Deri TB-1

Fundamentals of Futures and Options Markets, 8e (Hull)
Chapter 1 Introduction
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 time
B) One side has the obligation to buy an asset for a certain price in one year's time
C) One side has the obligation to buy an asset for a certain price at some time during the next
year
D) One side has the obligation to buy an asset for the market price in one year's time
Answer: B
2) Which of the following is NOT true?

A) When a CBOE call option on IBM is exercised, IBM issues more stock
B) An American option can be exercised at any time during its life
C) An call option will always be exercised at maturity if the underlying asset price is greater than
the strike price
D) A put option will always be exercised at maturity if the strike price is greater than the
underlying asset price
Answer: A
3) A one-year call option on a stock with a strike price of $30 costs $3; a one-year put option on
the stock with a strike price of $30 costs $4. Suppose that a trader buys two call options and one
put option. The breakeven stock price above which the trader makes a profit is
A) $35
B) $40
C) $30
D) $36
Answer: A
4) A one-year call option on a stock with a strike price of $30 costs $3; a one-year put option on
the stock with a strike price of $30 costs $4. Suppose that a trader buys two call options and one
put option. The breakeven stock price below which the trader makes a profit is
A) $25
B) $28
C) $26
D) $20
Answer: D
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 times as big as the over-the-counter market
D) The over-the-counter market is ten times as big as the exchange-traded market
Answer: D
1
Copyright © 2014 Pearson Education, Inc.
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 time
C) The price of an asset that has been damaged
D) The price of renting an asset
Answer: A
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 after the contract has been entered
into
D) The contract is worth zero if the price of the asset rises after the contract has been entered into
Answer: B
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
9) Which of the following describes European options?

A) Sold in Europe
B) Priced in Euros
C) Exercisable only at maturity
D) Calls (there are no puts)
Answer: C

A) A call option gives the holder the right to buy an asset by a certain date for a certain price
B) A put option 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 option 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
11) Which of the following is NOT true about call and put options?
A) An American option can be exercised at any time during its life
B) A European option can only be exercised only on the maturity date
C) Investors must pay an upfront price (the option premium) for an option contract
D) The price of a call option increases as the strike price increases
Answer: D
2
12) The price of a stock on July 1 is $57. A trader buys 100 call options on the stock with a strike
price of $60 when the option price is $2. The options are exercised when the stock price is $65.
The trader's net profit is
A) $700
B) $500
C) $300
D) $600
Answer: C
13) The price of a stock on February 1 is $124. A trader sells 200 put options on the stock with a
strike price of $120 when the option price is $5. The options are exercised when the stock price
is $110. The trader's net profit 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
14) The price of a stock on February 1 is $84. A trader buys 200 put options on the stock with a
strike price of $90 when the option price is $10. The options are exercised when the stock price
is $85. The trader's net profit or loss is
A) Loss of $1,000
B) Loss of $2,000
C) Gain of $200
D) Gain of $1000
Answer: A
15) The price of a stock on February 1 is $48. A trader sells 200 put options on the stock with a
strike price of $40 when the option price is $2. The options are exercised when the stock price is
$39. The trader's net profit or loss is
A) Loss of $800
B) Loss of $200
C) Gain of $200
D) Loss of $900
Answer: C
16) A speculator can choose between buying 100 shares of a stock for $40 per share and buying
1000 European call options on the stock with a strike price of $45 for $4 per option. For second
alternative to give a better outcome at the option maturity, the stock price must be above
A) $45
B) $46
C) $55
D) $50
Answer: D
3
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 better outcome than an option
C) An option will always give a better outcome than a forward contract
D) An option can be used to lock in the exchange rate
Answer: A
18) A short forward contract on an asset plus a long position in a European call option on the
asset with a strike price equal to the forward price is equivalent to
A) A short position in a call option
B) A short position in a put option
C) A long position in a put option
D) None of the above
Answer: C
19) A trader has a portfolio worth $5 million that mirrors the performance of a stock index. The
stock index is currently 1,250. Futures contract trade on the index with one contract being on 250
times the index. To remove market risk from the portfolio the trader should
A) Buy 16 contracts
B) Sell 16 contracts
C) Buy 20 contracts
D) Sell 20 contracts
Answer: B
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 parties in the over-the-counter market
C) It is a trader that works for a bank
D) It helps facilitate futures trades
Answer: B

Chapter 2 Mechanics of Futures Markets
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
4
A) Futures contracts nearly always last longer than forward contracts
B) Futures contracts are standardized; forward contracts are not
C) Delivery or final cash settlement usually takes place with forward contracts; the same is not
true of futures contracts
D) Forward contracts usually have one specified delivery date; futures contract often have a
range of delivery dates
Answer: A
3) In the corn futures contract a number of different types of corn can be delivered (with price
adjustments specified by the exchange) and there are a number of different delivery locations.
Which of the following is true?
A) This flexibility tends increase the futures price
B) This flexibility tends decrease the futures price
C) This flexibility may increase and may decrease the futures price
D) This flexibility has no effect on the futures price
Answer: B
4) A company enters into a short futures contract to sell 50,000 units of a commodity for 70
cents per unit. The initial 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
5) A company enters into a long futures contract to buy 1,000 units of a commodity for $60 per
unit. The initial 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?
5
A) $58
B) $62
C) $64
D) $66
Answer: B
6
6) One futures contract is traded where both the long and short parties are closing out existing
positions. 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
7) Who initiates delivery in a corn futures contract?

A) The party with the long position
B) The party with the short position
C) Either party
D) The exchange
Answer: B
8) You sell one December futures contracts when the futures price is $1,010 per unit. Each
contract is on 100 units and the initial 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: A
9) A hedger takes a long position in a futures contract on a commodity on November 1, 2012 to

hedge an exposure on March 1, 2013. The initial 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 accounting year January 1 to December 31, 2013? Each contract
is on 1000 units of the commodity.
A) $0
7
B) $1,000
C) $3,000
D) $4,000
Answer: D
10) A speculator takes a long position in a futures contract on a commodity on November 1,

2012 to hedge an exposure on March 1, 2013. The initial 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 accounting 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: C
11) The frequency with which margin accounts are adjusted for gains and losses is
A) Daily
B) Weekly
C) Monthly
D) Quarterly
Answer: A
12) Margin accounts have the effect of

A) Reducing the risk of one party regretting the deal and backing out
B) Ensuring funds are available to pay traders when they make a profit
C) Reducing systemic risk due to collapse of futures markets
D) All of the above
Answer: D
8
13) Which entity in the United States takes primary responsibility for regulating futures market?
A) Federal Reserve Board
B) Commodities Futures Trading Commission (CFTC)
C) Security and Exchange Commission (SEC)
D) US Treasury
Answer: B
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
A) Higher
B) Lower
C) The same
D) Equally likely to be higher or lower
Answer: A
15) Clearing houses are

A) Never used in futures markets and sometimes used in OTC markets
B) Used in OTC markets, but not in futures markets
C) Sometimes used in both futures markets and OTC markets
D) Always used in both futures markets and OTC markets
Answer: C
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 satisfy a
collateral request
B) A bond with a face value of $100 is considered to be worth $80 when used to satisfy a
collateral request
C) A bond with a market value of $100 is considered to be worth $83.3 when used to satisfy a
collateral request
9
D) A bond with a face value of $100 is considered to be worth $83.3 when used to satisfy a
collateral request
Answer: A
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
18) Which of the following best describes central clearing parties?

A) Help market participants to value derivative transactions
B) Must be used for all OTC derivative transactions
C) Are used for futures transactions
D) Perform a similar function to exchange clearing houses
Answer: D
19) Which of the following are cash settled?

A) All futures contracts
B) All option contracts
C) Futures on commodities
D) Futures on stock indices
Answer: D
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 specified price or one more favorable to the investor
10
C) Is an order that must be executed within a specified period of time
Answer: B

Chapter 3 Hedging Strategies Using Futures
1) The basis is defined as spot minus futures. A trader is hedging the sale of an asset with a short
futures position. The basis increases unexpectedly. Which of the following is true?
A) The hedger's position improves
B) The hedger's position worsens
C) The hedger's position sometimes worsens and sometimes improves
D) The hedger's position stays the same
Answer: A
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
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 position
on July 1. What is the effective price (after taking account of hedging) paid by the company?
A) $59.50
B) $60.50
C) $61.50
11
D) $63.50
Answer: A
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 position on November 1. What is the effective price
(after taking account of hedging) received by the company for the commodity?
A) $1,016
B) $1,001
C) $981
D) $1,014
Answer: D
12
5) Suppose that the standard deviation of monthly changes in the price of commodity A is $2.
The standard deviation of monthly changes in a futures price for a contract on commodity B
(which is similar to commodity A) is $3. The correlation between the futures price and the
commodity price is 0.9. What hedge ratio 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
6) A company has a $36 million portfolio with a beta of 1.2. The futures price for a contract on
an index is 900. Futures contracts on $250 times 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 increase beta to 1.8?
Answer: C

A) The optimal hedge ratio is the slope of the best fit line when the spot price (on the y-axis) is
regressed against the futures price (on the x-axis).
13
B) The optimal hedge ratio is the slope of the best fit line when the futures price (on the y-axis)
is regressed against the spot price (on the x-axis).
C) The optimal hedge ratio is the slope of the best fit 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 optimal hedge ratio is the slope of the best fit 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
9) Which of the following describes tailing the hedge?

A) A strategy where the hedge position is increased at the end of the life of the hedge
B) A strategy where the hedge position is increased at the end of the life of the futures contract
C) A more exact calculation of the hedge ratio when forward contracts are used for hedging
Answer: D
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 better 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 floor for the exchange rate that will be paid
Answer: B
11) Which of the following best describes the capital asset pricing model?
A) Determines the amount of capital that is needed in particular situations
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 volatility of a stock index
Answer: C
14
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
different maturity
D) Involves two different exposures simultaneously
Answer: A
13) Which of the following increases basis risk?

A) A large difference 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 reduction in the time between the date when the futures contract is closed and its delivery
month
Answer: B
14) Which of the following is a reason for hedging a portfolio with an index futures?
A) The investor believes the stocks in the portfolio will perform better than the market but is
uncertain about the future performance of the market
B) The investor believes the stocks in the portfolio will perform better than the market and the
market is expected to do well
C) The portfolio is not well diversified and so its return is uncertain
D) All of the above
Answer: A
15
15) Which of the following does NOT describe beta?
A) A measure of the sensitivity of the return on an asset to the return on an index
B) The slope of the best fit line when the return on an asset is regressed against the return on the
market
C) The hedge ratio necessary to remove market risk from a portfolio
D) Measures correlation between futures prices and spot prices
Answer: D

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

A) Comparing the size in units of the position being hedged with the size in units of the futures
contract
B) Comparing the value of the position being hedged with the value of one futures contract
C) Comparing the futures price of the asset being hedged to its forward price
Answer: B

A) Gold producers should always hedge the price they will receive for their production of gold
over the next three years
B) Gold producers should always hedge the price they will receive for their production of gold
over the next one year
16
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
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 dramatically
B) It is liable to experience liquidity problems if the price of silver rises dramatically
C) It is liable to experience liquidity problems if the price of silver rises dramatically or falls
dramatically
D) The operation of futures markets protects it from liquidity problems
Answer: B
17
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. Spot price and futures price are currently $100 and $90.
The one year futures price of the commodity is $90. If the spot price and the futures price in one
year turn out to be $112 and $110 respectively, what is the average price paid for the
commodity?
A) $92
B) $96
C) $102
D) $106
Answer: B

Chapter 4 Interest Rates
1) The compounding frequency for an interest rate defines

A) The frequency with which interest is paid
B) A unit of measurement for the interest rate
C) The relationship between the annual interest rate and the monthly interest rate
Answer: B
2) An interest rate is 6% per annum with annual compounding. What is the equivalent rate with
continuous compounding?
A) 5.79%
B) 6.21%
C) 5.83%
D) 6.18%
Answer: C
3) An interest rate is 5% per annum with continuous compounding. What is the equivalent rate
with semiannual compounding?
A) 5.06%
B) 5.03%
C) 4.97%
D) 4.94%
Answer: A
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%
18
Answer: A
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 continuously compounded.
A) 6.75%
B) 7.0%
C) 7.25%
D) 7.5%
Answer: D
19
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
continuously compounded zero rate?
A) 8.02%
B) 8.52%
C) 9.02%
D) 9.52%
Answer: C
7) The yield curve is flat 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
starting in two years? All rates are compounded semiannually.
A) $9.12
B) $9.02
C) $8.88
D) $8.63
Answer: D
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
9) The zero curve is upward sloping. Define 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
10) Prior to the credit crisis that started in 2007 which of the following was the proxy used by
derivatives traders for the risk-free rate?
A) The Treasury rate
B) The LIBOR rate
C) The repo rate
D) The overnight indexed swap rate
Answer: B
20
11) Since the credit crisis that started in 2007 which of the following have derivatives traders
started to use as the risk-free rate for some transactions?
B) The LIBOR rate
C) The repo rate
Answer: D
12) At what interest rate does a government borrow in its own currency?
A) Treasury rate
B) LIBOR
C) LIBID
D) Repo rate
Answer: A
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
14) Which of following describes forward rates?

A) Interest rates implied by current zero rates for future periods of time
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 hto 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 flows
Answer: A
15) Given a choice between 5-year and 1-year instruments most people would choose 5-year
instruments when borrowing and 1-year instruments when lending. Which of the following is a
theory consistent with this observation?
A) Expectations theory
B) Market segmentation theory
C) Liquidity preference theory
D) Maturity preference theory
Answer: C
16) A repo rate is

A) An uncollateralized rate
B) A rate where the credit risk is relatively high
C) The rate implicit in a transaction where securities are sold and bought back at a higher price
Answer: C
21
17) Bootstrapping involves
A) Calculating 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 calculation of par yields
Answer: B
18) The zero curve is downward sloping. Define 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?
Answer: D

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
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

Chapter 5 Determination of Forward and Futures Prices
1) Which of the following is a consumption asset?

A) The S&P 500 index
B) The Canadian dollar
C) Copper
22
D) IBM stock
Answer: C
2) An investor shorts 100 shares when the share price is $50 and closes out the position 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
3) The spot price of an investment asset that provides no income is $30 and the risk-free rate for
all maturities (with continuous compounding) is 10%. What is the three-year forward price?
A) $40.50
B) $22.22
C) $33.00
D) $33.16
Answer: A
4) The spot price of an investment asset is $30 and the risk-free rate for all maturities is 10%
with continuous compounding. The asset provides an income of $2 at the end of the first 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
D) $40.50
Answer: B
23
5) An exchange rate is 0.7000 and the six-month domestic and foreign risk-free interest rates are
5% and 7% (both expressed with continuous compounding). What is the six-month forward rate?
A) 0.7070
B) 0.7177
C) 0.7249
D) 0.6930
Answer: D
24
A) The convenience yield is always positive or zero
B) The convenience yield is always positive for an investment asset
C) The convenience yield is always negative for a consumption asset
D) The convenience yield measures the average return earned by holding futures contracts
Answer: A
7) A short forward contract that was negotiated some time 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 continuous 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
8) The spot price of an asset is positively 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 sometimes greater and sometimes less than the expected future spot
price
Answer: C
9) Which of the following describes the way the futures 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 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
25
D) There are no quotation conventions for futures prices
Answer: A
10) Which of the following describes the way the forward price of a foreign currency is quoted?
C) Some forward prices are always quoted as the number of U.S. dollars per unit of the foreign
D) There are no quotation conventions for forward prices
Answer: C
26
11) Which of the following is NOT a reason why a short position in a stock is closed out?
A) The investor with the short position chooses to close out the position
B) The lender of the shares issues instructions to close out the position
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) Gold and silver are investment assets
B) Investment assets are held by significant numbers of investors for investment purposes
C) Investment assets are never held for consumption
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
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
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
27
C) In theory forward prices and futures prices are equal when there is no uncertainty about future
interest rates
D) Taxes and transaction costs can lead to forward and futures prices being different
Answer: A
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
28
16) As inventories of a commodity decline, which of the following is true?
Answer: B
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 time when dividends are paid are
known
D) Dividends will yield a certain return to a person buying the stock today
Answer: C
18) Which of the following is an argument used by Keynes and Hicks?

A) If hedgers hold long positions and speculators holds short positions, the futures price will tend
to be higher than expected future spot prices
B) If hedgers hold long positions and speculators holds short positions, the futures price will tend
to be lower than expected future spot prices
C) If hedgers hold long positions and speculators holds short positions, the futures price will tend
to be lower than today's spot prices
D) If hedgers hold long positions and speculators holds short positions, the futures price will tend
to be higher than today's spot prices
Answer: 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 function of the time to maturity
29
D) The futures price is above the expected future spot price
Answer: D
20) Which of the following is true for a consumption commodity?

A) There is no limit to how high or low the futures price can be, except that the futures price
cannot be negative
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 negative
D) The futures price can be determined with reasonable accuracy from the spot price and interest
rates
Answer: C

Chapter 6 Interest Rate Futures
1) Which of the following is applicable to corporate bonds in the United States?

A) Actual/360
B) Actual/Actual
C) 30/360
D) Actual/365
Answer: C
2) It is May 1. The quoted price of a bond with an Actual/Actual (in period) 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
30
Answer: C
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
Answer: A
4) The most recent settlement 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
Answer: C
5) Which of the following is NOT an option open to the party with a short position in the
Treasury bond futures contract?
A) The ability to deliver any of a number of different bonds
B) The wild card play
C) The fact that delivery can be made any time during the delivery month
D) The interest rate used in the calculation of the conversion factor
Answer: D
31
6) A trader enters into a long position 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
Answer: B
7) A company invests $1,000 in a five-year zero-coupon bond and $4,000 in a ten-year zero-
coupon bond. What is the duration of the portfolio?
A) 6 years
B) 7 years
C) 8 years
D) 9 years
Answer: D
8) The modified duration of a bond portfolio worth $1 million is 5 years. By approximately how
much does the value of the portfolio 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
9) A portfolio 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 duration of the bond that is expected to be cheapest to deliver is 6 years and the duration of
the portfolio will be 5.5 years. How many contracts are necessary for hedging the portfolio?
A) 100
B) 200
C) 300
32
D) 400
Answer: B

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 corresponding
forward rate
D) The futures rates calculated from a Eurodollar futures quote are sometimes greater than and
sometimes less than the corresponding forward rate
Answer: B
33
11) How much is a basis point?
A) 1.0%
B) 0.1%
C) 0.01%
D) 0.001%
Answer: C
12) Which of the following day count conventions applies to a US Treasury bond?
A) Actual/360
B) Actual/Actual (in period)
C) 30/360
D) Actual/365
Answer: B
13) What is the quoted discount rate on a money market instrument?

