Fin 470 – Moore
Exam 2 – 1
Fall 2005
Second Examination – Finance 470
Fall 2005 (Moore)
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Multiple Choice (2 points each): Circle the Best response
1. In its absolute version, purchasing power parity states that price levels worldwide should be
_______when expressed in a common currency.
a. equal
b. roughly equal
c. different
d. opportunities for arbitrage
2.
The Fisher effect states that the _________ rate is made up of a real required rate of return and
an inflation premium.
a. nominal exchange
b.
real exchange
c.
nominal interest rate
d.
adjusted dividend
3.
A rise in the inflation rate in one nation relative to others will be associated with a fall in the
first nation’s exchange rate and with a rise of its interest rate relative to foreign interest rates.
The two conditions combined result in the _________ Effect.
a.
Fisher
b.
Herstatt
c.
Unbiased forward rate
d.
International Fisher
4.
If the nominal interest rate is 9.2% and the real required return is 5%, then the Fisher effect says
that the expected inflation rate should be (discrete compounding):
a. 1.092%
b. 4%
c. 4.2%
d. 5%
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Fin 470 – Moore
Exam 2 – 1
Fall 2005
5.
Inflation in the U.S. is projected at 5% annually for the next 5 years and at 12% annually in
South Korea for the same time period. South Korea currency is called the won. The current
won/$ spot rate is at 1309.5 won/$. The PPP estimate of the spot rate five years from now is
(continuous compounding)
a. 922.79
b. 1220.97
c. 1404.45
d. 1858.27
6.
The spot rate on the Dutch guilder is $0.39 and the 180-day forward rate is $0.40. The
difference between the spot and forward rates means that
a. interest rates are higher in the U.S. than in the Netherlands
b. the guilder has risen in relation to the dollar
c. the inflation rate in the Netherlands is declining
d. the guilder is expected to fall in value relative to the dollar
7.
Which one of the following factors makes the estimation of future (forward) rates using the IFE
more empirically sound than using PPP?
a. expected inflation rates of countries are an observable and tradable fact that can be
measured without error.
b. real required rates of returns for countries are an observable and tradable fact that
can be measured without error.
c. nominal interest rates of countries are an observable and tradable fact that can be
measured without error.
d. the time horizon using the IFE model can be better measured than the time horizon
using the PPP model.
8.
Annual inflation rates in the U.S. and Greece are expected to be 3% and 8%, respectively. If the
current spot rate for the dollar in Greece is 142.8571 drachma/$, then the expected spot rate in
three years is (discrete):
a. 123.92 (drachma/$)
b. 136.24 (drachma/$)
c. 149.79 (drachma/$)
d. 164.69 (drachma/$)
9.
The direct spot quote for the Canadian dollar is $.76 and the 180-day forward rate is $.79. The
difference between the two rates is likely to mean that
a. inflation in the U.S. is expected to be higher during the next 6 months than in Canada
b. interest rates are rising faster in Canada than in the U.S.
c. prices in Canada are expected to rise more rapidly than in the U.S during the next 6 months.
d. the Canadian dollar's spot rate is expected to rise in terms of the U.S. dollar
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Fin 470 – Moore
Exam 2 – 1
Fall 2005
10.
Which one of the following is consistent with the definition of an arbitrage opportunity?
a. Guaranteed positive cash inflows at time zero and possible zero net cash inflows at time 1.
b. Guaranteed net zero investment at time zero and possible positive cash inflows at time 1.
c. Guaranteed net zero investment at time zero and guaranteed positive cash inflows at time 1.
d. Possible net zero investment at time zero and guaranteed positive cash inflows at time 1.
11.
If the theoretical Futures price for Euros (direct US quote) is less than the Actual Futures price
for Euros, then which one of the following is correct?
a. The Euro is overvalued relative to the US dollar
b. The Euro is undervalued relative to the US dollar
c. The US dollar is overvalued relative to the Euro
d. You would begin the arbitrage trades by borrowing US dollars.
12.
