Q&A Hero

Q: What is the advantage of a futures hedge over an options hedge? A. The futures hedge has lower credit risk exposure. B. The futures hedge reduces volatility in profit gains on both sides. C. The futures hedge is marked to market less frequently. D. The futures hedge offers the least downside risk protection. E. The futures hedge completely offsets losses but only partly offsets gains.

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

Q: Which of the following is a good strategy to adopt when interest rates are expected to rise? 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. E. All of the above.

Q: Rising interest rates will cause the market value of 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. E. Answers A and B only.

Q: As interest rates increase, the buyer of a bond put option stands to A. make limited gains. B. incur limited losses. C. incur unlimited losses. D. lose the entire premium amount. E. Answers A and D only.

Q: Which of the following holds true for the writer of a bond call option if interest rates decrease? A. Makes profits limited to call premium B. Makes losses limited to call premium C. Potential to make large losses D. Potential to make unlimited profits E. Answers B and D only.

Q: As interest rates increase, the writer of a bond call option stands to make A. limited gains. B. limited losses. C. unlimited losses. D. unlimited gains. E. Answers A and B only.

Q: Buying a cap is similar to 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. E. buying a collar on interest rates.

Q: Purchasing a succession of call options on interest rates is called a A. open interest. B. pull-to-par. C. cap. D. floor. E. collar.

Q: Using the proceeds from the simultaneous sale of a floor to finance the purchase of a cap is to open a position called a A. open interest. B. pull-to-par. C. cap. D. floor. E. collar.

Q: The purchase often of a series of put options with multiple exercise dates results in a A. open interest. B. pull-to-par. C. cap. D. floor. E. collar.

Q: The outstanding number of put or call contracts is called A. open interest. B. pull-to-par. C. cap. D. floor. E. collar.

Q: Which of the following observations is NOT true? A. Variance of bond prices is nonconstant over time. B. Variance of bond prices rises at first and then falls as the bond approaches maturity. C. As the bond approaches maturity, all price paths must lead to 100 percent of the face value of the bond. D. As the bond approaches maturity, all price paths must lead to the principal paid by the issuer on maturity. E. Variance of a bond's price or return increases as maturity approaches.

Q: The tendency of the variance of a bond's price to decrease as maturity approaches is called A. open interest. B. pull-to-par. C. digital default option. D. futures option. E. credit spread call option.

Q: A contract that pays the par value of a loan in the event of default is a A. put option. B. call option. C. digital default option. D. futures option. E. credit spread call option.

Q: A contract whose payoff increases as a yield spread increases above some stated exercise spread is a A. put option. B. call option. C. digital default option. D. futures option. E. credit spread call option.

Q: An option that does NOT identifiably hedge an underlying asset is a A. put option. B. call option. C. naked option. D. futures option. E. credit spread call option.

Q: A contract that results in the delivery of a futures contract when exercised is a A. put option. B. call option. C. naked option. D. futures option. E. credit spread call option.

Q: The buyer of a bond put option 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 E. pays a premium and has the obligation to buy the underlying bond at the agreed exercise price

Q: The writer of a bond put option 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 E. pays a premium and has the obligation to buy the underlying bond at the agreed exercise price

Q: The writer of a bond call option A. receives a premium and must stand ready to sell the bond at the exercise price. B. receives a premium and must stand 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. E. pays a premium and has the obligation to buy the underlying bond at the agreed exercise price.

Q: The buyer of a bond call option 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 E. pays a premium and has the obligation to buy the underlying bond at the agreed exercise price

Q: Giving the purchaser the right to sell the underlying security at a prespecified price is a A. put option. B. call option. C. naked option. D. futures option. E. credit spread call option.

Q: Giving the purchaser the right to buy the underlying security at a prespecified price is a A. put option. B. call option. C. naked option. D. futures option. E. credit spread call option.

Q: The purchaser of an option must pay the writer a A. strike price. B. market price. C. margin. D. premium. E. basis.

Q: As of June 2012, commercial banks had listed for sale option contracts with a notational value of approximately A. $16.2 trillion. B. $33.6 trillion. C. $8.1 trillion. D. $51.0 trillion. E. $36.9 trillion.

Q: Managing interest rate risk for less creditworthy FI's by running a cap/floor book may require the backing of external guarantees such as standby letters of credit because of the nature of the options.

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

Q: Banks that are more exposed to rising interest rates than falling interest rates may seek to finance a cap by selling a floor.

