 120

18
c. 116
d. 125

15-21. Which of the following is not a factor of the Black-Scholes model of option pricing?

a. The volatility of an asset's price.

b. The interest rate on a riskless asset.
c. The exercise date.
d. The strike price.

15-22. The exchanges of interest rate payments or foreign currencies are called

a. swaps.
b. options.
c. futures.
d. forwards.

. In a forward contract the party who commits to sell an asset at a specified date in the future
takes a(n) position, and the party who commits to buy an asset at a specified date in the future
takes a(n) position.
(a) risk seeking; risk averse
(b) open; closed
(c) closed; open
(d) short; long
(e) long; short

An investment strategy that requires no outlay of an investor's own money to generate

positive riskless profits is:
(a) arbitrage
(b) risk seeking
(c) portfolio replicating
(d) beta adjusting
(e) minimum variance

4. An OTC forward contract is:

(a) an option to call
(b) a forward contract for which the payback is outside the contract period
(c) a customised agreement that is not traded on an exchange
(d) a standardised agreement that is traded on an exchange
(e) a forward contract in which the spot price of the asset at maturity is over the contract
forward price

A call option is in-the-money if the:

(a) strike price of the option is less than the current price of the underlying asset
(b) strike price of the option is greater than the current price of the underlying asset
(c) strike price of the option is equal to the price of the underlying asset
(d) intrinsic value of the option is zero
(e) settlement date is less than one month from the current date

Questions 21-25 refer to the following information.

Assume the current price of a stock is $43 and the volatility is 0.2. Assume the stock is not

19
expected to pay dividends during the next 6 months. Assume the risk-free interest rate is 10%
pa.

21. The Black-Scholes model suggests that the price of a 6 month European call option on the
stock where the exercise price of the option is $40 is:
(a) $6.29
(b) $5.56
(c) $4.83
(d) $3.72
(e) $1.86

22. What is the intrinsic value of the call option? What is its the time value?
(a) $4.00; $0.35
(b) $2.72; $1.00
(c) $3.00; $2.56
(d) $3.00; $3.29
(e) $0; $4.83

23. The probability that the call option expires in-the-money is approximately:
(a) 0.94
(b) 0.83
(c) 0.79
(d) 0.17
(e) 0.06

24. The Black-Scholes model suggests that the price of a 6 month European put option on the
stock where the exercise price of the option is $40 is:
(a) $0.61
(b) $0.78
(c) $0.84
(d) $1.34
(e) $2.63

25. The call option is , and the put option is :

(a) in-the-money; at-the-money
(b) out-of-the-money; in-the-money
(c) at-the-money; at-the-money
(d) in-the-money; out-of-the-money
(e) out-of-the-money; at-the-money

1. .............risk is a loss may occur from the failure of another party to perform
according to the terms of a contract? a)Credit b)Currency c)Market d)Liquidity

2.Financial derivatives includes? a)Stock b)Bonds c)Future d)None of these

3.By hedging a portfolio ; a bank manager a)Reduces interest rate riskb)Increases re

investment riskc)Increases exchange rate riskd)None of these

4.A long contract requires that the investora)Sell securities in thefutureb)Buy securities in the
futurec)Hedge in the futured)Close out his position in the future

5.The disadvantage of swaps is that theya)Lack of liquidityb)Suffer from default riskc)Both A

& Bd)B only

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6.Hedging by buying an optiona)Limitsgainb)Limitslossesc)Limitsgain & lossesd)Has no
limit on losses

7.All other things held constant premium on options will increase when thea)Exercise price
increasesb)Volatility of the underlying assets failsc)Term to maturity increasesd)Both B & C
An option allowing the owner tosell an asset at a future date is a ...............a)Put optionb)Call
optionc)Forward optiond)Future contract
9.Composite value of traded stocks group of secondary market is classified asa)Stock
indexb)Primary indexc)Stock market indexd)Limited liability index

10............... is theminimum amount which must be remained in a margin

accounta)Maintenance marginb)Variation marginc)Initial margind)None of these

11.The number of future contract outstanding is called

.............?a)Liquidityb)Floatc)Volumed)Turnover

12.The amount paid for an option is thea)Strike priceb)Discountc)Premiumd)Yield1

13.Futures contracts are more successful than interest rate forward contracts because they :
a)are less liquid
b)have greater default risk
c)are more liquid
d)have an interest rate tied to the discount rate

14.The payoffs for financial derivatives linked to

a) Securities that will be issued in the future
b) The volatality of interest rates
c) previously issued securities
d) none of the above.