A) The interest rate earned as a percentage of the final face value of a bond
B) The interest rate earned as a percentage of the initial 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 flows from a bond
Answer: A
14) Which of the following is closest to the duration of a 2-year bond that pays a coupon of 8%
per annum semiannually? The yield on the bond is 10% per annum with continuous
compounding.
A) 1.82
B) 1.85
C) 1.88
D) 1.92
Answer: C
34
15) Which of the following is NOT true about duration?
A) It equals the years-to-maturity for a zero coupon bond
B) It equals the weighted average of payment times for a bond, where weights are proportional to
the present value of payments
C) Equals the weighted average of individual bond durations for a portfolio, where weights are
proportional to the present value of bond prices
D) The prices of two bonds with the same duration change by the same percentage amount when
interest rate move up by 100 basis points
Answer: D
16) The conversion factor for a bond is approximately

A) The price it would have if all cash flows 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 flows were discounted at 8% per annum
D) The price it would have if it paid coupons at 8% per annum
Answer: A
17) The time-to-maturity of a Eurodollars futures contract is 4 years, and the time-to-maturity of
the rate underlying the futures contract is 4.25 years. The standard deviation of the change in the
short term interest rate, σ = 0.011. What is the difference between the futures and the forward
interest rate?
A) 0.105%
B) 0.103%
C) 0.098%
D) 0.093%
Answer: B
18) A trader uses 3-month Eurodollar futures to lock in a rate on $5 million for six months. How
many contracts are required?
35
A) 5
B) 10
C) 15
D) 20
Answer: B
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
Answer: C
20) Duration matching immunizes a portfolio against

A) Any parallel shift in the yield curve
B) All shifts in the yield curve
C) Changes in the steepness of the yield curve
D) Small parallel shifts in the yield curve
Answer: D

Chapter 7 Swaps
1) A company can invest funds for five years at LIBOR minus 30 basis points. The five-year
swap rate is 3%. What fixed rate of interest can the company earn by using the swap?
A) 2.4%
B) 2.7%
C) 3.0%
D) 3.3%
Answer: B
36
A) Principals are not usually exchanged in a currency swap
B) The principal amounts usually flow in the opposite direction to interest payments at the
beginning of a currency swap and in the same direction as interest payments at the end of the
swap
C) The principal amounts usually flow in the same direction as interest payments at the
beginning of a currency swap and in the opposite direction to interest payments at the end of the
swap
D) Principals are not usually specified in a currency swap
Answer: B
3) Which of the following is a way of valuing interest rate swaps where LIBOR is exchanged for
a fixed rate of interest?
A) Assume that floating payments will equal forward LIBOR rates and discount net cash flows
at the risk-free rate
B) Assume that floating payments will equal forward OIS rates and discount net cash flows at
the risk-free rate
C) Assume that floating payments will equal forward LIBOR rates and discount net cash flows at
the swap rate
D) Assume that floating payments will equal forward OIS rates and discount net cash flows at
the swap rate
Answer: A
4) Which of the following describes the five-year swap rate?

A) The fixed rate of interest which a swap market maker is prepared to pay in exchange for
LIBOR on a 5-year swap
B) The fixed rate of interest which a swap market maker is prepared to receive in exchange for
C) The average of A and B
D) The higher of A and B
Answer: C
37
38
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 situations where the tax rates in two countries are different
D) All of the above
Answer: D

A) OIS rates are less than the corresponding LIBOR rates
B) OIS rates are greater than corresponding LIBOR rates
C) OIS rates are sometimes greater and sometimes less than LIBOR rates
D) OIS rates are equivalent to one-day LIBOR rates
Answer: A
7) Which of the following describes an interest rate swap?

A) The exchange of a fixed rate bond for a floating rate bond
B) A portfolio of forward rate agreements
C) An agreement to exchange interest at a fixed rate for interest at a floating rate
D) All of the above
Answer: D
8) Which of the following is true for an interest rate swap?

A) A swap is usually worth close to zero when it is first negotiated
B) Each forward rate agreement underlying a swap is worth close to zero when the swap is first
entered into
C) Comparative advantage is a valid reason for entering into the swap
Answer: A
39
9) Which of the following is true for the party paying fixed in an interest rate swap?
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 financial institution is used as the intermediary
Answer: A
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 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 collateralized swaps
Answer: D
40
11) When LIBOR is used as the discount rate
A) The value of a swap is worth zero immediately after a coupon payment
B) The value of a swap is worth zero immediately before a coupon payment
C) The value of the floating rate bond underlying a swap is worth par immediately after a coupon
payment
D) The value of the floating rate bond underlying a swap is worth par immediately before a
coupon payment
Answer: C
12) A company enters into an interest rate swap where it is paying fixed 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
Answer: A
13) A floating for floating currency swap is equivalent to

A) Two interest rate swaps, one in each currency
B) A fixed-for-fixed currency swap and one interest rate swap
C) A fixed-for-fixed currency swap and two interest rate swaps, one in each currency
Answer: C
14) A floating-for-fixed currency swap is equivalent to

41
Answer: B
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 LIBOR discounting is used?
A) 0.00
B) 2.66
C) 2.06
D) 1.06
Answer: B
42
16) A semi-annual pay interest rate swap where the fixed 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% (continuously compounded) respectively. 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 fixed rate of interest?
A) $74,250
B) -$70,760
C) -$11,250
D) $103,790
Answer: B
17) Which of the following describes the way a LIBOR-in-arrears swap differs 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 floating interest is paid until the end of the life of the swap in a LIBOR-in-arrears swap,
but fixed payments are made throughout the life of the swap
D) Neither floating nor fixed payments are made until the end of the life of the swap
Answer: A
18) Which of the following describes a 3-month overnight indexed swap (OIS)?
A) A fixed 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 arithmetic average of overnight rates is exchanged for a fixed rate at the end of three
months
D) The geometric average of overnight rates is exchanged for a fixed rate at the end of three
months
Answer: D
19) Which of the following is a typical bid-offer spread on the swap rate for a plain vanilla
interest rate swap?
43
A) 3 basis points
B) 8 basis points
C) 13 basis points
D) 18 basis points
Answer: A

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

Chapter 8 Securitization and the Credit Crisis of 2007
1) Which of the following tends to lead to an increase in house prices?

A) An increase in interest rates
B) Regulators specifying a maximum level for the loan-to-value ratio on mortgages
C) Banks reducing the minimum FICO score that borrowers are required to have
D) An increase in foreclosures
Answer: C
2) Which of the following is true of a non-recourse mortgage?

A) The house buyer, if unable to make payments, can lose all possessions
B) The house buyer has an American style put option on the house
C) The house buyer has a European style put option on the house
44
D) The lender is less likely to lose money on the mortgage
Answer: B

A) The bonus structure at banks can lead to short-term horizons for decision making
B) Securitization involves the transfer of risk
C) The term "agency costs" describes the situation where the incentives of two parties in a
business relationship are not perfectly aligned
D) Correlations decrease in stressed market conditions
Answer: D
4) Suppose that ABSs are created from portfolios of subprime mortgages with the following
allocation of the principal to tranches: senior 80%, mezzanine 10%, and equity 10%. (The
portfolios of subprime mortgages have the same default rates.) An ABS CDO is then created
from the mezzanine tranches with the same allocation of principal. Losses on the mortgage
portfolio prove to be 16%. What, as a percent of tranche principal, are losses on the mezzanine
tranche of the ABS?
A) 50%
B) 60%
C) 80%
D) 100%
Answer: B
45
tranche of the ABS CDO?
A) 50%
B) 60%
C) 80%
D) 100%
Answer: D
portfolio prove to be 16%. What, as a percent of tranche principal, are losses on the senior
A) 50%
B) 60%
C) 80%
D) 100%
Answer: A
7) AIG lost money because

A) It bought tranches created from mortgages
B) It invested heavily in real estate
C) It invested heavily in the stock market
D) It insured AAA tranches of ABS CDOs
Answer: D
8) Which of the following survived the crisis without declaring bankruptcy or being taken over
by another financial institution?
46
A) Bear Stearns
B) Morgan Stanley
C) Lehman Brothers
D) Merrill Lynch
Answer: B
9) What are teaser rates?

A) Interest rates that appear lower than they are
B) Interest rates that depend on LIBOR
C) Interest rates on mortgages with a very long amortization period
D) Interest rates that apply only for the first two or three years
Answer: D
47
10) Which of the following describes a waterfall?
A) A distribution of cash flows to tranches with priority given to tranche with the highest rating
B) A distribution of cash flows to tranches in proportion to their outstanding principals
C) A distribution of losses to tranches so that tranches bear losses in proportion to their
outstanding principals
Answer: A
11) In 2008 the LIBOR-OIS spread reached a high of

A) 164 basis points
B) 264 basis points
C) 364 basis points
D) 464 basis points
Answer: C
12) Which of the following were introduced before the credit crisis that started in 2007?
A) Basel II
B) Dodd-Frank
C) Basel III
D) Requirements for living wills
Answer: A
13) Which of the following is true as the correlation between mortgage defaults increases?
A) Equity tranches are almost certain to incur losses
B) Senior tranches become more likely to incur losses
C) The expected number of defaults increases
D) Equity tranches are unaffected
Answer: B
48
14) Which of the following describes the S&P/Case-Shiller index?
A) A stock market index
B) An index of interest rates on mortgages
C) An index of house prices
D) An index showing the dollar amount of mortgages granted each month
Answer: C
from the mezzanine tranches with the same allocation of principal. How high can losses on the
mortgages be before the mezzanine tranche of the ABD CDO bears losses?
A) 5.0%
B) 5.5%
C) 6.0%
D) 6.5%
Answer: B
mortgages be before the senior tranche of the ABS CDO bears losses?
A) 5.5%
B) 6.0%
C) 6.5%
D) 7.0%
Answer: C
allocation of the principal to tranches: senior 94.5% (rated AAA), mezzanine 0.1% (rated BBB),
and equity 5% (rated C). The portfolios of subprime mortgages have the same default rates. An
49
ABS CDO is then created from the mezzanine tranches. Which of the following is true?
A) The ABS CDO tranches should have similar ratings ranging from AAA to C
B) The ABS CDO tranches should all be rated BBB
C) The ABS CDO tranches should all be rated C
D) The ABS CDO tranches are almost worthless because the mezzanine tranches are so thin
Answer: B
18) Which of the following describes regulatory arbitrage?

A) Finding a way of reducing capital requirements without changing the risks being taken
B) Buying products that are not subject to regulation
C) Shorting products that are not subject to regulation
D) Trading with the government
Answer: A
19) Which of the following describes a subprime mortgage?

A) The rate of interest is less than the prime rate of interest
B) The loan-to-value ratio is below average
C) The life of the mortgage is less than 25 years
D) The credit risk is high
Answer: D
20) Which of the following would be described by the term "liar loan"?
A) A situation where the lender concealed information from the borrower
B) A situation where the lender lied to the borrower about the interest rate
C) A situation where the borrower lied about his or her income
Answer: C
50
Chapter 9 Mechanics of Options Markets
1) Which of the following describes a call option?

A) The right to buy an asset for a certain price
B) The obligation to buy an asset for a certain price
C) The right to sell an asset for a certain price
D) The obligation to sell an asset for a certain price
Answer: A

A) A long call is the same as a short put
B) A short call is the same as a long put
C) A call on a stock plus a stock the same as a put
Answer: D
3) An investor has exchange-traded put options to sell 100 shares for $20. There is a 2 for 1 stock
split. Which of the following is the position of the investor after the stock split?
A) Put options to sell 100 shares for $20
B) Put options to sell 100 shares for $10
C) Put options to sell 200 shares for $10
D) Put options to sell 200 shares for $20
Answer: C
4) An investor has exchange-traded put options to sell 100 shares for $20. There is 25% stock
dividend. Which of the following is the position of the investor after the stock dividend?
51
Answer: D
5) An investor has exchange-traded put options to sell 100 shares for $20. There is a $1 cash
dividend. Which of the following is then the position of the investor?
A) The investor has put options to sell 100 shares for $20
B) The investor has put options to sell 100 shares for $19
C) The investor has put options to sell 105 shares for $19
D) The investor has put options to sell 105 shares for $19.05
Answer: A
6) Which of the following describes a short position in an option?

A) A position in an option lasting less than one month
B) A position in an option lasting less than three months
C) A position in an option lasting less than six months
D) A position where an option has been sold
Answer: D
7) Which of the following describes a difference between a warrant and an exchange-traded

stock option?
A) In a warrant issue, someone has guaranteed the performance of the option seller in the event
that the option is exercised
B) The number of warrants is fixed whereas the number of exchange-traded options in existence
depends on trading
C) Exchange-traded stock options have a strike price
D) Warrants cannot be traded after they have been purchased
Answer: B
8) Which of the following describes LEAPS?

52
A) Options which are partly American and partly European
B) Options where the strike price changes through time
C) Exchange-traded stock options with longer lives than regular exchange-traded stock options
D) Options on the average stock price during a period of time
Answer: C
9) Which of the following is an example of an option class?

A) All calls on a certain stock
B) All calls with a particular strike price on a certain stock
C) All calls with a particular time to maturity on a certain stock
D) All calls with a particular time to maturity and strike price on a certain stock
Answer: A
10) Which of the following is an example of an option series?

Answer: D
11) Which of the following must post margin?

A) The seller of an option
B) The buyer of an option
C) The seller and the buyer of an option
D) Neither the seller nor the buyer of an option
Answer: A
53
12) Which of the following describes a long position in an option?
A) A position where there is more than one year to maturity
B) A position where there is more than five years to maturity
C) A position where an option has been purchased
D) A position that has been held for a long time
Answer: C
54
13) Which of the following is NOT traded by the CBOE?
A) Weeklys
B) Monthlys
C) Binary options
D) DOOM options
Answer: B
14) When a six-month option is purchased

A) The price must be paid in full
B) Up to 25% of the option price can be borrowed using a margin account
C) Up to 50% of the option price can be borrowed using a margin account
D) Up to 75% of the option price can be borrowed using a margin account
Answer: A
15) Which of the following are true for CBOE stock options?
A) There are no margin requirements
B) The initial margin and maintenance margin are determined by formulas and are equal
C) The initial margin and maintenance margin are determined by formulas and are different
D) The maintenance margin is usually about 75% of the initial margin
Answer: B
16) The price of a stock is $67. A trader sells 5 put option contracts on the stock with a strike
What is the trader's net profit or loss?
A) Loss of $1,500
B) Loss of $500
C) Gain of $1,500
D) Loss of $1,000
Answer: C
55
17) A trader buys a call and sells a put with the same strike price and maturity date. What is the
position equivalent to?
A) A long forward
B) A short forward
C) Buying the asset
Answer: A
18) The price of a stock is $64. A trader buys 1 put option contract on the stock with a strike
price of $60 when the option price is $10. When does the trader make a profit?
A) When the stock price is below $60
B) When the stock price is below $64
C) When the stock price is below $54
D) When the stock price is below $50
Answer: D
56
19) Consider a put option and a call option with the same strike price and time to maturity.
A) It is possible for both options to be in the money
B) It is possible for both options to be out of the money
C) One of the options must be in the money
D) One of the options must be either in the money or at the money
Answer: D
20) In which of the following cases is an asset NOT considered constructively sold?
A) The owner shorts the asset
B) The owner buys an in-the-money put option on the asset
C) The owner shorts a forward contract on the asset
D) The owner shorts a futures contract on the stock
Answer: B
57
Chapter 2 Mechanics of Futures Markets

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

A) Futures contracts nearly always last longer than forward contracts
B) Futures contracts are standardized; forward contracts are not
C) Delivery or final cash settlement usually takes place with forward contracts; the same is not
true of futures contracts
D) Forward contracts usually have one specified delivery date; futures contract often have a
range of delivery dates
Answer: A
3) In the corn futures contract a number of different types of corn can be delivered (with price
adjustments specified by the exchange) and there are a number of different delivery locations.
A) This flexibility tends increase the futures price
B) This flexibility tends decrease the futures price
C) This flexibility may increase and may decrease the futures price
D) This flexibility has no effect on the futures price
Answer: B
4) A company enters into a short futures contract to sell 50,000 units of a commodity for 70
cents per unit. The initial 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
5) A company enters into a long futures contract to buy 1,000 units of a commodity for $60 per
unit. The initial 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
1
6) One futures contract is traded where both the long and short parties are closing out existing
positions. 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
7) Who initiates delivery in a corn futures contract?

A) The party with the long position
B) The party with the short position
C) Either party
D) The exchange
Answer: B
8) You sell one December futures contracts when the futures price is $1,010 per unit. Each
contract is on 100 units and the initial 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: A
9) A hedger takes a long position in a futures contract on a commodity on November 1, 2012 to

hedge an exposure on March 1, 2013. The initial 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 accounting 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
10) A speculator takes a long position in a futures contract on a commodity on November 1,

2012 to hedge an exposure on March 1, 2013. The initial 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 accounting 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: C
2
11) The frequency with which margin accounts are adjusted for gains and losses is
A) Daily
B) Weekly
C) Monthly
D) Quarterly
Answer: A
12) Margin accounts have the effect of

A) Reducing the risk of one party regretting the deal and backing out
B) Ensuring funds are available to pay traders when they make a profit
C) Reducing systemic risk due to collapse of futures markets
D) All of the above
Answer: D
13) Which entity in the United States takes primary responsibility for regulating futures market?
A) Federal Reserve Board
B) Commodities Futures Trading Commission (CFTC)
C) Security and Exchange Commission (SEC)
D) US Treasury
Answer: B
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
A) Higher
B) Lower
C) The same
D) Equally likely to be higher or lower
Answer: A
15) Clearing houses are

A) Never used in futures markets and sometimes used in OTC markets
B) Used in OTC markets, but not in futures markets
C) Sometimes used in both futures markets and OTC markets
D) Always used in both futures markets and OTC markets
Answer: C
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 satisfy a
collateral request
B) A bond with a face value of $100 is considered to be worth $80 when used to satisfy a
collateral request
C) A bond with a market value of $100 is considered to be worth $83.3 when used to satisfy a
collateral request
D) A bond with a face value of $100 is considered to be worth $83.3 when used to satisfy a
collateral request
Answer: A
3
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
18) Which of the following best describes central clearing parties?

