Financial risk management

Q.1 In put call parity relationship present value of exercise price is add it to call option which is equal
Stew In football parity relationship present value of exercise price is add it to call option which is equal to

Ans. Put option in stock

Q.2 To liquidate a futures position by entering an equivalent but opposite transaction which eliminates
the delivery organisation is called as

Ans. Offsetting

Q.3 Interest rate swaps involves counterparties who wants to

Ans. Exchange a floating rate commitment

Q.4 Currently selling for $50 the stock price could go up by 10% or fall by 5% each month. The monthly
interest rate is one periodic rate. calculate the price of European call option on the stock with an exercise
price of dollar 48 and a majority of two months

Ans. None of these

Q.5 If the volatility variance of underlying stock increases than the assume everything else remaining the
same Ans. value of both the put option and the call option.

Q.6 the current value of stock included in portfolio is subtracted from the present value of portfolio to
calculate.

Ans. Current option price

Q.7 The value of the option which is considered as its worth as soon as it is expired is

Ans. exercise value

Q.8 Under option the buyer/ holder gets the right to sell the underlying asset.

Ans. Put

Q.9 The variability of stock price option term to majority and the risk-free rate are dependents

Ans. Prise of an option

Q.10 Person a entered long in futures contract for corn on December 21. Locked price for the contract is
RS. 20 On December 22 the futures price at the close of the trading day is Rs.22 and on December 23 it is
24 and on December 24 it is Rs. 22 Calculate the profit or loss from the contract.

Ans. Profit of Rs. 2

Q.11 the premium for a British put pound with an exercise price of dollar $1.70 is dollar $05 what is the
breakeven spot of rate for the buyer of the put

Ans. $1.65

Q.12 Person a has a call option of 10 share of IBM. The time to majority for his contract is 10 months.
Person b also has call option for the same number of IBM shares with the maturity of 6 months.

Ans. Person A will pay more premium than person B

Q.13 The value of n(d) in the black-Scholes-models can take any value between

Ans. 0 and + 1
Q.14 If you grow sugarcane in your farms how will you hedge you risk.

Ans.

Q.15 which of the following statements regarding short selling is not true.

Ans. It is an arbitrage strategy

Q.17 A stock is currently selling for $100 one year from today the stock price could go up by 30% or go
down by 20%. The risk-free interest rate is 10%. Calculate the price of a one-year European call option on
the stock with an exercise price of $100

Ans.

Q.18 Which of the following is not true

A. The simplest type of order for an individual to place is a market order

B. a limited order specifies a particular price

C. a stop order or a stop loss order specifies a particular price

D. is problem it order is a combination of a limit order and stop order

Q.19 if that would like delete the variance of the underlying stock increases then the assume everything
else remaining the same.

Ans.

Q.20 the current value of stock include in portfolio is subtracted from the present value of portfolio to
calculate

Ans. Current option price

Q.21 calculation of the value of dividend paying securities the income is subtracted because

Ans.

Q.22 The higher majority the higher will be premium both call and put options because

Ans.

Q.23 A currency swap broker is a swap Bank who

Ans.

Q.24 ------- try to lock in a profit by involving two or more markets.

Ans. Arbitrageurs

Q.25 The options are said to be either deep in the money or deep out of the money

Ans.

Q.26 A one year long forward contract on a non-dividend paying stock with current price of Rs. 40 was
entered today. The delivery price was set to be Rs. 25 the risk-free rate is 8% per annum in the economy.
The value of forward contract computed will be.

Ans.

Q.27 The situation in financial position in which the strike price is less than the current price of a stock is
classified as

Ans. In the money

Q28. When one stream of future interest payments are exchanged for another based on the same
principal amount.

Ans. Interest rate swap

Q29. The basic aim of the hedger is to.

Ans. Minimize risk

Q30. Currency swap bank is usually

Ans. A financially intermediary

Q.31 A measure of the rate of change in the value of the option portfolio change in the interest rate is

Ans. Rho

Q.32 An investor is trying to determine the price of a forward contract of 9-months maturity on stocks
with the current market price or Rs. 70 assuming risk free rate as 6% per annum also assumes an equal
dividend of Rs. 10 is expected after 6 months and 9 months

Ans.