15.Which of the following is not a problem with an interest rate forward contract?
a) Low interest rate
b) default risk
c) lack of liquidity
d) finding a counterparty

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1) The payoffs for financial derivatives are linked to (a) securities that will
be issued in the future. (b) the volatility of interest rates. (c) previously
issued securities. (d) government regulations specifying allowable rates of
return. (e) none of the above. Answer: C Question Status: New

2) Financial derivatives include

(a) stocks. (b) bonds. (c) futures. (d) none of the above.

3) Financial derivatives include (a) stocks. (b) bonds. (c) forward

contracts. (d) both (a) and (b) are true.

4) Which of the following is not a financial derivative? (a) Stock (b) Futures
(c) Options (d) Forward contracts

(5) By hedging a portfolio, a bank manager (a) reduces interest rate risk.
(b) increases reinvestment risk. (c) increases exchange rate risk. (d)
increases the probability of gains.

6) Which of the following is a reason to hedge a portfolio? (a) To increase

the probability of gains. (b) To limit exposure to risk. (c) To profit from
capital gains when interest rates fall. (d) All of the above. (e) Both (a) and
(c) of the above.

7) Hedging risk for a long position is accomplished by (a) taking another

long position. (b) taking a short position. (c) taking additional long and
short positions in equal amounts. (d) taking a neutral position. (e) none of
the above.

8) Hedging risk for a short position is accomplished by (a) taking a long

position. (b) taking another short position. (c) taking additional long and
short positions in equal amounts. (d) taking a neutral position. (e) none of
the above. Answer: A

9) A contract that requires the investor to buy securities on a future date is

called a (a) short contract. (b) long contract. (c) hedge. (d) cross.

10) A long contract 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.

11) A person who agrees to buy an asset at a future date has gone (a) long.
(b) short. (c) back. (d) ahead. (e) even.

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12) A short contract 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.

13) A contract that requires the investor to sell securities on a future date is
called a (a) short contract. (b) long contract. (c) hedge. (d) micro hedge.

14) If a bank manager chooses to hedge his portfolio of treasury securities

by selling futures contracts, he (a) gives up the opportunity for gains. (b)
removes the chance of loss. (c) increases the probability of a gain. (d) both
(a) and (b) are true.

15) To say that the forward market lacks liquidity means that (a) forward
contracts usually result in losses. (b) forward contracts cannot be turned into
cash. (c) it may be difficult to make the transaction. (d) forward contracts
cannot be sold for cash. (e) none of the above. Answer: C

16) A disadvantage of a forward contract is that (a) it may be difficult to

locate a counterparty. (b) the forward market suffers from lack of liquidity.
(c) these contracts have default risk. (d) all of the above. (e) both (a) and (c)
of the above. Answer: D

17) Forward contracts are risky because they (a) are subject to lack of
liquidity (b) are subject to default risk. (c) hedge a portfolio. (d) both (a) and
(b) are true. Answer: D

18) The advantage of forward contracts over future contracts is that they (a)
are standardized. (b) have lower default risk. (c) are more liquid. (d) none of
the above. Answer: D

19) The advantage of forward contracts over futures contracts is that they (a)
are standardized. (b) have lower default risk. (c) are more flexible. (d) both
(a) and (b) are true. Answer: C

20) Forward contracts are of limited usefulness to financial institutions

because (a) of default risk. (b) it is impossible to hedge risk. (c) of lack of
liquidity. (d) all of the above. (e) both (a) and (c) of the above.

22) Hedging in the futures market (a) eliminates the opportunity for gains.
(b) eliminates the opportunity for losses. (c) increases the earnings potential
of the portfolio. (d) does all of the above. (e) does both (a) and (b) of the
above.

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23) When interest rates fall, a bank that perfectly hedges its portfolio of
Treasury securities in the futures market (a) suffers a loss. (b) experiences a
gain. (c) has no change in its income. (d) none of the above. Answer: C
Question Status: Study Guide

24) Futures markets have grown rapidly because futures (a) are
standardized. (b) have lower default risk. (c) are liquid. (d) all of the above.

