MC CH4

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Hull: Op(ons, Futures, and Other Deriva(ves, Ninth Edi(on, Global Edi(on
Chapter 1: Introduc(on
Mul(ple Choice Test Bank: Ques(ons with Answers
1. A one-year forward contract is an agreement where

A. One side has the right to buy an asset for a certain price in one year’s ;me.
B. One side has the obliga;on to buy an asset for a certain price in one year’s ;me.
C. One side has the obliga;on to buy an asset for a certain price at some ;me during the
next year.
D. One side has the obliga;on to buy an asset for the market price in one year’s ;me.
Answer: B
A one-year forward contract is an obliga;on to buy or sell in one year’s ;me for a
predetermined price. By contrast, an op;on is the right to buy or sell.
2. Which of the following is NOT true

A. When a CBOE call op;on on IBM is exercised, IBM issues more stock
B. An American op;on can be exercised at any ;me during its life
C. An call op;on will always be exercised at maturity if the underlying asset price is greater
than the strike price
D. A put op;on will always be exercised at maturity if the strike price is greater than the
underlying asset price.
Answer: A
When an IBM call op;on is exercised the op;on seller must buy shares in the market to sell to
the op;on buyer. IBM is not involved in any way. Answers B, C, and D are true.
3. A one-year call op;on on a stock with a strike price of $30 costs $3; a one-year put op;on on the
stock with a strike price of $30 costs $4. Suppose that a trader buys two call op;ons and one put
op;on. The breakeven stock price above which the trader makes a proRt is
A. $35
B. $40
C. $30
D. $36
Answer: A
When the stock price is $35, the two call op;ons provide a payoU of 2×(35−30) or $10. The put
op;on provides no payoU. The total cost of the op;ons is 2×3+ 4 or $10. The stock price in A,
$35, is therefore the breakeven stock price above which the posi;on is proRtable because it is
the price for which the cost of the op;ons equals the payoU.
4. A one-year call op;on on a stock with a strike price of $30 costs $3; a one-year put op;on on the
stock with a strike price of $30 costs $4. Suppose that a trader buys two call op;ons and one put
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op;on. The breakeven stock price below which the trader makes a proRt is
A. $25
B. $28
C. $26
D. $20
Answer: D
When the stock price is $20 the two call op;ons provide no payoU. The put op;on provides a
payoU of 30−20 or $10. The total cost of the op;ons is 2×3+ 4 or $10. The stock price in D, $20,
is therefore the breakeven stock price below which the posi;on is proRtable because it is the
price for which the cost of the op;ons equals the payoU.
5. Which of the following is approximately true when size is measured in terms of the underlying
principal amounts or value of the underlying assets
A. The exchange-traded market is twice as big as the over-the-counter market.
B. The over-the-counter market is twice as big as the exchange-traded market.
C. The exchange-traded market is ten ;mes as big as the over-the-counter market.
D. The over-the-counter market is ten ;mes as big as the exchange-traded market.
Answer: D
The OTC market is about $600 trillion whereas the exchange-traded market is about $60 trillion.
6. Which of the following best describes the term “spot price”

A. The price for immediate delivery
B. The price for delivery at a future ;me
C. The price of an asset that has been damaged
D. The price of ren;ng an asset
Answer: A
The spot price is the price for immediate delivery. The futures or forward price is the price for
delivery in the future
7. Which of the following is true about a long forward contract

A. The contract becomes more valuable as the price of the asset declines
B. The contract becomes more valuable as the price of the asset rises
C. The contract is worth zero if the price of the asset declines aaer the contract has been
entered into
D. The contract is worth zero if the price of the asset rises aaer the contract has been
entered into
Answer: B

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A long forward contract is an agreement to buy the asset at a predetermined price. The contract
becomes more abrac;ve as the market price of the asset rises. The contract is only worth zero
when the predetermined price in the forward contract equals the current forward price (as it
usually does at the beginning of the contract).
8. An investor sells a futures contract an asset when the futures price is $1,500. Each contract is on
100 units of the asset. The contract is closed out when the futures price is $1,540. Which of the
following is true
A. The investor has made a gain of $4,000
B. The investor has made a loss of $4,000
C. The investor has made a gain of $2,000
D. The investor has made a loss of $2,000
Answer: B
An investor who buys (has a long posi;on) has a gain when a futures price increases. An investor
who sells (has a short posi;on) has a loss when a futures price increases.
9. Which of the following describes European op;ons?

A. Sold in Europe
B. Priced in Euros
C. Exercisable only at maturity
D. Calls (there are no European puts)
Answer: C
European op;ons can be exercised only at maturity. This is in contrast to American op;ons
which can be exercised at any ;me. The term “European” has nothing to do with geographical
loca;on, currencies, or whether the op;on is a call or a put.

A. A call op;on gives the holder the right to buy an asset by a certain date for a certain
price
B. A put op;on gives the holder the right to sell an asset by a certain date for a certain
price
C. The holder of a call or put op;on must exercise the right to sell or buy an asset
D. The holder of a forward contract is obligated to buy or sell an asset
Answer: C
The holder of a call or put op;on has the right to exercise the op;on but is not required to do
so. A, B, and C are correct
11. Which of the following is NOT true about call and put op;ons:
A. An American op;on can be exercised at any ;me during its life

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B. A European op;on can only be exercised only on the maturity date

C. Investors must pay an upfront price (the op;on premium) for an op;on contract
D. The price of a call op;on increases as the strike price increases
Answer: D
A call op;on is the op;on to buy for the strike price. As the strike price increases this op;on
becomes less abrac;ve and is therefore less valuable. A, B, and C are true.
12. The price of a stock on July 1 is $57. A trader buys 100 call op;ons on the stock with a strike
price of $60 when the op;on price is $2. The op;ons are exercised when the stock price is $65.
The trader’s net proRt is
A. $700
B. $500
C. $300
D. $600
Answer: C
The payoU from the op;ons is 100×(65-60) or $500. The cost of the op;ons is 2×100 or $200.
The net proRt is therefore 500−200 or $300.
13. The price of a stock on February 1 is $124. A trader sells 200 put op;ons on the stock with a
strike price of $120 when the op;on price is $5. The op;ons are exercised when the stock price
is $110. The trader’s net proRt or loss is
A. Gain of $1,000
B. Loss of $2,000
C. Loss of $2,800
D. Loss of $1,000
Answer: D
The payoU that must be made on the op;ons is 200×(120−110) or $2000. The amount received
for the op;ons is 5×200 or $1000. The net loss is therefore 2000−1000 or $1000.
14. The price of a stock on February 1 is $84. A trader buys 200 put op;ons on the stock with a
strike price of $90 when the op;on price is $10. The op;ons are exercised when the stock price
is $85. The trader’s net proRt or loss is
A. Loss of $1,000
B. Loss of $2,000
C. Gain of $200
D. Gain of $1000
Answer: A
The payoU is 90−85 or $5 per op;on. For 200 op;ons the payoU is therefore 5×200 or $1000.
However the op;ons cost 10×200 or $2000. There is therefore a net loss of $1000.

