Financial Risk Management Final Exam

Futures prices are discovered by: - answer-when contracts are bought and sold The premise that makes hedging possible is cash and futures prices: - answer-generally change in the same direction by similar amounts Open interest refers to: - answer-total number of futures that have not been offset or fulfilled by delivery To hedge against an increase in prices, you would: - answer-purchase futures contracts The primary function of the exchanges is to: - answer-ensure the financial integrity of the contracts traded, and clear every trade made at the CME Group The CFTC's main responsibilities are to: - answer-protect the trading public from fraud and trading abuses on the exchange, protect the trading public from fraud and trading abuses off the exchange, prevent price distortions and manipulations, encourage overall competitiveness and efficiency on all U.S exchanges Gains and losses on futures positions are settled: - answer-each day after the close of trading Hedging involves: - answer-taking a futures position opposite to one's current cash market position Futures contacts are: - answer-standardized agreement to buy or sell a specific quantity and quality of an underlying asset at a certain price on a specified future date What do speculators do: - answer-assume market price risk while looking for profit opportunities, anticipate profiting from trading, believe that commodities can help diversify portfolios, provide liquidity The price of a stock is $64. A trader buys one 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? - answer-When the stock price is below $50. The payoff must be more than the $10 paid for the option. The stock price must, therefore, be below $50. The price of a stock is $67. A trader sells five put option contracts (each contract is 100 options) on the stock with a strike price of $70 when the option price is $4. The options are exercised when the stock price is $69. What is the trader's net profit or loss? - answer-Gain of $1500, The option payoff is 70 − 69 = $1. The amount received for the option is $4. The gain is $3 per option. In total 5 × 100 = 500 options are sold. The total gain is therefore $3 × 500 = $1,500. 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 investor's position after the stock split? - answer-Put options to sell 200 shares for $10. 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? - answer-$5.98, The lower bound in S0 − Ke-rT. In this case it is 30 - 25e-0.04×1 = $5.98. When the stock price increases with all else remaining the same, which of the following is true? - answer-Calls increase in value while puts decrease in value What is a call option? - answer-the right to buy an asset for a certain price in the future 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? (Hint: Use the put-call parity formula). - answer-$3.06, Put-call parity is c + Ke-rT = p + S0˗D. In this case K = 50, S0 = 51, r = 0.06, T = 1, and c = 6. The present value of the dividend, D, is 1 × e−0.06×0.5 = 0.97. It follows that p = 6 + 50e-0.06×1− (51− 0.97) = 3.06. How is an ABS structured? - answer-the cash flows from a portfolio of instruments such as mortgages are tranched out, that is, they are paid in priority sequence to different classes of investors. In stressed market conditions, does the correlation among investments tend to decrease or increase? - answer-increase An interest rate swap has three years of remaining life. Payments are exchanged annually. Interest at 5% is paid and 12-month LIBOR is received. An exchange of payments has just taken place. The one-year, two-year and three-year LIBOR/swap zero rates are 4%, 5% and 6%. All rates are annually compounded. What is the value of the swap as a percentage of the principal ($100) when OIS and LIBOR rates are the same? (Hint: Answer will be decimal format, not dollars. So, convert to percentage to find answer). - answer-2.50 The mezzanine tranche is - answer-between the senior tranche and the junior tranche OIS rates are greater than the corresponding LIBOR rates because they are riskier. - answer-False A fixed-for-fixed currency swap is not equivalent to a long position in one bond and a short position in another bond. - answer-False An interest rate swap is worth close to zero when it is first negotiated. - answer-True Resecuritiazation can only be successful if the default rates of the underlying ABS portfolios are - answer-not highly correlated What is the use of a currency swap? - answer-To exchange an investment in one currency for an investment in another currency, to exchange borrowing in one currency for borrowings in another currency, and to take advantage of situations where the tax rates in two countries are different. How does the CME Group describe the way the futures price of a foreign currency is quoted? - answer-U.S. dollars per unit of a foreign currency The one-year futures price as a percentage of the spot price decreases as inventories of a commodity rise. - answer-false It is May 1. The quoted price of a bond with an Actual/Actual (in period) day count and 9% per annum coupon (paid semiannually) in the United States is 102. It has a face value of 100 and pays coupons on April 1 and October 1. What is the cash price? (Round to two decimal places). Hint: There are 30 days between April 1 and May 1 and 183 days between April 1 and October 1 - answer-$102.74 A short forward contract that was negotiated some time ago will expire in three months and has a delivery price of $33. The current forward price for a three-month forward contract is $36. The three-month risk-free interest rate (with continuous compounding) is 8%. What is the value of the short-forward contract? (Round to two decimal places). - answer--$2.94 The spot price of an investment asset that provides no income is $43, and the risk-free rate for all maturities (with continuous compounding) is 10%. What is the three-year forward price? (Round to nearest dollar). - answer-$58 What is an ultra T bond futures contract? - answer-one where bonds with maturities greater than 25 years can be delivered Which of the following applies to corporate bonds in the United States? - answer-30/360 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. What happens to the hedger's position? - answer-The hedger's position improves. 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. - answer-7.5% 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 commodity purchase 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? - answer-$59.50 What is Bootstrapping? - answer-involves working from short maturity instruments to longer maturity instruments determining zero rates at each step.