Q.33 Victoria's stock price is currently $20 in the next six month it will either fall to $10 or rise to $30
what is the current value of option with an exercise price of $12 the 6 months risk free interest rate is 5%
periodic

Ans. 0.86

Q.34 Option premiums consist of

Ans. Intrinsic value, time value, and volatility

Q35. whenever the price of the underlying asset such that exercising the option will provide gain the
option is said to be

Ans.

Q36. in order to gain profit from an identified arbitrage apart unity the future price of the commodity
should be the spot price

Ans. Less than or more than

Q.37 the type of option which cannot be exercised before the expiry date is classified as

Ans. European option

Q38. The second step in binomial approach of option pricing is to define range of values

Ans. At expiration

Q.39 Take offsetting positions in two or more instruments to lock in a profit

Ans. Arbitrageurs

Q.40 The premium for British put found with an exercise prize of $1.70 is $05 what is the break-even spot
rate for the buyer of the put

Ans. $1.65

Q.41 For a futures contract entered into a January 15 the maintenance margin is Rs.1500 and the initial
margin is Rs. 4000. The balance in the margin account fall to Rs. 1000 the contract holder must

Ans. Add Rs. 3000 to the account

Q.42 Option trading is regulated by the

Ans. Securities and Exchange commission

Q.43 A combination of two calls and one put is

Ans. Straddle

Q.44 At the time to majority increases fall and put option become

A. Call option is not valuable

B. Put option is not valuable

C. Both call and put this option tended to become valuable

D. neither of the two type option is valuable

Q.45 None of the below is incorrect accept

A. minimum levels for initial and maintenance margin are set by the mutual consent of parties

B. maintenance margin is usually 75% of the initial

C. margin requirement on short futures positions are same as long one future position

D. To satisfy initial margin requirements investors can deposit securities with broker

Q.46 Which off the following is true

A. Forward contracts generally require delivery of assets in exchange for U.S. dollar

B. forward contract is an agreement to buy or sell a specified asset at a certain time in the future for a
market

C. Currency forward contracts are the contract for buying and selling a foreign currency on a future date
for an exchange rate that is fixed today

D. potential forward contract are the contract for buying and selling a Indian currency

Q.47 Spot rate of Canadian dollar is $0.08. A 90 day forward the rate of Canadian dollar is $0.079
Canadian interest rate is 4%- and 90-day US interest rate it's 2.5% if the initial investment is $1,000,000
what would be the percentage return to us investor

Ans.

Q.48 A ----- is a combination of a bullish call spread with exercise price and put spread using puts with
same exercise price

Ans.

Q.49 in the binomial approach of option pricing model the value of stock is subtracted from call option
obligation value to calculator.

Ans.

Q.50 The binomial options pricing model is based on the principle of no-arbitrage pricing which is also
known

Ans.

Q.51 The increase in value of option leads to low present value of exercise cost only if

Ans. Interest rates are high

Q.52 as per black Scholes option pricing model while determining effect of changes in variables on call
and put values if the underlying price increases, then call value and put value.

Ans.

Q.53 A call option has an exercise price of $48 and a premium of $2 per share what is the break-even
price of the underlying stock on the expiration date

Ans.

Q.54 A basis with respect to hedging using future contracts is defined as

Ans.

Q.55 According to the Black Scholes model, the purchaser can borrow fraction of security at risk free
interest rate. Which is?

Ans. Short term

Q.56 Interest rate swaps involves counter parties. Who wants to?

Ans.

Q.57 An order that should be executive immediately at the best possible price.

Ans. Market order

Q.58 If there are more traders with ------ Offers than ------ Offers for a particular contact. The futures price
will ----- until this imbalance is

Ans.

Q.59 Is an agreement to buy or sell an asset

Ans. Forward contract

Q.60 The option that gives investors the right to sell a stock at a predefined. Prize is classified as.

Ans. Put Option

Q.61 In short selling

A. a person takes long position in spot market and short position in forward contract

B. a person takes short position in spot market and long position in forward contract

C. short selling cannot be done in forward contracts

D. None of these

Q.62 The type of contracts in which the contract holder has the right to sell an asset at specific period for
predetermine price is classified as.