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15. The price of a stock on February 1 is $48. A trader sells 200 put op;ons on the stock with a strike
price of $40 when the op;on price is $2. The op;ons are exercised when the stock price is $39.
The trader’s net proRt or loss is
A. Loss of $800
B. Loss of $200
C. Gain of $200
D. Loss of $900
Answer: C
The payoU is 40−39 or $1 per op;on. For 200 op;ons the payoU is therefore 1×200 or $200.
However the premium received by the trader is 2×200 or $400. The trader therefore has a net
gain of $200.
16. A speculator can choose between buying 100 shares of a stock for $40 per share and buying
1000 European call op;ons on the stock with a strike price of $45 for $4 per op;on. For second
alterna;ve to give a beber outcome at the op;on maturity, the stock price must be above
A. $45
B. $46
C. $55
D. $50
Answer: D
When the stock price is $50 the Rrst alterna;ve leads to a posi;on in the stock worth 100×50 or
$5000. The second alterna;ve leads to a payoU from the op;ons of 1000×(50−45) or $5000. Both
alterna;ves cost $4000. It follows that the alterna;ves are equally proRtable when the stock price is
$50. For stock prices above $50 the op;on alterna;ve is more proRtable.
17. A company knows it will have to pay a certain amount of a foreign currency to one of its
suppliers in the future. Which of the following is true
A. A forward contract can be used to lock in the exchange rate
B. A forward contract will always give a beber outcome than an op;on
C. An op;on will always give a beber outcome than a forward contract
D. An op;on can be used to lock in the exchange rate
Answer: A
A forward contract ensures that the eUec;ve exchange rate will equal the current forward
exchange rate. An op;on provides insurance that the exchange rate will not be worse than a
certain level, but requires an upfront premium. Op;ons some;mes give a beber outcome and
some;mes give a worse outcome than forwards.
18. A short forward contract on an asset plus a long posi;on in a European call op;on on the asset
with a strike price equal to the forward price is equivalent to
A. A short posi;on in a call op;on
B. A short posi;on in a put op;on
C. A long posi;on in a put op;on
D. None of the above

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Answer: C
Suppose that ST is the Rnal asset price and K is the strike price/forward price. A short forward
contract leads to a payoU of K−ST. A long posi;on in a European call op;on leads to a payoU of
max(ST−K, 0). When added together we see that the total posi;on leads to a payoU of max(0,
K−ST), which is the payoU from a long posi;on in a put op;on. C can also be seen to be true by
plomng the payoUs as a func;on of the Rnal stock price.
19. A trader has a pornolio worth $5 million that mirrors the performance of a stock index. The
stock index is currently 1,250. Futures contracts trade on the index with one contract being on
250 ;mes the index. To remove market risk from the pornolio the trader should
A. Buy 16 contracts
B. Sell 16 contracts
C. Buy 20 contracts
D. Sell 20 contracts
Answer: B
One futures contract protects a pornolio worth 1250×250. The number of contract required is
therefore 5,000,000/(1250×250)=16. To remove market risk we need to gain on the contracts
when the market declines. A short futures posi;on is therefore required.
20. Which of the following best describes a central clearing party

A. It is a trader that works for an exchange
B. It stands between two par;es in the over-the-counter market
C. It is a trader that works for a bank
D. It helps facilitate futures trades
Answer: B
A central clearing party (CCP) is a clearing house that stands between two par;es in the over-
the-counter market. It serves the same purpose as an exchange clearing house.

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Hull: Op(ons, Futures, and Other Deriva(ves, Ninth Edi(on

Chapter 2: Mechanics of Futures Markets
Mul(ple Choice Test Bank: Ques(on with Answers
1. Which of the following is true

A. Both forward and futures contracts are traded on exchanges.
B. Forward contracts are traded on exchanges, but futures contracts are not.
C. Futures contracts are traded on exchanges, but forward contracts are not.
D. Neither futures contracts nor forward contracts are traded on exchanges.
Answer: C
Futures contracts trade only on exchanges. Forward contracts trade only in the over-the-counter
market.

A. Futures contracts nearly always last longer than forward contracts
B. Futures contracts are standardized; forward contracts are not.
C. Delivery or Inal cash seJlement usually takes place with forward contracts; the same is
not true of futures contracts.
D. Forward contracts usually have one speciIed delivery date; futures contract oLen have
a range of delivery dates.
Answer: A
Forward contracts oLen last longer than futures contracts. B, C, and D are true
3. In the corn futures contract a number of diOerent types of corn can be delivered (with price
adjustments speciIed by the exchange) and there are a number of diOerent delivery
locaSons. Which of the following is true
A. This Texibility tends increase the futures price.
B. This Texibility tends decrease the futures price.
C. This Texibility may increase and may decrease the futures price.
D. This Texibility has no eOect on the futures price
Answer: B
The party with the short posiSon chooses between the alternaSves. The alternaSves therefore
make the futures contract more aJracSve to the party with the short posiSon. The lower the
futures price the less aJracSve it is to the party with the short posiSon. The beneIt of the
alternaSves available to the party with the short posiSon is therefore compensated for by the
futures price being lower than it would otherwise be.

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4. A company enters into a short futures contract to sell 50,000 units of a commodity for 70
cents per unit. The iniSal margin is $4,000 and the maintenance margin is $3,000. What is
the futures price per unit above which there will be a margin call?
A. 78 cents
B. 76 cents
C. 74 cents
D. 72 cents
Answer: D
There will be a margin call when more than $1000 has been lost from the margin account so
that the balance in the account is below the maintenance margin level. Because the company is
short, each one cent rise in the price leads to a loss or 0.01×50,000 or $500. A greater than 2
cent rise in the futures price will therefore lead to a margin call. The future price is currently 70
cents. When the price rises above 72 cents there will be a margin call.
5. A company enters into a long futures contract to buy 1,000 units of a commodity for $60 per
unit. The iniSal margin is $6,000 and the maintenance margin is $4,000. What futures price
will allow $2,000 to be withdrawn from the margin account?
A. $58
B. $62
C. $64
D. $66
Answer: B
Amounts in the margin account in excess of the iniSal margin can be withdrawn. Each $1
increase in the futures price leads to a gain of $1000. When the futures price increases by $2 the
gain will be $2000 and this can be withdrawn. The futures price is currently $60. The answer is
therefore $62.
6. One futures contract is traded where both the long and short parSes are closing out exisSng
posiSons. What is the resultant change in the open interest?
A. No change
B. Decrease by one
C. Decrease by two
D. Increase by one
Answer: B
The open interest goes down by one. There is one less long posiSon and one less short posiSon.
7. Who iniSates delivery in a corn futures contract

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A. The party with the long posiSon

B. The party with the short posiSon
C. Either party
D. The exchange
Answer: B
The party with the short posiSon iniSates delivery by sending a “NoSce of IntenSon to Deliver”
to the exchange. The exchange has a procedure for choosing a party with a long posiSon to take
delivery.
8. You sell one December futures contracts when the futures price is $1,010 per unit. Each
contract is on 100 units and the iniSal margin per contract that you provide is $2,000. The
maintenance margin per contract is $1,500. During the next day the futures price rises to
$1,012 per unit. What is the balance of your margin account at the end of the day?
A. $1,800
B. $3,300
C. $2,200
D. $3,700
Answer: B
The price has increased by $2. Because you have a short posiSon you lose 2×100 or $200. The
balance in the margin account therefore goes down from $3,500 to $3,300.
9. A hedger takes a long posiSon in a futures contract on a commodity on November 1, 2012

to hedge an exposure on March 1, 2013. The iniSal futures price is $60. On December 31,
2012 the futures price is $61. On March 1, 2013 it is $64. The contract is closed out on
March 1, 2013. What gain is recognized in the accounSng year January 1 to December 31,
2013? Each contract is on 1000 units of the commodity.
A. $0
B. $1,000
C. $3,000
D. $4,000
Answer: D
Hedge accounSng is used. The whole of the gain or loss on the futures is therefore recognized in
2013. None is recognized in 2012. In this case the gain is $4 per unit or $4,000 in total.
10. A speculator takes a long posiSon in a futures contract on a commodity on November 1,

2012 to hedge an exposure on March 1, 2013. The iniSal futures price is $60. On December
31, 2012 the futures price is $61. On March 1, 2013 it is $64. The contract is closed out on
March 1, 2013. What gain is recognized in the accounSng year January 1 to December 31,
2013? Each contract is on 1000 units of the commodity.

