Test Bank For Introduction To Derivatives And Risk Management, 9th Edition

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9thEdition: Chapter 1Test Bank© 2012Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website,in wholeor in part.151CHAPTER 1: INTRODUCTIONMULTIPLE CHOICE TEST QUESTIONS1.The market value of the derivatives contracts worldwide totalsa.less than a trillion dollarsb.in the hundreds of trillion dollarsc.over a trillion dollars but less than a hundred trilliond.over quadrillion dollarse.none of the above2.Cash markets are also known asa.speculative marketsb.spot marketsc.derivative marketsd.dollar marketse.none of the above3.A call option gives the holdera.the right to buy somethingb.the right to sell somethingc.the obligation to buy somethingd.the obligation to sell somethinge.none of the above4.Which of the following instruments are contracts but are not securitiesa.stocksb.optionsc.swapsd.a and be.b and c5.The positive relationship between risk and return is calleda.expected returnb.market efficiencyc.the law of one priced.arbitragee.none of the above6.A transaction in which an investor holds a position in the spot market and sells a futures contract or writes acall isa.a gambleb.a speculative positionc.a hedged.a risk-free transactione.none of the above7.Which of the following are advantages of derivatives?a.lower transaction costs than securities and commoditiesb.reveal information about expected prices and volatilityc.help control riskd.make spot prices stay closer to their true values

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9thEdition: Chapter 1Test Bank© 2012Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website,in wholeor in part.152e.all of the above8.A forward contract has which of the following characteristics?a.has a buyer and a sellerb.trades on an organized exchangec.has a daily settlementd.gives the right but not the obligation to buye.all of the above9.Options on futures are also known asa.spot optionsb.commodity optionsc.exchange optionsd.security optionse.none of the above10.A market in which the price equals the true economic valuea.is risk-freeb.has high expected returnsc.is organizedd.is efficiente.all of the above11.Which of the following trade on organized exchanges?a.capsb.forwardsc.optionsd.swapse.none of the above12.Which of the following markets is/are said to provide price discovery?a.futuresb.forwardsc.optionsd.a and be.b and c13.Investors who do not consider risk in their decisions are said to bea.speculatingb.short sellingc.risk neutrald.traderse.none of the above14.Which of the following statements is not true about the law of one pricea.investors prefer more wealth to lessb.investments that offer the same return in all states must pay the risk-free ratec.if two investment opportunities offer equivalent outcomes, they must have the same priced.investors are risk neutrale.none of the above15.Which of the following contracts obligates a buyer to buy or sell something at a later date?

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9thEdition: Chapter 1Test Bank© 2012Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website,in wholeor in part.153a.callb.futuresc.capd.pute.swaption16.The process of creating new financial products is sometimes referred to asa.financial frontieringb.financial engineeringc.financial modelingd.financial innovatione.none of the above17.The process of selling borrowed assets with the intention of buying them back at a later date and lowerprice is referred to asa.longing an assetb.asset flippingc.shortingd.anticipated price fall arbitragee.none of the above18.In which one of the following types of contract between a seller and a buyer does the seller agree to sell aspecified asset to the buyer today and then buy it back at a specified time in the future at an agreed futureprice.a.repurchase agreementb.short sellingc.swapd.calle.none of the above19.The expected return minus the risk-free rate is calleda.the risk premiumb.the percentage returnc.the asset’s betad.the return premiume.none of the above20.When the law of one price is violated in that the same good is selling for two different prices, anopportunity for what type of transaction is created?a.return-to-equilibrium transactionb.risk-assuming transactionc.speculative transactiond.arbitrage transactione.none of the above

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9thEdition: Chapter 1Test Bank© 2012Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website,in wholeor in part.154CHAPTER 1: INTRODUCTIONTRUE/FALSE TEST QUESTIONSTF1.Options, forwards, swaps, and futures are financial assets.TF2.The absence of a daily settlement is one of the factors distinguishing a forward contractfrom a futures contract.TF3.A risk premium is the additional return investors expect for assuming risk.TF4.Arbitrage is a transaction designed to capture profits resulting from market efficiency.TF5.Derivatives permit investors to manage their risk more efficiently.TF6.The law of one price states that the price of an asset cannot change.TF7.Lower transaction costs are one advantage of derivative markets.TF8.Derivative markets make stock and bond markets more efficient.TF9.Speculation is equivalent to gambling.TF10.Most derivative contracts terminate with delivery of the underlying asset.TF11.Swaps, like options, trade on organized exchanges.TF12.Storing an asset entails risk.TF13.The theoretical fair value is the only value an asset can have.TF14.Short selling is a high risk activity.TF15.Uncertainty of future sales and cost of inputs are examples of financial risks businessesmay face.TF16.Exchange-traded derivatives volume is less than one billion according to theFuturesIndustrymagazine in 2010.TF17.The top ten derivatives exchanges have less than 50 percent of trading volume.TF18.A call option on a futures contract gives the buyer the right to buy a futures contract.TF19.A seller of a put option on a futures contract obligates them to buy a futures contractshould the put buyer exercise the option.TF20.Hybrid derivatives involve either bonds or stocks.