Ans. Option

Q.63 Axis Bank shares are selling in January 1 at INR 2500. Put options are available on Axis Bank shares
with expiry on January 29. And exercise price of INR 2600. These options are priced at INR 160. The
contract size is 132. These are American options and these options are not expected to pay any dividends
during January. What will be gain or lose is for the put buyer if Axis Bank shares prices INR 2400.

Ans.
Q.64 Relative to the underlying stock a call option always has.

Ans. A higher beta and a higher standard deviation of return

Q.65 The above situation deals with

Ans. A. (Swaps) B. (Hedging through future) c. (Hedging through options) D. (Hedging through forward)

Q.66 How many future contracts will you have to take?

Ans. A. (4.2) B. (4.5) C. (5.2) D. (5.5)

Q.67 If the price in the spot market drops by 10% what will be the amount of gain or loss?

Ans. A. (Loss Rs. 9,000) B. (Gain Rs. 9,000) C. (Loss Rs. 18,000) D. (Gain Rs. 18,000)

Q.68 If the price increases by 5%, what will be the amount of gain or loss?

Ans. A. (Loss Rs. 9,000) B. (Gain Rs. 9,000) C. (Loss Rs. 18,000) D. (Gain Rs. 18,000)
 Financial risk management
Q.1 In put call parity relationship present value of exercise price is add it to call option which is
equal Stew In football parity relationship present value of exercise price is add it to call option
which is equal to
Ans. Put option in stock
Q.2 To liquidate a futures position by entering an equivalent but opposite transaction which
eliminates the delivery organisation is called as
Ans. Offsetting
Q.3 Interest rate swaps involves counterparties who wants to
Ans. Exchange a floating rate commitment
Q.4 Currently selling for $50 the stock price could go up by 10% or fall by 5% each month. The
monthly interest rate is one periodic rate. calculate the price of European call option on the
stock with an exercise price of dollar 48 and a majority of two months
Ans. None of these
Q.5 If the volatility variance of underlying stock increases than the assume everything else
remaining the same Ans. value of both the put option and the call option.
Ans. value of both the put option and the call option increases
Q.6 the current value of stock included in portfolio is subtracted from the present value of
portfolio to calculate.
Ans. Current option price
Q.7 The value of the option which is considered as its worth as soon as it is expired is
Ans. exercise value
Q.8 Under option the buyer/ holder gets the right to sell the underlying asset.
Ans. Put
Q.9 The variability of stock price option term to majority and the risk-free rate are dependents
Ans. Prise of an option
Q.10 Person a entered long in futures contract for corn on December 21. Locked price for the
contract is RS. 20 On December 22 the futures price at the close of the trading day is Rs.22 and
on December 23 it is 24 and on December 24 it is Rs. 22 Calculate the profit or loss from the
contract.
Ans. Profit of Rs. 2
Q.11 the premium for a British put pound with an exercise price of dollar $1.70 is dollar $05
what is the breakeven spot of rate for the buyer of the put
Ans. $1.65
Q.12 Person a has a call option of 10 share of IBM. The time to majority for his contract is 10
months. Person b also has call option for the same number of IBM shares with the maturity of 6
months.
Ans. Person A will pay more premium than person B
Q.13 The value of n(d) in the black-Scholes-models can take any value between
Ans. 0 and + 1
Q.14 If you grow sugarcane in your farms how will you hedge you risk.
Ans. By taking contracts to sell at a pre-agreed forward price.
Q.15 which of the following statements regarding short selling is not true.
Ans. It is an arbitrage strategy
Q.16 A stock is currently selling for $100 one year from today the stock price could go up by