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A. $0
B. $1,000
C. $3,000
D. $4,000
Answer: C
In this case there is no hedge accounSng. Gains or losses are accounted for as they are accrued. The
price per unit increases by $3 in 2013. The total gain in 2013 is therefore $3,000.
11. The frequency with which futures margin accounts are adjusted for gains and losses is
A. Daily
B. Weekly
C. Monthly
D. Quarterly
Answer: A
In futures contracts margin accounts are adjusted for gains or losses daily.
12. Margin accounts have the eOect of

A. Reducing the risk of one party regrejng the deal and backing out
B. Ensuring funds are available to pay traders when they make a proIt
C. Reducing systemic risk due to collapse of futures markets
D. All of the above
Answer: D
IniSal margin requirements dramaScally reduce the risk that a party will walk away from a
futures contract. As a result they reduce the risk that the exchange clearing house will not have
enough funds to pays proIts to traders. Furthermore, if traders are less likely to suOer losses
because of counterparty defaults there is less systemic risk.
13. Which enSty in the United States takes primary responsibility for regulaSng futures market?
A. Federal Reserve Board
B. CommodiSes Futures Trading Commission (CFTC)
C. Security and Exchange Commission (SEC)
D. US Treasury
Answer: B
The CFTC has primary responsibility for regulaSng futures markets
14. For a futures contract trading in April 2012, the open interest for a June 2012 contract,
when compared to the open interest for Sept 2012 contracts, is usually

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A. Higher
B. Lower
C. The same
D. Equally likely to be higher or lower
Answer: A
The contracts which are close to maturity tend to have the highest open interest. However,
during the maturity month itself the open interest declines.
15. Clearing houses are

A. Never used in futures markets and someSmes used in OTC markets
B. Used in OTC markets, but not in futures markets
C. Always used in futures markets and someSmes used in OTC markets
D. Always used in both futures markets and OTC markets
Answer: C
Clearing houses are always used by exchanges trading futures. Increasingly, OTC products are
cleared through CCPs, which are a type of clearing house.
16. A haircut of 20% means that

A. A bond with a market value of $100 is considered to be worth $80 when used to
saSsfy a collateral request
B. A bond with a face value of $100 is considered to be worth $80 when used to saSsfy
a collateral request
C. A bond with a market value of $100 is considered to be worth $83.3 when used to
D. A bond with a face value of $100 is considered to be worth $83.3 when used to
Answer: A
A haircut is the amount the market price of asset is reduced by for the purposes of determining
its value for collateral purposes. A is therefore correct.
17. With bilateral clearing, the number of agreements between four dealers, who trade with
each other, is
A. 12
B. 1
C. 6
D. 2
Answer: C

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Suppose the dealers are W, X, Y , and Z. The agreements are between W and X, W and Y, W and
Z, X and Y, X and Z, and Y and Z. There are therefore a total of 6 agreements.
18. Which of the following best describes central clearing parSes

A. Help market parScipants to value derivaSve transacSons
B. Must be used for all OTC derivaSve transacSons
C. Are used for futures transacSons
D. Perform a similar funcSon to exchange clearing houses
Answer: D
CCPs do for the OTC market what exchange clearing houses do for the exchange-traded market.
The correct answer is therefore D. CCPs must be used for most standard OTC derivaSves
transacSons, but not for all derivaSves transacSons.
19. Which of the following are cash seJled

A. All futures contracts
B. All opSon contracts
C. Futures on commodiSes
D. Futures on stock indices
Answer: D
Futures on stock indices are usually cash seJled. The rest are seJled by delivery of the
underlying assets
20. A limit order

A. Is an order to trade up to a certain number of futures contracts at a certain price
B. Is an order that can be executed at a speciIed price or one more favorable to the
investor
C. Is an order that must be executed within a speciIed period of Sme
Answer: B
In a limit order a trader speciIes the worst price (from the trader’s perspecSve) at which the
trade can be carried out.

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Hull: Op(ons, Futures and Other Deriva(ves, Ninth Edi(on, Global Edi(on
Chapter 3: Hedging Strategies Using Futures
1. The basis is de,ned as spot minus futures. A trader is hedging the sale of an asset with a short
futures posi9on. The basis increases unexpectedly. Which of the following is true?
A. The hedger’s posi9on improves.
B. The hedger’s posi9on worsens.
C. The hedger’s posi9on some9mes worsens and some9mes improves.
D. The hedger’s posi9on stays the same.
Answer: A
The price received by the trader is the futures price plus the basis. It follows that the trader’s
posi9on improves when the basis increases.
2. Futures contracts trade with every month as a delivery month. A company is hedging the
purchase of the underlying asset on June 15. Which futures contract should it use?
A. The June contract
B. The July contract
C. The May contract
D. The August contract
Answer: B
As a general rule the futures maturity month should be as close as possible to but aKer the
month when the asset will be purchased. In this case the asset will be purchased in June and so
the best contract is the July contract.
3. On March 1 a commodity’s spot price is $60 and its August futures price is $59. On July 1 the
spot price is $64 and the August futures price is $63.50. A company entered into futures
contracts on March 1 to hedge its purchase of the commodity on July 1. It closed out its posi9on
on July 1. What is the eSec9ve price (aKer taking account of hedging) paid by the company?
A. $59.50
B. $60.50
C. $61.50
D. $63.50
Answer: A
The user of the commodity takes a long futures posi9on. The gain on the futures is 63.50−59 or
$4.50. The eSec9ve paid realized is therefore 64−4.50 or $59.50. This can also be calculated as
the March 1 futures price (=59) plus the basis on July 1 (=0.50).

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4. On March 1 the price of a commodity is $1,000 and the December futures price is $1,015. On
November 1 the price is $980 and the December futures price is $981. A producer of the
commodity entered into a December futures contracts on March 1 to hedge the sale of the
commodity on November 1. It closed out its posi9on on November 1. What is the eSec9ve price
(aKer taking account of hedging) received by the company for the commodity?
A. $1,016
B. $1,001
C. $981
D. $1,014
Answer: D
The producer of the commodity takes a short futures posi9on. The gain on the futures is
1015−981 or $34. The eSec9ve price realized is therefore 980+34 or $1014. This can also be
calculated as the March 1 futures price (=1015) plus the November 1 basis (=−1).
5. Suppose that the standard devia9on of monthly changes in the price of commodity A is $2. The
standard devia9on of monthly changes in a futures price for a contract on commodity B (which
is similar to commodity A) is $3. The correla9on between the futures price and the commodity
price is 0.9. What hedge ra9o should be used when hedging a one month exposure to the price
of commodity A?
A. 0.60
B. 0.67
C. 1.45
D. 0.90
Answer: A
The op9mal hedge ra9o is 0.9×(2/3) or 0.6.
6. A company has a $36 million porbolio with a beta of 1.2. The futures price for a contract on an
index is 900. Futures contracts on $250 9mes the index can be traded. What trade is necessary
to reduce beta to 0.9?
A. Long 192 contracts
B. Short 192 contracts
C. Long 48 contracts
D. Short 48 contracts
Answer: D
To reduce the beta by 0.3 we need to short 0.3×36,000,000/(900×250) or 48 contracts.
7. A company has a $36 million porbolio with a beta of 1.2. The futures price for a contract on an

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index is 900. Futures contracts on $250 9mes the index can be traded. What trade is necessary
to increase beta to 1.8?
A. Long 192 contracts
B. Short 192 contracts
C. Long 96 contracts
D. Short 96 contracts
Answer: C
To increase beta by 0.6 we need to go long 0.6×36,000,000/(900×250) or 96 contracts
8. Which of the following is true?

A. The op9mal hedge ra9o is the slope of the best ,t line when the spot price (on the y-axis) is
regressed against the futures price (on the x-axis).
B. The op9mal hedge ra9o is the slope of the best ,t line when the futures price (on the y-
axis) is regressed against the spot price (on the x-axis).
C. The op9mal hedge ra9o is the slope of the best ,t line when the change in the spot price
(on the y-axis) is regressed against the change in the futures price (on the x-axis).
D. The op9mal hedge ra9o is the slope of the best ,t line when the change in the futures price
(on the y-axis) is regressed against the change in the spot price (on the x-axis).
Answer: C
The op9mal hedge ra9o reeects the ra9o of movements in the spot price to movements in the
futures price.
9. Which of the following describes tailing the hedge?