A) Help market participants to value derivative transactions
B) Must be used for all OTC derivative transactions
C) Are used for futures transactions
D) Perform a similar function to exchange clearing houses
Answer: D
19) Which of the following are cash settled?

A) All futures contracts
B) All option contracts
C) Futures on commodities
D) Futures on stock indices
Answer: D
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 specified price or one more favorable to the investor
C) Is an order that must be executed within a specified period of time
Answer: B
4
Chapter 3 Hedging Strategies Using Futures
1) The basis is defined as spot minus futures. A trader is hedging the sale of an asset with a short
futures position. The basis increases unexpectedly. Which of the following is true?
A) The hedger's position improves
B) The hedger's position worsens
C) The hedger's position sometimes worsens and sometimes improves
D) The hedger's position stays the same
Answer: A
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
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 position
on July 1. What is the effective price (after taking account of hedging) paid by the company?
A) $59.50
B) $60.50
C) $61.50
D) $63.50
Answer: A
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 position on November 1. What is the effective price
(after taking account of hedging) received by the company for the commodity?
A) $1,016
B) $1,001
C) $981
D) $1,014
Answer: D
1
5) Suppose that the standard deviation of monthly changes in the price of commodity A is $2.
The standard deviation of monthly changes in a futures price for a contract on commodity B
(which is similar to commodity A) is $3. The correlation between the futures price and the
commodity price is 0.9. What hedge ratio 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
to reduce beta to 0.9?
Answer: D
to increase beta to 1.8?
Answer: C

A) The optimal hedge ratio is the slope of the best fit line when the spot price (on the y-axis) is
regressed against the futures price (on the x-axis).
B) The optimal hedge ratio is the slope of the best fit line when the futures price (on the y-axis)
is regressed against the spot price (on the x-axis).
C) The optimal hedge ratio is the slope of the best fit 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 optimal hedge ratio is the slope of the best fit 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
9) Which of the following describes tailing the hedge?

A) A strategy where the hedge position is increased at the end of the life of the hedge
B) A strategy where the hedge position is increased at the end of the life of the futures contract
C) A more exact calculation of the hedge ratio when forward contracts are used for hedging
Answer: D
2
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 better 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 floor for the exchange rate that will be paid
Answer: B
11) Which of the following best describes the capital asset pricing model?
A) Determines the amount of capital that is needed in particular situations
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 volatility of a stock index
Answer: C
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
different maturity
D) Involves two different exposures simultaneously
Answer: A
13) Which of the following increases basis risk?

A) A large difference 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 reduction in the time between the date when the futures contract is closed and its delivery
month
Answer: B
14) Which of the following is a reason for hedging a portfolio with an index futures?
A) The investor believes the stocks in the portfolio will perform better than the market but is
uncertain about the future performance of the market
B) The investor believes the stocks in the portfolio will perform better than the market and the
market is expected to do well
C) The portfolio is not well diversified and so its return is uncertain
D) All of the above
Answer: A
3
15) Which of the following does NOT describe beta?
A) A measure of the sensitivity of the return on an asset to the return on an index
B) The slope of the best fit line when the return on an asset is regressed against the return on the
market
C) The hedge ratio necessary to remove market risk from a portfolio
D) Measures correlation between futures prices and spot prices
Answer: D

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

A) Comparing the size in units of the position being hedged with the size in units of the futures
contract
B) Comparing the value of the position being hedged with the value of one futures contract
C) Comparing the futures price of the asset being hedged to its forward price
Answer: B

A) Gold producers should always hedge the price they will receive for their production of gold
over the next three years
B) Gold producers should always hedge the price they will receive for their production 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
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 dramatically
B) It is liable to experience liquidity problems if the price of silver rises dramatically
C) It is liable to experience liquidity problems if the price of silver rises dramatically or falls
dramatically
D) The operation of futures markets protects it from liquidity problems
Answer: B
4
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. Spot price and futures price are currently $100 and $90.
The one year futures price of the commodity is $90. If the spot price and the futures price in one
year turn out to be $112 and $110 respectively, what is the average price paid for the
commodity?
A) $92
B) $96
C) $102
D) $106
Answer: B
5
Chapter 4 Interest Rates
1) The compounding frequency for an interest rate defines

A) The frequency with which interest is paid
B) A unit of measurement for the interest rate
C) The relationship between the annual interest rate and the monthly interest rate
Answer: B
2) An interest rate is 6% per annum with annual compounding. What is the equivalent rate with
continuous compounding?
A) 5.79%
B) 6.21%
C) 5.83%
D) 6.18%
Answer: C
3) An interest rate is 5% per annum with continuous compounding. What is the equivalent rate
with semiannual compounding?
A) 5.06%
B) 5.03%
C) 4.97%
D) 4.94%
Answer: A
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
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 continuously compounded.
A) 6.75%
B) 7.0%
C) 7.25%
D) 7.5%
Answer: D
1
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
continuously compounded zero rate?
A) 8.02%
B) 8.52%
C) 9.02%
D) 9.52%
Answer: C
7) The yield curve is flat 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
starting in two years? All rates are compounded semiannually.
A) $9.12
B) $9.02
C) $8.88
D) $8.63
Answer: D
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
9) The zero curve is upward sloping. Define 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?
Answer: A
10) Prior to the credit crisis that started in 2007 which of the following was the proxy used by
derivatives traders for the risk-free rate?
B) The LIBOR rate
C) The repo rate
Answer: B
2
11) Since the credit crisis that started in 2007 which of the following have derivatives traders
started to use as the risk-free rate for some transactions?
B) The LIBOR rate
C) The repo rate
Answer: D
12) At what interest rate does a government borrow in its own currency?
A) Treasury rate
B) LIBOR
C) LIBID
D) Repo rate
Answer: A
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
14) Which of following describes forward rates?

A) Interest rates implied by current zero rates for future periods of time
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 hto 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 flows
Answer: A
15) Given a choice between 5-year and 1-year instruments most people would choose 5-year
instruments when borrowing and 1-year instruments when lending. Which of the following is a
theory consistent with this observation?
A) Expectations theory
B) Market segmentation theory
C) Liquidity preference theory
D) Maturity preference theory
Answer: C
16) A repo rate is

A) An uncollateralized rate
B) A rate where the credit risk is relatively high
C) The rate implicit in a transaction where securities are sold and bought back at a higher price
Answer: C
3
17) Bootstrapping involves
A) Calculating 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 calculation of par yields
Answer: B
18) The zero curve is downward sloping. Define 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?
Answer: D

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
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
4
Chapter 5 Determination of Forward and Futures Prices
1) Which of the following is a consumption asset?

A) The S&P 500 index
B) The Canadian dollar
C) Copper
D) IBM stock
Answer: C
2) An investor shorts 100 shares when the share price is $50 and closes out the position 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
3) The spot price of an investment asset that provides no income is $30 and the risk-free rate for
all maturities (with continuous compounding) is 10%. What is the three-year forward price?
A) $40.50
B) $22.22
C) $33.00
D) $33.16
Answer: A
4) The spot price of an investment asset is $30 and the risk-free rate for all maturities is 10%
with continuous compounding. The asset provides an income of $2 at the end of the first 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
D) $40.50
Answer: B
5) An exchange rate is 0.7000 and the six-month domestic and foreign risk-free interest rates are
5% and 7% (both expressed with continuous compounding). What is the six-month forward rate?
A) 0.7070
B) 0.7177
C) 0.7249
D) 0.6930
Answer: D
1
A) The convenience yield is always positive or zero
B) The convenience yield is always positive for an investment asset
C) The convenience yield is always negative for a consumption asset
D) The convenience yield measures the average return earned by holding futures contracts
Answer: A
7) A short forward contract that was negotiated some time 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 continuous 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
8) The spot price of an asset is positively 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 sometimes greater and sometimes less than the expected future spot
price
Answer: C
9) Which of the following describes the way the futures price of a foreign currency is quoted?
C) Some futures prices are always quoted as the number of U.S. dollars per unit of the foreign
D) There are no quotation conventions for futures prices
Answer: A
10) Which of the following describes the way the forward price of a foreign currency is quoted?
C) Some forward prices are always quoted as the number of U.S. dollars per unit of the foreign
D) There are no quotation conventions for forward prices
Answer: C
2
11) Which of the following is NOT a reason why a short position in a stock is closed out?
A) The investor with the short position chooses to close out the position
B) The lender of the shares issues instructions to close out the position
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) Gold and silver are investment assets
B) Investment assets are held by significant numbers of investors for investment purposes
C) Investment assets are never held for consumption
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
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
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 transaction costs can lead to forward and futures prices being different
Answer: A
15) As the convenience yield increases, which of the following is true?

Answer: B
3
16) As inventories of a commodity decline, which of the following is true?
Answer: B
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 time when dividends are paid are
known
D) Dividends will yield a certain return to a person buying the stock today
Answer: C
18) Which of the following is an argument used by Keynes and Hicks?

A) If hedgers hold long positions and speculators holds short positions, the futures price will tend
to be higher than expected future spot prices
B) If hedgers hold long positions and speculators holds short positions, the futures price will tend
to be lower than expected future spot prices
C) If hedgers hold long positions and speculators holds short positions, the futures price will tend
to be lower than today's spot prices
D) If hedgers hold long positions and speculators holds short positions, the futures price will tend
to be higher than today's spot prices
Answer: 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 function of the time to maturity
D) The futures price is above the expected future spot price
Answer: D
20) Which of the following is true for a consumption commodity?

A) There is no limit to how high or low the futures price can be, except that the futures price
cannot be negative
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 negative
D) The futures price can be determined with reasonable accuracy from the spot price and interest
rates
Answer: C
4
Chapter 6 Interest Rate Futures
1) Which of the following is applicable to corporate bonds in the United States?

A) Actual/360
B) Actual/Actual
C) 30/360
D) Actual/365
Answer: C
2) It is May 1. The quoted price of a bond with an Actual/Actual (in period) 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
Answer: C
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
Answer: A
4) The most recent settlement 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
Answer: C
5) Which of the following is NOT an option open to the party with a short position in the
Treasury bond futures contract?
A) The ability to deliver any of a number of different bonds
B) The wild card play
C) The fact that delivery can be made any time during the delivery month
D) The interest rate used in the calculation of the conversion factor
Answer: D
1
6) A trader enters into a long position 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
Answer: B
7) A company invests $1,000 in a five-year zero-coupon bond and $4,000 in a ten-year zero-
coupon bond. What is the duration of the portfolio?
A) 6 years
B) 7 years
C) 8 years
D) 9 years
Answer: D
8) The modified duration of a bond portfolio worth $1 million is 5 years. By approximately how
much does the value of the portfolio 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
9) A portfolio 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 duration of the bond that is expected to be cheapest to deliver is 6 years and the duration of
the portfolio will be 5.5 years. How many contracts are necessary for hedging the portfolio?
A) 100
B) 200
C) 300
D) 400
Answer: B

A) The futures rates calculated from a Eurodollar futures quote are always less than the
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 corresponding
forward rate
D) The futures rates calculated from a Eurodollar futures quote are sometimes greater than and
sometimes less than the corresponding forward rate
Answer: B
2
11) How much is a basis point?
A) 1.0%
B) 0.1%
C) 0.01%
D) 0.001%
Answer: C
12) Which of the following day count conventions applies to a US Treasury bond?
A) Actual/360
B) Actual/Actual (in period)
C) 30/360
D) Actual/365
Answer: B
13) What is the quoted discount rate on a money market instrument?

A) The interest rate earned as a percentage of the final face value of a bond
B) The interest rate earned as a percentage of the initial 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 flows from a bond
Answer: A
14) Which of the following is closest to the duration of a 2-year bond that pays a coupon of 8%
per annum semiannually? The yield on the bond is 10% per annum with continuous
compounding.
A) 1.82
B) 1.85
C) 1.88
D) 1.92
Answer: C
15) Which of the following is NOT true about duration?

A) It equals the years-to-maturity for a zero coupon bond
B) It equals the weighted average of payment times for a bond, where weights are proportional to
the present value of payments
C) Equals the weighted average of individual bond durations for a portfolio, where weights are
proportional to the present value of bond prices
D) The prices of two bonds with the same duration change by the same percentage amount when
interest rate move up by 100 basis points
Answer: D
16) The conversion factor for a bond is approximately

A) The price it would have if all cash flows 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 flows were discounted at 8% per annum
D) The price it would have if it paid coupons at 8% per annum
Answer: A
3
17) The time-to-maturity of a Eurodollars futures contract is 4 years, and the time-to-maturity of
the rate underlying the futures contract is 4.25 years. The standard deviation of the change in the
short term interest rate, σ = 0.011. What is the difference between the futures and the forward
interest rate?
A) 0.105%
B) 0.103%
C) 0.098%
D) 0.093%
Answer: B
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
Answer: B
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
Answer: C
20) Duration matching immunizes a portfolio against

A) Any parallel shift in the yield curve
B) All shifts in the yield curve
C) Changes in the steepness of the yield curve
D) Small parallel shifts in the yield curve
Answer: D
4
Chapter 7 Swaps
1) A company can invest funds for five years at LIBOR minus 30 basis points. The five-year
swap rate is 3%. What fixed rate of interest can the company earn by using the swap?
A) 2.4%
B) 2.7%
C) 3.0%
D) 3.3%
Answer: B

A) Principals are not usually exchanged in a currency swap
B) The principal amounts usually flow in the opposite direction to interest payments at the
beginning of a currency swap and in the same direction as interest payments at the end of the
swap
C) The principal amounts usually flow in the same direction as interest payments at the
beginning of a currency swap and in the opposite direction to interest payments at the end of the
swap
D) Principals are not usually specified in a currency swap
Answer: B
3) Which of the following is a way of valuing interest rate swaps where LIBOR is exchanged for
a fixed rate of interest?
A) Assume that floating payments will equal forward LIBOR rates and discount net cash flows
at the risk-free rate
B) Assume that floating payments will equal forward OIS rates and discount net cash flows at
the risk-free rate
C) Assume that floating payments will equal forward LIBOR rates and discount net cash flows at
the swap rate
D) Assume that floating payments will equal forward OIS rates and discount net cash flows at
the swap rate
Answer: A

A) The fixed rate of interest which a swap market maker is prepared to pay in exchange for
B) The fixed rate of interest which a swap market maker is prepared to receive in exchange for
C) The average of A and B
D) The higher of A and B
Answer: C
1
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 situations where the tax rates in two countries are different
D) All of the above
Answer: D

A) OIS rates are less than the corresponding LIBOR rates
B) OIS rates are greater than corresponding LIBOR rates
C) OIS rates are sometimes greater and sometimes less than LIBOR rates
D) OIS rates are equivalent to one-day LIBOR rates
Answer: A
7) Which of the following describes an interest rate swap?

A) The exchange of a fixed rate bond for a floating rate bond
B) A portfolio of forward rate agreements
C) An agreement to exchange interest at a fixed rate for interest at a floating rate
D) All of the above
Answer: D
8) Which of the following is true for an interest rate swap?

A) A swap is usually worth close to zero when it is first negotiated
B) Each forward rate agreement underlying a swap is worth close to zero when the swap is first
entered into
C) Comparative advantage is a valid reason for entering into the swap
Answer: A
9) Which of the following is true for the party paying fixed in an interest rate swap?
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 financial institution is used as the intermediary
Answer: A
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 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 collateralized swaps
Answer: D
2
11) When LIBOR is used as the discount rate
A) The value of a swap is worth zero immediately after a coupon payment
B) The value of a swap is worth zero immediately before a coupon payment
C) The value of the floating rate bond underlying a swap is worth par immediately after a coupon
payment
D) The value of the floating rate bond underlying a swap is worth par immediately before a
coupon payment
Answer: C
12) A company enters into an interest rate swap where it is paying fixed 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
Answer: A
13) A floating for floating currency swap is equivalent to

Answer: C
14) A floating-for-fixed currency swap is equivalent to

Answer: B
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 LIBOR discounting is used?
A) 0.00
B) 2.66
C) 2.06
D) 1.06
Answer: B
3
16) A semi-annual pay interest rate swap where the fixed 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% (continuously compounded) respectively. 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 fixed rate of interest?
A) $74,250
B) -$70,760
C) -$11,250
D) $103,790
Answer: B
17) Which of the following describes the way a LIBOR-in-arrears swap differs 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 floating interest is paid until the end of the life of the swap in a LIBOR-in-arrears swap,
but fixed payments are made throughout the life of the swap
D) Neither floating nor fixed payments are made until the end of the life of the swap
Answer: A
18) Which of the following describes a 3-month overnight indexed swap (OIS)?
A) A fixed 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 arithmetic average of overnight rates is exchanged for a fixed rate at the end of three
months
D) The geometric average of overnight rates is exchanged for a fixed rate at the end of three
months
Answer: D
19) Which of the following is a typical bid-offer 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
Answer: A

A) The rate on a five-year loan to a AA-rated company
B) The rate on a five-year loan to an A-rated company
C) The rate that can be earned over five years from a series of short-term loans to AA-rated
companies
D) The rate that can be earned over five years from a series of short-term loans to A-rated
companies
Answer: C
4
Chapter 8 Securitization and the Credit Crisis of 2007
1) Which of the following tends to lead to an increase in house prices?

A) An increase in interest rates
B) Regulators specifying a maximum level for the loan-to-value ratio on mortgages
C) Banks reducing the minimum FICO score that borrowers are required to have
D) An increase in foreclosures
Answer: C
2) Which of the following is true of a non-recourse mortgage?