30% or go down by 20%. The risk-free interest rate is 10%. Calculate the price of a one-year
European call option on the stock with an exercise price of $100
Ans. 16.36
Q.17 Which of the following is not true
A. The simplest type of order for an individual to place is a market order
B. a limited order specifies a particular price
C. a stop order or a stop loss order specifies a particular price
D. is problem it order is a combination of a limit order and stop order
Q.18 if that would like delete the variance of the underlying stock increases then the assume
everything else remaining the same.
Ans.
Q.19 the current value of stock include in portfolio is subtracted from the present value of
portfolio to calculate
Ans. Current option price
Q.20 calculation of the value of dividend paying securities the income is subtracted because
Ans.
Q.21 The higher maturity the higher will be premium both call and put options because
Ans. The option holder has more time to exercise the option
Q.22 A currency swap broker is a swap Bank who
Ans. Is strictly an agent to take orders from her client
Q.23 ------- try to lock in a profit by involving two or more markets.
Ans. Arbitrageurs
Q.24 The options are said to be either deep in the money or deep out of the money
Ans. If the difference between the share price and exercise price is very large
Q.25 A one year long forward contract on a non-dividend paying stock with current price of Rs.
40 was entered today. The delivery price was set to be Rs. 25 the risk-free rate is 8% per annum
in the economy. The value of forward contract computed will be.
Ans. 44.2
Q.26 The situation in financial position in which the strike price is less than the current price of
a stock is classified as
Ans. In the money
Q27. When one stream of future interest payments are exchanged for another based on the
same principal amount.
Ans. Interest rate swap
Q28. The basic aim of the hedger is to.
Ans. Minimize risk
Q29. Currency swap bank is usually
Ans. A financially intermediary
Q.33 A measure of the rate of change in the value of the option portfolio change in the interest
rate is
Ans. Modified duration
Q.31 An investor is trying to determine the price of a forward contract of 9-months maturity on
stocks with the current market price or Rs. 70 assuming risk free rate as 6% per annum also
assumes an equal dividend of Rs. 10 is expected after 6 months and 9 months
Ans. None of these
Q.32 Victoria's stock price is currently $20 in the next six month it will either fall to $10 or rise
to $30 what is the current value of option with an exercise price of $12 the 6 months risk free
interest rate is 5% periodic
Ans. 0.86
Q.33 Option premiums consist of
Ans. Intrinsic value, time value, and volatility
Q.34 whenever the price of the underlying asset such that exercising the option will provide
gain the option is said to be
Ans. In the money
Q.35 in order to gain profit from an identified arbitrage apart unity the future price of the
commodity should be the spot price
Ans. Less than or more than
Q.36 the type of option which cannot be exercised before the expiry date is classified as
Ans. European option
Q.37 The second step in binomial approach of option pricing is to define range of values
Ans. At expiration
Q.38 Take offsetting positions in two or more instruments to lock in a profit
Ans. Arbitrageurs
Q.39 The premium for British put found with an exercise prize of $1.70 is $05 what is the break-
even spot rate for the buyer of the put
Ans. $1.65
Q.40 For a futures contract entered into a January 15 the maintenance margin is Rs.1500 and
the initial margin is Rs. 4000. The balance in the margin account fall to Rs. 1000 the contract
holder must
Ans. Add Rs. 3000 to the account
Q.41 Option trading is regulated by the
Ans. Securities and Exchange commission
Q.42 A combination of two calls and one put is
Ans. Straddle

