Sample Questions 3
1- ____________ is the process of reducing a firm's exposure to price or rate fluctuations.
A) Hedging
B) Volatility
C) Diversification
D) Value minimization
E) Translation
2- A plot showing how the value of the firm is affected by changes in prices is called a:
A) Security market line.
B) Net present value profile.
C) Risk profile.
D) Scatter plot.
3- Short-run financial risk arising from the need to buy or sell at uncertain prices or rates
in the near future is called __________________.
A) risk maximization
B) volatility maximization
C) economic exposure
D) transactions exposure
E) translation exposure
4- Long-term financial risk arising from permanent changes in prices or other market
fundamentals is called ___________________.
A) risk maximization
B) volatility maximization
C) economic exposure
D) transactions exposure
E) translation exposure
5- A(n) _____________ contract is a legally binding agreement between two parties
calling for the purchase/sale of an asset in the future at an agreed-upon price
today.
A) forward
B) spot
C) swap
D) option
E) floating
6- A forward contract with the feature that gains and losses are realized on a daily basis,
rather than at the settlement date, is called a(n) ________________ contract.
A) floating
B) spot
C) option
D) swap
E) futures
7- Hedging an asset with contracts written on a similar, but not identical, asset is called:
A) Primary trading.
B) Open trading.
C) Open-hedging.
D) Cross-hedging.
E) Perfect-hedging.
8- An agreement that gives the owner the right, but not the obligation, to buy or sell a
specific asset at a specific price for a set period of time is called a(n)
_______________ contract.
A) option
B) forward
C) futures
D) swap
E) spot
9- Hedging is:
A) Plotting how the value of a firm is affected by changes in prices.
B) An option that gives the owner the right, but not the obligation, to buy an
asset at a specific price up to a specific point in time.
C) A financial asset that represents a claim on a different type of asset.
D) Reducing a firm's exposure to rate and price fluctuations.
E) Plotting the potential gains and losses incurred as a consequence of price
changes.
10- The process of using available financial instruments to create new ones is called:
A) Security derivation.
B) Risk profiling.
C) Financial engineering.
D) Forward contracting.
E) Futures trading.
11- A forward contract is an agreement between two parties for a sale:
A) Of goods delivered today and the price determined in the future.
B) Of an unspecified quantity in the future at a price set today.
C) At some future date with both the quantity and the price determined on that
future date.
D) At some future date with the quantity determined today and the price
determined in the future.
E) At some future date with both the quantity and price determined today.
12- A derivative security is a:
A) Financial asset that derives its value based solely on values in the futures
market.
B) Real asset whose value is based on the market value of a financial asset.
C) Financial asset that represents a claim to another financial asset.
D) Financial asset with a life equal to the life of the underlying asset.
E) Real asset that obligates both the buyer and the seller to complete an
exchange on a predetermined date at a predetermined price.
13- An American call option is a contract that _______ the agreed upon quantity at the
agreed upon price no later than the expiration date.
A) Obligates the owner to buy
B) Gives the owner the option, but not the obligation, to buy
C) Grants the owner the option, but not the obligation, to sell
D) Obligates the buyer to buy, at the discretion of the seller,
E) Obligates the owner to sell
14- When a strategy is put in place to limit the rate of interest that a firm pays on its debt
such that the rate will remain within a stated upper and lower bound, the firm is
said to have created an interest rate:
A) Swap.
B) Floor.
C) Cap.
D) Ceiling.
E) Collar.
15- The _______ of a forward contract is obligated to ______ delivery and pay for the
contracted goods at the forward price; the _______ of a forward contract is
obligated to ______ delivery and accept payment for the goods at the forward
price.
A) seller; make; buyer; take
B) seller; take; buyer; make
C) buyer; make; seller; take
D) buyer; take; seller; take
E) buyer; take; seller; make
16- Which of the following derivative securities derives its value primarily from changes
in interest rates?
A) A forward contract on Eurobonds
B) A call option contract on IBM stock
C) A position in wheat futures contracts
D) A put option contract on the S&P/TSX Composite index
17- Which of the following securities does NOT create a transaction obligation for both
contracting parties in the future?
I. Futures contracts
II. Option contracts
III. Swap contracts
IV. Forward contracts
A) I only
B) II only
C) III only
D) II and IV only
E) I and III only
18- Which of the following items obligates the writer to sell an asset at a specified price
if the holder chooses to exercise?
A) Put option
B) Call option
C) Forward contract
D) Futures contract
E) Swap contract
19- In which of the following does money NOT change hands when the contract is
created?
I. Futures contracts
II. Options contracts
III. Forward contracts
A) I only
B) II only
C) III only
D) I and II only
E) I and III only
20- The Bretton Woods accord helped reduce the volatility of:
A) Interest rates.
B) Prices of commodities.
C) Options prices.
D) Exchange rates.
E) Futures prices.
21- An option that may be exercised at any time up to its expiration date is called a(n):
A) Futures option.
B) Asian option.
C) Bermudan option.
D) European option.
E) American option.
22- A security that gives the holder the right, but not the obligation, to purchase shares of
stock in a firm for a fixed price over a specified period of time is called a(n):
A) Convertible bond.
B) Warrant.
C) Initial public offering.
D) Seasoned equity offering.
E)
Forward sale of equity
23- An option that can only be exercised on the expiration date is called a(n):
A) Implied option.
B) European option.
C) Parity call option.