A) The house buyer, if unable to make payments, can lose all possessions
B) The house buyer has an American style put option on the house
C) The house buyer has a European style put option on the house
D) The lender is less likely to lose money on the mortgage
Answer: B

A) The bonus structure at banks can lead to short-term horizons for decision making
B) Securitization involves the transfer of risk
C) The term "agency costs" describes the situation where the incentives of two parties in a
business relationship are not perfectly aligned
D) Correlations decrease in stressed market conditions
Answer: D
tranche of the ABS?
A) 50%
B) 60%
C) 80%
D) 100%
Answer: B
1
A) 50%
B) 60%
C) 80%
D) 100%
Answer: D
portfolio prove to be 16%. What, as a percent of tranche principal, are losses on the senior
A) 50%
B) 60%
C) 80%
D) 100%
Answer: A
7) AIG lost money because

A) It bought tranches created from mortgages
B) It invested heavily in real estate
C) It invested heavily in the stock market
D) It insured AAA tranches of ABS CDOs
Answer: D
8) Which of the following survived the crisis without declaring bankruptcy or being taken over
by another financial institution?
A) Bear Stearns
B) Morgan Stanley
C) Lehman Brothers
D) Merrill Lynch
Answer: B
9) What are teaser rates?

A) Interest rates that appear lower than they are
B) Interest rates that depend on LIBOR
C) Interest rates on mortgages with a very long amortization period
D) Interest rates that apply only for the first two or three years
Answer: D
2
10) Which of the following describes a waterfall?
A) A distribution of cash flows to tranches with priority given to tranche with the highest rating
B) A distribution of cash flows to tranches in proportion to their outstanding principals
C) A distribution of losses to tranches so that tranches bear losses in proportion to their
outstanding principals
Answer: A
11) In 2008 the LIBOR-OIS spread reached a high of

A) 164 basis points
B) 264 basis points
C) 364 basis points
D) 464 basis points
Answer: C
12) Which of the following were introduced before the credit crisis that started in 2007?
A) Basel II
B) Dodd-Frank
C) Basel III
D) Requirements for living wills
Answer: A
13) Which of the following is true as the correlation between mortgage defaults increases?
A) Equity tranches are almost certain to incur losses
B) Senior tranches become more likely to incur losses
C) The expected number of defaults increases
D) Equity tranches are unaffected
Answer: B
14) Which of the following describes the S&P/Case-Shiller index?

A) A stock market index
B) An index of interest rates on mortgages
C) An index of house prices
D) An index showing the dollar amount of mortgages granted each month
Answer: C
mortgages be before the mezzanine tranche of the ABD CDO bears losses?
A) 5.0%
B) 5.5%
C) 6.0%
D) 6.5%
Answer: B
3
mortgages be before the senior tranche of the ABS CDO bears losses?
A) 5.5%
B) 6.0%
C) 6.5%
D) 7.0%
Answer: C
allocation of the principal to tranches: senior 94.5% (rated AAA), mezzanine 0.1% (rated BBB),
and equity 5% (rated C). The portfolios of subprime mortgages have the same default rates. An
ABS CDO is then created from the mezzanine tranches. Which of the following is true?
A) The ABS CDO tranches should have similar ratings ranging from AAA to C
B) The ABS CDO tranches should all be rated BBB
C) The ABS CDO tranches should all be rated C
D) The ABS CDO tranches are almost worthless because the mezzanine tranches are so thin
Answer: B
18) Which of the following describes regulatory arbitrage?

A) Finding a way of reducing capital requirements without changing the risks being taken
B) Buying products that are not subject to regulation
C) Shorting products that are not subject to regulation
D) Trading with the government
Answer: A
19) Which of the following describes a subprime mortgage?

A) The rate of interest is less than the prime rate of interest
B) The loan-to-value ratio is below average
C) The life of the mortgage is less than 25 years
D) The credit risk is high
Answer: D
20) Which of the following would be described by the term "liar loan"?
A) A situation where the lender concealed information from the borrower
B) A situation where the lender lied to the borrower about the interest rate
C) A situation where the borrower lied about his or her income
Answer: C
4
Chapter 9 Mechanics of Options Markets
1) Which of the following describes a call option?

A) The right to buy an asset for a certain price
B) The obligation to buy an asset for a certain price
C) The right to sell an asset for a certain price
D) The obligation to sell an asset for a certain price
Answer: A

A) A long call is the same as a short put
B) A short call is the same as a long put
C) A call on a stock plus a stock the same as a put
Answer: D
3) An investor has exchange-traded put options to sell 100 shares for $20. There is a 2 for 1 stock
split. Which of the following is the position of the investor after the stock split?
Answer: C
4) An investor has exchange-traded put options to sell 100 shares for $20. There is 25% stock
dividend. Which of the following is the position of the investor after the stock dividend?
Answer: D
5) An investor has exchange-traded put options to sell 100 shares for $20. There is a $1 cash
dividend. Which of the following is then the position of the investor?
A) The investor has put options to sell 100 shares for $20
B) The investor has put options to sell 100 shares for $19
C) The investor has put options to sell 105 shares for $19
D) The investor has put options to sell 105 shares for $19.05
Answer: A
6) Which of the following describes a short position in an option?

A) A position in an option lasting less than one month
B) A position in an option lasting less than three months
C) A position in an option lasting less than six months
D) A position where an option has been sold
Answer: D
1
7) Which of the following describes a difference between a warrant and an exchange-traded
stock option?
A) In a warrant issue, someone has guaranteed the performance of the option seller in the event
that the option is exercised
B) The number of warrants is fixed whereas the number of exchange-traded options in existence
depends on trading
C) Exchange-traded stock options have a strike price
D) Warrants cannot be traded after they have been purchased
Answer: B
8) Which of the following describes LEAPS?

A) Options which are partly American and partly European
B) Options where the strike price changes through time
C) Exchange-traded stock options with longer lives than regular exchange-traded stock options
D) Options on the average stock price during a period of time
Answer: C
9) Which of the following is an example of an option class?

Answer: A
10) Which of the following is an example of an option series?

Answer: D
11) Which of the following must post margin?

A) The seller of an option
B) The buyer of an option
C) The seller and the buyer of an option
D) Neither the seller nor the buyer of an option
Answer: A
12) Which of the following describes a long position in an option?

A) A position where there is more than one year to maturity
B) A position where there is more than five years to maturity
C) A position where an option has been purchased
D) A position that has been held for a long time
Answer: C
2
13) Which of the following is NOT traded by the CBOE?
A) Weeklys
B) Monthlys
C) Binary options
D) DOOM options
Answer: B
14) When a six-month option is purchased

A) The price must be paid in full
B) Up to 25% of the option price can be borrowed using a margin account
C) Up to 50% of the option price can be borrowed using a margin account
D) Up to 75% of the option price can be borrowed using a margin account
Answer: A
15) Which of the following are true for CBOE stock options?
A) There are no margin requirements
B) The initial margin and maintenance margin are determined by formulas and are equal
C) The initial margin and maintenance margin are determined by formulas and are different
D) The maintenance margin is usually about 75% of the initial margin
Answer: B
16) The price of a stock is $67. A trader sells 5 put option contracts on the stock with a strike
What is the trader's net profit or loss?
A) Loss of $1,500
B) Loss of $500
C) Gain of $1,500
D) Loss of $1,000
Answer: C
17) A trader buys a call and sells a put with the same strike price and maturity date. What is the
position equivalent to?
A) A long forward
B) A short forward
C) Buying the asset
Answer: A
18) The price of a stock is $64. A trader buys 1 put option contract on the stock with a strike
price of $60 when the option price is $10. When does the trader make a profit?
A) When the stock price is below $60
B) When the stock price is below $64
C) When the stock price is below $54
D) When the stock price is below $50
Answer: D
3
19) Consider a put option and a call option with the same strike price and time to maturity.
A) It is possible for both options to be in the money
B) It is possible for both options to be out of the money
C) One of the options must be in the money
D) One of the options must be either in the money or at the money
Answer: D
20) In which of the following cases is an asset NOT considered constructively sold?
A) The owner shorts the asset
B) The owner buys an in-the-money put option on the asset
C) The owner shorts a forward contract on the asset
D) The owner shorts a futures contract on the stock
Answer: B
4
Chapter 10 Properties of Stock Options
1) When the stock price increases with all else remaining the same, which of the following is
true?
A) Both calls and puts increase in value
B) Both calls and puts decrease in value
C) Calls increase in value while puts decrease in value
D) Puts increase in value while calls decrease in value
Answer: C
2) When the strike price increases with all else remaining the same, which of the following is
true?
Answer: D
3) When volatility increases with all else remaining the same, which of the following is true?
Answer: A
4) When dividends increases with all else remaining the same, which of the following is true?
Answer: D
5) When interest rates increase with all else remaining the same, which of the following is true?
Answer: C
6) When the time to maturity increases with all else remaining the same, which of the following
is true?
A) European options always increase in value
B) The value of European options either stays the same or increases
C) There is no effect on European option values
D) European options are liable to increase or decrease in value
Answer: D
1
7) The price of a stock, which pays no dividends, is $30 and the strike price of a one year
European call option on the stock is $25. The risk-free rate is 4% (continuously compounded).
Which of the following is a lower bound for the option such that there are arbitrage opportunities
if the price is below the lower bound and no arbitrage opportunities if it is above the lower
bound?
A) $5.00
B) $5.98
C) $4.98
D) $3.98
Answer: B
8) A stock price (which pays no dividends) is $50 and the strike price of a two year European put
option is $54. The risk-free rate is 3% (continuously compounded). Which of the following is a
lower bound for the option such that there are arbitrage opportunities if the price is below the
lower bound and no arbitrage opportunities if it is above the lower bound?
A) $4.00
B) $3.86
C) $2.86
D) $0.86
Answer: D

A) An American put option is always worth less than the present value of the strike price
B) A European put option is always worth less than the present value of the strike price
C) A European call option is always worth less than the stock price
D) An American call option is always worth less than the stock price
Answer: A
10) Which of the following best describes the intrinsic value of an option?
A) The value it would have if the owner were forced to exercise immediately
B) The Black-Scholes-Merton price of the option
C) The lower bound for the option's price
D) The amount paid for the option
Answer: A
11) Which of the following describes a situation where an American put option on a stock
becomes more likely to be exercised early?
A) Expected dividends increase
B) Interest rates decrease
C) The stock price volatility decreases
D) All of the above
Answer: C
2
A) An American call option on a stock should never be exercised early
B) An American call option on a stock should never be exercised early when no dividends are
expected
C) There is always some chance that an American call option on a stock will be exercised early
D) There is always some chance that an American call option on a stock will be exercised early
when no dividends are expected
Answer: B
13) Which of the following is the put-call parity result for a non-dividend-paying stock?
A) The European put price plus the European call price must equal the stock price plus the
present value of the strike price
B) The European put price plus the present value of the strike price must equal the European call
price plus the stock price
C) The European put price plus the stock price must equal the European call price plus the strike
price
D) The European put price plus the stock price must equal the European call price plus the
present value of the strike price
Answer: D
14) Which of the following is true when dividends are expected?

A) Put-call parity does not hold
B) The basic put-call parity formula can be adjusted by subtracting the present value of expected
dividends from the stock price
C) The basic put-call parity formula can be adjusted by adding the present value of expected
dividends to the stock price
D) The basic put-call parity formula can be adjusted by subtracting the dividend yield from the
interest rate
Answer: B
15) The price of a European call option on a non-dividend-paying stock with a strike price of $50
is $6. The stock price is $51, the continuously compounded risk-free rate (all maturities) is 6%
and the time to maturity is one year. What is the price of a one-year European put option on the
stock with a strike price of $50?
A) $9.91
B) $7.00
C) $6.00
D) $2.09
Answer: D
3
16) The price of a European call option on a stock with a strike price of $50 is $6. The stock
price is $51, the continuously compounded risk-free rate (all maturities) is 6% and the time to
maturity is one year. A dividend of $1 is expected in six months. What is the price of a one-year
European put option on the stock with a strike price of $50?
A) $8.97
B) $6.97
C) $3.06
D) $1.12
Answer: C
17) A European call and a European put on a stock have the same strike price and time to
maturity. At 10:00am on a certain day, the price of the call is $3 and the price of the put is $4. At
10:01am news reaches the market that has no effect on the stock price or interest rates, but
increases volatilities. As a result the price of the call changes to $4.50. Which of the following is
correct?
A) The put price increases to $6.00
B) The put price decreases to $2.00
C) The put price increases to $5.50
D) It is possible that there is no effect on the price
Answer: C
18) Interest rates are zero. A European call with a strike price of $50 and a maturity of one year
is worth $6. A European put with a strike price of $50 and a maturity of one year is worth $7.
The current stock price is $49. Which of the following is true?
A) The call price is high relative to the put price
B) The put price is high relative to the call price
C) Both the call and put must be mispriced
Answer: D
19) Which of the following is true for American options?

A) Put-call parity provides an upper and lower bound for the difference between call and put
prices
B) Put call parity provides an upper bound but no lower bound for the difference between call
and put prices
C) Put call parity provides an lower bound but no upper bound for the difference between call
and put prices
D) There are no put-call parity results
Answer: A
20) Which of the following can be used to create a long position in a European put option on a
stock?
A) Buy a call option on the stock and buy the stock
B) Buy a call on the stock and short the stock
C) Sell a call option on the stock and buy the stock
D) Sell a call option on the stock and sell the stock
Answer: B
4
Chapter 11 Trading Strategies Involving Options
1) Which of the following creates a bull spread?

A) Buy a low strike price call and sell a high strike price call
B) Buy a high strike price call and sell a low strike price call
C) Buy a low strike price call and sell a high strike price put
D) Buy a low strike price put and sell a high strike price call
Answer: A
2) Which of the following creates a bear spread?

A) Buy a low strike price call and sell a high strike price call
B) Buy a high strike price call and sell a low strike price call
C) Buy a low strike price call and sell a high strike price put
D) Buy a low strike price put and sell a high strike price call
Answer: B
3) Which of the following creates a bull spread?

A) Buy a low strike price put and sell a high strike price put
B) Buy a high strike price put and sell a low strike price put
C) Buy a high strike price call and sell a low strike price put
D) Buy a high strike price put and sell a low strike price call
Answer: A
4) Which of the following creates a bear spread?

A) Buy a low strike price put and sell a high strike price put
B) Buy a high strike price put and sell a low strike price put
C) Buy a high strike price call and sell a low strike price put
D) Buy a high strike price put and sell a low strike price call
Answer: B
5) What is the number of different option series used in creating a butterfly spread?
A) 1
B) 2
C) 3
D) 4
Answer: C
1
6) A stock price is currently $23. A reverse (i.e., short) butterfly spread is created from options
with strike prices of $20, $25, and $30. Which of the following is true?
A) The gain when the stock price is greater that $30 is less than the gain when the stock price is
less than $20
B) The gain when the stock price is greater that $30 is greater than the gain when the stock price
is less than $20
C) The gain when the stock price is greater that $30 is the same as the gain when the stock price
is less than $20
D) It is incorrect to assume that there is always a gain when the stock price is greater than $30 or
less than $20
Answer: C
7) Which of the following is correct?

A) A calendar spread can be created by buying a call and selling a put when the strike prices are
the same and the times to maturity are different
B) A calendar spread can be created by buying a put and selling a call when the strike prices are
C) A calendar spread can be created by buying a call and selling a call when the strike prices are
different and the times to maturity are different
D) A calendar spread can be created by buying a call and selling a call when the strike prices are
Answer: D
8) What is a description of the trading strategy where an investor sells a 3-month call option and
buys a one-year call option, where both options have a strike price of $100 and the underlying
stock price is $75?
A) Neutral Calendar Spread
B) Bullish Calendar Spread
C) Bearish Calendar Spread
Answer: B
9) Which of the following is correct?

A) A diagonal spread can be created by buying a call and selling a put when the strike prices are
B) A diagonal spread can be created by buying a put and selling a call when the strike prices are
C) A diagonal spread can be created by buying a call and selling a call when the strike prices are
different and the times to maturity are different
D) A diagonal spread can be created by buying a call and selling a call when the strike prices are
Answer: C
2
10) Which of the following is true of a box spread?
A) It is a package consisting of a bull spread and a bear spread
B) It involves two call options and two put options
C) It has a known value at maturity
D) All of the above
Answer: D
11) How can a straddle be created?

A) Buy one call and one put with the same strike price and same expiration date
B) Buy one call and one put with different strike prices and same expiration date
C) Buy one call and two puts with the same strike price and expiration date
D) Buy two calls and one put with the same strike price and expiration date
Answer: A
12) How can a strip trading strategy be created?

Answer: C
13) How can a strap trading strategy be created?

Answer: D
14) How can a strangle trading strategy be created?

Answer: B
15) Which of the following describes a protective put?