Q.43 At the time to majority increases fall and put option become
A. Call option is not valuable
B. Put option is not valuable
C. Both call and put this option tended to become valuable
D. neither of the two type option is valuable

Q.44 None of the below is incorrect accept

A. minimum levels for initial and maintenance margin are set by the mutual consent of parties
B. maintenance margin is usually 75% of the initial
C. margin requirement on short futures positions are same as long one future position
D. To satisfy initial margin requirements investors can deposit securities with broker

Q.45 Which off the following is true

A. Forward contracts generally require delivery of assets in exchange for U.S. dollar
B. forward contract is an agreement to buy or sell a specified asset at a certain time in the future
for a market
C. Currency forward contracts are the contract for buying and selling a foreign currency on a
future date for an exchange rate that is fixed today
D. potential forward contract are the contract for buying and selling a Indian currency

Q.46 Spot rate of Canadian dollar is $0.08. A 90 day forward the rate of Canadian dollar is
$0.079 Canadian interest rate is 4%- and 90-day US interest rate it's 2.5% if the initial
investment is $1,000,000 what would be the percentage return to us investor
Ans. 0.027
Q.47 A ----- is a combination of a bullish call spread with exercise price and put spread using
puts with same exercise price
Ans. D iron Condor spread
Q.48 in the binomial approach of option pricing model the value of stock is subtracted from call
option obligation value to calculator.
Ans.
Q.49 The binomial options pricing model is based on the principle of no-arbitrage pricing which
is also known
Ans.
Q.50 The increase in value of option leads to low present value of exercise cost only if
Ans. Interest rates are high
Q.51 as per black Scholes option pricing model while determining effect of changes in variables
on call and put values if the underlying price increases, then call value and put value.
Ans. Increase decrease
Q.52 A call option has an exercise price of $48 and a premium of $2 per share what is the break-
even price of the underlying stock on the expiration date
Ans. 46
Q.53 A basis with respect to hedging using future contracts is defined as
Ans.
Q.54 According to the Black Scholes model, the purchaser can borrow fraction of security at risk
free interest rate. Which is?
Ans. Short term
Q.55 Interest rate swaps involves counter parties. Who wants to?
Ans. exchange a floating rate commitment for a fixed rate loan
Q.56 An order that should be executive immediately at the best possible price.
Ans. Market order
Q.57 If there are more traders with ------ Offers than ------ Offers for a particular contact. The
futures price will ----- until this imbalance is
Ans. Buy sell rise
Q.58 Is an agreement to buy or sell an asset
Ans. Forward contract
Q.59 The option that gives investors the right to sell a stock at a predefined. Prize is classified
Ans. Put Option
Q.60 In short selling
Ans. a person takes short position in spot market and long position in forward contract
Q.61 The type of contracts in which the contract holder has the right to sell an asset at specific
period for predetermine price is classified as.
Ans. Option
Q.62 Axis Bank shares are selling in January 1 at INR 2500. Put options are available on Axis
Bank shares with expiry on January 29. And exercise price of INR 2600. These options are
priced at INR 160. The contract size is 132. These are American options and these options are
not expected to pay any dividends during January. What will be gain or lose is for the put buyer
if Axis Bank shares prices INR 2400.
Ans. 2240
Q.63 Relative to the underlying stock a call option always has.
Ans. A higher beta and a higher standard deviation of return
Q.64 The above situation deals with
Ans. A. (Swaps) B. (Hedging through future) c. (Hedging through options) D. (Hedging through
forward)
Q.65 How many future contracts will you have to take?
Ans. A. (4.2) B. (4.5) C. (5.2) D. (5.5)
Q.66 If the price in the spot market drops by 10% what will be the amount of gain or loss?
Ans. A. (Loss Rs. 9,000) B. (Gain Rs. 9,000) C. (Loss Rs. 18,000) D. (Gain Rs. 18,000)
Q.67 If the price increases by 5%, what will be the amount of gain or loss?
Ans. A. (Loss Rs. 9,000) B. (Gain Rs. 9,000) C. (Loss Rs. 18,000) D. (Gain Rs. 18,000)
Q.68 the major types of risk in derivatives trading are
Ans. All of above
Q.69 A _____is the minimum level by which an investor equity position may follow as a result of
an favourable price movement report the investor is required to deposit
Ans. Maintenance margin
Q.70 An investor expects a stock to increase in value from its current price of $23 per share. The
investor purchases a call option on the stock that has an exercise price of $27 per share. The
option premium is $3 per share. On the expiration date, the stock
Ans. Profit of $2
Q.71 in calculation of the value of dividend paying securities the income is subtracted because
Ans all of the above
Q.72 If an investor provide fund of 500000 at a normal rate of 7% for one year in the inflation
during the year is 5% the increase in the purchasing power of an investor can be
Ans 567750
Q.73 A currency swap bank is usually
Ans a financial Intermediary
Q.74 Black Scholes model using the following variable value non-dividend-paying call option
except
Ans. quality of call option

