Question 1

Buying a cap is similar to

Accepted Answer

A) writing a call option on interest rates. 
B) buying a call option on interest rates. 
C) buying a put option on interest rates. 
D) buying a floor on interest rates. 
A) writing a call option on interest rates. 
B) buying a call option on interest rates. 
C) buying a put option on interest rates. 
D) buying a floor on interest rates.

Question 2

A hedge of interest rate risk with a put option on futures completely offsets gains but only partly offsets losses.

Accepted Answer

A) True 
 B)False

Question 3

An investment company has purchased $100 million of 10 percent annual coupon,6-year Eurobonds.The bonds have a duration of 4.79 years at the current market yields of 10 percent.The company wishes to hedge these bonds with Treasury-bond options that have a delta of 0.7.The duration of the underlying asset is 8.82,and the market value of the underlying asset is $98,000 per $100,000 face value.Finally,the volatility of the interest rates on the underlying bond of the options and the Eurobond is 0.84.

Given this information,what type of T-bond option,and how many options should be purchased,to hedge this investment?

Accepted Answer

A) 792 put options. 
B) 792 call options. 
C) 942 put options. 
D) 942 call options. 
A) 792 put options. 
B) 792 call options. 
C) 942 put options. 
D) 942 call options.

Question 4

In April 2016,an FI bought a one-month sterling T-bill paying £100 million in May 2016.The FI's liabilities are in dollars,and current exchange rate is $1.6401/£1.The bank can buy one-month options on sterling at an exercise price of $1.60/£1.Each contract has a size of £31,250,and the contracts currently have a premium of $0.014 per £.Alternatively,options on foreign currency futures contracts,which have a size of £62,500,are available for $0.0106 per £.

How many options should the FI purchase,and what will be the cost?

Accepted Answer

A) 1,600 contracts for $16.96. 
B) 1,600 contracts for $1,060,000. 
C) 3,200 contracts for $44.80. 
D) 3,200 contracts for $1,400,000. 
A) 1,600 contracts for $16.96. 
B) 1,600 contracts for $1,060,000. 
C) 3,200 contracts for $44.80. 
D) 3,200 contracts for $1,400,000.

Question 5

The premium on a credit spread call option is the maximum potential loss to the buyer of the option when the credit spread increases.

Accepted Answer

A) True 
 B)False

Question 6

Unlike futures and forward contracts,the use of options by FIs has deceased in recent years.

Accepted Answer

A) True 
 B)False

Question 7

A naked option is an option written that has no identifiable underlying asset or liability position.

Accepted Answer

A) True 
 B)False

Question 8

What is the advantage of an options hedge over a futures hedge?

Accepted Answer

A) The options hedge has lower credit risk exposure. 
B) The options hedge has lower transaction costs. 
C) The options hedge is marked to market less frequently. 
D) The options hedge offers the most downside risk protection. 
E) The options hedge offers the most upside gain potential. 
A) The options hedge has lower credit risk exposure. 
B) The options hedge has lower transaction costs. 
C) The options hedge is marked to market less frequently. 
D) The options hedge offers the most downside risk protection. 
E) The options hedge offers the most upside gain potential.

Question 9

The preferred method of FIs when hedging interest rates is an option on interest rate futures rather than using a pure bond option.

Accepted Answer

A) True 
 B)False

Question 10

The writer of a bond put option

Accepted Answer

A) receives a premium in return for standing ready to sell the bond at the exercise price. 
B) receives a premium in return for standing ready to buy bonds at the exercise price. 
C) pays a premium and has the right to sell the underlying bond at the agreed exercise price. 
D) pays a premium and has the right to buy the underlying bond at the agreed exercise price. 
A) receives a premium in return for standing ready to sell the bond at the exercise price. 
B) receives a premium in return for standing ready to buy bonds at the exercise price. 
C) pays a premium and has the right to sell the underlying bond at the agreed exercise price. 
D) pays a premium and has the right to buy the underlying bond at the agreed exercise price.