A) A long put option on a stock plus a long position in the stock
B) A long put option on a stock plus a short position in the stock
C) A short put option on a stock plus a short call option on the stock
D) A short put option on a stock plus a long position in the stock
Answer: A
3
16) Which of the following describes a covered call?
A) A long call option on a stock plus a long position in the stock
B) A long call option on a stock plus a short put option on the stock
C) A short call option on a stock plus a short position in the stock
D) A short call option on a stock plus a long position in the stock
Answer: D
17) When the interest rate is 5% per annum with continuous compounding, which of the
following creates a $1000 principal protected note?
A) A one-year zero-coupon bond plus a one-year call option worth about $59
B) A one-year zero-coupon bond plus a one-year call option worth about $49
C) A one-year zero-coupon bond plus a one-year call option worth about $39
D) A one-year zero-coupon bond plus a one-year call option worth about $29
Answer: B
18) A trader creates a long butterfly spread from options with strike prices $60, $65, and $70 by
trading a total of 400 options. The options are worth $11, $14, and $18. What is the maximum
net gain (after the cost of the options is taken into account)?
A) $100
B) $200
C) $300
D) $400
Answer: D
19) A trader creates a long butterfly spread from options with strike prices $60, $65, and $70 by
trading a total of 400 options. The options are worth $11, $14, and $18. What is the maximum
net loss (after the cost of the options is taken into account)?
A) $100
B) $200
C) $300
D) $400
Answer: A
20) Six-month call options with strike prices of $35 and $40 cost $6 and $4, respectively. What
is the maximum gain when a bull spread is created by trading a total of 200 options?
A) $100
B) $200
C) $300
D) $400
Answer: C
4
Chapter 12 Introduction to Binomial Trees
1) The current price of a non-dividend-paying stock is $30. Over the next six months it is
expected to rise to $36 or fall to $26. Assume the risk-free rate is zero. An investor sells call
options with a strike price of $32. Which of the following hedges the position?
A) Buy 0.6 shares for each call option sold
B) Buy 0.4 shares for each call option sold
C) Short 0.6 shares for each call option sold
D) Short 0.4 shares for each call option sold
Answer: B
expected to rise to $36 or fall to $26. Assume the risk-free rate is zero. What is the risk-neutral
probability of that the stock price will be $36?
A) 0.6
B) 0.5
C) 0.4
D) 0.3
Answer: C
expected to rise to $36 or fall to $26. Assume the risk-free rate is zero. An investor sells call
options with a strike price of $32. What is the value of each call option?
A) $1.6
B) $2.0
C) $2.4
D) $3.0
Answer: A
4) The current price of a non-dividend-paying stock is $40. Over the next year it is expected to
rise to $42 or fall to $37. An investor buys put options with a strike price of $41. Which of the
following is necessary to hedge the position?
A) Buy 0.2 shares for each option purchased
B) Sell 0.2 shares for each option purchased
C) Buy 0.8 shares for each option purchased
D) Sell 0.8 shares for each option purchased
Answer: C
5) The current price of a non-dividend-paying stock is $40. Over the next year it is expected to
rise to $42 or fall to $37. An investor buys put options with a strike price of $41. What is the
value of each option? The risk-free interest rate is 2% per annum with continuous compounding.
A) $3.93
B) $2.93
C) $1.93
D) $0.93
Answer: D
1
6) Which of the following describes how American options can be valued using a binomial tree?
A) Check whether early exercise is optimal at all nodes where the option is in-the-money
B) Check whether early exercise is optimal at the final nodes
C) Check whether early exercise is optimal at the penultimate nodes and the final nodes
Answer: A
7) In a binomial tree created to value an option on a stock, the expected return on stock is
A) Zero
B) The return required by the market
C) The risk-free rate
D) It is impossible to know without more information
Answer: C
8) In a binomial tree created to value an option on a stock, what is the expected return on the
option?
A) Zero
B) The return required by the market
C) The risk-free rate
D) It is impossible to know without more information
Answer: C
9) A stock is expected to return 10% when the risk-free rate is 4%. What is the correct discount
rate to use for the expected payoff on an option in the real world?
A) 4%
B) 10%
C) More than 10%
D) It could be more or less than 10%
Answer: D
10) Which of the following is true for a call option on a stock worth $50?
A) As a stock's expected return increases the price of the option increases
B) As a stock's expected return increases the price of the option decreases
C) As a stock's expected return increases the price of the option might increase or decrease
D) As a stock's expected return increases the price of the option on the stock stays the same
Answer: D
11) Which of the following are NOT true?

A) Risk-neutral valuation and no-arbitrage arguments give the same option prices
B) Risk-neutral valuation involves assuming that the expected return is the risk-free rate and then
discounting expected payoffs at the risk-free rate
C) A hedge set up to value an option does not need to be changed
D) All of the above
Answer: C
2
12) The current price of a non-dividend paying stock is $30. Use a two-sthe stock with a strike
price of $32 that expires in 6 months. Each step is 3 months, the risk free rate is 8% per annum
with continuous compounding. What is the option price when u = 1.1 and d = 0.9?
A) $1.29
B) $1.49
C) $1.69
D) $1.89
Answer: B
13) The current price of a non-dividend paying stock is $30. Use a two-step tree to value a
European put option on the stock with a strike price of $32 that expires in 6 months. Each step is
3 months, the risk free rate is 8%, and u = 1.1 and d = 0.9.
A) $2.24
B) $2.44
C) $2.64
D) $2.84
Answer: A
14) Which of the following is NOT true in a risk-neutral world?

A) The expected return on a call option is independent of its strike price
B) Investors expect higher returns to compensate for higher risk
C) The expected return on a stock is the risk-free rate
D) The discount rate used for the expected payoff on an option is the risk-free rate
Answer: B
15) If the volatility of a stock is 20% per annum and a risk-free rate is 5% per annum, which of
the following is closest to the Cox, Ross, Rubinstein parameter u for a tree with a three-month
time step?
A) 1.05
B) 1.07
C) 1.09
D) 1.11
Answer: D
16) If the volatility of a stock is 20% per annum and a risk-free rate is 5% per annum, which of
the following is closest to the Cox, Ross, Rubinstein parameter p for a tree with a three-month
time step?
A) 0.50
B) 0.54
C) 0.58
D) 0.62
Answer: B
3
17) The current price of a non-dividend paying stock is $50. Use a two-step tree to value an
American put option on the stock with a strike price of $48 that expires in 12 months. Each step
is 6 months, the risk free rate is 5% per annum, and the volatility is 20%. Which of the following
is the option price?
A) $1.95
B) $2.00
C) $2.05
D) $2.10
Answer: B
18) Which of the following describes delta?

A) The ratio of the option price to the stock price
B) The ratio of the stock price to the option price
C) The ratio of a change in the option price to the corresponding change in the stock price
D) The ratio of a change in the stock price to the corresponding change in the option price
Answer: C
19) When moving from valuing an option on a non-dividend paying stock to an option on a
currency which of the following is true?
A) The risk-free rate is replaced by the excess of the domestic risk-free rate over the foreign risk-
free rate in all calculations
B) The formula for u changes
C) The risk-free rate be replaced by the excess of the domestic risk-free rate over the foreign
risk-free rate for discounting
D) The risk-free rate be replaced by the excess of the domestic risk-free rate over the foreign
risk-free rate when p is calculated
Answer: D
20) A tree is constructed to value an option on an index which is currently worth 100 and has a
volatility of 25%. The index provides a dividend yield of 2%. Another tree is constructed to
value an option on a non-dividend-paying stock which is currently worth 100 and has a volatility
of 25%.
A) The parameters p and u are the same for both trees
B) The parameter p is the same for both trees but u is not
C) The parameter u is the same for both trees but p is not
Answer: C
4
Chapter 13 Valuing Stock Options: The BSM Model
1) Which of the following is assumed by the Black-Scholes-Merton model?

A) The return from the stock in a short period of time is lognormal
B) The stock price at a future time is lognormal
C) The stock price at a future time is normal
Answer: B
2) The original Black-Scholes and Merton papers on stock option pricing were published in
which year?
A) 1983
B) 1984
C) 1974
D) 1973
Answer: D
3) Which of the following is a definition of volatility?

A) The standard deviation of the return, measured with continuous compounding, in one year
B) The variance of the return, measured with continuous compounding, in one year
C) The standard deviation of the stock price in one year
D) The variance of the stock price in one year
Answer: A
4) A stock price is $100. Volatility is estimated to be 20% per year. What is an estimate of the
standard deviation of the change in the stock price in one week?
A) $0.38
B) $2.77
C) $3.02
D) $0.76
Answer: B
5) What does N(x) denote?

A) The area under a normal distribution from zero to x
B) The area under a normal distribution up to x
C) The area under a normal distribution beyond x
D) The area under the normal distribution between -x and x
Answer: B
6) Which of the following is true when there are dividends?

A) It is never optimal to exercise a call option on the stock early
B) It can be optimal to exercise a call option at any time
C) It is only ever optimal to exercise a call option immediately after an ex-dividend date
Answer: D
1
7) What is the number of trading days in a year usually assumed for equities?
A) 365
B) 252
C) 262
D) 272
Answer: B
8) The risk-free rate is 5% and the expected return on a non-dividend-paying stock is 12%.
Which of the following is a way of valuing a derivative?
A) Assume that the expected growth rate for the stock price is 17% and discount the expected
payoff at 12%
B) Assuming that the expected growth rate for the stock price is 5% and discounting the
expected payoff at 12%
C) Assuming that the expected growth rate for the stock price is 5% and discounting the
D) Assuming that the expected growth rate for the stock price is 12% and discounting the
Answer: C
9) When there are two dividends on a stock, Black's approximation sets the value of an American
call option equal to which of the following?
A) The value of a European option maturing just before the first dividend
B) The value of a European option maturing just before the second (final) dividend
C) The greater of the values in A and B
D) The greater of the value in B and the value assuming no early exercise
Answer: D
10) Which of the following is measured by the VIX index?

A) Implied volatilities for stock options trading on the CBOE
B) Historical volatilities for stock options trading on CBOE
C) Implied volatilities for options trading on the S&P 500 index
D) Historical volatilities for options trading on the S&P 500 index
Answer: C
11) What was the original Black-Scholes-Merton model designed to value?

A) A European option on a stock providing no dividends
B) A European or American option on a stock providing no dividends
C) A European option on any stock
D) A European or American option on any stock
Answer: A
2
12) A stock provides an expected return of 10% per year and has a volatility of 20% per year.
What is the continuously compounded expected return in one year?
A) 6%
B) 8%
C) 10%
D) 12%
Answer: B
13) An investor has earned 2%, 12% and -10% on equity investments in successive years
(annually compounded). This is equivalent to earning which of the following annually
compounded rates for the three year period.
A) 1.33%
B) 1.23%
C) 1.13%
D) 0.93%
Answer: D

A) Risk-neutral valuation assumes that investors are risk neutral
B) Options can be valued based on the assumption that investors are risk neutral
C) In risk-neutral valuation the expected return on all investment assets is set equal to the risk-
free rate
D) In risk-neutral valuation the risk-free rate is used to discount expected cash flows
Answer: A
15) Which of the following is a way of extending the Black-Scholes-Merton formula to value a
European call option on a stock paying a single dividend?
A) Reduce the maturity of the option so that it equals the time of the dividend
B) Subtract the dividend from the stock price
C) Add the dividend to the stock price
D) Subtract the present value of the dividend from the stock price
Answer: D
16) When the Black-Scholes-Merton and binomial tree models are used to value an option on a
non-dividend-paying stock, which of the following is true?
A) The binomial tree price converges to a price slightly above the Black-Scholes-Merton price as
the number of time steps is increased
B) The binomial tree price converges to a price slightly below the Black-Scholes-Merton price as
the number of time steps is increased
C) Either A or B can be true
D) The binomial tree price converges to the Black-Scholes-Merton price as the number of time
steps is increased
Answer: D
3
17) When the non-dividend paying stock price is $20, the strike price is $20, the risk-free rate is
6%, the volatility is 20% and the time to maturity is 3 months, which of the following is the price
of a European call option on the stock?
A) 20N(0.1)-19.7N(0.2)
B) 20N(0.2)-19.7N(0.1)
C) 19.7N(0.2)-20N(0.1)
D) 19.7N(0.1)-20N(0.2)
Answer: B
18) When the non-dividend paying stock price is $20, the strike price is $20, the risk-free rate is
5%, the volatility is 20% and the time to maturity is 3 months, which of the following is the price
of a European put option on the stock?
A) 19.7N(-0.1)-20N(-0.2)
B) 20N(-0.1)-20N(-0.2)
C) 19.7N(-0.2)-20N(-0.1)
D) 20N(-0.2)-20N(-0.1)
Answer: A
19) A stock price is 20, 22, 19, 21, 24, and 24 on six successive Fridays. Which of the following
is closest to the volatility per annum estimated from this data?
A) 50%
B) 60%
C) 70%
D) 80%
Answer: D
20) The volatility of a stock is 18% per year. What is the volatility per month?
A) 1.5%
B) 3.0%
C) 5.2%
Answer: C
4
Chapter 14 Employee Stock Options

A) An employee stock option is usually held to maturity
B) An employee stock option tends to be exercised earlier than an OTC option with the same
terms
C) An employee stock options tends to be exercised later than an OTC option with the same
terms
D) Employee stock options are usually exercised as early as possible
Answer: B
2) Which of the following is NOT usually true about employee stock options?
A) There is a vesting period
B) They can be sold to other employees
C) They are often at-the-money when issued
D) Their value is currently a charge to the income statement
Answer: B
3) What term is used to describe losses shareholders experience because the interests of
managers are not aligned with their own?
A) Agency costs
B) Backdating scandals
C) Dilution
D) Income statement expense
Answer: A
4) Which of the following are true of employee stock options?

A) They are commonly valued as though they are regular American options
B) They are commonly valued as though they are regular American options, but with a reduced
life
C) They are commonly valued as though they are regular European option
D) They are commonly valued as though they are regular European options but with a reduced
life
Answer: D
5) Which of the following was true about employee stock options prior to 1995?
A) The options never had any affect on a company's financial statements
B) The value of options which were at-the-money when issued had to be expensed on the income
statement
C) The value of options which were at-the-money when issued had to be reported in the notes to
the financial statements
D) Options which were at-the-money when issued did not affect a company's financial
statements
Answer: D
1
6) Which of the following was true about employee stock options between 1996 and 2004?
statement
statements
Answer: C
7) Which of the following was true after 2005?

statement
statements
Answer: B
8) Which of the following is true about employee stock options after they have been issued?
A) They have to be revalued every year
B) They have to be revalued every quarter
C) They have to be revalued every day like other derivatives
D) They never have to be revalued
Answer: D
9) Which of the following is true about the practice of backdating a stock options grant?
A) It is illegal
B) It is illegal in the majority of states in the U.S., but not all states
C) It is illegal in roughly half the states in the U.S.
D) It is unethical, but not illegal
Answer: A
10) A company surprises the market with an announcement that it has granted stock options to
senior executives. The options are exercised four years later. When does dilution take place?
A) Dilution takes place when the options are exercised
B) Dilution takes place on the announcement date
C) Dilution takes place gradually over the four years
D) There is no dilution
Answer: B
2
11) When an employee leaves the company which of the following is usually true?
A) All outstanding employee stock options are forfeited
B) Out-of the money employee stock options are forfeited
C) All options which have vested are forfeited
D) All options are retained
Answer: B
12) Which of the following defines the vesting period?

A) The period during which employee stock options can be exercised
B) The period during which the options are issued
C) The period during which the strike price of the options equals the stock price
D) The period during which employee stock options cannot be exercised
Answer: D

A) Management has an incentive to issue executive stock options after bad news
B) Management has an incentive to issue executive stock options before good news
C) Executive stock options encourage management to pursue strategies that are best for the
company in the long run
D) Management have an incentive to time the announcement of good news just before they plan
to exercise their stock options
Answer: C
14) Which of the following strategies makes no sense?

A) An employee exercises stock options early and sells the stock. No dividends are expected
B) An employee exercises stock options early and keeps the stock. No dividends are expected
C) An employee exercises stock options early and sells the stock. Dividends are expected
D) An employee exercises stock options early and keeps the stock. Dividends are expected
Answer: B
15) When a CEO has employee stock options, he or she is in theory motivated to do which of the
following?
A) Take more risk
B) Take less risk
C) Buy some of the company's stock
Answer: A
16) When an employee stock option is exercised, which of the following is usually true?
A) The employee pays the market price for the shares and the company refunds the difference
between the market price and the strike price
B) The company or the company's agent buys stock in the market for the employee
C) The company issues more shares and sells them to the employee for the strike price
D) The employee cannot immediately sell the shares
Answer: C
3
17) Which of the following increases the expected life of employee stock options?
A) An increase in the vesting period
B) An increase in employee turnover
C) A fast growth rate for the stock price
D) A tendency for employees to exercise earlier than in the past
Answer: A
18) Which of the following hypotheses is supported by empirical research?