A. A strategy where the hedge posi9on is increased at the end of the life of the hedge
B. A strategy where the hedge posi9on is increased at the end of the life of the futures
contract
C. A more exact calcula9on of the hedge ra9o when forward contracts are used for hedging
Answer: D
Tailing the hedge is a calcula9on appropriate when futures are used for hedging. It corrects for
daily seflement
10. A company due to pay a certain amount of a foreign currency in the future decides to hedge
with futures contracts. Which of the following best describes the advantage of hedging?
A. It leads to a befer exchange rate being paid
B. It leads to a more predictable exchange rate being paid
C. It caps the exchange rate that will be paid
D. It provides a eoor for the exchange rate that will be paid

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Answer: B
Hedging is designed to reduce risk not increase expected pro,t. Op9ons can be used to create a
cap or eoor on the price. Futures afempt to lock in the price
11. Which of the following best describes the capital asset pricing model?
A. Determines the amount of capital that is needed in par9cular situa9ons
B. Is used to determine the price of futures contracts
C. Relates the return on an asset to the return on a stock index
D. Is used to determine the vola9lity of a stock index
Answer: C
CAPM relates the return on an asset to its beta. The parameter beta measures the sensi9vity of
the return on the asset to the return on the market. The lafer is usually assumed to be the
return on a stock index such as the S&P 500.
12. Which of the following best describes “stack and roll”?

A. Creates long-term hedges from short term futures contracts
B. Can avoid losses on futures contracts by entering into further futures contracts
C. Involves buying a futures contract with one maturity and selling a futures contract with a
diSerent maturity
D. Involves two diSerent exposures simultaneously
Answer: A
Stack and roll is a procedure where short maturity futures contracts are entered into. When
they are close to maturity they are replaced by more short maturity futures contracts and so on.
The result is the crea9on of a long term hedge from short-term futures contracts.
13. Which of the following increases basis risk?

A. A large diSerence between the futures prices when the hedge is put in place and when it is
closed out
B. Dissimilarity between the underlying asset of the futures contract and the hedger’s exposure
C. A reduc9on in the 9me between the date when the futures contract is closed and its delivery
month
Answer: B
Basis is the diSerence between spot and futures at the 9me the hedge is closed out. This
increases as the 9me between the date when the futures contract is put in place and the
delivery month increases. (C is not therefore correct). It also increases as the asset underlying
the futures contract becomes more diSerent from the asset being hedged. (B is therefore
correct.)

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14. Which of the following is a reason for hedging a porbolio with an index futures?
A. The investor believes the stocks in the porbolio will perform befer than the market but is
uncertain about the future performance of the market
B. The investor believes the stocks in the porbolio will perform befer than the market and the
market is expected to do well
C. The porbolio is not well diversi,ed and so its return is uncertain
D. All of the above
Answer: A
Index futures can be used to remove the impact of the performance of the overall market on the
porbolio. If the market is expected to do well hedging against the performance of the market is
not appropriate. Hedging cannot correct for a poorly diversi,ed porbolio.
15. Which of the following does NOT describe beta?

A. A measure of the sensi9vity of the return on an asset to the return on an index
B. The slope of the best ,t line when the return on an asset is regressed against the return on the
market
C. The hedge ra9o necessary to remove market risk from a porbolio
D. Measures correla9on between futures prices and spot prices for a commodity
Answer: D
A, B, and C all describe beta but beta has nothing to do with the correla9on between futures
and spot prices for a commodity

A. Hedging can always be done more easily by a company’s shareholders than by the company itself
B. If all companies in an industry hedge, a company in the industry can some9mes reduce its risk by
choosing not to hedge
C. If all companies in an industry do not hedge, a company in the industry can reduce its risk by
hedging
D. If all companies in an industry do not hedge, a company is liable increase its risk by hedging
Answer: D
If all companies in a industry hedge, the price of the end product tends to reeect movements in
relevant market variables. Afemp9ng to hedge those movements can therefore increase risk.
17. Which of the following is necessary for tailing a hedge?

A. Comparing the size in units of the posi9on being hedged with the size in units of the futures
contract
B. Comparing the value of the posi9on being hedged with the value of one futures contract

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C. Comparing the futures price of the asset being hedged to its forward price
Answer: B
When tailing a hedge the op9mal hedge ra9o is applied to the ra9o of the value of the
posi9on being hedged to the value of one futures contract.

A. Gold producers should always hedge the price they will receive for their produc9on of gold over
the next three years
B. Gold producers should always hedge the price they will receive for their produc9on of gold over
the next one year
C. The hedging strategies of a gold producer should depend on whether it shareholders want
exposure to the price of gold
D. Gold producers can hedge by buying gold in the forward market
Answer: C
Some shareholders buy gold stocks to gain exposure to the price of gold. They do not
want the company they invest in to hedge. In prac9ce gold mining companies make their
hedging strategies clear to shareholders.
19. A silver mining company has used futures markets to hedge the price it will
receive for everything it will produce over the next 5 years. Which of the following is true?
A. It is liable to experience liquidity problems if the price of silver falls drama9cally
B. It is liable to experience liquidity problems if the price of silver rises drama9cally
C. It is liable to experience liquidity problems if the price of silver rises drama9cally or falls
drama9cally
D. The opera9on of futures markets protects it from liquidity problems
Answer: B
The mining company shorts futures. It gains on the futures when the price decreases and
loses when the price increases. It may get margin calls which lead to liquidity problems
when the price rises even though the silver in the ground is worth more.
20. A company will buy 1000 units of a certain commodity in one year. It decides to
hedge 80% of its exposure using futures contracts. The spot price and the futures price are
currently $100 and $90, respec9vely. The spot price and the futures price in one year turn
out to be $112 and $110, respec9vely. What is the average price paid for the commodity?
A. $92
B. $96

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C. $102
D. $106
Answer: B
On the 80% (hedged) part of the commodity purchase the price paid will 112−(110−90) or
$92. On the other 20% the price paid will be the spot price of $112. The weighted average
of the two prices is 0.8×92+0.2×112 or $96.

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Hull: Op(ons, Futures and Other Deriva(ves, Ninth Edi(on, Global Edi(on
Chapter 4: Interest Rates
1. The compounding frequency for an interest rate de7nes

A. The frequency with which interest is paid
B. A unit of measurement for the interest rate
C. The rela=onship between the annual interest rate and the monthly interest rate
Answer: B
The compounding frequency is a unit of measurement. The frequency with which interest is paid
may be diCerent from the compounding frequency used for quo=ng the rate.
2. An interest rate is 6% per annum with annual compounding. What is the equivalent rate with
con=nuous compounding?
A. 5.79%
B. 6.21%
C. 5.83%
D. 6.18%
Answer: C
The equivalent rate with con=nuous compounding is ln(1.06) = 0.0583 or 5.83%.
3. An interest rate is 5% per annum with con=nuous compounding. What is the equivalent rate
with semiannual compounding?
A. 5.06%
B. 5.03%
C. 4.97%
D. 4.94%
Answer: A
The equivalent rate with semiannual compounding is 2×(e 0.05/2−1) = 0.0506 or 5.06%.
4. An interest rate is 12% per annum with semiannual compounding. What is the equivalent rate
with quarterly compounding?
A. 11.83%
B. 11.66%
C. 11.77%
D. 11.92%
Answer: A

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The equivalent rate per quarter is 1.06  1 2.956% . The annualized rate with quarterly
compounding is four =mes this or 11.83%.
5. The two-year zero rate is 6% and the three year zero rate is 6.5%. What is the forward rate for
the third year? All rates are con=nuously compounded.
A. 6.75%
B. 7.0%
C. 7.25%
D. 7.5%
Answer: D
The forward rate for the third year is (3×0.065−2×0.06)/(3−2) = 0.075 or 7.5%.
6. The six-month zero rate is 8% per annum with semiannual compounding. The price of a one-
year bond that provides a coupon of 6% per annum semiannually is 97. What is the one-year
con=nuously compounded zero rate?
A. 8.02%
B. 8.52%
C. 9.02%
D. 9.52%
Answer: C
If the rate is R we must have

3
 103e  R1 97
1.04
or
97  3 / 1.04
e R  0.9137
103
so that R = ln(1/0.9137) = 0.0902 or 9.02%.
7. The yield curve is Zat at 6% per annum. What is the value of an FRA where the holder receives
interest at the rate of 8% per annum for a six-month period on a principal of $1,000 star=ng in
two years? All rates are compounded semiannually.
A. $9.12
B. $9.02
C. $8.88
D. $8.63
Answer: D
The value of the FRA is the value of receiving an extra 0.5×(0.08−0.06)×1000 = $10 in 2.5 years.
This is 10/(1.035) = $8.63.