Nominal interest rates in the US and UK are 4.59% and 4.01%, respectively. In the absence of
arbitrage, which one of the following statements is correct regarding the relationship between
the futures and spot rate (direct US quote)?
a. The futures contract will be selling at a premium
b. The futures contract will be selling at a discount
c. Inflation must be higher in the US
d. Inflation must be higher in the UK
13.
The intrinsic value of a call option is defined as:
a. Max(0, X – S) - call premium
b. Max(0, S – X) – call premium
c. Max(0, S – X)
d. Max(0, X – S)
14.
The intrinsic value of a put option is defined as:
a. Max(0, X – S) - put premium
b. Max(0, S – X) – put premium
c. Max(0, S – X)
d. Max(0, X – S)
15.
Which of the following is true as it relates to the time premium of options?
a. Call options increase in value and put options decrease in value as the time to maturity
increases.
b. Call options increase in value and put options decrease in value as the time to maturity
decreases.
c. Both call options and put options increase in value as the time to maturity increases.
d. Both call options and put options decrease in value as the time to maturity increases.
16.
Which of the following is true as it relates to decreases in the strike (exercise) price of
an option contract?
a. The value of long calls decrease with decreases in strike prices.
b. The value of short calls increase with decreases in strike prices.
c. The value of long puts increase with decreases in strike prices.
d. The value of short puts increase with decreases in strike prices.
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Fin 470 – Moore
Exam 2 – 1
Fall 2005
Use the following Option information for Robert Half, International in questions
17-20
CALL OPTIONS
Strike
Expire at close Fri, Mar 17, 2006
Symbol
Last
Chg
Bid
Ask
Vol
Open Int
30.00
RHICF.X
7.30
0.00
7.90
8.20
10
23
35.00
RHICG.X
4.80
0.00
4.20
4.50
11
1,943
PUT OPTIONS
Strike
Expire at close Fri, Mar 17, 2006
Symbol
Last
Chg
Bid
Ask
Vol
Open Int
30.00
RHIOF.X
0.70
0.00
0.60
0.80
250
3,872
35.00
RHIOG.X
2.10
0.00
1.90
2.05
5
87
17.
What is the position in terms of number of shares of Robert Half represented by the March 2006
call options with a $35.00 strike price?
a. 11
b. 1,100
c. 8,700
d. 194,300
18.
How much revenue will you get for selling 2 (two) short March 2006 put option contracts with
a strike price of $30.00?
a. $1.20
b. $60.00
c. $120.00
d. $160.00
19.
What is your break-even stock price for a long call with a $30.00 strike price?
a. $26.80
b. $30.00
c. $37.90
d. $38.20
20.
What is your breakeven stock price for a short put with a $35.00 strike price?
a. $32.95
b. $33.10
c. $35.00
d. $36.90
21.
Which of the following is true with respect to contractual protections that option holders
are provided by organized option exchanges?
a. Option values are protected against dividends
b. Option values are protected against stock splits
c. Option values are protected against interest rate changes
d. Option values are protected against stock price volatility
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Fin 470 – Moore
Exam 2 – 1
Fall 2005
22.
Which of the following best distinguishes option contracts from futures contracts?
a. Long options are obligations to buy or sell and futures are rights to buy or sell.
b. Long options are rights to buy or sell and futures are obligations to buy or sell.
c. Long options are rights to buy and obligations to sell whereas futures are obligations
to buy or sell.
d. Long options are obligations to buy and rights to sell whereas futures are obligations
to buy or sell.
23.
You can speculate (bet) on the UK pound depreciation (declines) by
a. selling a pound call option and buying a pound call option
b. buying a pound put option and a selling pound call option
c. selling a pound call option and a selling a pound put option
d. buying a pound call option and selling a pound call put option
24.
Suppose the current spot rate for the DM is $0.5925. The put premium on a put option with an
exercise price of $0.5675 is $0.0373. What is the intrinsic value of one DM 62,500 put option?
a. $2,331.25
b. $1,562.50
c. $950.00
d. $0
25.
The current spot rate for the DM is $0.5925. The put premium on a put option with an exercise
price of $0.5675 is $0.0373. What is the time premium value of one DM 62,500 put contract?
a. $2,331.25
b. $1,562.50
c. $950.00
d. $0
Use the following information for questions 26-28.
