Chapter 13
Financial Derivatives
 Multiple Choice
The payoffs for financial derivatives are linked to
securities that will be issued in the future.
the volatility of interest rates.
previously issued securities.
government regulations specifying allowable rates of return.
none of the above.
Question Status: New
Financial derivatives include
stocks.
bonds.
futures.
none of the above.
Question Status: Previous Edition
Financial derivatives include
stocks.
bonds.
forward contracts.
both (a) and (b) are true.
Question Status: Previous Edition
Which of the following is not a financial derivative?
Stock
Futures
Options
Forward contracts
Question Status: Previous Edition
Chapter 13
By hedging a portfolio, a bank manager
reduces interest rate risk.
increases reinvestment risk.
increases exchange rate risk.
increases the probability of gains.
Question Status: Previous Edition
Which of the following is a reason to hedge a portfolio?
To increase the probability of gains.
To limit exposure to risk.
To profit from capital gains when interest rates fall.
All of the above.
Both (a) and (c) of the above.
Question Status: Revised
Hedging risk for a long position is accomplished by
taking another long position.
taking a short position.
taking additional long and short positions in equal amounts.
taking a neutral position.
none of the above.
Question Status: New
Hedging risk for a short position is accomplished by
taking a long position.
taking another short position.
taking additional long and short positions in equal amounts.
taking a neutral position.
none of the above.
Question Status: New
A contract that requires the investor to buy securities on a future date is called a
short contract.
long contract.
hedge.
cross.
Question Status: Previous Edition
Financial Derivatives
443
444
Frederic S. Mishkin • Economics of Money, Banking, and Financial Markets, Seventh Edition
A long contract requires that the investor
sell securities in the future.
buy securities in the future.
hedge in the future.
close out his position in the future.
Question Status: Previous Edition
A person who agrees to buy an asset at a future date has gone
long.
short.
back.
ahead.
even.
Question Status: Study Guide
A short contract requires that the investor
sell securities in the future.
buy securities in the future.
hedge in the future.
close out his position in the future.
Question Status: Previous Edition
A contract that requires the investor to sell securities on a future date is called a
short contract.
long contract.
hedge.
micro hedge.
Question Status: Previous Edition
If a bank manager chooses to hedge his portfolio of treasury securities by selling futures contracts, he
gives up the opportunity for gains.
removes the chance of loss.
increases the probability of a gain.
both (a) and (b) are true.
Question Status: Previous Edition
Chapter 13
To say that the forward market lacks liquidity means that
forward contracts usually result in losses.
forward contracts cannot be turned into cash.
it may be difficult to make the transaction.
forward contracts cannot be sold for cash.
none of the above.
Question Status: New
A disadvantage of a forward contract is that
it may be difficult to locate a counterparty.
the forward market suffers from lack of liquidity.
these contracts have default risk.
all of the above.
both (a) and (c) of the above.
Question Status: New
Forward contracts are risky because they
are subject to lack of liquidity
are subject to default risk.
hedge a portfolio.
both (a) and (b) are true.
Question Status: Revised
The advantage of forward contracts over future contracts is that they
are standardized.
have lower default risk.
are more liquid.
none of the above.
Question Status: Previous Edition
The advantage of forward contracts over futures contracts is that they
are standardized.
have lower default risk.
are more flexible.
both (a) and (b) are true.
Question Status: Previous Edition
Financial Derivatives
445
446
Frederic S. Mishkin • Economics of Money, Banking, and Financial Markets, Seventh Edition
Forward contracts are of limited usefulness to financial institutions because
of default risk.
it is impossible to hedge risk.
of lack of liquidity.
all of the above.
both (a) and (c) of the above.
Question Status: New
Futures contracts are regularly traded on the
Chicago Board of Trade.
New York Stock Exchange.
American Stock Exchange.
Chicago Board of Options Exchange.
Question Status: Previous Edition
Hedging in the futures market
eliminates the opportunity for gains.
eliminates the opportunity for losses.
increases the earnings potential of the portfolio.
does all of the above.
does both (a) and (b) of the above.
