Exam 24: Options, Caps, Floors, and Collars

Managing interest rate risk for less creditworthy FI's by running a cap/floor book may require the backing of external guarantees such as standby letters of credit because of the nature of the options.

Using the proceeds from the simultaneous sale of a floor to finance the purchase of a cap is to open a position called a

A hedge using a put option contract completely offsets gains but only but only partially offsets losses on an FIs balance sheet.

One advantage of caps, collars, and floors is that because they are exchange-traded options there is no counterparty risk present in the transactions.

Interest rate futures options are preferred to bond options because they have more favorable liquidity, credit risk, and market-to-market features.

Rising interest rates will cause the market value of

Hedging the FI's interest rate risk by buying a put option on a bond is an attractive alternative for an FI.

Assume a binomial pricing model where there is an equal probability of interest rates increasing or decreasing 1 percent per year. What should be the net price of a $5,000,000 collar if the bank purchases a three-year 6 percent cap and sells a 5 percent floor, if the current (spot) rates are 6 percent?

A digital default option

An FI concerned that the risk on a loan will increase can

An FI would normally purchase a cap if it was funding fixed-rate assets with variable-rate liabilities.

The concept of pull-to-maturity reflects the increasing variance of a bond's price as the maturity of the bond approaches.

The Chicago Board of Trade (CBOT) catastrophe call spread options have variable payoffs that are capped at a level of less than 100 percent of extreme losses.

Identify a problem associated with using the Black-Scholes model to value bond options.

Which of the following shows the change in the value of a put option for each $1 change in the underlying bond?

The trading process of options is the same as that of futures contracts.

The buyer of a bond call option stands to make a positive payoff if changes in market interest rates cause the bond price to rise above the exercise price by enough to recoup the call premium paid for the option.

Credit spread call options are useful because

A contract that pays the par value of a loan in the event of default is a

A contract that results in the delivery of a futures contract when exercised is a