Question 1

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

Accepted Answer

A) put option. 
B) call option. 
C) naked option. 
D) futures option. 
A) put option. 
B) call option. 
C) naked option. 
D) futures option.

Question 2

An FI buys a collar by buying a floor and selling a cap.

Accepted Answer

A) True 
 B)False

Question 3

Allright Insurance has total assets of $140 million consisting of $50 million in 2-year,6 percent Treasury notes and $90 million in 10-year,7.2 percent fixed-rate Baa bonds.These assets are funded by $100 million 5-year,5 percent fixed rate GICs and equity.

Market interest rates are expected to increase 1 percent to 11 percent in the next year.If this occurs,what will be the effect on the market value of equity of Allright?

Accepted Answer

A) -$801,818. 
B) -$2,430,909. 
C) -$6,529,091. 
D) +$2,430,909. 
A) -$801,818. 
B) -$2,430,909. 
C) -$6,529,091. 
D) +$2,430,909.

Question 4

The potential gain to the seller of a bond call option is unlimited.

Accepted Answer

A) True 
 B)False

Question 5

The payoff of a credit spread call option increases as the yield spread on a specified benchmark bond increases above some exercise spread.

Accepted Answer

A) True 
 B)False

Question 6

The tendency of the variance of a bond's price to decrease as maturity approaches is called

Accepted Answer

A) open interest. 
B) pull-to-par. 
C) digital default option. 
D) futures option. 
A) open interest. 
B) pull-to-par. 
C) digital default option. 
D) futures option.

Question 7

The maximum potential loss to a buyer of bond put options is limited to the premium paid.

Accepted Answer

A) True 
 B)False

Question 8

A bank purchases a 3-year,6 percent $5 million cap (call options on interest rates),where payments are paid or received at the end of year 2 and 3 as shown below:

$\begin{array}{lllll}
\text { End of Year: } & 0 & 1 & 2 & 3 \
\text { Cash Flow at end of year:  }&- & - & x & x \
\hline
\end{array}$

Instead of a cap,if the bank had purchased a 3-year 6 percent floor and interest rates are 5 percent and 6 percent in years 2 and 3,respectively,what are the payoffs to the bank?

Accepted Answer

A) The bank will receive $50,000 at the end of year 2 and receive $50,000 at the end of year 3. 
B) The bank will receive $50,000 at the end of year 2 and pay $50,000 at the end of year 3. 
C) The bank will receive $0 at the end of year 2 and pay $50,000 at the end of year 3. 
D) The bank will receive $0 at the end of year 2 and receive $50,000 at the end of year 3. 
E) The bank will receive $50,000 at the end of year 2 and pay $0 at the end of year 3. 
A) The bank will receive $50,000 at the end of year 2 and receive $50,000 at the end of year 3. 
B) The bank will receive $50,000 at the end of year 2 and pay $50,000 at the end of year 3. 
C) The bank will receive $0 at the end of year 2 and pay $50,000 at the end of year 3. 
D) The bank will receive $0 at the end of year 2 and receive $50,000 at the end of year 3. 
E) The bank will receive $50,000 at the end of year 2 and pay $0 at the end of year 3.

Question 9

The outstanding number of put or call contracts is called

Accepted Answer

A) open interest. 
B) pull-to-par. 
C) cap. 
D) floor. 
A) open interest. 
B) pull-to-par. 
C) cap. 
D) floor.

Question 10

As of 2015,commercial banks had listed for sale option contracts with a notational value of approximately

Accepted Answer

A) $16.2 trillion. 
B) $31.9 trillion. 
C) $8.1 trillion. 
D) $51.0 trillion. 
A) $16.2 trillion. 
B) $31.9 trillion. 
C) $8.1 trillion. 
D) $51.0 trillion.

Question 11

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

Accepted Answer

A) True 
 B)False

Question 12

The purchase often of a series of put options with multiple exercise dates results in a

Accepted Answer

A) open interest. 
B) pull-to-par. 
C) cap. 
D) floor. 
A) open interest. 
B) pull-to-par. 
C) cap. 
D) floor.

