FINA0301 DERIVATIVES

Sample Exam Paper

Dr. Huiyan Qiu

Note: this exam paper serves the purpose of sample paper for both midterm exam and final
exam though here it only tests material covered during the first half of the course. Final exam
will be cumulative with more weight on the materials covered after the midterm exam. Both
midterm exam and final exam have the same format: part I with multiple choice questions
and part II with long questions.

Part I: multiple choice questions. There are 53 points total, 4 points each for questions 1-7
and 5 points each for questions 8-12. If not specified explicitly, interest rate given is per
annum and continuously compounding.

1. All of the positions listed will benefit from a price decline, except:
A. Short put
B. Long put
C. Short call
D. Short stock

2. Assume that you open a 100 share short position in IP, Inc. common stock at the bid-ask
price of $24.00 – $24.50. When you close your position the bid-ask prices are $24.50 –
$25.00. If you pay a commission rate of 0.5%, calculate your profit or loss on the short
investment?
A. $24.50 gain
B. $12.25 loss
C. $124.50 loss
D. $100.00 gain

3. The spot exchange rate of dollars per euro is 0.95. Dollar and euro interest rates are 7.0%
and 6.0%, respectively. The price of a $0.93 strike 6-month call option is $0.08. What is the
price of the $0.93 strike 6-month put?
A. $0.024
B. $0.052
C. $0.056
D. $0.078

4. A 6-month forward contract for corn exists with a price of $1.70 per bushel. If Farmer
Jayne decides to hedge her 20,000 bushels of corn with the forward contract, what is her
profit or loss if spot prices are $1.65 or $1.80 when she sells he crop in 6 months? Her total
costs are $33,000.
 A. $1,000 gain or $1,000 loss
B. $0 gain or $3,000 gain
C. $0 loss or $3,000 loss
D. $1,000 gain or $1,000 gain

5. The forward prices on a barrel of crude oil are $43 and $45 in years one and two,
respectively. The interest rates on zero coupon government bonds are 4.0% and 4.5% in years
one and two, respectively. What is the likely two year swap price on a barrel of crude oil?
A. $43.00
B. $43.98
C. $44.50
D. $45.00

6. The prices of 1, 2, 3, and 4-year zero coupon government bonds are 95.42, 90.36, 85.16,
and 78.81, respectively. What is the implied 2-year non-annualized forward rate between
years 2 and 4?
A. 7.08%
B. 7.33%
C. 12.64%
D. 14.66%

7. An investor purchases a call option with an exercise price of $55 for $2.60. The same
investor sells a call on the same security with an exercise price of $60 for $1.40. At
expiration, 3 months later, the stock price is $56.75. All other things being equal and given an
annual interest rate of 4.0%, what is the net profit or loss to the investor?
A. $1.21 loss
B. $0.54 gain
C. $0.95 gain
D. $1.75 gain

8. Which of the positions can result in the following profit diagram?

Profit

Stock price

A. Buy a call and sell a put with the same strike price, sell a call with higher strike price
B. Sell a put and sell a call with the same strike price, buy a put with lower strike price
C. Sell two calls with the same strike price, buy a call with higher strike price
D. Buy two puts with the same strike price, sell a call with higher strike price

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9. A Forward Rate Agreement contains an agreed effective 6-month interest rate of 3.1% on a
6-month loan. If settled at the time of borrowing, what amount would the borrower pay or
receive on a $500,000 loan if the prevailing 6-month interest rate is 2.9%?
A. $1,000 payment
B. $969.93 payment
C. $971.82 payment
D. $971.82 receipt

10. When selecting among various put options with different strike prices, in order to hedge a
long asset position, which of the following statements is true?
A. Lower strike puts cost less and provide higher floors
B. Lower strike puts cost more and provide higher floors
C. Higher strike puts cost less and provide higher floors
D. Higher strike puts cost more and provide higher floors

11. A strategy consists of longing a put on the market index with a strike of 830 and shorting
a call option on the market index with a strike price of 830. The put premium is $18.00 and
the call premium is $44.00. Interest rates are 0.5% per month. At the expiration 6 months
later, at what price of the market index, the strategy breaks even? i.e., the profit from the
strategy is exactly zero.
A. $803.21
B. $830.00
C. $855.23
D. $856.79

12. HAW, Inc. plans to pay a $1.10 dividend per share in 3 months and a $1.15 dividend in 6
months. HAW’s share price today is $45.60 and the continuously compounded quarterly
interest rate is 2.1%. What is the price of a forward contract, which expires immediately after
the second dividend?
A. $45.28
B. $45.96
C. $45.60
D. $46.24

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Part II Other Questions. Total 47 points.
1. (6 points) Draw the profit diagram of the position consisting of buying an out-of-the-
money call, selling an at-the-money call, buying an out-of-the-money put, and selling an at-
the-money put. (Diagram similar to that in multiple choice question #8 will work. No need to
specify the exact prices and profits.)