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8. Under liquidity preference theory, which of the following is always true?

A. The forward rate is higher than the spot rate when both have the same maturity.
B. Forward rates are unbiased predictors of expected future spot rates.
C. The spot rate for a certain maturity is higher than the par yield for that maturity.
D. Forward rates are higher than expected future spot rates.
Answer: D
Liquidity preference theory argues that individuals like their borrowings to have a long maturity
and their deposits to have a short maturity. To induce people to lend for long periods forward
rates are raised rela=ve to what expected future short rates would predict.
9. The zero curve is upward sloping. De7ne X as the 1-year par yield, Y as the 1-year zero rate and Z
as the forward rate for the period between 1 and 1.5 year. Which of the following is true?
A. X is less than Y which is less than Z
B. Y is less than X which is less than Z
C. X is less than Z which is less than Y
D. Z is less than Y which is less than X
Answer: A
When the zero curve is upward sloping, the one-year zero rate is higher than the one-year par
yield and the forward rate corresponding to the period between 1.0 and 1.5 years is higher than
the one-year zero rate. The correct answer is therefore A.
10. Which of the following is true of the fed funds rate

A. It is the same as the Treasury rate
B. It is an overnight interbank rate
C. It is a rate for which collateral is posted
D. It is a type of repo rate
Answer: B
At the end of each day some banks have surplus reserves on deposit with the Federal Reserve
others have de7cits. They use overnight borrowing and lending at what is termed the fed funds
rate to rec=fy this.
11. The modi7ed dura=on of a bond poreolio worth $1 million is 5 years. By approximately how
much does the value of the poreolio change if all yields increase by 5 basis points?
A. Increase of $2,500
B. Decrease of $2,500
C. Increase of $25,000
D. Decrease of $25,000
Answer: B

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When yields increase bond prices decrease. The propor=onal decrease is the modi7ed dura=on
=mes the yield increase. In this case, it is 5×0.0005=0.0025. The decrease is therefore
0.0025×1,000,000 or $2,500.
12. A company invests $1,000 in a 7ve-year zero-coupon bond and $4,000 in a ten-year zero-
coupon bond. What is the dura=on of the poreolio?
A. 6 years
B. 7 years
C. 8 years
D. 9 years
Answer: D
The dura=on of the 7rst bond is 5 years and the dura=on of the second bond is 10 years. The
dura=on of the poreolio is a weighted average with weights corresponding to the amounts
invested in the bonds. It is 0.2×5+0.8×10=9 years.
13. Which of the following is true of LIBOR

A. The LIBOR rate is free of credit risk
B. A LIBOR rate is lower than the Treasury rate when the two have the same maturity
C. It is a rate used when borrowing and lending takes place between banks
D. It is subject to favorable tax treatment in the U.S.
Answer: C
LIBOR is a rate used for interbank transac=ons.
14. Which of following describes forward rates?

A. Interest rates implied by current zero rates for future periods of =me
B. Interest rate earned on an investment that starts today and last for n-years in the future
without coupons
C. The coupon rate that causes a bond price to equal its par (or principal) value
D. A single discount rate that gives the value of a bond equal to its market price when
applied to all cash Zows
Answer: A
The forward rate is the interest rate implied by the current term structure for future periods of
=me. For example, earning the zero rate for one year and the forward rate for the period
between one and two years gives the same result as earning the zero rate for two years.
15. Which of the following is NOT a theory of the term structure

A. Expecta=ons theory
B. Market segmenta=on theory
C. Liquidity preference theory

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D. Maturity preference theory
Answer: C
Maturity preference theory is not a theory of the term structure. The other three are.
16. A repo rate is

A.An uncollateralized rate
B.A rate where the credit risk is rela=ve high
C.The rate implicit in a transac=on where securi=es are sold and bought back later at a
higher price
D.None of the above
Answer: C
A repo transac=on is one where a company agrees to sell securi=es today and buy them back at
a future =me. It is a form of collateralized borrowing. The credit risk is very low.
17. Bootstrapping involves

A.Calcula=ng the yield on a bond
B.Working from short maturity instruments to longer maturity instruments determining zero
rates at each step
C.Working from long maturity instruments to shorter maturity instruments determining zero
rates at each step
D.The calcula=on of par yields
Answer: B
Bootstrapping is a way of construc=ng the zero coupon yield curve from coupon-bearing bonds.
It involves working from the shortest maturity bond to progressively longer maturity bonds
making sure that the calculated zero coupon yield curve is consistent with the market prices of
the instruments.
18. The zero curve is downward sloping. De7ne X as the 1-year par yield, Y as the 1-year zero rate
and Z as the forward rate for the period between 1 and 1.5 year. Which of the following is true?
A. X is less than Y which is less than Z
B. Y is less than X which is less than Z
C. X is less than Z which is less than Y
D. Z is less than Y which is less than X
Answer: D

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The forward rate accentuates trends in the zero curve. The par yield shows the same trends but
in a less pronounced way.

A. When interest rates in the economy increase, all bond prices increase
B. As its coupon increases, a bond’s price decreases
C. Longer maturity bonds are always worth more that shorter maturity bonds when the
coupon rates are the same
Answer: D
When interest rates increase the impact of discoun=ng is to make future cash Zows worth less.
Bond prices therefore decline. A is therefore wrong. As coupons increase a bond becomes more
valuable because higher cash Zows will be received. B is therefore wrong. When the coupon is
higher than prevailing interest rates, longer maturity bonds are worth more than shorter
maturity bonds. When it is less than prevailing interest rates, longer maturity bonds are worth
less than shorter maturity bonds. C is therefore not true. The correct answer is therefore D.
20. The six month and one-year rates are 3% and 4% per annum with semiannual compounding.
Which of the following is closest to the one-year par yield expressed with semiannual
compounding?
A. 3.99%
B. 3.98%
C. 3.97%
D. 3.96%
Answer: A
The six month rate is 1.5% per six months. The one year rate is 2% per six months. The one year
par yield is the coupon that leads to a bond being worth par. A is the correct answer because
(3.99/2)/1.015+(100+3.99/2)/1.022 = 100. The formula in the text can also be used to give the
par yield as [(100-100/1.022)×2]/(1/1.015+1.022)=3.99.

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Hull: Op(ons, Futures, and Other Deriva(ves, Ninth Edi(on, Global Edi(on
Chapter 5: Determina(on of Forward and Futures Prices
1. Which of the following is a consump5on asset?