A Swiss franc futures contract traded on the CME is specified for 125,000 Swiss francs. The initial
margin for one contract is $1890 and the maintenance margin is $1400 per contract. A one point
change in the value of a futures contract is defined as $.0001 per Swiss franc. Thus, a one point change
will result in a $12.50 change in the futures contract value. You have just gone long on 1 futures
contract at a price of $0.7786 per Swiss franc.
26.
How much cash will you have to deposit in your account with the futures exchange when you
bought the contract?
a. $12.50
b. $1400.00
c. $1471.55
d. $1890.00
27.
Given daily marking to market, at what futures price will you receive your first margin call?
a. When the futures contract hits $0.7747
b. When the futures contract drop below $0.7747
c. When the futures contract is $0.0039
d. When the futures contract is $0.0040
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Fin 470 – Moore
Exam 2 – 1
Fall 2005
28.
Given daily marking to market, how much profit will be credited to you account if the Swiss
franc futures contract settles at $0.7875 at the close of your first day’s trading?
a. $0.0089
b. $0.11125
c. $1,112.50
d. $3,002.50
29.
A decline in the domestic interest rate will
a. raise the value of foreign-currency call options and reduce the value of foreign-currency put
options
b. raise the value of foreign-currency put options and reduce the value of foreign-currency call
options
c. raise the value of both foreign-currency put and call options
d. reduce the value of both foreign-currency put and call options
30.
The basic difference(s between forward and futures contracts is that
a.
forward contracts are individually tailored while futures contracts are standardized
b.
forward contracts are negotiated with banks whereas futures contracts are bought and
sold on an organized exchange
c.
forward contracts have no daily limits on price fluctuations whereas futures contracts
have a daily limit on price fluctuations
d.
all of the above
Short Problem 1 (10 Points) – Show all work for full credit
Suppose the price indexes in Mexico and the U.S., which both began the year at 100, are at 150 and
110, respectively, by the end of the year. Assume the exchange rate began the year at 4.5 pesos = $1
and ended the year at 6.9 pesos = $1. Compute the change in the real value of the peso during the one
year period. Use continuous compounding.
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Fin 470 – Moore
Exam 2 – 1
Fall 2005
Short Problem 2 (10 Points) – Show all work for full credit
Use the following Option information for Robert Half, International in this question.
CALL OPTIONS
Strike
Expire at close Fri, Mar 17, 2006
Symbol
Last
Chg
Bid
Ask
Vol
Open Int
30.00
RHICF.X
7.30
0.00
7.90
8.20
10
23
35.00
RHICG.X
4.80
0.00
4.20
4.50
11
1,943
PUT OPTIONS
Strike
Expire at close Fri, Mar 17, 2006
Symbol
Last
Chg
Bid
Ask
Vol
Open Int
30.00
RHIOF.X
0.70
0.00
0.60
0.80
250
3,872
35.00
RHIOG.X
2.10
0.00
1.90
2.05
5
87
Suppose you short one $30.00 call option and long one $30.00 put option. Assume the current stock
price is $38.84 per share.
1. How much will your profit or loss be if the stock price drops to $26.00 per share at expiration
(assume a European option)?
2. Is this strategy profitable for anticipated stock price increases or decreases?
3. Comment on the downside exposure potential of this strategy.
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Fin 470 – Moore
Exam 2 – 1
Fall 2005
Short Problem 3 (Arbitrage) – 20 Points.
Country
Canada
Home Currency
$ Canadian
Current
Spot__
$0.8539
Japan
Yen
$0.008851
US
$ US
6-month
Futures
$0.8682
Home
Interest Rate
3.339 %
$0.008935
0.26 %
4.199 %

Using continuous compounding, determine (prove) that an arbitrage opportunity exists
on the relation between the US dollar and Japanese Yen.

Is the Canadian dollar under or over valued? why??

Given continuous compounding, determine the arbitrage profits per million $US that is
available (without considering transaction costs). In effect, set up zero net cash flows
at time zero and compute the riskless positive time 1 cash flow or set up guaranteed
positive time zero cash flows and guaranteed net zero cash flows at time 1.
Assume you can borrow and lend at each country’s stated interest rate.
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