30) On the expiration date of a futures contract, the price of the contract (a)
always equals the purchase price of the contract. (b) always equals the
average price over the life of the contract. (c) always equals the price of
the underlying asset. (d) always equals the average of the purchase price
and the price of underlying asset. (e) cannot be determined.

31) The price of a futures contract at the expiration date of the contract (a)
equals the price of the underlying asset. (b) equals the price of the
counterparty. (c) equals the hedge position. (d) equals the value of the
hedged asset. (e) none of the above. Guide

32) Elimination of riskless profit opportunities in the futures market is (a)

hedging. (b) arbitrage. (c) speculation. (d) underwriting. (e) diversification.
Answer: B Question Status: New 33) If you purchase a $100,000 interest-
rate futures contract for 110, and the price of the Treasury securities on the
expiration date is 106 (a) your profit is $4000. (b) your loss is $4000. (c)
your profit is $6000. (d) your loss is $6000. (e) your profit is $10,000.

34) If you purchase a $100,000 interest-rate futures contract for 105, and the
price of the Treasury securities on the expiration date is 108 (a) your profit
is $3000. (b) your loss is $3000. (c) your profit is $8000. (d) your loss is
$8000. (e) your profit is $5000. Answer: A

35) If you sell a $100,000 interest-rate futures contract for 110, and the price
of the Treasury securities on the expiration date is 106 (a) your profit is
$4000. (b) your loss is $4000. (c) your profit is $6000. (d) your loss is
$6000. (e) your profit is $10,000. Answer: A

36) If you sell a $100,000 interest-rate futures contract for 105, and the price
of the Treasury securities on the expiration date is 108 (a) your profit is
$3000. (b) your loss is $3000. (c) your profit is $8000. (d) your loss is
$8000. (e) your profit is $5000. Answer: B

37) If you sold a short contract on financial futures you hope interest rates
(a) rise. (b) fall. (c) are stable. (d) fluctuate. Answer: A

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38) If you sold a short futures contract you will hope that interest rates (a)
rise. (b) fall. (c) are stable. (d) fluctuate. Answer: A

39) 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 Question

40) If you bought a long futures contract you hope that bond prices (a) rise.
(b) fall. (c) are stable. (d) fluctuate. Answer: A

41) If you sold a short futures contract you will hope that bond prices (a)
rise. (b) fall. (c) are stable. (d) fluctuate. Answer: B

42) To hedge the interest rate risk on $4 million of Treasury bonds with
$100,000 futures contracts, you would need to purchase (a) 4 contracts. (b)
20 contracts. (c) 25 contracts. (d) 40 contracts. (e) 400 contracts. Answer: D

43) If you sell twenty-five $100,000 futures contracts to hedge holdings of a

Treasury security, the value of the Treasury securities you are holding is (a)
$250,000. (b) $1,000,000. (c) $2,500,000. (d) $5,000,000. (e) $25,000,000.

44) Assume you are holding Treasury securities and have sold futures to
hedge against interest rate risk. If interest rates rise (a) the increase in the
value of the securities equals the decrease in the value of the futures
contracts. (b) the decrease in the value of the securities equals the
increase in the value of the futures contracts. (c) the increase ion the
value of the securities exceeds the decrease in the values of the futures
contracts. (d) both the securities and the futures contracts increase in value.
(e) both the securities and the futures contracts decrease in value

45) Assume you are holding Treasury securities and have sold futures to
hedge against interest rate risk. If interest rates fall (a) the increase in the
value of the securities equals the decrease in the value of the futures
contracts. (b) the decrease in the value of the securities equals the increase
in the value of the futures contracts. (c) the increase in the value of the
securities exceeds the decrease in the values of the futures contracts. (d)
both the securities and the futures contracts increase in value. (e) both the
securities and the futures contracts decrease in value. Answer: A

46) 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

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47) 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

48) The number of futures contracts outstanding is called (a) liquidity. (b)
volume. (c) float. (d) open interest. (e) turnover. Answer: D

49) 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

50. 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

51) 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) a standardized contract.