A. The S&P 500 index
B. The Canadian dollar
C. Copper
D. IBM stock
Answer: C
A, B, and D are investment assets (held by at least some investors purely for investment
purposes). C is a consump5on asset.
2. An investor shorts 100 shares when the share price is $50 and closes out the posi5on six months
later when the share price is $43. The shares pay a dividend of $3 per share during the six
months. How much does the investor gain?
A. $1,000
B. $400
C. $700
D. $300
Answer: B
The investor gains $7 per share because he or she sells at $50 and buys at $43. However, the
investor has to pay the $3 per share dividend. The net proTt is therefore 7−3 or $4 per share.
100 shares are involved. The total gain is therefore $400.
3. The spot price of an investment asset that provides no income is $30 and the risk-free rate for
all maturi5es (with con5nuous compounding) is 10%. What is the three-year forward price?
A. $40.50
B. $22.22
C. $33.00
D. $33.16
Answer: A
The 3-year forward price is the spot price grossed up for 3 years at the risk-free rate. It is 30e0.1×3
=$40.50.
4. The spot price of an investment asset is $30 and the risk-free rate for all maturi5es is 10% with
con5nuous compounding. The asset provides an income of $2 at the end of the Trst year and at
the end of the second year. What is the three-year forward price?
A. $19.67
B. $35.84
C. $45.15

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D. $40.50
Answer: B
The present value of the income is 2e-0.1×1+2e-0.1×2= $3.447. The three year forward price is
obtained by subtrac5ng the present value of the income from the current stock price and then
grossing up the result for three years at the risk-free rate. It is (30−3.447)e0.1×3 = $35.84.
5. An exchange rate is 0.7000 and the six-month domes5c and foreign risk-free interest rates are
5% and 7% (both expressed with con5nuous compounding). What is the six-month forward
rate?
A. 0.7070
B. 0.7177
C. 0.7249
D. 0.6930
Answer: D
The six-month forward rate is 0.7000e−(0.05−0.07)×0.5=0.6930.

A. The convenience yield is always posi5ve or zero.
B. The convenience yield is always posi5ve for an investment asset.
C. The convenience yield is always nega5ve for a consump5on asset.
D. The convenience yield measures the average return earned by holding futures contracts.
Answer: A
The convenience yield measures the beneTt of owning an asset rather than having a
forward/futures contract on an asset. For an investment asset it is always zero. For a
consump5on asset it is greater than or equal to zero.
7. A short forward contract that was nego5ated some 5me ago will expire in three months and has
a delivery price of $40. The current forward price for three-month forward contract is $42. The
three month risk-free interest rate (with con5nuous compounding) is 8%. What is the value of
the short forward contract?
A. +$2.00
B. −$2.00
C. +$1.96
D. −$1.96
Answer: D
The contract gives one the obliga5on to sell for $40 when a forward price nego5ated today
would give one the obliga5on to sell for $42. The value of the contract is the present value of −
$2 or −2e-0.08×0.25 = −$1.96.

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8. The spot price of an asset is posi5vely correlated with the market. Which of the following would
you expect to be true?
A. The forward price equals the expected future spot price.
B. The forward price is greater than the expected future spot price.
C. The forward price is less than the expected future spot price.
D. The forward price is some5mes greater and some5mes less than the expected future spot
price.
Answer: C
When the spot price is posi5vely correlated with the market the forward price is less than the
expected future spot price. This is because the spot price is expected to provide a return greater
than the risk-free rate and the forward price is the spot price grossed up at the risk-free rate.
9. Which of the following describes the way the futures price of a foreign currency is quoted by the
CME group?
A. The number of U.S. dollars per unit of the foreign currency
B. The number of the foreign currency per U.S. dollar
C. Some futures prices are always quoted as the number of U.S. dollars per unit of the
foreign currency and some are always quoted the other way round
D. There are no quota5on conven5ons for futures prices
Answer: A
The futures price is quoted as the number of US dollars per unit of the foreign currency.
Spot exchange rates and forward exchange rates are some5mes quoted this way and
some5mes quoted the other way round.
10. Which of the following describes the way the forward price of a foreign currency is quoted?
A. The number of U.S. dollars per unit of the foreign currency
B. The number of the foreign currency per U.S. dollar
C. Some forward prices are quoted as the number of U.S. dollars per unit of the foreign
currency and some are quoted the other way round
D. There are no quota5on conven5ons for forward prices
Answer: C
The futures price is quoted as the number of US dollars per unit of the foreign currency.
Spot exchange rates and forward exchange rates are some5mes quoted this way and
some5mes quoted the other way round.
11. Which of the following is NOT a reason why a short posi5on in a stock is closed out?
A. The investor with the short posi5on chooses to close out the posi5on
B. The lender of the shares issues instruc5ons to close out the posi5on

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C. The broker is no longer able to borrow shares from other clients

D. The investor does not maintain margins required on his/her margin account
Answer: B
A, C, and D are all reasons why the short posi5on might be closed out. B is not. The lender of
shares cannot issue instruc5ons to close out the short posi5on.
12. Which of the following is NOT true?

A. Gold and silver are investment assets
B. Investment assets are held by signiTcant numbers of investors for investment purposes
C. Investment assets are never held for consump5on
D. The forward price of an investment asset can be obtained from the spot price, interest
rates, and the income paid on the asset
Answer: C
Investment assets are some5mes held for consump5on. Silver is an example. To be an

investment asset, an asset has to be held for investment by at least some traders
13. What should a trader do when the one-year forward price of an asset is too low? Assume that
the asset provides no income.
A. The trader should borrow the price of the asset, buy one unit of the asset and enter into
a short forward contract to sell the asset in one year.
B. The trader should borrow the price of the asset, buy one unit of the asset and enter into
a long forward contract to buy the asset in one year.
C. The trader should short the asset, invest the proceeds of the short sale at the risk-free
rate, enter into a short forward contract to sell the asset in one year
D. The trader should short the asset, invest the proceeds of the short sale at the risk-free
rate, enter into a long forward contract to buy the asset in one year
Answer: D
If the forward price is too low rela5ve to the spot price the trader should short the asset in
the spot market and buy it in the forward market.
14. Which of the following is NOT true about forward and futures contracts?
A. Forward contracts are more liquid than futures contracts
B. The futures contracts are traded on exchanges while forward contracts are traded in the
over-the-counter market
C. In theory forward prices and futures prices are equal when there is no uncertainty about
future interest rates
D. Taxes and transac5on costs can lead to forward and futures prices being digerent
Answer: A

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Futures contracts are more liquid than forward contracts. To unwind a futures posi5on it is
simply necessary to take an ogsehng posi5on. The statements in B, C, and D are correct
15. As the convenience yield increases, which of the following is true?

A. The one-year futures price as a percentage of the spot price increases
B. The one-year futures price as a percentage of the spot price decreases
C. The one-year futures price as a percentage of the spot price stays the same
D. Any of the above can happen
Answer: B
As the convenience yield increases, the futures price declines rela5ve to the spot price. This is
because the convenience of owning the asset (as opposed to having a futures contract) becomes
more important.
16. As inventories of a commodity decline, which of the following is true?

A. The one-year futures price as a percentage of the spot price increases
B. The one-year futures price as a percentage of the spot price decreases
C. The one-year futures price as a percentage of the spot price stays the same
D. Any of the above can happen
Answer: B
When inventories decline, the convenience yield increases and the futures price as a percentage
of the spot price declines.
17. Which of the following describes a known dividend yield on a stock?

A. The size of the dividend payments each year is known
B. Dividends per year as a percentage of today’s stock price are known
C. Dividends per year as a percentage of the stock price at the 5me when dividends are
paid are known
D. Dividends will yield a certain return to a person buying the stock today
Answer: C
The dividend yield is the dividend per year as a percent of the stock price at the 5me when the
dividend is paid.
18. Which of the following is an argument used by Keynes and Hicks?

A. If hedgers hold long posi5ons and speculators holds short posi5ons, the futures price
will tend to be higher than the expected future spot price
B. If hedgers hold long posi5ons and speculators holds short posi5ons, the futures price
will tend to be lower than the expected future spot price
C. If hedgers hold long posi5ons and speculators holds short posi5ons, the futures price
will tend to be lower than today’s spot price

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D. If hedgers hold long posi5ons and speculators holds short posi5ons, the futures price
will tend to be higher than today’s spot price
Answer: A
Keynes and Hicks argued that hedgers will be prepared to accept nega5ve returns on average
because of the beneTts of hedging whereas speculators require posi5ve returns on average. This
leads to A.
19. Which of the following describes contango?