Question 11

An FI manager purchases a zero-coupon bond that has two years to maturity.The manager paid $76.95 per $100 for the bond.The current yield on a one-year bond of equal risk is 12 percent,and the one-year rate in one year is expected to be either 16.65 percent or 15.35 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) $84.00. 
B) $85.99. 
C) $86.21. 
D) $85.74. 
A) $84.00. 
B) $85.99. 
C) $86.21. 
D) $85.74.

Question 12

Futures options on bonds have interest rate futures contracts as the underlying asset.

Accepted Answer

A) True 
 B)False

Question 13

Rising interest rates will cause the market value of

Accepted Answer

A) call options on bonds to increase. 
B) put options on bonds to decrease. 
C) call options on bonds to decrease. 
D) bond futures to increase. 
A) call options on bonds to increase. 
B) put options on bonds to decrease. 
C) call options on bonds to decrease. 
D) bond futures to increase.

Question 14

A bank with total assets of $271 million and equity of $31 million has a leverage adjusted duration gap of +0.21 years.Use the following quotation from the Wall Street Journal to construct an at-the-money futures option hedge of the bank's duration gap position.

$\text { TREASURY BULS (IMMM)-\$1 }$
$\text { million; 91-day (\$25.28 ea.) }$

$\begin{array}{ccc}
 \text { Strike Price} & \text {Calls-Settle} & \text {Putesettle}\
96.00 & 28 \text { basis points } & 63 \text { basis points } \
96.25 & 19 \text { basis points } & 78 \text { basis points } \
96.50 & 12 \text { basis points } & 96 \text { basis points }
\end{array}$

If 91-day Treasury bill rates increase from 3.75 percent to 4.75 percent,what will be the profit/loss per contract on the bank's futures option hedge?

Accepted Answer

A) A loss of $556.10 per put option contract. 
B) A profit of $556.10 per put option contract. 
C) A loss of $1,971.84 per call option contract. 
D) A profit of $1,971.84 per call option contract. 
A) A loss of $556.10 per put option contract. 
B) A profit of $556.10 per put option contract. 
C) A loss of $1,971.84 per call option contract. 
D) A profit of $1,971.84 per call option contract.

Question 15

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

Accepted Answer

A) Open interest. 
B) Volatility. 
C) Delta. 
D) Basis. 
A) Open interest. 
B) Volatility. 
C) Delta. 
D) Basis.

Question 16

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

Accepted Answer

A) put option. 
B) call option. 
C) digital default option. 
D) futures option. 
A) put option. 
B) call option. 
C) digital default option. 
D) futures option.

Question 17

Unlike futures contracts,options are traded electronically through an option dealer network known as the Options Clearing Corporation (OCC).

Accepted Answer

A) True 
 B)False

Question 18

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?

Accepted Answer

A) The bank will receive net $2,010. 
B) The bank will receive net $31,651. 
C) The bank will pay net $31,651. 
D) The bank will pay net $2,010. 
A) The bank will receive net $2,010. 
B) The bank will receive net $31,651. 
C) The bank will pay net $31,651. 
D) The bank will pay net $2,010.

Question 19

In April 2016,an FI bought a one-month sterling T-bill paying £100 million in May 2016.The FI's liabilities are in dollars,and current exchange rate is $1.6401/£1.The bank can buy one-month options on sterling at an exercise price of $1.60/£1.Each contract has a size of £31,250,and the contracts currently have a premium of $0.014 per £.Alternatively,options on foreign currency futures contracts,which have a size of £62,500,are available for $0.0106 per £.

If the exchange rate in one month is $1.55/£1,what action should the FI take in regards to the hedge?