Question 13

A hedge with a futures contract reduces volatility in payoff gains on both the upside and downside of interest rate movements.

Accepted Answer

A) True 
 B)False

Question 14

An FI manager purchases a zero-coupon bond that has two years to maturity.The manager paid $826.45 per $1,000 for the bond.The current yield on a one-year bond of equal risk is 9 percent,and the one-year rate in one year is expected to be either 11.60 percent or 10.40 percent.Either rate is equally probable.

Given the exercise price of the option,what premium should be paid for this option?

Accepted Answer

A) $2.2339 per $1,000 of bond option purchased. 
B) $4.0275 per $1,000 of bond option purchased. 
C) $2.2752 per $1,000 of bond option purchased. 
D) $2.2156 per $1,000 of bond option purchased. 
A) $2.2339 per $1,000 of bond option purchased. 
B) $4.0275 per $1,000 of bond option purchased. 
C) $2.2752 per $1,000 of bond option purchased. 
D) $2.2156 per $1,000 of bond option purchased.

Question 15

All else equal,the value of an option increases with an increase in the variance of returns in the underlying asset.

Accepted Answer

A) True 
 B)False

Question 16

A digital default option pays a stated amount in the event that a portion of the loan is not paid.

Accepted Answer

A) True 
 B)False

Question 17

Open interest refers to the dollar amount of outstanding option contracts.

Accepted Answer

A) True 
 B)False

Question 18

The combination of being long in the bond and buying a put option on a bond mimics the profit function of

Accepted Answer

A) buying a put option. 
B) writing a put option. 
C) writing a call option. 
D) buying a call option. 
A) buying a put option. 
B) writing a put option. 
C) writing a call option. 
D) buying a call option.

Question 19

Which of the following is a good strategy to adopt when interest rates are expected to rise?

Accepted Answer

A) Buying a call option on a bond. 
B) Writing a call option on a bond. 
C) Writing a put option on a bond. 
D) Buying bond futures. 
A) Buying a call option on a bond. 
B) Writing a call option on a bond. 
C) Writing a put option on a bond. 
D) Buying bond futures.

Question 20

An FI manager purchases a zero-coupon bond that has two years to maturity.The manager paid $826.45 per $1,000 for the bond.The current yield on a one-year bond of equal risk is 9 percent,and the one-year rate in one year is expected to be either 11.60 percent or 10.40 percent.Either rate is equally probable.

If the manager buys a one-year option with an exercise price equal to the expected price of the bond in one year,what will be the exercise price of the option?

Accepted Answer

A) $862.10. 
B) $743.23. 
C) $900.93. 
D) $811.70. 
A) $862.10. 
B) $743.23. 
C) $900.93. 
D) $811.70.

Exam 23: Options, Caps, Floors, and Collars

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

An FI buys a collar by buying a floor and selling a cap.

The potential gain to the seller of a bond call option is unlimited.

The payoff of a credit spread call option increases as the yield spread on a specified benchmark bond increases above some exercise spread.

The tendency of the variance of a bond's price to decrease as maturity approaches is called

The maximum potential loss to a buyer of bond put options is limited to the premium paid.

The outstanding number of put or call contracts is called

As of 2015,commercial banks had listed for sale option contracts with a notational value of approximately

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

The purchase often of a series of put options with multiple exercise dates results in a

A hedge with a futures contract reduces volatility in payoff gains on both the upside and downside of interest rate movements.

All else equal,the value of an option increases with an increase in the variance of returns in the underlying asset.

A digital default option pays a stated amount in the event that a portion of the loan is not paid.

Open interest refers to the dollar amount of outstanding option contracts.

The combination of being long in the bond and buying a put option on a bond mimics the profit function of

Which of the following is a good strategy to adopt when interest rates are expected to rise?

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