A. The futures price is below the expected future spot price
B. The futures price is below today’s spot price
C. The futures price is a declining func5on of the 5me to maturity
D. The futures price is above the expected future spot price
Answer: D
Contango is deTned as the futures price being above the expected future spot price. It is also
some5mes used to describe the situa5on where the futures price is above the spot price.
20. Which of the following is true for a consump5on commodity?

A. There is no limit to how high or low the futures price can be, except that the futures
price cannot be nega5ve
B. There is a lower limit to the futures price but no upper limit
C. There is an upper limit to the futures price but no lower limit, except that the futures
price cannot be nega5ve
D. The futures price can be determined with reasonable accuracy from the spot price and
interest rates
Answer: C
If the futures price of a consump5on commodity becomes too high an arbitrageur will buy the
commodity and sell futures to lock in a proTt. An arbitrageur cannot follow the opposite
strategy of buying futures and selling or shor5ng the asset when the futures price is low. This is
because consump5on assets cannot be shorted . Furthermore, people who hold the asset in
general do so because they need the asset for their business. They are not prepared to swap
their posi5on in the asset for a similar posi5on in a futures. Consequently, there is an upper limit
but no lower limit to the futures price.

Hull: Op(ons, Futures and Other Deriva(ves, Tenth Edi(on
Chapter 6: Interest Rate Futures
Mul(ple Choice Test Bank
1. Which of following is applicable to corporate bonds in the United States?

A. Actual/360
B. Actual/Actual
C. 30/360
D. Actual/365
2. It is May 1. The quoted price of a bond with an Actual/Actual (in period) day count and 12% per
annum coupon (paid semiannually) in the United States is 105. It has a face value of 100 and
pays coupons on April 1 and October 1. What is the cash price?
A. 106.00
B. 106.02
C. 105.98
D. 106.04
3. It is May 1. The quoted price of a bond with a 30/360 day count and 12% per annum coupon in
the United States is 105. It has a face value of 100 and pays coupons on April 1 and October 1.
What is the cash price?\
A. 106.00
B. 106.02
C. 105.98
D. 106.04
4. The most recent se3lement bond futures price is 103.5. Which of the following four bonds is
cheapest to deliver?
A. Quoted bond price = 110; conversion factor = 1.0400.
B. Quoted bond price = 160; conversion factor = 1.5200.
C. Quoted bond price = 131; conversion factor = 1.2500.
D. Quoted bond price = 143; conversion factor = 1.3500.
5. Which of the following is NOT an op8on open to the party with a short posi8on in the Treasury
bond futures contract?
A. The ability to deliver any of a number of di9erent bonds
B. The wild card play
C. The fact that delivery can be made any 8me during the delivery month
D. The interest rate used in the calcula8on of the conversion factor
6. A trader enters into a long posi8on in one Eurodollar futures contract. How much does the
trader gain when the futures price quote increases by 6 basis points?
A. $6
B. $150
C. $60
D. $600
7. The bonds that can be delivered in a Treasury bond futures contract are
A. Assets that provide no income
B. Assets that provide a known cash income
C. Assets that provide a known yield
8. An ultra T-bond futures contract is one where

A. Bonds with maturi8es less than 3 years can be delivered
B. Bonds with maturi8es less than 10 years can be delivered
C. Bonds with maturi8es greater than 15 years can be delivered
D. Bonds with maturi8es greater than 25 year can be delivered
9. A por@olio is worth $24,000,000. The futures price for a Treasury note futures contract is 110
and each contract is for the delivery of bonds with a face value of $100,000. On the delivery
date the dura8on of the bond that is expected to be cheapest to deliver is 6 years and the
dura8on of the por@olio will be 5.5 years. How many contracts are necessary for hedging the
por@olio?
A. 100
B. 200
C. 300
D. 400

A. The futures rates calculated from a Eurodollar futures quote are always less than the
corresponding forward rate
B. The futures rates calculated from a Eurodollar futures quote are always greater than the
C. The futures rates calculated from a Eurodollar futures quote should equal the
D. The futures rates calculated from a Eurodollar futures quote are some8mes greater than
and some8mes less than the corresponding forward rate
11. How much is a basis point?

A. 1.0%
B. 0.1%
C. 0.01%
D. 0.001%
12. Which of the following day count conven8ons applies to a US Treasury bond?
A. Actual/360
B. Actual/Actual (in period)
C. 30/360
D. Actual/365
13. What is the quoted discount rate on a money market instrument?
A. The interest rate earned as a percentage of the Cnal face value of a bond
B. The interest rate earned as a percentage of the ini8al price of a bond
C. The interest rate earned as a percentage of the average price of a bond
D. The risk-free rate used to calculate the present value of future cash Dows from a bond
14. Which of the following is closest to the dura8on of a 2-year bond that pays a coupon of 8% per
annum semiannually? The yield on the bond is 10% per annum with con8nuous compounding.
A. 1.82
B. 1.85
C. 1.88
D. 1.92
15. Which of the following is NOT true about dura8on?

A. It equals the years-to-maturity for a zero coupon bond
B. It equals the weighted average of payment 8mes for a bond, where weights are
propor8onal to the present value of payments
C. Equals the weighted average of individual bond dura8ons for a por@olio, where weights
are propor8onal to the present value of bond prices
D. The prices of two bonds with the same dura8on change by the same percentage amount
when interest rate moves up by 100 basis points
16. The conversion factor for a bond is approximately

A. The price it would have if all cash Dows were discounted at 6% per annum
B. The price it would have if it paid coupons at 6% per annum
C. The price it would have if all cash Dows were discounted at 8% per annum
D. The price it would have if it paid coupons at 8% per annum
17. The 8me-to-maturity of a Eurodollar futures contract is 4 years and the 8me-to-maturity of the
rate underlying the futures contract is 4.25 years. The standard devia8on of the change in the
short term interest rate,  = 0.011. What does the model in the text es8mate as the di9erence
between the futures and the forward interest rate?
A. 0.105%
B. 0.103%
C. 0.098%
D. 0.093%
18. A trader uses 3-month Eurodollar futures to lock in a rate on $5 million for six months. How
many contracts are required?
A. 5
B. 10
C. 15
D. 20
19. In the U.S. what is the longest maturity for 3-month Eurodollar futures contracts?
A: 2 years
B: 5 years
C: 10 years
D: 20 years
20. Dura8on matching immunizes a por@olio against

A. Any parallel shiG in the yield curve
B. All shiGs in the yield curve
C. Changes in the steepness of the yield curve
D. Small parallel shiGs in the yield curve
Hull: Op(ons, Futures and Other Deriva(ves, Tenth Edi(on
Chapter 7: Swaps
Mul(ple Choice Test Bank
1. A company can invest funds for 5ve years at LIBOR minus 30 basis points. The 5ve-year swap rate
is 3%. What 5xed rate of interest can the company earn by using the swap?
A. 2.4%
B. 2.7%
C. 3.0%
D. 3.3%

A. Principals are not usually exchanged in a currency swap
B. The principal amounts usually .ow in the opposite direc/on to interest payments at the
beginning of a currency swap and in the same direc/on as interest payments at the end
of the swap.
C. The principal amounts usually .ow in the same direc/on as interest payments at the
beginning of a currency swap and in the opposite direc/on to interest payments at the
end of the swap.
D. Principals are not usually speci5ed in a currency swap
3. Which of the following is a way of valuing interest rate swaps where LIBOR is exchanged for a
5xed rate of interest?
A. Assume that .oa/ng payments will equal forward LIBOR rates and discount net cash
.ows at the risk-free rate
B. Assume that .oa/ng payments will equal forward OIS rates and discount net cash .ows
at the risk-free rate
C. Assume that .oa/ng payments will equal forward LIBOR rates and discount net cash
.ows at the swap rate
D. Assume that .oa/ng payments will equal forward OIS rates and discount net cash .ows
at the swap rate
4. Which of the following describes the 5ve-year swap rate?