Question Status: Study Guide
When interest rates fall, a bank that perfectly hedges its portfolio of Treasury securities in the futures
market
suffers a loss.
experiences a gain.
has no change in its income.
none of the above.
Question Status: Study Guide
Futures markets have grown rapidly because futures
are standardized.
have lower default risk.
are liquid.
all of the above.
Question Status: Previous Edition
Chapter 13
Financial Derivatives
447
Parties who have bought a futures contract and thereby agreed to _____ (take delivery of) the bonds are
said to have taken a ____ position.
sell; short
buy; short
sell; long
buy; long
Question Status: Previous Edition
Parties who have sold a futures contract and thereby agreed to _____ (deliver) the bonds are said to have
taken a ____ position.
sell; short
buy; short
sell; long
buy; long
Question Status: Previous Edition
By selling short a futures contract of $100,000 at a price of 115 you are agreeing to deliver
$100,000 face value securities for $115,000.
$115,000 face value securities for $110,000.
$100,000 face value securities for $100,000.
$115,000 face value securities for $115,000.
Question Status: Previous Edition
By selling short a futures contract of $100,000 at a price of 96 you are agreeing to deliver
$100,000 face value securities for $104,167.
$96,000 face value securities for $100,000.
$100,000 face value securities for $96,000.
$96,000 face value securities for $104,167.
Question Status: Revised
By buying a long $100,000 futures contract for 115 you agree to pay
$100,000 for $115,000 face value bonds.
$115,000 for $100,000 face value bonds.
$86,956 for $100,000 face value bonds.
$86,956 for $115,000 face value bonds.
Question Status: Previous Edition
448
Frederic S. Mishkin • Economics of Money, Banking, and Financial Markets, Seventh Edition
On the expiration date of a futures contract, the price of the contract
always equals the purchase price of the contract.
always equals the average price over the life of the contract.
always equals the price of the underlying asset.
always equals the average of the purchase price and the price of underlying asset.
cannot be determined.
Question Status: New
The price of a futures contract at the expiration date of the contract
equals the price of the underlying asset.
equals the price of the counterparty.
equals the hedge position.
equals the value of the hedged asset.
none of the above.
Question Status: Study Guide
Elimination of riskless profit opportunities in the futures market is
hedging.
arbitrage.
speculation.
underwriting.
diversification.
Question Status: New
If you purchase a $100,000 interest-rate futures contract for 110, and the price of the Treasury securities
on the expiration date is 106
your profit is $4000.
your loss is $4000.
your profit is $6000.
your loss is $6000.
your profit is $10,000.
Question Status: New
If you purchase a $100,000 interest-rate futures contract for 105, and the price of the Treasury securities
on the expiration date is 108
your profit is $3000.
your loss is $3000.
your profit is $8000.
your loss is $8000.
your profit is $5000.
Question Status: New
Chapter 13
Financial Derivatives
449
If you sell a $100,000 interest-rate futures contract for 110, and the price of the Treasury securities on the
expiration date is 106
your profit is $4000.
your loss is $4000.
your profit is $6000.
your loss is $6000.
your profit is $10,000.
Question Status: New
If you sell a $100,000 interest-rate futures contract for 105, and the price of the Treasury securities on the
expiration date is 108
your profit is $3000.
your loss is $3000.
your profit is $8000.
your loss is $8000.
your profit is $5000.
Question Status: New
If you sold a short contract on financial futures you hope interest rates
rise.
fall.
are stable.
fluctuate.
Question Status: Previous Edition
If you sold a short futures contract you will hope that interest rates
rise.
fall.
are stable.
fluctuate.
Question Status: Previous Edition
If you bought a long contract on financial futures you hope that interest rates
rise.
fall.
are stable.
fluctuate.
Question Status: Previous Edition
450
Frederic S. Mishkin • Economics of Money, Banking, and Financial Markets, Seventh Edition
If you bought a long futures contract you hope that bond prices
rise.
fall.
are stable.
fluctuate.