A) The grant date for executive stock options tends to be when the stock price is high
B) The grant date for executive stock options tends to be when the stock price is low
C) The grant date for executive stock options tends to be after a growth spurt in the stock price
D) The is no relationship between the timing of grants and the stock price
Answer: B
19) Which of the following ensures that managers are rewarded only when a company performs
better than its competitors?
A) A constant strike price for executive stock options
B) A strike price that increases with time
C) A strike price that changes in line with an index of stock prices
D) A strike price that is tied to reported profit
Answer: C
20) Employee stock options are particularly popular with start ups because
A) They encourage employees to work hard
B) The start up cannot afford to pay high salaries
C) The risk associated with the company's success is shared with employees
D) All of the above
Answer: D
4
Chapter 15 Options on Stock Indices and Currencies
1) Which of the following describes what a company should do to create a range forward
contract in order to hedge foreign currency that will be received?
A) Buy a put and sell a call on the currency with the strike price of the put higher than that of the
call
B) Buy a put and sell a call on the currency with the strike price of the put lower than that of the
call
C) Buy a call and sell a put on the currency with the strike price of the put higher than that of the
call
D) Buy a call and sell a put on the currency with the strike price of the put lower than that of the
call
Answer: B
2) Which of the following describes what a company should do to create a range forward
contract in order to hedge foreign currency that will be paid?
A) Buy a put and sell a call on the currency with the strike price of the put higher than that of the
call
B) Buy a put and sell a call on the currency with the strike price of the put lower than that of the
call
C) Buy a call and sell a put on the currency with the strike price of the put higher than that of the
call
D) Buy a call and sell a put on the currency with the strike price of the put lower than that of the
call
Answer: D
3) What should the continuous dividend yield be replaced by when options on an exchange rate
are valued using the formula for an option of a stock paying a continuous dividend yield?
A) The domestic risk-free rate
B) The foreign risk-free rate
C) The foreign risk-free rate minus the domestic risk-free rate
Answer: B
4) Suppose that the domestic risk free rate is r and dividend yield on an index is q. How should
the put-call parity formula for options on a non-dividend-paying stock be changed to provide a
put-call parity formula for options on a stock index? Assume the options last T years.
A) The stock price is replaced by the value of the index multiplied by exp(qT)
B) The stock price is replaced by the value of the index multiplied by exp(rT)
C) The stock price is replaced by the value of the index multiplied by exp(-qT)
D) The stock price is replaced by the value of the index multiplied by exp(-rT)
Answer: C
1
5) A portfolio manager in charge of a portfolio worth $10 million is concerned that stock prices
might decline rapidly during the next six months and would like to use options on an index to
provide protection against the portfolio falling below $9.5 million. The index is currently
standing at 500 and each contract is on 100 times the index. What position is required if the
portfolio has a beta of 1?
A) Short 200 contracts
B) Long 200 contracts
C) Short 100 contracts
D) Long 100 contracts
Answer: A
6) A portfolio manager in charge of a portfolio worth $10 million is concerned that the market
standing at 500 and each contract is on 100 times the index. What should the strike price of
options on the index be the portfolio has a beta of 1?
A) 425
B) 450
C) 475
D) 500
Answer: C
standing at 500 and each contract is on 100 times the index. What position is required if the
portfolio has a beta of 0.5?
A) Short 200 contracts
B) Long 200 contracts
C) Short 100 contracts
D) Long 100 contracts
Answer: C
standing at 500 and each contract is on 100 times the index. What should the strike price of
options on the index be the portfolio has a beta of 0.5? Assume that the risk-free rate is 10% per
annum and the dividend yield on both the portfolio and the index is 2% per annum.
A) 400
B) 410
C) 420
D) 430
Answer: D
2
9) For a European put option on an index, the index level is 1,000, the strike price is 1050, the
time to maturity is six months, the risk-free rate is 4% per annum, and the dividend yield on the
index is 2% per annum. How low can the option price be without there being an arbitrage
opportunity?
A) $50.00
B) $43.11
C) $29.21
D) $39.16
Answer: D
10) For a European call option on a currency, the exchange rate is 1.0000, the strike price is
0.9100, the time to maturity is one year, the domestic risk-free rate is 5% per annum, and the
foreign risk-free rate is 3% per annum. How low can the option price be without there being an
arbitrage opportunity?
A) 0.1048
B) 0.0900
C) 0.1344
D) 0.1211
Answer: A
11) Index put options are used to provide protection against the value of the portfolio falling
below a certain level. Which of the following is true as the beta of the portfolio increases?
A) The cost of hedging increases
B) The options require a lower strike price
C) The number of options required increases
D) All of the above
Answer: D
12) Which of the following is NOT true about a range forward contract?
A) It ensures that the exchange rate for a future transaction will lie between two values
B) It can be structured so that it costs nothing to set up
C) It is constructed from two options and a forward contract
D) It can be used to hedge either a future inflow or a future outflow of a foreign currency
Answer: C
13) A binomial tree with three-month time steps is used to value a currency option. The domestic
and foreign risk-free rates are 4% and 6% respectively. The volatility of the exchange rate is
12%. What is the probability of an up movement?
A) 0.4435
B) 0.5267
C) 0.5565
D) 0.5771
Answer: A
3
14) A binomial tree with one-month time steps is used to value an index option. The interest rate
is 3% per annum and the dividend yield is 1% per annum. The volatility of the index is 16%.
What is the probability of an up movement?
A) 0.4704
B) 0.5065
C) 0.5592
D) 0.5833
Answer: B
15) A European at-the-money call option on a currency has four years until maturity. The
exchange rate volatility is 10%, the domestic risk-free rate is 2% and the foreign risk-free rate is
5%. The current exchange rate is 1.2000. What is the value of the option?
A) 0.98N(0.25)-1.11(0.05)
B) 0.98N(-0.3)-1.11N(-0.5)
C) 0.98N(-0.5)-1.11N(-0.7)
D) 0.98N(0.10)-1.11N(0.06)
Answer: C
16) A European at-the-money call option on a currency has four years until maturity. The
exchange rate volatility is 10%, the domestic risk-free rate is 2% and the foreign risk-free rate is
5%. The current exchange rate is 1.2000. What is the value of the option?
A) 1.11N(0.7)-0.98N(0.5)
B) 1.11N(-0.7)-0.98N(-0.5)
C) 1.11N(0.7)-0.98N(0.4)
D) 1.11N(-0.06)-0.98N(-0.10)
Answer: A
17) Which of the following is true when a European currency option is valued using forward
exchange rates?
A) It is not necessary to know the domestic interest rate or the spot exchange rate
B) It is not necessary to know either the foreign or domestic interest rate
C) It is necessary to know the difference between the foreign and domestic interest rates but not
the rates themselves
D) It is not necessary to know the foreign interest rate or the spot exchange rate
Answer: D
18) What is the size of one option contract on the S&P 500?
A) 250 times the index
B) 100 times the index
C) 50 times the index
D) 25 times the index
Answer: B
4
19) The domestic risk-free rate is 3%. The foreign risk-free rate is 5%. What is the risk-neutral
growth rate of the exchange rate?
A) +2%
B) -2%
C) +5%
D) +3%
Answer: B
20) What is the same as 100 call options to buy one unit of currency A with currency B at a
strike price of 1.25?
A) 100 call options to buy one unit of currency B with currency A at a strike price of 0.8
B) 125 call options to buy one unit of currency B with currency A at a strike price of 0.8
C) 100 put options to sell one unit of currency B for currency A at a strike price of 0.8
D) 125 put options to sell one unit of currency B for currency A at a strike price of 0.8
Answer: D
5
Chapter 16 Futures Options
1) Which of the following is acquired (in addition to a cash payoff) when the holder of a put
futures exercises?
A) A long position in a futures contract
B) A short position in a futures contract
C) A long position in the underlying asset
D) A short position in the underlying asset
Answer: B
2) Which of the following is acquired (in addition to a cash payoff) when the holder of a call
futures exercises?
A) A long position in a futures contract
B) A short position in a futures contract
C) A long position in the underlying asset
D) A short position in the underlying asset
Answer: A
3) The risk-free rate is 5% and the dividend yield on the S&P 500 index is 2%. Which of the
following is correct when a futures option on the index is being valued?
A) The futures price of the S&P 500 is treated like a stock paying a dividend yield of 5%
B) The futures price of the S&P 500 is treated like a stock paying a dividend yield of 2%
C) The futures price of the S&P 500 is treated like a stock paying a dividend yield of 3%
D) The futures price of the S&P 500 is treated like a non-dividend-paying stock
Answer: A

A) Black's model can be used to value an American-style option on futures
B) Black's model can be used to value a European-style option on futures
C) Black's model can be used to value a European-style option on spot
D) Black's model is widely used by practitioners
Answer: A
5) Which of the following is true when the futures price exceeds the spot price?
A) Calls on futures should never be exercised early
B) Put on futures should never be exercised early
C) A call on futures is always worth at least as much as the corresponding call on spot
D) A call on spot is always worth at least as much as the corresponding call on futures
Answer: C
6) Which of the following describes a futures-style option?

A) An option on a futures
B) An option on spot with daily settlement
C) A futures on an option payoff
Answer: C
1
7) A futures price is currently 40 cents. It is expected to move up to 44 cents or down to 34 cents
in the next six months. The risk-free interest rate is 6%. What is the probability of an up
movement in a risk-neutral world?
A) 0.4
B) 0.5
C) 0.72
D) 0.6
Answer: D

in the next six months. The risk-free interest rate is 6%. What is the value of a six-month put
option with a strike price of 37 cents?
A) 3.00 cents
B) 2.91 cents
C) 1.16 cents
D) 1.20 cents
Answer: C

in the next six months. The risk-free interest rate is 6%. What is the value of a six month call
option with a strike price of 39 cents?
A) 5.00 cents
B) 2.91 cents
C) 3.00 cents
D) 4.21 cents
Answer: B
10) Which of the following are true?

A) Futures options are usually European
B) Futures options are usually American
C) Both American and European futures options trade actively are exchanges
D) Both American and European futures options trade actively in the OTC market
Answer: B
11) Which of the following is true for a September futures option?

A) The expiration month of option is September
B) The option was first traded in September
C) The delivery month of the underlying futures contract is September
D) September is the first month when the option can be exercised
Answer: C
2
12) What is the cash settlement if a put futures option on 50 units of the underlying asset is
exercised?
A) (Current Futures Price - Strike Price) times 50
B) (Strike Price - Current Futures Price) times 50
C) (Most Recent Futures Settlement Price - Strike Price) times 50
D) (Strike Price - Most Recent Futures Settlement Price) times 50
Answer: D
13) What is the cash settlement if a call futures option on 50 units of the underlying asset is
exercised?
A) (Current Futures Price - Strike Price) times 50
B) (Strike Price - Current Futures Price) times 50
C) (Most Recent Futures Settlement Price - Strike Price) times 50
D) (Strike Price - Most Recent Futures Settlement Price) times 50
Answer: C

A) A futures option is settled daily
B) A futures-style option is settled daily
C) Both a futures option and a futures-style option are settled daily
D) Neither a futures option nor a futures-style option is settled daily
Answer: B
15) Which of the following is true about a futures option and a spot option on the same
underlying asset with an identical strike price and expiration date?
A) A European call spot option and an American call futures option are equivalent
B) An American call spot option and a European call futures option are equivalent
C) A European put spot option and European put futures option are equivalent
D) An American put spot option and American put futures option are equivalent
Answer: C
16) What is the value of a European call futures option where the futures price is 50, the strike
price is 50, the risk-free rate is 5%, the volatility is 20% and the time to maturity is three
months?
A) 49.38N(0.05)-49.38N(-0.05)
B) 50N(0.05)-50N(-0.05)
C) 49.38N(0.1)-49.38N(-0.1)
D) 50N(0.1)-49.38N(-0.1)
Answer: A
17) What is the growth rate of an index futures price in the risk-neutral world?
A) The excess of the risk-free rate over the dividend yield
B) The risk-free rate
C) The dividend yield on the index
D) Zero
Answer: D
3
18) When Black's model used to value a European option on the spot price of an asset, which of
the following is NOT true?
A) It is necessary to know the futures or forward price for a contract maturing at the same time
as the option
B) It is not necessary to estimate income on the underlying asset
C) It is not necessary to know the risk-free rate
D) The underlying asset can be an investment or a consumption asset
Answer: C
19) Consider a European one-year call futures option and a European one-year put futures
options when the futures price equals the strike price. Which of the following is true?
A) The call futures option is worth more than the put futures option
B) The put futures option is worth more than the call futures option
C) The call futures option is sometimes worth more and sometimes worth less than the put
futures option
D) The call futures option is worth the same as the put futures option
Answer: D
20) One-year European call and put options on an asset are worth $3 and $4 respectively when
the strike price is $20 and the one-year risk-free rate is 5%. What is the one-year futures price of
the asset if there are no arbitrage opportunities? (Use put-call parity.)
A) $19.55
B) $18.95
C) $20.95
D) $20.45
Answer: B
4
Chapter 17 The Greek Letters
1) A call option on a stock has a delta of 0.3. A trader has sold 1,000 options. What position
should the trader take to hedge the position?
A) Sell 300 shares
B) Buy 300 shares
C) Sell 700 shares
D) Buy 700 shares
Answer: B
2) What does theta measure?

A) The rate of change of delta with the asset price
B) The rate of change of the portfolio value with the passage of time
C) The sensitivity of a portfolio value to interest rate changes
Answer: B
3) What does gamma measure?

Answer: A
4) What does vega measure?

Answer: D
5) What does rho measure?

Answer: C

A) The delta of a European put equals minus the delta of a European call
B) The delta of a European put equals the delta of a European call
C) The gamma of a European put equals minus the gamma of a European call
D) The gamma of a European put equals the gamma of a European call
Answer: D
1
7) A portfolio of derivatives on a stock has a delta of 2400 and a gamma of -10. An option on the
stock with a delta of 0.5 and a gamma of 0.04 can be traded. What position in the option is
necessary to make the portfolio gamma neutral?
A) Long position in 250 options
B) Short position in 250 options
C) Long position in 20 options
D) Short position in 20 options
Answer: A
8) A trader uses a stop-loss strategy to hedge a short position in a three-month call option with a
strike price of 0.7000 on an exchange rate. The current exchange rate is 0.6950 and value of the
option is 0.1. The trader covers the option when the exchange rate reaches 0.7005 and uncovers
(i.e., assumes a naked position) if the exchange rate falls to 0.6995. Which of the following is
NOT true?
A) The exchange rate trading might cost nothing so that the trader gains 0.1 for each option sold
B) The exchange rate trading might cost considerably more than 0.1 for each option sold so that
the trader loses money
C) The present value of the gain or loss from the exchange rate trading should be about 0.1 on
average for each option sold
D) The hedge works reasonably well
Answer: D
9) Maintaining a delta-neutral portfolio is an example of which of the following?

A) Stop-loss strategy
B) Dynamic hedging
C) Hedge and forget strategy
D) Static hedging
Answer: B
10) Which of the following could NOT be a delta-neutral portfolio?

A) A long position in call options plus a short position in the underlying stock
B) A short position in call options plus a short position in the underlying stock
C) A long position in put options and a long position in the underlying stock
D) A long position in a put option and a long position in a call option
Answer: B
11) Which of the following is NOT true about gamma?

A) A highly positive or highly negative value of gamma indicates that a portfolio needs frequent
rebalancing to stay delta neutral
B) The magnitude of gamma is a measure of the curvature of the portfolio value as a function of
the underlying asset price
C) A big positive value for gamma indicates that a big movement in the asset price in either
direction will lead to a loss
D) A long position in either a call or a put has a positive gamma
Answer: C
2
12) Gamma tends to be high for which of the following?
A) At-the money options
B) Out-of-the money options
C) In-the-money options
D) Options with a long time to maturity
Answer: A
13) Which of the following is true for a call option on a non-dividend-paying stock?
A) If the option is at the money (stock price equals strike price) it must have a delta of 0.5
B) If the strike price equals the forward price of the stock, it must have a delta of 0.5
C) If the option has a delta of 0.5, it must be out of the money
D) If the option has a delta of 0.5, it must be in of the money
Answer: C
14) The risk-free rate is 5% and the dividend yield on an index is 2%. Which of the following is
the delta with respect to the index of a one-year futures on the index?
A) 0.98
B) 1.05
C) 1.03
D) 1.02
Answer: C
15) The gamma of a delta-neutral portfolio is 500. What is the impact of a jump of $3 in the
price of the underlying asset?
A) A gain of $2,250
B) A loss of $2,250
C) A gain of $750
D) A loss of $750
Answer: A
16) Vega tends to be high for which of the following?

A) At-the money options
B) Out-of-the money options
C) In-the-money options
D) Options with a short time to maturity
Answer: A
17) The delta of a call option on a non-dividend-paying stock is 0.4. What is the delta of the
corresponding put option?
A) -0.4
B) 0.4
C) -0.6
D) 0.6
Answer: C
3
18) A call option on a non-dividend-paying stock has a strike price of $30 and a time to maturity
of six months. The risk-free rate is 4% and the volatility is 25%. The stock price is $28. What is
the delta of the option?
A) N(-0.1342)
B) N(-0.1888)
C) N(-0.2034)
D) N(-0.2241)
Answer: B
19) Which of the following is NOT a letter in the Greek alphabet?

A) delta
B) rho
C) vega
D) gamma
Answer: C
20) When the interest rate is zero which of the following is true for a delta-neutral portfolio with
a positive gamma?
A) As gamma increases theta becomes more positive
B) As gamma decreases theta declines
C) Theta is zero
D) As gamma increases theta becomes more negative
Answer: D
4
Chapter 18 Binomial Trees in Practice
1) How many nodes are there at the end of a Cox-Ross-Rubinstein five-step binomial tree?
A) 4
B) 5
C) 6
D) 7
Answer: C
2) Which of the following cannot be estimated from a single binomial tree?

A) delta
B) gamma
C) theta
D) vega
Answer: D
3) Which of the following is true for u in a Cox-Ross-Rubinstein binomial tree?

A) It depends on the interest rate and the volatility
B) It depends on the volatility but not the interest rate
C) It depends on the interest rate but not the volatility
D) It depends on neither the interest rate nor the volatility
Answer: B
4) How many different paths are there through a Cox-Ross-Rubinstein tree with four-steps?
A) 5
B) 9
C) 12
D) 16
Answer: D
5) When we move from assuming no dividends to assuming a constant dividend yield, which of
the following is true for a Cox, Ross, Rubinstein tree?
A) The parameters u and p change
B) p changes but u does not
C) u changes but p does not
D) Neither p nor u changes
Answer: B
1
6) When the stock price is 20 and the present value of dividends is 2, which of the following is
the recommended way of constructing a tree?
A) Draw a tree for an initial stock price of 20 and subtract the present value of future dividends
at each node
B) Draw a tree for an initial stock price of 22 and subtract the present value of future dividends
at each node
C) Draw a tree with an initial stock price of 18 and add the present value of future dividends at
each node
D) Draw a tree with an initial stock price of 18 and add 2 at each node
Answer: C
7) What is the recommended way of making interest rates a function of time in a Cox, Ross,
Rubinstein tree?
A) Make u a function of time
B) Make p a function of time
C) Make u and p a function of time
D) Make the lengths of the time steps unequal
Answer: B
8) What is the recommended way of making volatility a function of time in a Cox, Ross,
Rubinstein tree?
A) Make u a function of time
B) Make p a function of time
C) Make u and p a function of time
D) Make the lengths of the time steps unequal
Answer: D
9) A binomial tree prices an American option at $3.12 and the corresponding European option at
$3.04. The Black-Scholes price of the European option is $2.98. What is the control variate price
of the American option?
A) $3.06
B) $3.18
C) $2.90
D) $3.08
Answer: A
10) The chapter discusses an alternative to the Cox, Ross, Rubinstein tree. In this alternative,
which of the following are true?
A) The relationship between u and d is: u=1/d
B) The relationship between u and d is: u-1=1-d
C) The probabilities on the tree are all 0.5
Answer: C
2
11) Which of the following cannot be valued by simulating paths through a tree in the way
described in the chapter?
A) European options
B) American options
C) Asian options (i.e., options on the average stock price)
D) An option which provides a payoff of $100 if the stock price is greater than the strike price at
maturity
Answer: B
12) For an option on futures, the volatility is 35%, the time step is three months, and the risk-free
rate is 5%. What is the Cox, Ross, Rubinstein parameter, u?
A) 1.34
B) 1.29
C) 1.09
D) 1.19
Answer: D
13) For an option on futures, the volatility is 35%, the time step is three months, and the risk-free
rate is 5%. What is the Cox, Ross, Rubinstein parameter, p?
A) 0.52
B) 0.46
C) 0.48
D) 0.50
Answer: B
14) When the volatility of an option increases from 30% to 32% the value of the option increases
from $2.00 to $2.40. What is the vega of the option?
A) 0.20 dollars per %
B) 0.50 dollars per %
C) 0.80 dollars per %
D) 2.00 dollars per %
Answer: A
15) The values of a stock price at the end of the second time step are $80, $100, $125. The
corresponding values of an option are $0, $5, and $20 respectively. What is an estimate of
gamma?
A) 0.136
B) 0.146
C) 0.156
D) 0.166
Answer: C
3
16) What is the difference between valuing an American and a European option using a tree?
A) The value of u is higher for American options
B) The value of u is lower for American options
C) The time steps for American options are not equal
D) It is necessary to do two calculations at nodes where the option is in the money
Answer: D
17) A European option on a stock with known dollar dividend is valued by setting the stock price
variable equal to the stock price minus the present value of the dividend in the Black-Scholes-
Merton formula. A second price can be obtained using the tree building procedure in the chapter.
Which of the following is true when a very large number of time steps are used in the tree?
A) The first price is higher than the second price
B) The first price is lower than the second price
C) The first price is sometimes higher and sometimes lower than the second price
D) The two prices are almost exactly the same
Answer: D
18) Which of the following is possible in a modified Cox, Ross, Rubinstein binomial tree?
A) The interest rate and volatility can both be functions of time
B) The interest rate or the volatility can be a function of time, but not both
C) The interest rate can be a function of time but the volatility cannot
D) The interest rate and volatility must be constant
Answer: A
19) Which of the following describes the way that the parameters in a binomial tree are chosen?
A) The expected return during each time step is the risk-free rate
B) The standard deviation of the return in each time step is, for small time steps, almost exactly
equal to the volatility per annum times the square root of the length on the time step in years
C) The tree recombines
D) All of the above
Answer: D
20) Which of the following can be valued without using a numerical procedure such as a
binomial tree?
A) American put options on a non-dividend paying stock
B) American call options on a non-dividend paying stock
C) American call options on a currency
D) American put options on futures
Answer: B
4
Chapter 19 Volatility Smiles
1) Which of the following is true of a volatility smile?

