9: DERIVATIVES MARKET

Swaps

A private agreement between two companies to exchange cash flows in the future according to a prearranged formula.

a. swaps

b. forwards

c. options

d. futures

A hedge in which an investor buys a stock and simultaneously sells a call option on that stock and ends up with a riskless position.

A riskless hedge can best be defined as

a. A situation in which aggregate risk can be reduced by derivatives transactions between two parties.

b. A hedge in which an investor buys a stock and simultaneously sells a call option on that stock and ends up with a riskless position.

c. Standardized contracts that are traded on exchanges and are "marked to market" daily, but where physical delivery of the underlying asset is virtually never taken.

d. Two parties agree to exchange obligations to make specified payment streams.

Exercise or striking price.

The price at which the stock or asset may be purchased from (or sold to) the option writer is referred to as:

a. intrinsic value of the option.

b. option premium.

c. open interest.

d. exercise or striking price.

Accept one set of payments in exchange for another.

When a party enters into a swap contract it agrees to:

a. Accept one set of payments in exchange for another.

b. exchange principles on loans with different interest rates.

c. exchange a loan for a different loan with a different time to maturity.

d. swap a debt obligation for an equity obligation.

The time remaining before the expiration date

Which of the following variables is NOT part of the Black-Scholes option pricing model?

a. The expected rate of return on the market

b. The current stock price

c. The strike price or exercise price

d. The time remaining before the expiration date

A put option is said to be in the money if the underlying stock is selling below the exercise price of the option.

Which of the following statements is true?

a. A call option is said to be out-of-the-money if the underlying stock is selling above the exercise price of the option.

b. A put option is said to be in the money if the underlying stock is selling below the exercise price of the option.

c. A put option is said to be out-of-the-money if the underlying stock is selling below the exercise price of the option.

d. A call option is said to be in the money if the underlying stock is selling below the exercise price of the option.

Stock price - exercise price.

The minimum value of a call option equals:

a. exercise price - the stock price.

b. stock price - exercise price.

c. call premium - (stock price - exercise price).

d. put premium - (exercise price - stock price).

Futures contracts generally trade on an organized exchange and are marked to market daily.

Which of the following statements is most correct?

a. One advantage of forwarding contracts is that they are default-free.

b. Futures contracts generally trade on an organized exchange and are marked to market daily.

c. Goods are never delivered under forwarding contracts but are almost always delivered under futures contracts.

d. Forward contracts are generally standardized instruments, whereas futures contracts are generally tailor-made for the 2 parties of the contract.

Price at which the stock or asset may be purchased from the writer.

The striking price is the:

a. price paid for the option.

b. price at which the stock or asset may be purchased from the writer.

c. minimum value of the option.

d. premium minus the exercise price.

American option

It is an option that can be exercised even before the expiration date.

a. European option

b. put option

c. American option

d. call option

Future

A(n) ________ is a contract that requires the holder to buy or sell a stated commodity at a specified

price at a specified time in the future.

a. warrant

b. option

c. future

d. convertible contract

Put option

An investor would buy a ________ if he or she believes that the price of the underlying stock or asset will fall short.

a. call option

b. convertible bond

c. put option

d. futures contract to take delivery of an asset at a future date

the stock price would stay above P12.

Kathleen short a put option on the stock with an exercise price of P20 and earn a P8 premium only if he thought

a. the stock price would stay above P12.

b. the stock price would stay above P20.

c. the stock price would fall below P28.

d. the stock price would rise above P28 or fall below P12.

are entering into a futures contract to offset the risk of higher fuel prices during the winter.

Sheltron allows its customers to prepurchase heating oil in June for the coming winter. Sheltron's customers who take advantage of the offer:

a. are speculating that fuel prices will be higher in the future.

b. have purchased a form of a call option for heating fuel.

c. are entering into a futures contract to offset the risk of higher fuel prices during the winter.

d. are purchasing a form of insurance against fuel shortages.

Short position

The party that agrees to sell a commodity or currency in the forward market is said to have a:

a. long position.

b. short position

c. protected position.

d. split position.

The price of copper for electrical contractors.

An example of commodity risk would be:

a. volatile exchange rates with countries from which commodities are imported.

b. the price of copper for electrical contractors.

c. volatile exchange rates with countries to which commodities are exported.

d. raw materials that do not meet quality specifications.

The price of a call option increases as the risk-free rate increases.

Which of the following statements regarding factors that affect call option prices is correct?

a. The longer the call option has to run the smaller its value and the smaller its premium.

b. An option on an extremely volatile stock is worth less than one on a very stable stock.

c. The price of a call option increases as the risk-free rate increases.

d. Two call options on the same stock will have the same value even if they have different strike prices.

Futures contract

An agreement between two parties to buy or sell an asset at a certain time in the future for a certain price. They are normally traded on an exchange.

a. futures contract

b. options

c. forward contract

d. swaps

Put Option

An option to sell a share of stock at a certain price within a specified period:

a. Call Option

b. Ceiling Option

c. Floor Option

d. Put Option

Max(ST – K, 0)

One of the following is the payoff for a long call option.

a. max(ST – K, 0)

b. min(ST – K, 0)

c. max(K – ST, 0)

d. min(K – ST, 0)