Question Status: Previous Edition
If you sold a short futures contract you will hope that bond prices
rise.
fall.
are stable.
fluctuate.
Question Status: Previous Edition
To hedge the interest rate risk on $4 million of Treasury bonds with $100,000 futures contracts, you would
need to purchase
4 contracts.
20 contracts.
25 contracts.
40 contracts.
400 contracts.
Question Status: New
If you sell twenty-five $100,000 futures contracts to hedge holdings of a Treasury security, the value of the
Treasury securities you are holding is
$250,000.
$1,000,000.
$2,500,000.
$5,000,000.
$25,000,000.
Question Status: New
Assume you are holding Treasury securities and have sold futures to hedge against interest rate risk. If
interest rates rise
the increase in the value of the securities equals the decrease in the value of the futures contracts.
the decrease in the value of the securities equals the increase in the value of the futures contracts.
the increase ion the value of the securities exceeds the decrease in the values of the futures contracts.
both the securities and the futures contracts increase in value.
both the securities and the futures contracts decrease in value
Question Status: New
Chapter 13
Financial Derivatives
451
Assume you are holding Treasury securities and have sold futures to hedge against interest rate risk. If
interest rates fall
the increase in the value of the securities equals the decrease in the value of the futures contracts.
the decrease in the value of the securities equals the increase in the value of the futures contracts.
the increase in the value of the securities exceeds the decrease in the values of the futures contracts.
both the securities and the futures contracts increase in value.
both the securities and the futures contracts decrease in value.
Question Status: New
When a financial institution hedges the interest-rate risk for a specific asset, the hedge is called a
macro hedge.
micro hedge.
cross hedge.
futures hedge.
Question Status: Previous Edition
When the financial institution is hedging interest-rate risk on its overall portfolio, then the hedge is a
macro hedge.
micro hedge.
cross hedge.
futures hedge.
Question Status: Previous Edition
The number of futures contracts outstanding is called
liquidity.
volume.
float.
open interest.
turnover.
Question Status: New
Which of the following features of futures contracts were not designed to increase liquidity?
Standardized contracts
Traded up until maturity
Not tied to one specific type of bond
Marked to market daily
Question Status: Previous Edition
452
Frederic S. Mishkin • Economics of Money, Banking, and Financial Markets, Seventh Edition
Which of the following features of futures contracts were not designed to increase liquidity?
Standardized contracts
Traded up until maturity
Not tied to one specific type of bond
Can be closed with off setting trade
Question Status: Previous Edition
Futures differ from forwards because they are
used to hedge portfolios.
used to hedge individual securities.
used in both financial and foreign exchange markets.
a standardized contract.
Question Status: Previous Edition
Futures differ from forwards because they are
used to hedge portfolios.
used to hedge individual securities.
used in both financial and foreign exchange markets.
marked to market daily.
Question Status: Previous Edition
The advantage of futures contracts relative to forward contracts is that futures contracts
are standardized, making it easier to match parties, thereby increasing liquidity.
specify that more than one bond is eligible for delivery, making it harder for someone to corner the
market and squeeze traders.
cannot be traded prior to the delivery date, thereby increasing market liquidity.
all of the above.
both (a) and (b) of the above.
Question Status: Study Guide
If a firm is due to be paid in deutsche marks in two months, to hedge against exchange rate risk the firm
should
sell foreign exchange futures short.
buy foreign exchange futures long.
stay out of the exchange futures market.
none of the above.
Question Status: Previous Edition
Chapter 13
Financial Derivatives
If a firm must pay for goods it has ordered with foreign currency, it can hedge its foreign exchange rate
risk by
selling foreign exchange futures short.
buying foreign exchange futures long.
staying out of the exchange futures market.
none of the above.