Accepted Answer

A) Call the £100 million proceeds of the T-bill from the option writer for $160 million. 
B) Put the £100 million proceeds from the T-bill to the option writer for $160 million. 
C) Put the £100 million proceeds from the T-bill to the option writer for $155 million. 
D) Call the £100 million proceeds of the T-bill from the option writer for $155 million. 
A) Call the £100 million proceeds of the T-bill from the option writer for $160 million. 
B) Put the £100 million proceeds from the T-bill to the option writer for $160 million. 
C) Put the £100 million proceeds from the T-bill to the option writer for $155 million. 
D) Call the £100 million proceeds of the T-bill from the option writer for $155 million.

Question 20

Giving the purchaser the right to sell the underlying security at a prespecified price 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.

Buying a cap is similar to

A hedge of interest rate risk with a put option on futures completely offsets gains but only partly offsets losses.

The premium on a credit spread call option is the maximum potential loss to the buyer of the option when the credit spread increases.

Unlike futures and forward contracts,the use of options by FIs has deceased in recent years.

A naked option is an option written that has no identifiable underlying asset or liability position.

What is the advantage of an options hedge over a futures hedge?

The preferred method of FIs when hedging interest rates is an option on interest rate futures rather than using a pure bond option.

The writer of a bond put option

Futures options on bonds have interest rate futures contracts as the underlying asset.

Rising interest rates will cause the market value of

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

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

Unlike futures contracts,options are traded electronically through an option dealer network known as the Options Clearing Corporation (OCC).

Giving the purchaser the right to sell the underlying security at a prespecified price is a

Why Are Financial Institutions Special

Financial Services: Depository Institutions

Financial Services: Finance Companies

Financial Services: Securities Firms and Investment Banks

Financial Services: Mutual Fund and Hedge Fund Companies

Financial Services: Insurance Companies

Risks of Financial Institutions

Interest Rate Risk I

Interest Rate Risk II

Credit Risk: Individual Loan Risk

Credit Risk: Loan Portfolio and Concentration Risk

Liquidity Risk

Foreign Exchange Risk

Sovereign Risk

Market Risk

Off-Balance-Sheet Risk

Technology and Other Operational Risks

Liability and Liquidity Management

Deposit Insurance and Other Liability Guarantees

Capital Adequacy

Product and Geographic Expansion

Futures and Forwards

Swaps

Loan Sales

Securitization

Filters

Exam 23: Options, Caps, Floors, and Collars

Buying a cap is similar to

A hedge of interest rate risk with a put option on futures completely offsets gains but only partly offsets losses.

The premium on a credit spread call option is the maximum potential loss to the buyer of the option when the credit spread increases.

Unlike futures and forward contracts,the use of options by FIs has deceased in recent years.

A naked option is an option written that has no identifiable underlying asset or liability position.

What is the advantage of an options hedge over a futures hedge?

The preferred method of FIs when hedging interest rates is an option on interest rate futures rather than using a pure bond option.

The writer of a bond put option

Futures options on bonds have interest rate futures contracts as the underlying asset.

Rising interest rates will cause the market value of

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

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

Unlike futures contracts,options are traded electronically through an option dealer network known as the Options Clearing Corporation (OCC).

Giving the purchaser the right to sell the underlying security at a prespecified price is a

Why Are Financial Institutions Special

Financial Services: Depository Institutions

Financial Services: Finance Companies

Financial Services: Securities Firms and Investment Banks

Financial Services: Mutual Fund and Hedge Fund Companies

Financial Services: Insurance Companies

Risks of Financial Institutions

Interest Rate Risk I

Interest Rate Risk II

Credit Risk: Individual Loan Risk

Credit Risk: Loan Portfolio and Concentration Risk

Liquidity Risk

Foreign Exchange Risk

Sovereign Risk

Market Risk

Off-Balance-Sheet Risk

Technology and Other Operational Risks

Liability and Liquidity Management

Deposit Insurance and Other Liability Guarantees

Capital Adequacy

Product and Geographic Expansion

Futures and Forwards

Swaps

Loan Sales

Securitization

Filters