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9thEdition: Chapter 2Test Bank© 2012Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in wholeor in part.155CHAPTER 2: STRUCTURE OF OPTIONS MARKETSMULTIPLE CHOICE TEST QUESTIONS1.Options are traded on which of the following exchanges?a.NYSE Amexb.NYSE Euronext (Arca)c.Chicago Board Options Exchanged.International Securities Exchangee.all of the above2.A call option priced at $2 with a stock price of $30 and an exercise price of $35 allows the holder to buythe stock ata.$2b.$32c.$33d.$35e.none of the above3.A put option in which the stock price is $60 and the exercise price is $65 is said to bea.in-the-moneyb.out-of-the-moneyc.at-the-moneyd.exercisablee.none of the above4.Organized options markets are different from over-the-counter options markets for all of the followingreasons excepta.exercise termsb.physical trading floorc.regulationd.standardized contractse.credit risk5.The number of options acquired when one contract is purchased on an exchange isa.1b.5c.100d.500e.8,0006.The advantages of the over-the-counter options market include all of the following excepta.customized contractsb.privately executedc.freedom from government regulationd.lower pricese.none of the above7.Which one of the following is not a type of transaction cost in options trading?

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9thEdition: Chapter 2Test Bank© 2012Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in wholeor in part.156a.the bid-ask spreadb.the commissionc.clearing feesd.the cost of obtaining a quotee.all of the above8.If the market maker will buy at 4 and sell at 4.50, the bid-ask spread isa.8.50b.4.25c.0.50d.4.00e.none of the above9.Which of the following is a legitimate type of option order on the exchange?a.purchase orderb.limit orderc.execution orderd.floor ordere.all of the above10.The exercise price can be set at any desired level on each of the following types of optionsexcepta.FLEX optionsb.equity optionsc.over-the-counter optionsd.all of the abovee.none of the above11.An investor who owns a call option can close out the position by any of the following types of transactionsexcepta.exerciseb.offsetc.expiring out-of-the-moneyd.buying a pute.none of the above12.Which type of trader legitimately practices dual trading?a.floor brokersb.off–floor option tradersc.board brokersd.designated primary market makerse.none of the above13.The option price is also referred to as thea.strikeb.spreadc.premiumd.feee.none of the above14.Index options trading on organized exchanges expire according to which of the following cycles?a.March, June, September, and December

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9thEdition: Chapter 2Test Bank© 2012Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in wholeor in part.157b.each of the next four consecutive monthsc.the current month, the next month, and the next two months in one of the other cyclesd.every other month for each of the next nine monthse.none of the above15.An investor who exercises a call option on an index musta.accept the cash difference between the index and the exercise priceb.purchase all of the stocks in the index in their appropriate proportions from the writerc.immediately buy a put option to offset the call optiond.immediately write another call option to offsete.none of the above16.Which of the following are long-term options?a.Bond optionsb.LEAPSc.currency optionsd.Nikkei put warrantse.none of the above17.The exchange with the largest share of the options market is thea.American Stock Exchangeb.Boston Options Exchangec.Chicago Board Options Exchanged.Pacific Stock Exchangee.Philadelphia Stock Exchange18.A writer selected to exercise an option is said to bea.marginalb.assignedc.restrictedd.designatede.none of the above19.All of the following are forms of optionsexcepta.convertible bondsb.callable bondsc.warrantsd.mutual fundse.none of the above20.Which of the following index options is the most widely traded?a.S&P 500b.Nikkei 225c.Technology Indexd.New York Stock Exchange Indexe.none of the above21.In which city did organized option markets originate?a.New Yorkb.Chicago

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9thEdition: Chapter 2Test Bank© 2012Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in wholeor in part.158c.Philadelphiad.San Franciscoe.none of the above22.Who determines whether options on a company’s stock will be listed?a.the clearing houseb.Securities Exchange Commissionc.the companyd.the exchangee.none of the above23.An order that specifies a maximum price to pay if buying is aa.stop orderb.market orderc.limit orderd.all or none ordere.none of the above24.What amount must a call writer pay if a cash–settled index call is exercised?a.difference between the index level and the exercise priceb.exercise pricec.difference between the exercise price and the index leveld.index levele.none of the above25.Option traders incur which of the following types of costs?a.margin requirementsb.taxesc.stock trading commissionsd.a and be.a, b and c26.The total number of long option contracts outstanding at any given time is called thea.market capb.sum options outstanding (SOO)c.option wealth outstanding (OWO)d.open intereste.none of the above27.“Wal-Mart calls” are an example ofa.an option seriesb.an option classc.an option graded.a and be.none of the above28.This individual maintains and attempts to fill public option orders but does not disclose them to others.a.liquidity providerb.board brokerc.order book officiald.registered option tradere.none of the above