52) 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) marked to market daily.

53) The advantage of futures contracts relative to forward contracts is that

futures contracts (a) are standardized, making it easier to match parties,
thereby increasing liquidity. (b) specify that more than one bond is eligible
for delivery, making it harder for someone to corner the market and squeeze
traders. (c) cannot be traded prior to the delivery date, thereby increasing
market liquidity. (d) all of the above. (e) both (a) and (b) of the above.

54) If a firm is due to be paid in deutsche marks 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) none of the above. Answer: A

55) 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) none of the above. Answer: B

56) If a firm is due to be paid in deutsche marks in two months, to hedge

against exchange rate risk the firm should _____ foreign exchange futures
_____. (a) sell; short (b) buy; long (c) sell; long (d) buy; short Answer: A

26
57) If a firm must pay for goods it has ordered with foreign currency, it can
hedge its foreign exchange rate risk by _____ foreign exchange futures
_____. (a) selling; short (b) buying; long (c) buying; short (d) selling; long
Answer: B

58) 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

59) The price specified on an option that the holder can buy or sell the
underlying asset is called the (a) premium. (b) call. (c) strike price. (d) put.
Answer: C

60) The price specified on an option that the holder can buy or sell the
underlying asset is called the (a) premium. (b) strike price. (c) exercise
price. (d) both (b) and (c) are true. Answer: D

61) 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

62) The seller of an option is ______ to buy or sell the underlying asset
while the purchaser of an option has the ______ to buy or sell the asset. (a)
obligated; right (b) right; obligation (c) obligated; obligation (d) right; right
Answer: A

63) The amount paid for an option is the (a) strike price. (b) premium. (c)
discount. (d) commission. (e) yield. Answer: B

64) 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

65) An option that can only be exercised at maturity is called a(n) (a) swap.
(b) stock option. (c) European option. (d) American option. Answer: C

66) Options on individual stocks are referred to as (a) stock options. (b)
futures options. (c) American options. (d) individual options. Answer: A

67) Options on futures contracts are referred to as (a) stock options. (b)
futures options. (c) American options. (d) individual options. Answer: B

27
68) 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 (a) call option. (b)
put option. (c) American option. (d) European option. Answer: A

69) 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

70) 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

71) An option allowing the holder to buy an asset in the future is a (a) put
option. (b) call option. (c) swap. (d) premium. (e) forward contract. Answer:
B

72) An option that gives the owner the right to sell a financial instrument at
the exercise price within a specified period of time is a (a) call option. (b)
put option. (c) American option. (d) European option. Answer: B Question
Status: Previous Edition

73) 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

74) 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

75) An option allowing the owner to sell an asset at a future date is a (a) put
option. (b) call option. (c) swap. (d) forward contract. (e) futures contract.
Answer: A

76) If you buy a call option on treasury 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

77) If you buy a call option on treasury futures at 110, and at expiration the
market price is 115, (a) the call will be exercised. (b) the put will be

28
exercised. (c) the call will not be exercised. (d) the put will not be exercised.
Answer: A

78) If you buy a put option on treasury 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

79) If you buy a put option on treasury 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

80) If, for a $1000 premium, you buy a $100,000 call option on bond futures
with a strike price of 110, and at the expiration date the price is 114 (a) your
profit is $4000. (b) your loss is $4000. (c) your profit is $3000. (d) your
loss is $3000. (e) your loss is $1000.

81) If, for a $1000 premium, you buy a $100,000 call option on bond futures
with a strike price of 114, and at the expiration date the price is 110 (a) your
profit is $4000. (b) your loss is $4000. (c) your profit is $3000. (d) your loss
is $3000. (e) your loss is $1000. Answer: E

82) If, for a $1000 premium, you buy a $100,000 put option on bond futures
with a strike price of 110, and at the expiration date the price is 114 (a) your
profit is $4000. (b) your loss is $4000. (c) your profit is $3000. (d) your loss
is $3000. (e) your loss is $1000

83) If, for a $1000 premium, you buy a $100,000 put option on bond futures
with a strike price of 114, and at the expiration date the price is 110 (a) your
profit is $4000. (b) your loss is $4000. (c) your profit is $3000. (d) your
loss is $3000. (e) your loss is $1000.

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