Question Status: Previous Edition
If a firm is due to be paid in deutsche marks in two months, to hedge against exchange rate risk the firm
should _____ foreign exchange futures _____.
sell; short
buy; long
sell; long
buy; short
Question Status: Previous Edition
If a firm must pay for goods it has ordered with foreign currency, it can hedge its foreign exchange rate
risk by _____ foreign exchange futures _____.
selling; short
buying; long
buying; short
selling; long
Question Status: Previous Edition
Options are contracts that give the purchasers the
option to buy or sell an underlying asset.
the obligation to buy or sell an underlying asset.
the right to hold an underlying asset.
the right to switch payment streams.
Question Status: Previous Edition
The price specified on an option that the holder can buy or sell the underlying asset is called the
premium.
call.
strike price.
put.
Question Status: Previous Edition
453
454
Frederic S. Mishkin • Economics of Money, Banking, and Financial Markets, Seventh Edition
The price specified on an option that the holder can buy or sell the underlying asset is called the
premium.
strike price.
exercise price.
both (b) and (c) are true.
Question Status: Previous Edition
The seller of an option has the
right to buy or sell the underlying asset.
the obligation to buy or sell the underlying asset.
ability to reduce transaction risk.
right to exchange one payment stream for another.
Question Status: Previous Edition
The seller of an option is ______ to buy or sell the underlying asset while the purchaser of an option has
the ______ to buy or sell the asset.
obligated; right
right; obligation
obligated; obligation
right; right
Question Status: Previous Edition
The amount paid for an option is the
strike price.
premium.
discount.
commission.
yield.
Question Status: New
An option that can be exercised at any time up to maturity is called a(n)
swap.
stock option.
European option.
American option.
Question Status: Previous Edition
Chapter 13
Financial Derivatives
An option that can only be exercised at maturity is called a(n)
swap.
stock option.
European option.
American option.
Question Status: Previous Edition
Options on individual stocks are referred to as
stock options.
futures options.
American options.
individual options.
Question Status: Previous Edition
Options on futures contracts are referred to as
stock options.
futures options.
American options.
individual options.
Question Status: Previous Edition
An option that gives the owner the right to buy a financial instrument at the exercise price within a
specified period of time is a
call option.
put option.
American option.
European option.
Question Status: Previous Edition
A call option gives the owner
the right to sell the underlying security.
the obligation to sell the underlying security.
the right to buy the underlying security.
the obligation to buy the underlying security.
Question Status: Previous Edition
455
456
Frederic S. Mishkin • Economics of Money, Banking, and Financial Markets, Seventh Edition
A call option gives the seller
the right to sell the underlying security.
the obligation to sell the underlying security.
the right to buy the underlying security.
the obligation to buy the underlying security.
Question Status: Previous Edition
An option allowing the holder to buy an asset in the future is a
put option.
call option.
swap.
premium.
forward contract.
Question Status: Study Guide
An option that gives the owner the right to sell a financial instrument at the exercise price within a
specified period of time is a
call option.
put option.
American option.
European option.
Question Status: Previous Edition
A put option gives the owner
the right to sell the underlying security.
the obligation to sell the underlying security.
the right to buy the underlying security.
the obligation to buy the underlying security.
Question Status: Previous Edition
A put option gives the seller
the right to sell the underlying security.
the obligation to sell the underlying security.
the right to buy the underlying security.
the obligation to buy the underlying security.
Question Status: Previous Edition
Chapter 13
Financial Derivatives
An option allowing the owner to sell an asset at a future date is a
put option.
call option.
swap.
forward contract.
futures contract.
Question Status: Study Guide
If you buy a call option on treasury futures at 115, and at expiration the market price is 110,
the call will be exercised.
the put will be exercised.
the call will not be exercised.
the put will not be exercised.
Question Status: Previous Edition
If you buy a call option on treasury futures at 110, and at expiration the market price is 115,
the call will be exercised.
the put will be exercised.
the call will not be exercised.
the put will not be exercised.
Question Status: Previous Edition
If you buy a put option on treasury futures at 115, and at expiration the market price is 110,
the call will be exercised.
the put will be exercised.
the call will not be exercised.
the put will not be exercised.
Question Status: Previous Edition
If you buy a put option on treasury futures at 110, and at expiration the market price is 115,
the call will be exercised.
the put will be exercised.
the call will not be exercised.
the put will not be exercised.