A) Implied volatility is on the horizontal axis and strike price is on the vertical axis
B) Historical volatility is on the horizontal axis and strike price is on the vertical axis
C) Implied volatility is on the vertical axis and strike price is on the horizontal axis
D) Historical volatility is on the vertical axis and strike price is on the horizontal axis
Answer: C

A) Volatility smile for European puts is the same as for European calls
B) Volatility smile for European puts is the same as for American puts
C) Volatility smile for European calls is the same as for American calls
D) Volatility smile for American puts is the same as for American calls
Answer: A
3) Which of the following is true when the tails of a future foreign currency distribution are
compared with those of a lognormal distribution with the same mean and standard deviation?
A) The left tail and right tail are thinner
B) The left tail is thinner and the right tail is fatter
C) The right tail is thinner and the left tail is fatter
D) Both tails are fatter
Answer: D
4) Which of the following is true when the tails of a future stock price distribution are compared
with those of a lognormal distribution with the same mean and standard deviation?
A) The left tail and right tail are thinner
B) The left tail is thinner and the right tail is fatter
C) The right tail is thinner and the left tail is fatter
D) Both tails are fatter
Answer: C
5) Which of the following could cause the volatility smile typically seen for foreign currency
options?
A) Currencies are traded in different countries at different times of the day
B) Currencies tend to have low volatilities
C) The activities of central banks causes occasional jumps in the exchange rate
D) Interest rates may be different in the two countries
Answer: C

A) The volatility skew for equities is much more pronounced now than it was in 1985
B) The volatility skew for equities has a positive gradient
C) The volatility skew for equities is consistent with the Black-Scholes-Merton model
D) The volatility skew for equities is similar to that for foreign currencies
Answer: A
1
7) Why do traders use volatility smiles for pricing options?
A) To allow for non-lognormality of the probability distribution of future asset price
B) Because it is consistent with recent market moves
C) As a tool to reflect their views about extreme market moves
D) Because extreme market moves are always more likely than Black-Scholes-Merton assumes
Answer: A
8) What does the shape of the volatility smile reveal about put options on equity?
A) Options close-to-the-money have the lowest implied volatility
B) Options deep-in-the-money have a relatively high implied volatility
C) Options deep-out-of-the-money have a relatively high implied volatility
D) All of the above
Answer: C
9) What does the shape of the volatility smile reveal about call options on a currency?
A) Options close-to-the-money have the lowest implied volatility
B) Options deep-in-the-money have a relatively high implied volatility
C) Options deep-out-of-the-money have a relatively high implied volatility
D) All of the above
Answer: D

A) A volatility surface provides more information than a single volatility smile
B) A volatility surface is used to determine the implied volatility of an option that does not trade
actively
C) A volatility surface can be determined from a single volatility smile using interpolation
D) A volatility surface incorporates information about options with different maturity dates
Answer: C
11) A volatility surface is a table showing the relationship between which of the following?
A) Implied volatility, time to maturity, and strike price
B) Implied volatility, historical volatility, and time to maturity
C) Historical volatility, strike price, and time to maturity
Answer: A
12) Which of the following causes a volatility smile that is a "frown"?

A) There is a small probability of a large stock price decrease in one week
B) There is a small probability of a large stock price increase in one week
C) The outcome of a lawsuit (roughly equal chance of being favorable or unfavorable) will
create a large movement up or down in one week
Answer: C
2
13) Which of the following could be a result of "crashophobia"?
A) High volatilities for in-the-money calls
B) High volatilities for in-the-money puts
C) High volatilities for at-the-money calls
D) Low volatilities for at-the-money puts
Answer: A
14) Which of the following is true for European call and put options?
A) If they have the same strike price, they have the same implied volatility
B) If they have the same time to maturity, they have the same implied volatility
C) If they have the same strike price and time to maturity, they have the same implied volatility
Answer: C
15) Which of the following is true about daily exchange rate moves?
A) Four standard deviation daily moves in an exchange rate happen less frequently than they
would do if changes were normally distributed
B) Four standard deviation daily movements in an exchange rate happen more frequently than
three standard deviation moves in the exchange rate
C) The frequency of six standard deviation daily movements in an exchange rate is about once
every 100 years
Answer: D
16) The daily percentage change in an exchange rate is compared to a normal distribution with
the same mean and standard deviation. Which of the following is true?
A) Both small and large exchange rate moves are more likely than with the normal distribution
B) Small exchange rate moves are less likely and large exchange rate moves are more likely than
with the normal distribution
C) Large exchange rate moves are less likely and small exchange rate moves are more likely than
with the normal distribution
D) Both small and large exchange rate moves are less likely than with the normal distribution
Answer: A
17) Which of the following is true as time to maturity increases?

A) The volatility smile for currency options tends to become more pronounced
B) The volatility smile for currency options tends to become less pronounced
C) The volatility smile for currency options first becomes less pronounced and then becomes
more pronounced
D) The volatility smile for currency options remains approximately the same
Answer: B
3
18) If the volatility implied from an at-the-money put currency option were used to price other
put options on the currency, which of the following would be true?
A) Out-of-the money and in-the-money prices would be too high
B) Out-of-the money and in-the-money prices would be too low
C) Out-of-the-money option prices would be too high and in-the-money option prices would be
too low
D) Out-of-the-money option prices would be too low and in-the-money option prices would be
too high
Answer: B
19) If the volatility implied from an at-the-money put stock option were used to price other put
options on the stock, which of the following would be true?
A) Out-of-the money and in-the-money prices would be too high
B) Out-of-the money and in-the-money prices would be too low
C) Out-of-the-money option prices would be too high and in-the-money option prices would be
too low
D) Out-of-the-money option prices would be too low and in-the-money option prices would be
too high
Answer: D
20) The implied volatilities for strike prices of 1.1 and 1.2 when the time to maturity is 6 months
are 20% and 22%. The implied volatilities for strike prices of 1.1 and 1.2 when the time to
maturity is 1 year are 18.8% and 20.2%. Using linear interpolation, what is the implied volatility
for a strike price of 1.12 and a time to maturity of 10 months?
A) 19.24%
B) 19.52%
C) 20.48%
D) 19.96%
Answer: B
4
Chapter 20 Value at Risk
1) Which of the following is true of the 99.9% value at risk?

A) There is 1 chance in 10 that the loss will be greater than the value of risk
B) There is 1 chance in 100 that the loss will be greater than the value of risk
C) There is 1 chance in 1000 that the loss will be greater than the value of risk
Answer: C
2) The gain from a project is equally likely to have any value between -$0.15 million and +$0.85
million. What is the 99% value at risk?
A) $0.145 million
B) $0.14 million
C) $0.13 million
D) $0.10 million
Answer: B
3) The gain from a project is equally likely to have any value between -$0.15 million and +$0.85
million. What is the 99% expected shortfall?
A) $0.145 million
B) $0.14 million
C) $0.13 million
D) $0.10 million
Answer: A
4) Which of the following is true of the historical simulation method for calculating VaR?
A) It fits historical data on the behavior of variables to a normal distribution
B) It fits historical data on the behavior of variables to a lognormal distribution
C) It assumes that what will happen in the future is a random sample from what has happened in
the past
D) It uses Monte Carlo simulation to create random future scenarios
Answer: C
5) At the end of Thursday, the estimated volatility of asset A is 2% per day. During Friday asset
A produces a return of 3%. An EWMA model with lambda equal to 0.9 is used. What is an
estimate of the volatility of asset A at the end of Friday?
A) 2.08%
B) 2.10%
C) 2.12%
D) 2.14%
Answer: C
1
6) At the end of Thursday, the estimated volatility of asset B is 1% per day. During Friday asset
B produces a return of zero. An EWMA model with lambda equal to 0.9 is used. What is an
estimate of the volatility of asset A at the end of Friday?
A) 0.98%
B) 0.95%
C) 0.92%
D) 0.90%
Answer: B
7) At the end of Thursday, the estimated covariance between assets A and B is 0.0001. During
Friday asset A produces a return of 3% and asset B produces a return of zero. An EWMA model
with lambda equal to 0.9 is used. What is an estimate of the covariance at the end of Friday?
A) 0.000090
B) 0.000081
C) 0.000100
D) 0.000095
Answer: A
8) Which of the following is a definition of the covariance between X and Y?

A) Correlation between X and Y times variance of X times variance of Y
B) Variance of X times the variance of Y
C) Correlation between X and Y divided by the product of the standard deviation of X and the
standard deviation of Y
D) Correlation between X and Y times standard deviation of X times standard deviation of Y
Answer: D
9) Which of the following is true of a covariance matrix?

A) The numbers on the diagonal are variances
B) The numbers on the diagonal are standard deviations
C) The numbers on the diagonal are all one
D) The numbers on the diagonal are all zero
Answer: A
10) What does EWMA stand for?

A) Equally weighted moving average
B) Equally weighted median approximation
C) Exponentially weighted moving average
D) Exponentially weighted median average
Answer: C
2
11) Which of the following is true when lambda equals 0.95?
A) The weight given to the most recent observation is 0.95
B) The weight given to the observation one day ago is 95% of the weight given to the
observation two days ago
C) The weights given to observations add up to 0.95
D) The weights given to the observation two days ago is 95% of the weight given to the
observation one day ago
Answer: D
12) The 10-day VaR is often assumed to be which of the following?

A) The 1-day VaR multiplied by 10
B) The 1-day VaR multiplied by the square root of 10
C) The 1-day VaR divided by 10
D) The 1-day VaR divided by the square root of 10
Answer: B
13) Which was the minimum capital requirement for market risk in the 1996 BIS Amendment?
A) At least 3 times the 10-day VaR with a 99% confidence level
B) At least 3 times 7-day VaR with a 97% confidence level
C) At least 2 times 5-day VaR with a 95% confidence level
D) 1-day VaR with a 99% confidence level
Answer: A
14) An investor has $2,000 invested in stock A and $5,000 in stock B. The daily volatilities of A
and B are 1.5% and 1% respectively and the coefficient of correlation is 0.8. What is the one day
99% VaR? (Note that N(-2.33)=0.01)
A) $177
B) $135
C) $215
D) $331
Answer: A
15) What is the method of testing how often a VaR with a certain confidence level was exceeded
in the past called?
A) Stress testing
B) Backtesting
C) EWMA
D) The model-building approach
Answer: B
16) If the volatility for a portfolio is 20% per year, what is the volatility per quarter?
A) 20%
B) 10%
C) 5%
D) 2%
Answer: B
3
17) Which of the following is true when delta, but not gamma, is used in calculating VaR for
option positions?
A) VaR for a long call is too low and VaR for a long put is too low
B) VaR for a long call is too low and VaR for a long put is too high
C) VaR for a long call is too high and VaR for a long put is too low
D) VaR for a long call is too high and VaR for a long put is too high
Answer: D

A) The quadratic model approximates daily changes in using delta and gamma
B) The quadratic model approximates daily changes using delta, but not gamma
C) The quadratic model approximates daily changes using gamma, but not delta
Answer: A

A) Cash flow mapping is a way of calculating the present value of cash flows
B) Cash flow mapping is used to handle interest rate exposures in the model building approach
C) Cash flow mapping is used to handle interest rate exposures in the historical simulation
approach
Answer: B
20) Which of the following describes stressed VaR?

A) It is based on movements in market variables in stressed market conditions
B) It is VaR with a very high confidence level
C) It is VaR multiplied by a factor of 3
Answer: A
4
Chapter 21 Interest Rate Options

A) A callable bond allows the lender to ask for the principal to be repaid early
B) A callable bond allows the borrower to repay the principal early
C) A callable bond is a bond with an embedded stock option
Answer: A

A) A puttable bond allows the lender to ask for the principal to be repaid early
B) A puttable bond allows the borrower to repay the principal early
C) A puttable bond is a bond with an embedded stock option
Answer: B

A) A swaption that gives the holder the right to pay fixed is equivalent to a call option on a bond
B) A swaption that gives the holder the right to pay fixed is equivalent to a put option on a bond
C) A swaption that gives the holder the right to pay fixed is equivalent to a put option on one
bond combined with a call option on another bond
Answer: B
4) In a cap with quarterly reset dates, the cap rate is 3.5% per annum and the notional principal is
$1 million. Suppose that the LIBOR rate is 4.0% per annum for a particular 3-month period.
What is the approximate payoff at the end of the 3 months?
A) $10,000
B) $5,000
C) $2,500
D) $1,250
Answer: D
5) In a floor with semiannual reset dates, the floor rate is 3.5% per annum and the notional
principal is $1 million. Suppose that the LIBOR rate is 3% per annum for a particular 6-month
period. What is the approximate payoff at the end of the 6 months?
A) $10,000
B) $5,000
C) $2,500
D) $1,250
Answer: C
1
6) A floating-rate borrower wants to use a collar as a hedge. Which of the following is
appropriate?
A) Buy a cap and sell a floor
B) Buy a cap and buy a floor
C) Sell a cap and sell a floor
D) Sell a cap and buy a floor
Answer: A
7) A floating-rate lender wants to use a collar as a hedge. Which of the following is appropriate?
A) Buy a cap and sell a floor
B) Buy a cap and buy a floor
C) Sell a cap and sell a floor
D) Sell a cap and buy a floor
Answer: D
8) Which of the following is assumed to be lognormal when a swap option is valued?

A) A future bond price
B) A future swap rate
C) A future short-term rate
D) A future bond yield
Answer: B
9) Which of the following is assumed to be lognormal when a bond option is valued?

D) A future bond yield
Answer: A
10) Which of the following is assumed to be lognormal when a caplet is valued?

D) A future long-term rate
Answer: C
11) At the maturity of a bond option, it is estimated that the underlying bond will have a duration
of 6 years and a yield of 5%. The forward yield volatility is quoted as 25%. What is the volatility
of the forward bond price?
A) 3%
B) 30%
C) 20.8%
D) 7.5%
Answer: D
2
12) A Eurodollar futures option contract has a strike price of 97 and the Eurodollar interest rate
is 2.50%. What is the intrinsic value of the contract if the option is a call?
A) $0
B) $1,250
C) $1,750
D) $2,500
Answer: B
13) A Eurodollar futures option contract has a strike price of 97 and the Eurodollar interest rate
is 2.50%. What is the intrinsic value of the contract if the option is a put?
A) $0
B) $1,250
C) $1,750
D) $2,500
Answer: A
14) A ten year interest rate cap has quarterly resets. How many caplets does the cap consist of?
A) 38
B) 39
C) 40
D) 41
Answer: B
15) In put-call parity for caps and floors, which of the following is true?
A) Long cap plus long floor equals swap
B) Long cap plus swap equals short floor
C) Long cap equals long floor plus swap
D) Long cap minus long floor equals swaption
Answer: C
16) Which of the following is an implication of the mean reversion of interest rates?
A) Interest rates cannot become negative
B) When short-term interest rates are high they tend to move down
C) The term structure of interest rates tends to be upward sloping
D) When short-term interest rates are low they tend to stay low
Answer: B
17) The price of a December put futures option is quoted as 5-52. Each Treasury bond futures
contract is for delivery of $100,000 in Treasury bonds. What is the cost of one contract?
A) $5,520.00
B) $5,812.50
C) $6,625.00
D) $8,250.00
Answer: B
3
18) What is exchanged when a put option on an interest rate futures is exercised?
A) A long position in a futures contract for the holder of the option and a short position in a
futures contract for the option writer
B) A short position in a futures contract for the holder of the option and a long position in a
futures contract for the option writer
C) Cash payoff, a long position in a futures contract for the holder of the option, and a short
position in a futures contract for the option writer
D) Cash payoff, a short position in a futures contract for the holder of the option, and a long
position in a futures contract for the option writer
Answer: D
19) A five-year cap is reset annually period. The cap rate is 3% and the notional principal is $100
million. The 12-month LIBOR interest rate for the third year proves to be 5%. Which of the
following is approximately true?
A) The resulting payoff is $2 million at the beginning of the third year
B) The resulting payoff is $2 million at the end of the fifth year
C) The resulting payoff is $2 million at the end of the third year
D) The resulting payoff is $2 million half way through the third year
Answer: C

A) A cap is a portfolio of put options on interest rates
B) A cap is a put option on a coupon-bearing bond
C) A cap is a call option on a coupon-bearing bond
Answer: D
4
Chapter 22 Exotic Options and Other Nonstandard Products
1) An Asian option is a term used to describe which of the following?