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9thEdition: Chapter 2Test Bank© 2012Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in wholeor in part.15929.What intermediary guarantees an option writer’s performance?a.credit worthiness rating companyb.brokeragec.good-till-canceled orderd.clearinghousee.none of the above30.Suppose you hold a call option. The stock price has recently been increasing-making your call option morevaluable. Through what process might you take advantage of the liquid nature of the options market?a.offsetting orderb.contract reconciliationc.mark to market orderd.settling upe.none of the above

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9thEdition: Chapter 2Test Bank© 2012Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in wholeor in part.160CHAPTER 2: STRUCTURE OF OPTIONS MARKETSTRUE/FALSE TEST QUESTIONSTF1.The exercise price is also called the striking price.TF2.The Put and Call Brokers and Dealers Association created the first organized optionsexchange.TF3.An out-of-the-money call option has an exercise price less than the stock price.TF4.A put option increases in value when the stock price decreases.TF5.All of the options on Microsoft comprise an option class.TF6.The AT&T October puts are an option series.TF7.Exercise prices are set in $5 increments for options on exchanges.TF8.The over-the-counter options market is much larger than the exchange-listed optionsmarket.TF9.Exchange-listed options expire on the Saturday following the third Friday of the month.TF10.Position limits are restrictions on the number of transactions an investor can execute on agiven day.TF11.Exercise limits are restrictions on the number of options that can be exercised by aninvestor in a given day or series of days.TF12.A market maker is an options trader who buys and sells options off of the exchange floor.TF13.The bid price is the price paid to buy an option from a market maker.TF14.Options traders who hold their positions for very short periods of time are called positiontraders.TF15.An order placed by an investor for the broker to buy an option at the best available priceis called a market order.TF16.The number of option contracts outstanding at any given time is called the open interest.TF17.Most investors close their positions by exercising their options.TF18.Over-the-counter options are not subject to default.TF19.Indices measuring options market activity are simple to construct and widely quoted.TF20.The spread between the bid price and the ask price is a transaction cost to the optiontrader.TF21.The options market is regulated by the Securities Investor Protection Corporation.

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9thEdition: Chapter 2Test Bank© 2012Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in wholeor in part.161TF22.Index options have less volume than stock options.TF23.The Options Clearing Corporation guarantees the obligations of traders on optionsexchanges.TF24.Offsetting an over-the-counter option contract cancels both contracts.TF25.The order book official executes limit order option trades for the general public.TF26.CBOE option market makers are also called liquidity providers.TF27.Over-the-counter options dealers do not have to be members of an options exchange.TF28.A market maker always avoids the cost of the bid-ask spread.TF29.The majority of options exchanges in the U.S. are fully automated.TF30.Option commissions are set by the Chicago Board Options Exchange.TF31.On the CBOE, option tables represent each option with a series of letters and number,such as, MSFT\12B17\20.0. The last number represents the calendar date, the 20thof themonth in this example.TF32.Again, on the CBOE, option tables represent each option with a series of letters andnumber, such as, MSFT\12B17\20.0. The middle letter represents the calendar month andwhether it is a call or put.TF33.An investor who is long an over-the-counter call option is exposed to the risk that the callwriter will default on her obligations should the call option end up in-the-money.TF34.Exercising a stock put option means the put seller must sell stock at the stated strikeprice.TF35.A call option to buy euros expressed in $/€is equivalent to a put option to sell dollarsexpressed in€/$.