Q.75 Ann's stock price is currently $25.In the next six months it will either fall to $15 or riseto
$40.What is the current value of a six-month call option with an exercise price of $20?
Ans 8.57
Q.76 In binomial approach of option pricing model, value of stock is subtracted from call option
obligation value to calculate
Ans current value of portfolio
Q.77 A palm oil trader want to enter into a forward contract on May 1 for delivery on june 1 the
spot price of palm oil is USD 120 per liter and the trader want to buy 5000 litre of oil if the cost
of carry is 5% pm of the spot price what will be the forward price
Ans 126.
Q.78 If strike price increase, then the everything else is the same
Ans value of the put option increase and that the call option decrease
Q.79 risk management is
Ans setting position continuous basis
Q.80 At last day when European and American option can be exercised is classified as
Ans expiration date
Q.81 Carol's stock price is currently $20. In the next six months it will either fall to $10
or rise to $40. What is the current value of a six-month call option with an exercise price
of $12? The six-month risk-free interest rate (periodic rate) is 5%
Ans $9.78
Q.82 the binomial options pricing model based on the principle of no arbitrage pricing which is
also known
Ans Law of one price
Q.83 are transactions for which there are, at present, no contracts or agreements between
parties
Ans Anticipated exposure
Q.84 As the time to maturity increase call and put options become
Ans Both call and put option tend to become valuable
Q.85 the risk of price change in input and output that have an impact on a business cash flow is
Ans price risk
Q.86 Which movement of price of the rise or fall of prices of ocean is classified as
Ans pricing movement
Q.87 n cross hedging when the future contract is highly correlated with the portfolio being
hedged the value of the future contract changes by
Ans a higher or lower percentage than the portfolio's market value
Q.88 a short forward contract is profitable until
Ans. ST>E
Q.89 Which of the following is not true
Ans currency forward contracts are the contract for buying and selling foreign currency on
Q.90 Difference between the futures market and the forward market include
Ans All of the above
Q.91 In binomial approach of option pricing model, fourth step is to create
Ans riskless investment
Q.92 Which of the following statements regarding American puts is/are true?
Ans all of the above
Q.93 Carol’s stock price is currently $20 in the next six months it will either fall to $10
or rise to $40. What is the current value of a six months call option with an exercise
price of $12? The six months risk free interest rate is 5%
Ans.9.78
Q.94 Ann’s stock price is currently $25 in the next six months it will be fall to $15 or rise
to $40. What is the current value of a six months call option with an exercise price of
$20? The six months risk free interest rate is 5%
Ans. 8.57
Q.95 If strike price is more than the spot price of the asset the call option is known as
Ans. Out of money option
Q.96 The major type of risk in derivatives trading are
Ans. All of these
Q.97 A ____________ is the minimum level by which an investor’s equity position may fall
as a result of unfavourable price movements before the investor is required to deposit
additional amount.
Ans.
Q.98 The basic aim of the hedger is to
Ans. Minimize risk
Q.99 An investor expects a stock to increase in Value from its current price of $23 per
share. The investor purchases a call option on the stock that has an exercise price of $27
per share. The option premium is $3 per share. On the expiration date the stock
Ans. Profit of $2
Q.100 The current value of stock included in portfolio is subtracted from present value
of portfolio to calculate
Ans. Current Option Price
Q.101 In calculation of the value of dividend paying securities the income is subtracted
because
Ans. All of the above
Q.102 If an investor provides fund of INR 500000 at a nominal rate of 7% inflation is 5%
Ans. 509524
Q.103 For a future contract entered into on Jan 15, the maintenance margin is Rs 1500
and the initial margin is Rs 4000. The balance in the margin account fall to Rs 1000. The
contract holder must.
Ans.
Q.104 A currency swap bank is usually
Ans. A currency speculators
Q.105 Black Scholes model uses the following variables to value non-dividend paying
call option except
Ans. Current stock price
Q.106 In binomial approach of option pricing model, the value of stock is subtracted
from call option obligation value to calculate.
Ans. Current value of portfolio
Q.107 A palm oil trader wants to enter into a forward contract on May 1 for delivery on
Jun 1 the cost of carry is 5% pm of the spot price what will be the forward price
Ans. INR 126
Q.108 Which of the following statements regarding short selling is not true?
Ans. it is an arbitrage strategy
Q.109 Options trading is regulated by the ________
Ans. Securities and exchange commission
Q.110 If the strike price increases then the (assume everything else remaining the
same)
Ans. value of the put option increases and that of the call option decreases.
Q.111 The situation in call options in which the strike price is greater than current price