2. (7 points) The annualized dividend yield on the S&P Index is 1.4%. The continuously
compounded interest rate is 6.4%. If the 9-month forward price is $925.28 and the index is
priced at $950.46. What arbitrage would you take? What is the profit from the arbitrage
strategy?

3. (10 points) Consider an investment in five S&P 500 Index futures contracts (size per
contract: $250×S&P 500 Index) at a price of $924.80. The initial margin requirement is 15%
and the maintenance margin is 10%. The continuously compounded interest rate is 5%. What
will the futures price need to be for a marginal call to occur one month from now? Assume no
settlement within the month.

4. (12 points) Assume an investor can borrow at 5.1% and lend at 4.9% in domestic currency
(D$), and borrow at 7.1% and lend at 6.9% in foreign currency (F$). (All rates are annual and
with continuous compounding.) Also, the investor can buy F$1 at spot for D$2.01 and sell
F$1 at spot for D$1.99. What is the lowest price at which the investor would be allowed to
buy F$s 1 year forward, without having an arbitrage opportunity? What is the highest price at
which the investor would be allowed to sell F$s 1 year forward? Ignore any other transaction
costs.

5. (12 points) Suppose that the yields on 1-year zero coupon bond, 2-year zero coupon bond,
and 3-year zero coupon bond are 5%, 6%, and 7%, respectively.
a. Compute the implied forward rate from year 1 to year 3.
b. Compute the implied coupon rate for the par 2-year coupon bond that will be issued at
time 1.

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Answers for MC questions:

Problem 1 2 3 4 5 6
Answer A C C D B D
7 8 9 10 11 12
B B C D D A

Short Answers for long questions: (For your reference. It is recommended that students
provide detail solution to the questions during exams instead of short answers as provided
here. Partial credit will be given in the case that final answer is not correct.)

1.

2.
The forward price by formula is $950.46×e(0.064-0.014)×9/12 = $986.78.
The 9-month forward is undervalued. One position is to long the forward: agree to buy at
$925.28 9 month later.
To offset the position, the investor should short sell the S&P Index and invest the proceeds at
the risk-free interest rate.
Time-0 cash flow: $0.
Time-9 cash flow: $956.46×e(0.064-0.014)×9/12 – $925.28 = $61.50.

3.
The initial margin is $924.80×5×250×15% = $173,400
The maintenance margin is $924.80×5×250×10% = $115,600
Suppose the futures price is X for the marginal call to occur, then
$173,400×e0.05×1/12 – ($924.80 – X) ×5×250 < $115,600 Æ X < $877.98
Thus, if the futures price is below $877.98 one month from now, a marginal call will occur.

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4.
For long F$s 1-year forward, the synthetic long contract is borrowing D$s, exchanging into
F$s, and lending out F$s. (Outcome is returning borrowed D$s and getting F$1 one year later.)
F$1 one year later = F$e-0.069 now = D$ e-0.069 x 2.01 now = D$ e-0.069 x 2.01 x e0.051 one year
later
Therefore, the highest price for short forward of F$1 is D$ e-0.069 x 2.01 x e0.051 = D$1.9761
(Otherwise, short forward and take synthetic long forward position to arbitrage.)
Similarly, the lowest price for long forward of F$1 is D$ e-0.071 x 1.99 x e0.049 = D$1.9467
(Otherwise, long forward and take synthetic short forward position to arbitrage.)

5.

1.073
a. [1 + r0 (0,1)][1 + r0 (1,3)]2 = [1 + r0 (0,3)]3 Æ r0 (1,3) = − 1 = 8.0142%
1.05

C 1+ C 1.06 2
b. 1= + and r0 (1,2) = = 7.0095%
1 + r0 (1,2) [1 + r0 (1,3)]2 1.05

Æ C = 7.9754%