A) An option where the payoff depends on whether a barrier is hit
B) An option where the payoff depends on the average value of a variable over a period of time
C) An option that trades on an exchange in the Far East
D) Any option with a nonstandard payoff
Answer: B
2) As the barrier is observed more frequently, a knock out option becomes which of the
following?
A) More valuable
B) Less valuable
C) There is no effect on value
D) May become more valuable or less valuable
Answer: B
3) There are two types of regular options (calls and puts). How many types of compound options
are there?
A) Two
B) Four
C) Six
D) Eight
Answer: B
4) There are two types of regular options (calls and puts). How many types of barrier options are
there?
A) Two
B) Four
C) Six
D) Eight
Answer: D
5) In a shout call option the strike price is $30. The holder shouts when the asset price is $40.
What is the payoff from the option if the final asset price is $35?
A) $0
B) $5
C) $10
D) $15
Answer: C
1
6) A floating lookback put option pays off which of the following?
A) The amount by which the final stock price exceeds the minimum stock price
B) The amount by which the maximum stock price exceeds the final stock price
C) The amount by which the strike price exceeds the minimum stock price
D) The amount by which the maximum stock price exceeds the strike price
Answer: B
7) A fixed lookback put option pays off which of the following?

A) The amount by which the final stock price exceeds the minimum stock price
B) The amount by which the maximum stock price exceeds the final stock price
C) The amount by which the strike price exceeds the minimum stock price
D) The amount by which the maximum stock price exceeds the strike price
Answer: C
8) A PO is a "principal only" MBS and an IO is an "interest only" MBS. As prepayments

increase which of the following happens?
A) Both the PO and IO become more valuable
B) The PO becomes more valuable and the IO becomes less valuable
C) The PO becomes less valuable and the IO becomes more valuable
D) Both the PO and IO become less valuable
Answer: B
9) In a LIBOR-in-arrears swap, which of the following is true?

A) The floating payment made on a date is the LIBOR rate on the previous payment date
B) The floating payment on a date is the LIBOR rate two payment dates ago
C) The floating payment on a date is the LIBOR rate on that date
D) The floating payment on a date is the LIBOR rate on that date only when it is higher than the
LIBOR rate on the previous payment date
Answer: C
10) Which of the following would be referred to as an equity swap?

A) An exchange of the return from an equity index for a fixed rate of interest
B) An exchange of a long position in one stock for a long position in another stock
C) An exchange of a short position in one stock for a short position in another stock
Answer: A
11) Which of the following is a five-year interest rate swap that can be canceled at the two year
point?
A) The difference between two plain vanilla interest rate swaps
B) The difference between a plain vanilla interest rate swap and a forward start swap
C) A regular interest rate swap plus a European swap option
D) A regular interest rate swap plus a Bermudan swap option
Answer: C
2
12) Which of the following is equivalent to a long position in a European call option?
A) A short position in a cash-or-nothing put option plus a long position in an asset-or-nothing put
option
B) A long position in an asset-or-nothing put option plus a long position in a cash-or-nothing put
option
C) A long position in an asset-or-nothing call option plus a long position in a cash-or-nothing
call option
D) A long position in an asset-or-nothing call option plus a short position in a cash-or-nothing
call option
Answer: D
13) Which of the following is equivalent to a short position in a European put option?
A) A short position in a cash-or-nothing put option plus a long position in an asset-or-nothing put
option
B) A long position in an asset-or-nothing put option plus a long position in a cash-or-nothing put
option
C) A long position in an asset-or-nothing call option plus a long position in a cash-or-nothing
call option
D) A long position in an asset-or-nothing call option plus a short position in a cash-or-nothing
call option
Answer: A
14) Which of the following describes a cliquet option?

A) An option to exchange one asset for another
B) An instrument when the holder can choose between several alternative options
C) An option on an option with predetermined strike prices for the two options
D) A series of options with rules for determining strike prices
Answer: D
15) An employer has promised that it will grant employees three year options in one year's time
and that the options will be at the money at the time they are granted. What describes these
options?
A) Chooser options
B) Forward start options
C) Compound options
D) Shout options
Answer: B
16) When can Bermudan options be exercised?

A) Any time during the life of the options
B) Any time after a certain date up to the end of the life
C) Any time before a certain date or at the end of the option's life
D) On dates specified at the start of the option
Answer: D
3
17) Which of the following are subject to prepayment risk?
A) Collateralized mortgage obligations
B) POs
C) IOs
D) All of the above
Answer: D
18) Which of the following is the payoff from an average strike call option?
A) The excess of the strike price over the average stock price, if positive
B) The excess of the final stock price over the average stock price, if positive
C) The excess of the average stock price over the strike price, if positive
D) The excess of the average stock price over the final stock price, if positive
Answer: B
19) Which of the following is the payoff from an average strike put option?
A) The excess of the strike price over the average stock price, if positive
B) The excess of the final stock price over the average stock price, if positive
C) The excess of the average stock price over the strike price, if positive
D) The excess of the average stock price over the final stock price, if positive
Answer: D
20) A binary option pays of $100 if a stock price is greater than its current value in three months.
The risk-free rate is 3% and the volatility is 40%. Which of the following is its value?
A) 99.25N(-0.1375)
B) 99.25N(0.1375)
C) 99.25N(-0.0625)
D) 99.25N(0.0625)
Answer: C
4
Chapter 23 Credit Derivatives
1) Suppose that the cumulative probability of a company defaulting by years one, two, three and
four are 3%, 6.5%, 10%, and 14.5%, respectively. What is the probability of default in the fourth
year conditional on no earlier default?
A) 4.5%
B) 5.0%
C) 5.5%
D) 6.0%
Answer: B
2) What is the number of companies underlying the CDX NA IG index?

A) 50
B) 75
C) 100
D) 125
Answer: D
3) What is the number of companies underlying the iTraxx index?

A) 50
B) 75
C) 100
D) 125
Answer: D
4) What is the rating of the companies underlying the iTraxx index?

A) A or above
B) BBB or above
C) BB or below
D) BBB or below
Answer: B
5) In a CDS with a notional principal of $100 million the reference entity defaults. What is the
payoff to the buyer of protection when the recovery rate is 30%?
A) $100 million
B) $30 million
C) $130 million
D) $70 million
Answer: D
1
6) In a one-year forward contract on a CDS that will last five years, what usually happens if there
is a default during the first year?
A) There is a payoff to the forward protection buyer at the time of default
B) There is a payoff to the forward protection buyer at the end of one year
C) There is a payoff to the forward protection buyer at the end of six years
D) The contract ceases to exist
Answer: D
7) Which of the following is usually used to define the recovery rate of a bond?
A) The value of the bond immediately after default as a percent of its face value
B) The value of the bond immediately after default as a percent of the sum of the bond's face
value and accrued interest
C) The amount finally realized by a bondholder as a percent of face value
D) The amount finally realized by a bondholder as a percent of the sum of the bond's face value
and accrued interest
Answer: A

A) Risk neutral default probabilities are usually much lower than real world default probabilities
B) Risk neutral default probabilities are usually much higher than real world default probabilities
C) Risk neutral and real world probabilities must be close to each other if there are to be no
arbitrage opportunities
D) Risk-neutral default probabilities cannot be calculated from CDS spreads
Answer: B
9) Which of the following happens when the default correlation of the companies underlying a
CDO increases?
A) The value of the senior tranche and the equity tranche to the protection buyer both increase
B) The value of the senior tranche and the equity tranche to the protection buyer both decrease
C) The value of the senior tranche to the protection buyer decreases and the value of the equity
tranche to the protection buyer increases
D) The value of the senior tranche to the protection buyer increases and the value of the equity
tranche to the protection buyer decreases
Answer: D
10) Which of the following is true of a synthetic CDO?

A) It is created from portfolios of bonds
B) It is created from portfolios of CDSs
C) It references a standard portfolio of bonds
Answer: B
2
11) A CDS with a number of reference entities provides a payoff when any of the reference
entities defaults. What is a name for this CDS?
A) Binary CDS
B) Add-up Basket CDS
C) First-to-Default CDS
D) n-to-Default CDS
Answer: B
12) Which of the following is the most popular life for a credit default swap?
A) 1 year
B) 3 years
C) 5 years
D) 10 years
Answer: C
13) A hazard rate is 1% per annum. What is the probability of a default during the first two
years?
A) 2.00%
B) 2.02%
C) 1.98%
D) 1.96%
Answer: C
14) If the CDS spread for a regular 5-year CDS is 120 basis points, what is the CDS spread for a
5-year binary CDS on the same underlying reference entity? Assume a recovery rate of 40%.
A) 48 basis points
B) 72 basis points
C) 200 basis points
D) 300 basis points
Answer: C
15) For what range of losses is the equity tranche of iTraxx (or CDX NA IG) responsible?
A) 0 to 10%
B) 0 to 7%
C) 0 to 6%
D) 0 to 3%
Answer: D
16) Which of the following is true about a CDS?

A) Restructuring is never a credit event
B) Restructuring is always a credit event
C) Certain types of restructuring qualify as credit events but others do not
D) Sometimes a CDS is defined so that restructuring is a credit event and sometimes it is not
Answer: D
3
17) If the CDS-bond basis is X minus Y, what are X and Y?
A) X is the CDS spread and Y is the excess of the bond yield over the swap rate
B) X is the excess of the bond yield over the swap rate and Y is the CDS spread
C) X is the CDS spread and Y is the excess of the bond yield over the Treasury rate
D) X is the excess of the bond yield over the Treasury rate and Y is the CDS spread
Answer: A
18) In the Lehman bankruptcy the payoff to people who had bought CDS protection was
91.375% of the notional principal. How was this determined?
A) By calculation of the cheapest-to-deliver bond
B) By an auction process
C) By a calculation agent
D) By Lehman's liquidators
Answer: B
19) Which of the following best describes a total return swap?

A) It exchanges the realized return on an asset, including both income and capital gains/losses,
for a return, equal to LIBOR plus a spread on the initial value of the asset
B) It exchanges the promised return on an asset, including both income and capital gains/losses,
for a return equal to LIBOR plus a spread on the initial value of the asset
C) It exchanges the realized return on an asset, including income but not capital gains/losses, for
a return equal to LIBOR plus a spread on the initial value of the asset
D) It exchanges the promised return on an asset, including income but not capital gains/losses,
for a return equal to LIBOR plus a spread on the initial value of the asset
Answer: A
20) If a tranche spread is 55 basis points and the fixed coupon is 60 basis points, which of the
following happens when a trader buys protection?
A) The trader pays an estimate of the present value of 5 basis points per year and then pays 55
basis points per year
B) The trader pays an estimate of the present value of 5 basis points per year and then pays 60
basis points per year
C) The trader receives an estimate of the present value of 5 basis points per year and then pays
55 basis points per year
D) The trader receives an estimate of the present value of 5 basis points per year and then pays
60 basis points per year
Answer: D
4
Chapter 24 Weather, Energy, and Insurance Derivatives
1) On a certain day the highest temperature is 77 degrees and the lowest temperature is 61
degrees. What is the day's HDD?
A) 5
B) 12
C) 4
D) 0
Answer: D
2) On a certain day the highest temperature is 77 degrees and the lowest temperature is 61
degrees. What is the day's CDD?
A) 5
B) 12
C) 4
D) 0
Answer: C
3) Which of the following are products refined from crude oil?

A) Heating oil
B) Gasoline
C) Kerosene
D) All of the above
Answer: D
4) Which of the following typically has the highest volatility?

A) Crude oil
B) Natural gas
C) Electricity
D) Sometimes crude oil and sometimes natural gas
Answer: C
5) Which of the following typically has the lowest volatility?

A) Crude oil
B) Natural gas
C) Electricity in the winter
D) Electricity in the summer
Answer: A
6) Which of the following describes a typical reinsurance contract?

A) Covers a percentage of all losses by an insurance company
B) Covers all losses of the insurance company up to a certain amount
C) Covers all losses of the insurance company above a certain amount
D) Covers all losses of the insurance company between two amounts
Answer: D
1
7) Which of the following describes a CAT bond?
A) Has a great deal of systematic risk
B) Has very little systematic risk
C) Has a moderate amount of systematic risk
D) Has negative systematic risk
Answer: B
8) Which of the following is a common use of weather derivatives?

A) Hedge the volume of electricity that will be demanded by customers in the summer
B) Hedge the price of oil that must be purchased in the winter
C) Hedge the price of electricity that must be purchased in the summer
D) Hedge the price and volume of gas that must be purchased for heating in the winter
Answer: A
9) Which of the following describes the period during which a "5 times 8" contract provides
electricity?
A) From 11pm to 7am on five successive days
B) From 8am to 4pm on five successive days
C) For any 5 hours of a day on 8 successive days
D) For any 8 hours of a day in five successive days
Answer: A
10) Which of the following describes the period during which a "5 times 16" contract provides
electricity?
A) From 7am to 11pm on five successive days
B) From 4pm to 8am on five successive days
C) For any 5 hours of a day on 16 successive days
D) For any 16 hours of a day in five successive days
Answer: A
11) Which of the following is NOT true about electricity?

A) Supply and demand for electricity are matched within 140 control areas in the US, then
excess power sold to other control areas
B) The ability to sell excess power is constrained by transmission capacity
C) Electricity is a commodity that can be easily stored
D) Air conditioning is a big use of electricity
Answer: C
12) Where are oil, gas, and electricity derivatives traded?

A) On exchanges and the OTC market
B) On exchanges, but not on the OTC market
C) On the OTC market, but not on exchanges
D) Oil is traded in both markets, but the other two are traded only in the OTC market
Answer: A
2
13) Which of the following is NOT seasonal?
A) Spot electricity
B) Spot natural gas
C) Electricity futures prices
D) Spot price of corn
Answer: C
14) How can an energy producer hedge its risks?

A) Use weather derivatives for price risk and energy derivatives for volume risk
B) Use energy derivatives for price and volume risk
C) Use energy derivatives for price risk and weather derivatives for volume risk
D) Use weather derivatives for price and volume risk
Answer: C
15) Which of the following are least likely to use weather derivatives?
A) Energy producers
B) Food and drink manufacturers
C) Companies in the leisure industry
D) Automobile manufacturers
Answer: D
16) When a reinsurer covers the layer of hurricane losses for an insurance company between $20
million and $30 million, which of the following describes the insurance company's losses?
A) A bull spread on total hurricane losses
B) A bear spread on total hurricane losses
C) A long call option on total hurricane losses
D) A short put option on total hurricane losses
Answer: A
17) An August CDD weather option is offered on the cumulative monthly CDD at an Atlanta
weather station. An investor has a long call with a strike price of 375 and a short call with a
strike price of 400. The payment is $10,000 per degree day. What is the maximum payoff?
A) $500,000
B) $250,000
C) $100,000
D) $50,000
Answer: B
18) Which of the following is the average of CDD and HDD for a day?
A) The highest temperature during the day
B) The lowest temperature during the day
C) The average temperature during the day
Answer: D
3
19) Which of the following is the basis for calculating HDD and CDD?
A) The average temperature during the day
B) The average of the highest and lowest temperature during the day
C) The temperature at 12 noon during the day
Answer: B
20) Which of the following might we expect to be the result of global warming?
A) An decrease in observed CDDs
B) An increase in observed CDDs
C) An increase in observed HDDs
Answer: B
4

Deri TB-1

Uploaded by

Copyright:

Available Formats

Deri TB-1

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Deri TB-1

Uploaded by

Copyright:

Available Formats

Fundamentals of Futures and Options Markets, 8e (Hull)

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

2) Which of the following is NOT true?

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

9) Which of the following describes European options?

10) Which of the following is NOT true?

20) Which of the following best describes a central clearing party?

Fundamentals of Futures and Options Markets, 8e (Hull)

1) Which of the following is true?

7) Who initiates delivery in a corn futures contract?

9) A hedger takes a long position in a futures contract on a commodity on November 1, 2012 to

10) A speculator takes a long position in a futures contract on a commodity on November 1,

12) Margin accounts have the effect of

15) Clearing houses are

16) A haircut of 20% means that

18) Which of the following best describes central clearing parties?

19) Which of the following are cash settled?

20) A limit order

Fundamentals of Futures and Options Markets, 8e (Hull)

8) Which of the following is true?

9) Which of the following describes tailing the hedge?

13) Which of the following increases basis risk?

16) Which of the following is true?

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

18) Which of the following is true?

Fundamentals of Futures and Options Markets, 8e (Hull)

1) The compounding frequency for an interest rate defines

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

13) Which of the following is true of LIBOR?

14) Which of following describes forward rates?

16) A repo rate is

19) Which of the following is true?

Fundamentals of Futures and Options Markets, 8e (Hull)

1) Which of the following is a consumption asset?

12) Which of the following is NOT true?

15) As the convenience yield increases, which of the following is true?

17) Which of the following describes a known dividend yield on a stock?

18) Which of the following is an argument used by Keynes and Hicks?

19) Which of the following describes contango?

20) Which of the following is true for a consumption commodity?

Fundamentals of Futures and Options Markets, 8e (Hull)

1) Which of the following is applicable to corporate bonds in the United States?

10) Which of the following is true?

13) What is the quoted discount rate on a money market instrument?

16) The conversion factor for a bond is approximately

20) Duration matching immunizes a portfolio against

Fundamentals of Futures and Options Markets, 8e (Hull)

4) Which of the following describes the five-year swap rate?

6) Which of the following is true?

7) Which of the following describes an interest rate swap?

8) Which of the following is true for an interest rate swap?

10) Since the 2008 credit crisis

13) A floating for floating currency swap is equivalent to

14) A floating-for-fixed currency swap is equivalent to

20) Which of the following describes the five-year swap rate?

Fundamentals of Futures and Options Markets, 8e (Hull)

1) Which of the following tends to lead to an increase in house prices?

2) Which of the following is true of a non-recourse mortgage?

3) Which of the following is NOT true?