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TEST BANK for An Introduction to Derivative Securities, Financial Markets, and Risk Management 1st Edition by Robert Jarrow & Arkadev Chatterjea. ISBN-13 978-7. TABLE OF CONTENTS: CH 1: D erivatives and Risk Management CH 2: Interest Rates CH 3: Stocks CH 4: Forwards and Futures CH 5: Options CH 6:...

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,CHAPTER 1: Derivatives and Risk Management


MULTIPLE CHOICE

1. The following is NOT a feature of current derivatives markets:
a. there is a huge variety in the number and type of derivatives contracts that are traded
b. the derivatives markets are now global and measured in trillions of dollars
c. commodity derivatives have emerged as the most popular kind of derivatives traded in the
new millennium
d. colleges and universities now offer many kinds of derivative courses
e. Wall Street firms hire graduate degree holders in finance and quantitative methods for
designing and trading derivatives
ANS: C DIF: Easy REF: 1.1 TOP: Introduction
MSC: Factual

2. A derivative security:
a. is useful only for speculation
b. is useful only for hedging
c. is useful only for manipulating markets
d. can be used for all of these purposes
e. is useful for none of these purposes
ANS: D DIF: Easy REF: 1.2 TOP: Financial Innovation
MSC: Factual

3. Foreign exchange prices became volatile during the 1970s mainly because of:
a. an end of the policy of fixing interest rates by the US Federal Reserve Bank
b. the demise of the Bretton Woods system of fixed exchange rates
c. supply shocks of the 1970s
d. technology that helped us overcome the vagaries of Mother Earth
e. hedge funds manipulating exchange trades
ANS: B DIF: Easy REF: 1.2 TOP: Financial Innovation
MSC: Factual

4. Interest rates in the United States became volatile during the late 1970s mainly due to:
a. an end of the policy of fixing interest rates by the US Federal Reserve Bank
b. the demise of the Bretton Woods system of fixed exchange rates
c. technological changes that enabled banks to modify interest rates
d. hedge funds manipulating interest rates
ANS: A DIF: Easy REF: 1.2 TOP: Financial Innovation
MSC: Factual

5. The International Monetary Market is:
a. an OTC market where money market instruments trade

, b. a part of the World Bank that lends funds to developing countries
c. a division of the Chicago Mercantile Exchange created for trading foreign currency futures
d. a London-based market for interbank lending
e. None of these answers are correct.
ANS: C DIF: Easy REF: 1.2 TOP: Financial Innovation
MSC: Factual

6. In the United States, the Great Moderation refers to:
a. a 15-year-long period that began around 1900 during which the growth of real output
fluctuated, inflation declined, stock market volatility was reduced, and business cycles
were moderated
b. the time period between 1920 and 1933 when sale, manufacture, and transportation of
alcohol was prohibited
c. a time period that began in 1955 and lasted for nearly a decade during which business
cycle fluctuations declined and inflation was under control
d. a time period that began after World War II and lasted for nearly a decade during the
growth of real output fluctuated, inflation declined, stock market volatility was reduced,
and business cycles were moderated
e. a time period that began during the mid-1980s and lasted a little over two decades during
which the growth of real output fluctuated, inflation declined, stock market volatility was
reduced, and business cycles were moderated
ANS: E DIF: Easy REF: 1.2 TOP: Financial Innovation
MSC: Factual

7. Nobel Prize–winning economist Ronald Coase’s view is:
a. arbitrage is the adhesive that holds financial markets together
b. derivatives destroy financial markets via excessive speculation
c. derivatives improve social welfare through better risk allocation in the economy
d. firms often appear when they can lower transaction costs
e. regulations and taxes cause financial innovation
ANS: D DIF: Easy REF: 1.2 TOP: Financial Innovation
MSC: Factual

8. The following was NOT an example cited by Nobel laureate economist Merton Miller in support of his
view that “regulations and taxes cause financial innovation”:
a. Eurobonds
b. Eurodollars
c. futures contracts
d. swaps
e. zero-coupon bonds
ANS: C DIF: Easy REF: 1.2 TOP: Financial Innovation
MSC: Factual

9. In financial markets, a coupon refers to:
a. the detachable part of a stock that entitles the holder to get dividends from the company
b. the interest paid on a bond on a regular basis, typically semiannually
c. one side of a financial swap that entitles the holder to net payments
d. the discount from the principal amount at which a zero-coupon bond is sold in the market
e. a paper on whose submission a trader gets a reduction in brokerage fees
ANS: B DIF: Moderate REF: 1.3 TOP: Traded Derivative Securities

, MSC: Factual

10. Who has described derivatives as “time bombs, both for the parties that deal in them and the economic
system”?
a. Warren Buffett
b. Ronald Coase
c. Alan Greenspan
d. Peter Lynch
e. Merton Miller
ANS: A DIF: Easy REF: 1.3 TOP: Traded Derivative Securities
MSC: Factual

11. Which of the following statements is INCORRECT?
a. Derivatives trade in zero net supply markets.
b. A derivatives trade is a zero-sum game in the absence of market imperfections like
transaction costs.
c. Derivatives are powerful financial tools that can be used for speculation as well as
hedging.
d. Derivatives have a history of always causing significant losses to any trader who trades
these contracts.
e. Derivatives can help traders to reduce price risk from economic activities.
ANS: D DIF: Moderate REF: 1.3 TOP: Traded Derivative Securities
MSC: Factual

12. Suppose regulators cap the maximum interest one can charge at 5 percent. Let the underlying market
interest rate be 8 percent. Charging anything lower will drive you out of business.
You devise a compensatory balance scheme: for every $100 that the customer borrows, she
will have to keep a certain amount with you as a compensatory balance. What should the amount of
the loan and the compensatory balance be if the customer wants to borrow $5,000?
a. $5,000 loan and $1,000 as compensatory balance
b. $5,000 loan and $1,500 as compensatory balance
c. $5,000 loan and $3,000 as compensatory balance
d. $8,000 loan and $3,000 as compensatory balance
e. $8,000 loan and $5,000 as compensatory balance
ANS: D DIF: Difficult REF: 1.3 TOP: Traded Derivative Securities
MSC: Applied

13. The Basel Committee’s Risk Management Guidelines for Derivatives (July 1994) did NOT list which
of the following risks?
a. credit risk
b. legal risk
c. liquidity risk
d. market risk
e. value-at-risk
ANS: E DIF: Easy REF: 1.5
TOP: The Regulator’s Classification of Risk MSC: Factual

14. Which of the following risks can be very difficult to hedge?
a. credit risk
b. legal risk
c. market risk

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