Question Status: Previous Edition
457
458
Frederic S. Mishkin • Economics of Money, Banking, and Financial Markets, Seventh Edition
If, for a $1000 premium, you buy a $100,000 call option on bond futures with a strike price of 110, and at
the expiration date the price is 114
your profit is $4000.
your loss is $4000.
your profit is $3000.
your loss is $3000.
your loss is $1000.
Question Status: New
If, for a $1000 premium, you buy a $100,000 call option on bond futures with a strike price of 114, and at
the expiration date the price is 110
your profit is $4000.
your loss is $4000.
your profit is $3000.
your loss is $3000.
your loss is $1000.
Question Status: New
If, for a $1000 premium, you buy a $100,000 put option on bond futures with a strike price of 110, and at
the expiration date the price is 114
your profit is $4000.
your loss is $4000.
your profit is $3000.
your loss is $3000.
your loss is $1000.
Question Status: New
If, for a $1000 premium, you buy a $100,000 put option on bond futures with a strike price of 114, and at
the expiration date the price is 110
your profit is $4000.
your loss is $4000.
your profit is $3000.
your loss is $3000.
your loss is $1000.
Question Status: New
Chapter 13
Figure 13-1
In figure 13-1, with a expiration price of 110, the best return is obtained by
buying futures.
buying a call option.
selling futures.
buying a put option.
none of the above.
Question Status: New
In figure 13-1, with a expiration price of 120, the best return is obtained by
buying futures.
buying a call option.
selling futures.
buying a put option.
none of the above.
Question Status: New
Financial Derivatives
459
460
Frederic S. Mishkin • Economics of Money, Banking, and Financial Markets, Seventh Edition
Figure 13-2
In figure 13-2, with a expiration price of 110, the best return is obtained by
buying futures.
buying a call option.
selling futures.
buying a put option.
none of the above.
Question Status: New
In figure 13-2, with a expiration price of 120, the best return is obtained by
buying futures.
buying a call option.
selling futures.
buying a put option.
none of the above.
Question Status: New
Chapter 13
Financial Derivatives
The main advantage of using options on futures contracts rather than the futures contracts themselves is
that
interest rate risk is controlled while preserving the possibility of gains.
interest rate risk is controlled, while removing the possibility of losses.
interest rate risk is not controlled, but the possibility of gains is preserved.
interest rate risk is not controlled, but the possibility of gains is lost.
Question Status: Previous Edition
The main reason to buy an option on a futures contract rather than the futures contract is
to reduce transaction cost.
to preserve the possibility for gains.
to limit losses.
remove the possibility for gains.
Question Status: Previous Edition
The main disadvantage of hedging with futures contracts as compared to options on futures contracts is
that futures
remove the possibility of gains.
increase the transactions cost.
are not as an effective a hedge.
do not remove the possibility of losses.
Question Status: Revised
If a bank manager wants to protect the bank against losses that would be incurred on its portfolio of
treasury securities should interest rates rise, he could
buy put options on financial futures.
buy call options on financial futures.
sell put options on financial futures.
sell call options on financial futures.
Question Status: Previous Edition
Hedging by buying an option
limits gains.
limits losses.
limits gains and losses.
has no limit on option premiums.
has no limit on losses.
Question Status: Study Guide
461
462
Frederic S. Mishkin • Economics of Money, Banking, and Financial Markets, Seventh Edition
All other things held constant, premiums on options will increase when the
exercise price increases.
volatility of the underlying asset falls.
term to maturity increases.
(a) and (c) are both true.
Question Status: Previous Edition
All other things held constant, premiums on call options will increase when the
exercise price falls.
volatility of the underlying asset falls.
term to maturity decreases.
futures price increases.
Question Status: Revised
An increase in the exercise price, all other things held constant, will ______ the call option premium.
increase
decrease
increase or decrease
Not enough information is given.
Question Status: Revised
All other things held constant, premiums on options will increase when the
exercise price increases.
volatility of the underlying asset increases.
term to maturity decreases.
futures price increases.