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9thEdition: Chapter 3Test Bank© 2012Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website,in wholeor in part.162CHAPTER 3: PRINCIPLES OF OPTION PRICINGMULTIPLE CHOICE TEST QUESTIONS1.Consider a portfolio consisting of a long call with an exercise price of X, a short position in a non-dividendpaying stock at an initial price of S0, and the purchase of riskless bonds with a face value of X and maturingwhen the call expires. What should such a portfolio be worth?a.C + P–X(1 + r)-Tb.C–S0c.P–Xd.P + S0–X(1 + r)-Te.none of the above2.What is the lowest possible value of a European put?a.Max(0, X–S0)b.X(1 + r)-Tc.Max[0, S0–X(1 + r)-T]d.Max[0, X(1 + r)-T–S0)]e.none of the above3.Another expression for intrinsic value isa.parityb.parity valuec.exercise valued.all of the abovee.none of the above4.On March 2, a Treasury bill expiring on April 20 had a bid discount of 5.80, and an ask discount of 5.86.What is the best estimate of the risk-free rate as given in the text?a.5.86 %b.5.83 %c.6.11 %d.6.14 %e.none of the above5.Suppose you use put-call parity to compute a European call price from the European put price, the stockprice, and the risk-free rate. You find the market price of the call to be less than the price given by put-callparity. Ignoring transaction costs, what trades should you do?a.buy the call and the risk-free bonds and sell the put and the stockb.buy the stock and the risk-free bonds and sell the put and the callc.buy the put and the stock and sell the risk-free bonds and the calld.buy the put and the call and sell the risk-free bonds and the stocke.none of the above6.If there are no dividends on a stock, which of the following statements is correct?a.An American call will sell for more than a European callb.A European call will sell for more than an American callc.An American call will be immediately exercisedd.An American call and an American put will sell for the same pricee.none of the aboveThe following quotes were observed for options on a given stock on November 1 of a given year.These

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9thEdition: Chapter 3Test Bank© 2012Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website,in wholeor in part.163are American calls except where indicated. Use the information to answer questions 7 through 20.CallsPutsStrikeNovDecJanNovDecJan1058.401011.505.301.302.001104.407.108.300.902.503.801151.503.905.302.804.804.80The stock price was 113.25.The risk-free rates were 7.30 percent (November), 7.50 percent (December)and 7.62 percent (January).The times to expiration were 0.0384 (November), 0.1342 (December), and0.211 (January). Assume no dividends unless indicated.7.What is the intrinsic value of the December 115 put?a.1.75b.0.00c.3.90d.3.00e.none of the above8.What is the intrinsic value of the November 105 put?a.0.30b.8.25c.8.50d.0.00e.none of the above9.What is the intrinsic value of the January 110 call?a.0.00b.8.30c.3.75d.5.00e.none of the above10.What is the intrinsic value of the November 115 call?a.1.50b.0.00c.2.80d.1.75e.none of the above11.What is the time value of the December 105 put?a.1.30b.8.30c.0.00d.7.00e.none of the above12.What is the time value of the November 115 put?

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9thEdition: Chapter 3Test Bank© 2012Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website,in wholeor in part.164a.1.75b.2.80c.1.10d.0.00e.none of the above13.What is the time value of the November 110 call?a.0.00b.4.40c.1.15d.3.25e.none of the above14.What is the time value of the January 115 call?a.5.30b.0.00c.3.50d.1.70e.none of the above15.What is the European lower bound of the December 105 call?a.9.86b.0.00c.8.25d.9.26e.none of the above16.What is the European lower bound of the November 115 call?a.1.44b.0.00c.1.75d.2.06e.none of the above17.From American put-call parity, what are the minimum and maximum values that the sum of the stock priceand December 110 put price can be?a.101.81 and 102.87b.2.50 and 113.25c.116.038 and 117.10d.7.125 and 110e.none of the above18.The maximum difference between the January 105 and 110 calls is which of the following?a.11.50b.4.92c.5.00d.4.0e.none of the above19.Suppose you knew that the January 115 options were correctly priced but suspected that the stock wasmispriced. Using put-call parity, what would you expect the stock price to be? For this problem, treat theoptions as if they were European.

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9thEdition: Chapter 3Test Bank© 2012Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website,in wholeor in part.165a.113.73b.123.23c.121.23d.112.77e.none of the above20.Suppose the stock is about to go ex-dividend in one day.The dividend will be $4.00.Which of thefollowing calls will you consider for exercise?a.November 115b.November 110c.December 115d.all of the abovee.none of the above21.The time value of an option is also referred to as thea.synthetic valueb.strike valuec.speculative valued.parity valuee.none of the above22.Which of the following is the lowest possible value of an American call on a stock with no dividends?a.Max(0, S0–X(1 + r)-T)b.S0c.Max(0, S0–X)d.Max(0, S0(1 + r)-T–X)e.none of the above23.Which of the following is the lowest possible value of an American put on a stock with no dividends?a.X(1 + r)-Tb.Xc.Max(0, X(1 + r)-T–S0)d.Max(0, X–S0)e.none of the above24.The difference between a Treasury bill's face value and its price is called thea.time valueb.discountc.coupon rated.bide.none of the above25.Which of the following statements about an American call is not true?a.Its time value decreases as expiration approachesb.Its maximum value is the stock pricec.It can be exercised prior to expirationd.It pays dividendse.none of the above26.Given a longer-lived American call and a shorter-lived American call with the same terms, the longer-livedcall must always be wortha.at most the value of the shorter-lived call

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