Q: An FI would normally purchase a cap if it was funding fixed-rate assets with variable-rate liabilities.

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

Q: Buying a floor means buying a put option on interest rates.

Q: Buying a cap is like buying insurance against a decrease in interest rates.

Q: CBOT catastrophe call spread options have variable payoffs that are capped at a level of less than 100 percent of extreme losses.

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

Q: A digital default option expires unexercised in situations where the loan is paid in accordance with the loan agreement.

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

Q: The premium on a credit spread call option is the maximum loss attainable to the buyer of the option in situations where the credit spread increases.

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

Q: The total premium cost to an FI of hedging by buying put options is the price of each put option times the number of put options purchased.

Q: Exercise of a put option on interest rate futures by the buyer of the option results in the buyer putting to the writer the bond futures contract at an exercise price higher than the currently trading bond future.

Q: Exercise of a put option on futures by the buyer of the option will occur if interest rates have increased.

Q: Interest rate futures options are preferred to bond options because they have more favorable liquidity, credit risk, and market-to-market features.

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

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

Q: An option's delta has a value between 0 and 100.

Q: Most bond options trade on the over the counter markets as opposed to organized exchanges such as the Chicago Board Options Exchange.

Q: Options become more valuable as the variability of interest rates decreases.

Q: The concept of pull-to-maturity reflects the increasing variance of a bond's price as the maturity of the bond approaches.

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

Q: The Black-Scholes model does not work well to value bond options because of violations of the underlying assumption of a constant variance of returns on the underlying asset.

Q: A hedge using a put option contract completely offsets gains but only but only partially offsets losses on an FIs balance sheet.

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

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

Q: Simultaneously buying a bond and a put option on a bond produces the same payoff as buying a call option on a bond.

Q: The losses on a purchased put option position when rates fall are limited to the option premium paid.

Q: Hedging the FI's interest rate risk by buying a put option on a bond is an attractive alternative to a manager.

Q: When interest rates rise, writing a bond call option may cause profits to offset the loss on an FI's bonds.

Q: Writing an interest rate call option may hedge an FI when rates rise and bond prices fall.

Q: Regulators tend to discourage, and even prohibit in some cases, FIs from writing options because the upside potential is unlimited and the downside losses are potentially limited.

Q: The profit on bond call options moves asymmetrically with interest rates.

Q: The trading process of options is the same as that of futures contracts.

Q: The loss to the buyer of a bond option is unlimited.

Q: The gain to the writer of a bond option is unlimited.

Q: The loss to a buyer of bond put options is limited to the premium paid.

Q: The buyer of a bond put option stands to make a profit if changes in market interest rates cause the bond price to fall below the exercise price.

Q: The gain to a buyer of bond call options is unlimited, even if interest rates decrease to zero.

Q: The payoffs on bond call options move symmetrically with changes in interest rates.

Q: Buying a call option on a bond ensures a bank that it will be able to sell the bond at a given point in time for a price at least equal to the exercise price of the option.

Q: The buyer of a bond call option stands to make a positive payoff if changes in market interest rates cause the bond price to rise above the exercise price.

Q: FIs may increase fee income by serving as a counterparty for other entities wanting to hedge risk on their own balance sheet.

Q: A bond call option gives the holder the right to sell the underlying bond at a pre-specified exercise price.

Q: The payoff values on bond options are positively linked to the changes in interest rates.

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Q: Use the following two choices to identify whether each intermediary or entity is a net buyer or net seller of credit derivative securities.a. Net buyer (typically)b. Net seller (typically)Mutual funds

Q: Use the following two choices to identify whether each intermediary or entity is a net buyer or net seller of credit derivative securities.a. Net buyer (typically)b. Net seller (typically)Hedge funds

Q: Use the following two choices to identify whether each intermediary or entity is a net buyer or net seller of credit derivative securities.a. Net buyer (typically)b. Net seller (typically)Securities firms

Q: Use the following two choices to identify whether each intermediary or entity is a net buyer or net seller of credit derivative securities.a. Net buyer (typically)b. Net seller (typically)Pension funds

Q: Use the following two choices to identify whether each intermediary or entity is a net buyer or net seller of credit derivative securities.a. Net buyer (typically)b. Net seller (typically)Insurance companies

Q: Use the following two choices to identify whether each intermediary or entity is a net buyer or net seller of credit derivative securities.a. Net buyer (typically)b. Net seller (typically)Banks