Question Status: Previous Edition
An increase in the volatility of the underlying asset, all other things held constant, will ______ the option
premium.
increase
decrease
increase or decrease
Not enough information is given.
Question Status: Previous Edition
Chapter 13
Financial Derivatives
463
A tool for managing interest rate risk that requires exchange of payment streams is a
futures contract.
forward contract.
swap.
micro hedge.
macro hedge.
Question Status: Study Guide
A financial contract that obligates one party to exchange a set of payments it owns for another set of
payments owned by another party is called a
hedge.
call option.
put option.
swap.
Question Status: Revised
A swap that involves the exchange of a set of payments in one currency for a set of payments in another
currency is a(n)
interest rate swap.
currency swap.
swaptions.
national swap.
Question Status: Previous Edition
A swap that involves the exchange of one set of interest payments for another set of interest payments is
called a(n)
interest rate swap.
currency swap.
swaptions.
national swap.
Question Status: Previous Edition
A firm that sells goods to foreign countries on a regular basis can avoid exchange rate risk by
buying stock options.
selling puts on financial futures.
selling a foreign exchange swap.
buying swaptions.
Question Status: Previous Edition
464
Frederic S. Mishkin • Economics of Money, Banking, and Financial Markets, Seventh Edition
The most common type of interest rate swap is
the plain vanilla swap.
the basic swap.
the swaption.
the notional swap.
the ordinary swap.
Question Status: New
If Second National Bank has more rate-sensitive assets than rate-sensitive liabilities, it can reduce interest
rate risk with a swap that requires Second National to
pay fixed rate while receiving floating rate.
receive fixed rate while paying floating rate.
both receive and pay fixed rate.
both receive and pay floating rate.
Question Status: Previous Edition
If a bank has more rate-sensitive assets than rate-sensitive liabilities
it reduces interest rate risk by swapping rate-sensitive income for fixed rate income.
it reduces interest rate risk by swapping fixed rate income for rate-sensitive income.
it increases interest rate risk by swapping rate-sensitive income for fixed rate income.
it neutralizes interest rate risk by receiving and paying fixed-rate streams.
it cannot reduce its interest rate risk.
Question Status: New
If Second National Bank has more rate-sensitive liabilities then rate-sensitive assets, it can reduce interest
rate risk with a swap that requires Second National to
pay fixed rate while receiving floating rate.
receive fixed rate while paying floating rate.
both receive and pay fixed rate.
both receive and pay floating rate.
Question Status: Previous Edition
One advantage of using swaps to eliminate interest rate risk is that swaps
are less costly than futures.
are less costly than rearranging balance sheets.
are more liquid than futures.
have better accounting treatment than options.
Question Status: Previous Edition
Chapter 13
Financial Derivatives
465
A advantage of using swaps to hedge interest rate risk is that swaps
are less costly than futures.
can be written for long horizons.
are not subject to default risk.
are more liquid than futures.
have better accounting treatment than options.
Question Status: New
The disadvantage of swaps is that they
lack liquidity.
are difficult to arrange for a counterparty.
suffer from default risk.
all of the above.
Question Status: Previous Edition
A disadvantage of using swaps to control interest rate risk is that
swaps cannot be written for long horizons.
swaps are more expensive than restructuring balance sheets.
swaps, like forward contracts, lack liquidity.
all of the above are disadvantages of swaps.
only (a) and (b) of the above are disadvantages of swaps.
Question Status: Study Guide
The problems of default risk and finding counterparties for interest rate swaps has been reduced by
government regulation.
writing complex contracts.
commercial and investment banks serving as intermediaries.
all of the above.
both (b) and (c) of the above.
Question Status: New

Essay Questions
What is arbitrage? Explain why arbitrage drives the contract price of futures to the price of the underlying
asset on the expiration date, for prices above and below the asset price.
Explain the margin requirement for financial futures and how marking to market affects the margin
account.
Show graphically and explain the profits and losses of buying futures relative to buying call options.