D) American option.
E) Put option.
24- If a call option is "in-the-money" on the expiration date, the:
A) Strike price is more than the market price of the stock.
B) Option is expiring unexercised that day and the seller gets to keep the option
premium.
C) Buyer of the option is getting a refund equal to the option premium paid.
D) Call price is equal to the stock price minus the strike price.
E) Seller of the call gets to keep the option premium without relinquishing any
shares of stock
25- A local retail store allows you to return the merchandise you purchase and get your
money back for up to 30 days after the purchase date. The store has, in effect,
provided each shopper with _______________ options.
A) American call
B) European call
C) American put
D) European put
E) convertible bond
26- A ticket to a baseball game gives the holder the right, but not the obligation, to attend
a specified game. Thus, a baseball ticket is effectively a(n) ________ option on
the possession of a seat, which has an expiration date equal to __________.
A) American call; the end of the baseball season
B) European call; the end of the baseball season
C) American call; the day of the game
D) European call; the day of the game
E) Convertible bond; the end of the baseball season
27- If you sell a call option on a stock:
A) Have the right to force exercise of the option anytime prior to maturity.
B) May be forced to buy the underlying stock at the exercise price.
C) Have a right to receive dividends on the underlying stock until exercise or
maturity of the option.
D) May be forced to sell the underlying stock at a fixed price if the option is
exercised against you.
E) May let the option expire without exercising it.
28- If you exercise a put option you ______________.
A) sell the asset underlying the option contract at the option strike price
B) must have been the "writer" of the option when it was created
C) have behaved in a rational manner if the market price exceeds the strike
price
D) must own a European option
29- Which of the following statements is false?
A) Option contracts are a zero sum game.
B) If an in-the-money option is not exercised at expiration, you will lose
money.
C) It is possible for you to lose all of your investment in an option.
D) One advantage to buying options on a stock rather than the stock itself is
that it requires a smaller initial investment.
E) As the price of a stock falls, the value of a put option on the stock also falls.
30- Which of the following is/are true regarding stock options?
I. Buying a call option gives you the right to purchase shares.
II. Selling a call option may give you the obligation to sell shares.
III. Buying a put option gives you the right to sell shares.
IV. Selling a put option may give you the obligation to buy shares.
A) None of the above
B) I and IV only
C) II and III only
D) I, II, and IV only
E) I, II, III, and IV
31- The intrinsic value of a call option is defined as:
A) max [S + E, 0]
B) max [E – S, 0]
C) min [S – E, 0]
D) max [S – E, 0]
E) min [E – S, 0]
32- Which of the following would increase the value of a call option?
I. The exercise price is decreased
II. The value of the underlying asset increases
III. The expiration date is extended
IV. The variance of the underlying asset increases
A) I and III only
B) II and IV only
C) II, III, and IV only
D) I, II, and III only
E) I, II, III, and IV
33- As the variance of the asset price decreases, the value of a call option decreases
because
A) downside risk is virtually eliminated
B) the possible payoffs increase
C) downside risk is virtually eliminated while the possible payoffs increase
D) downside risk doesn't change but the possible payoffs decrease
E) it becomes more likely that the option will finish out of the money
34- Because _____________, equity in a leveraged firm can be considered a call option
on the firm's assets.
A) of the M&M capital structure irrelevance theorem
B) stockholders have unlimited liability for the debts of the firm
C) the possible loss on a share of common stock is limited to the initial
investment
D) the bondholders can elect to "walk away" leaving the stockholders holding
the bag
E) call options are more prevalent than put options
35- Which of the following statements about warrants is true?
A) Warrants are usually issued in conjunction with a security offering.
B) Warrants are issued by individuals.
C) Warrant exercise will not increase the number of shares outstanding.
D) Warrant exercise will increase earnings per share.
E) Warrants may not be traded separately from the security with which they
were issued.
36- Which of the following is a characteristic difference between a warrant and a call
option?
A) A call option will typically have a longer maturity than a warrant.
B) Call options are issued by individuals while warrants are issued by firms.
C) Call options can be allowed to expire while warrants cannot.
D) Neither warrants nor call options affect firm value.
E) Unlike warrants, when call options are exercised, the number of shares of
stock outstanding increases.
37- Which of the following would decrease the value of a call option?
I. The exercise price is increased
II. The risk-free rate increases
III. The expiration date is extended
IV. The variance of the underlying asset decreases
A) I only
B) I and III only
C) I and IV only
D) II and III only
E) II and IV only
38- Which two of the following correctly identify the value of a call option at expiration?
I. C1 = 0 if S1 - E  0
II. C1 = 0 if S1 - E >0
III. C1 = S1 - E if S1 - E > 0
IV. C1 = S1 - E if S1 - E  0
A) I and III only
B) I and IV only
C) II and III only
D) II and IV only
E) I and II only
39- The value of a call option that is expected to expire in the money can be expressed as:
A) C0 = E – S0 /(1 + Rf)t.
B) C0 = S0 – E/(1 + Rf)t.
C) C0 = ( S/C)(C0) + S0/(1 + Rf)t.
D) C0 = (S/C)(C0) – E/(1 + Rf)t.
E) C0 = E – S1.
40- When employee stock options are issued they are usually priced:
A) At 10% above the market value of stock.
B) At an intrinsic value of $10.
C) At the money.
D) Such that they will not go “underwater”.
E) So that they can be exercised immediately at a profit.