A. The 5xed rate of interest which a swap market maker is prepared to pay in exchange for
LIBOR on a 5-year swap
B. The 5xed rate of interest which a swap market maker is prepared to receive in exchange
for LIBOR on a 5-year swap
C. The average of A and B
D. The higher of A and B
5. Which of the following is a use of a currency swap?

A. To exchange an investment in one currency for an investment in another currency
B. To exchange borrowing in one currency for borrowings in another currency
C. To take advantage situa/ons where the tax rates in two countries are di4erent
D. All of the above
Copyright © John Hull 2016. All rights reserved.

6. Which of the following is usually true
A. OIS rates are less than the corresponding LIBOR rates
B. OIS rates are greater than corresponding LIBOR rates
C. OIS rates are some/mes greater and some/mes less than LIBOR rates
D. OIS rates are equivalent to one-day LIBOR rates
7. Which of the following describes an interest rate swap?

A. A way of conver/ng a liability from Hxed to .oa/ng
B. A por9olio of forward rate agreements
C. An agreement to exchange interest at a Hxed rate for interest at a .oa/ng rate
D. All of the above
8. Which of the following is true for an interest rate swap?

A. A swap is usually worth close to zero when it is Hrst nego/ated
B. Each forward rate agreement underlying a swap is worth close to zero when the swap is
Hrst entered into
C. Compara/ve advantage is a valid reason for entering into the swap
9. Which of the following is true for the party paying Hxed in an interest rate swap? Assume no
other transac/ons with the counterparty.
A. There is more credit risk when the yield curve is upward sloping than when it is
downward sloping
B. There is more credit risk when the yield curve is downward sloping than when it is
upward sloping
C. The credit exposure increases when interest rates decline
D. There is no credit exposure providing a Hnancial ins/tu/on is used as the intermediary
10. Since the 2008 credit crisis

A. LIBOR has replaced OIS as the discount rate for non-collateralized swaps
B. OIS has replaced LIBOR as the discount rate, but only for non-collateralized swaps
C. LIBOR has replaced OIS as the discount rate for collateralized swaps
D. OIS has replaced LIBOR as the discount rate for swaps
11. A Hxed-for-Hxed currency swap

A. Is equivalent to a por9olio of FRAs
B. Is equivalent to a long posi/on in one bond and a short posi/on in another bond
C. Is worth the same whether or not principals are exchanged
D. Involves no exchange of principals at the beginning of its life
12. A company enters into an interest rate swap where it is paying Hxed and receiving LIBOR. When
interest rates increase, which of the following is true?
A. The value of the swap to the company increases
B. The value of the swap to the company decreases
C. The value of the swap can either increase or decrease
D. The value of the swap does not change providing the swap rate remains the same

13. A .oa/ng for .oa/ng currency swap is equivalent to
A. Two interest rate swaps, one in each currency
B. A >xed-for->xed currency swap and one interest rate swap
C. A >xed-for->xed currency swap and two interest rate swaps, one in each currency
14. A .oa/ng-for->xed currency swap is equivalent to

A. Two interest rate swaps, one in each currency
B. A >xed-for->xed currency swap and one interest rate swap
C. A >xed-for->xed currency swap and two interest rate swaps, one in each currency
15. An interest rate swap has three years of remaining life. Payments are exchanged annually. Interest
at 3% is paid and 12-month LIBOR is received. A exchange of payments has just taken place. The
one-year, two-year and three-year LIBOR/swap zero rates are 2%, 3% and 4%. All rates an
annually compounded. What is the value of the swap as a percentage of the principal when OIS
and LIBOR rates are the same
A. 0.00
B. 2.66
C. 2.06
D. 1.06
16. A semi-annual pay interest rate swap where the >xed rate is 5.00% (with semi-annual
compounding) has a remaining life of nine months. The six-month LIBOR rate observed three
months ago was 4.85% with semi-annual compounding. Today’s three and nine month LIBOR
rates are 5.3% and 5.8% (con/nuously compounded) respec/vely. From this it can be calculated
that the forward LIBOR rate for the period between three- and nine-months is 6.14% with semi-
annual compounding. If the swap has a principal value of $15,000,000, what is the value of the
swap to the party receiving a >xed rate of interest? Assume OIS rates are the same as LIBOR rates.
A. $74,250
B. −$70,933
C. −$11,250
D. $103,790
17. Which of the following describes the way a LIBOR-in-arrears swap di4ers from a plain vanilla
interest rate swap?
A. Interest is paid at the beginning of the accrual period in a LIBOR-in-arrears swap
B. Interest is paid at the end of the accrual period in a LIBOR-in-arrears swap
C. No .oa/ng interest is paid un/l the end of the life of the swap in a LIBOR-in-arrears
swap, but >xed payments are made throughout the life of the swap
D. Neither .oa/ng nor >xed payments are made un/l the end of the life of the swap
18. Which of the following describes a 3-month overnight indexed swap (OIS)?
A. A >xed rate is exchanged for the overnight rate every day for three months
B. LIBOR is exchanged for the overnight rate every day for three months
C. The arithme/c average of overnight rates is exchanged for a <xed rate at the end of
three months
D. The geometric average of overnight rates is exchanged for a <xed rate at the end of
three months
19. Which of the following is a typical bid-o4er spread on the swap rate for a plain vanilla interest
rate swap?
A. 3 basis points
B. 8 basis points
C. 13 basis points
D. 18 basis points
20. Which of the following describes the <ve-year swap rate?

A. The rate on a <ve-year loan to a AA-rated company
B. The rate on a <ve-year loan to an A-rated company
C. The rate that can be earned over <ve years from a series of short-term loans to AA-rated
companies
D. The rate that can be earned over <ve years from a series of short-term loans to A-rated
companies

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1. A one-year forward contract is an agreement where

2. Which of the following is NOT true

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6. Which of the following best describes the term “spot price”

7. Which of the following is true about a long forward contract

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9. Which of the following describes European op;ons?

10. Which of the following is NOT true

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B. A European op;on can only be exercised only on the maturity date

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20. Which of the following best describes a central clearing party

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Hull: Op(ons, Futures, and Other Deriva(ves, Ninth Edi(on

1. Which of the following is true

2. Which of the following is NOT true

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7. Who iniSates delivery in a corn futures contract

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A. The party with the long posiSon

9. A hedger takes a long posiSon in a futures contract on a commodity on November 1, 2012

10. A speculator takes a long posiSon in a futures contract on a commodity on November 1,

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12. Margin accounts have the eOect of

The CFTC has primary responsibility for regulaSng futures markets

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15. Clearing houses are

16. A haircut of 20% means that

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18. Which of the following best describes central clearing parSes

19. Which of the following are cash seJled

20. A limit order

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The op9mal hedge ra9o is 0.9×(2/3) or 0.6.

To reduce the beta by 0.3 we need to short 0.3×36,000,000/(900×250) or 48 contracts.

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To increase beta by 0.6 we need to go long 0.6×36,000,000/(900×250) or 96 contracts

8. Which of the following is true?

9. Which of the following describes tailing the hedge?

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12. Which of the following best describes “stack and roll”?

13. Which of the following increases basis risk?

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15. Which of the following does NOT describe beta?

16. Which of the following is true?

17. Which of the following is necessary for tailing a hedge?

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18. Which of the following is true?

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1. The compounding frequency for an interest rate de7nes

The equivalent rate with con=nuous compounding is ln(1.06) = 0.0583 or 5.83%.

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If the rate is R we must have

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8. Under liquidity preference theory, which of the following is always true?

10. Which of the following is true of the fed funds rate

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13. Which of the following is true of LIBOR

LIBOR is a rate used for interbank transac=ons.