of stock is classified as
Ans.
Q.112 Interest rate forward is also called
Ans. Forward rate agreement
Q.113 The last day at which the European and American can be exercise is classified as
Ans. Expiration Date
Q.114 Are transactions for which there are at present no contracts or agreements
between parties.
Ans. Anticipated exposure
Q.115 A measure of sensitivity of a bond price to changes in yield is
Ans. Modified duration
Q.116 As the time to maturity increases call and put option become
Ans. Both call and put option tend to become valuable
Q.117 The risk of price changes in input and outputs that have an impact on a business
cash flows
Ans. Price risk
Q.118 The movement of price or rise or the fall of prices of option classified as
Ans. Binomial Lattice
Q.119 In cross-hedging, when the futures contract is highly correlated with the portfolio
being hedged, the value of future contract changes by
Ans. Either the hedge percentage …. same percentage………. Market value
Q.120 The higher the maturity the higher will be the premium the higher will be the
premium of both call and put option because?
Ans. the extra time decreases that probability of profit for option holder and loss for
option writer
Q.121 A short forward contract is profitable until
Ans. ST
Q.122 Differences between the futures market and the forward market includes
Ans.
Q.123 In binomial approach of option pricing model, the fourth step is to create
Ans. Riskless investment
Q.124 in put call parity relationship, the put option minus call option plus stock is equal
Ans. Exercise price Future value
Q.125 Today is 30th of Nov and you have entered a long futures contract to buy 300
ounces of silver that settles on 30th of Feb the futures price is Rs 800 per ounce on 1st
Dec the current market price is Rs 827 per ounce. You are having
Ans.
Q.126 Stock volatility refers to
Ans. Uncertainty in future stock price
Q.127______risk refers to fluctuations in the value of the instrument as a result of market
conditions.
Ans. Market
Q.128 Margin level is determined by
Ans.
Q.129 A stock is currently selling for $50. The stock price could go up by 10% or fall by
5% each month. The monthly interest rate is 1% (periodic rate). Calculate the price of a
European call option on the stock with an exercise price of $48 and a maturity of two
months
Ans. 3.96
Q.130 A stock is currently selling for $50. The stock price could go up by 10% or fall by
5% each month. The monthly interest rate is 1% (periodic rate). Calculate the price of a
European call option on the stock with an exercise price of $48 and a maturity of one
month
Ans. 2.77
Q.131 Difference between the future market and the forward market includes
Ans
Q.132 When the future price is above the expected spot price the situation is referred to
as
Ans. Speculative profits
Q.133 The Black-Scholes OPM is dependent on which five parameters?
Ans. Stock price, exercise price, risk free rate, variance and time to maturity
Q.134 A stock is currently selling for $50. The stock price could go up by 10% or fall by
5% each month. The monthly interest rate is 1% (periodic rate). Calculate the price of
an put option on the stock with an exercise price of $55 and a maturity of two months
Ans. $5.1
Q.135 Options are traded in __________
Ans. Exchanges as well as OTC market
Q.136 The excess of actual price of option over the exercise value of option is classified
Ans. Time value of option
Q.137 Which of the following statements regarding American puts is/are true?
Ans. All of the above
 Financial risk management
Q.1 In put call parity relationship present value of exercise price is add it to call option which is equal
Stew In football parity relationship present value of exercise price is add it to call option which is equal to

Ans. Put option in stock

Q.2 To liquidate a futures position by entering an equivalent but opposite transaction which eliminates
the delivery organisation is called as

Ans. Offsetting

Q.3 Interest rate swaps involves counterparties who wants to

Ans. Exchange a floating rate commitment

Q.4 Currently selling for $50 the stock price could go up by 10% or fall by 5% each month. The monthly
interest rate is one periodic rate. calculate the price of European call option on the stock with an exercise
price of dollar 48 and a majority of two months

Ans. None of these

Q.5 If the volatility variance of underlying stock increases than the assume everything else remaining the
same Ans. value of both the put option and the call option.

Q.6 the current value of stock included in portfolio is subtracted from the present value of portfolio to
calculate.

Ans. Current option price

Q.7 The value of the option which is considered as its worth as soon as it is expired is

Ans. exercise value

Q.8 Under option the buyer/ holder gets the right to sell the underlying asset.

Ans. Put

Q.9 The variability of stock price option term to majority and the risk-free rate are dependents

Ans. Prise of an option

Q.10 Person a entered long in futures contract for corn on December 21. Locked price for the contract is
RS. 20 On December 22 the futures price at the close of the trading day is Rs.22 and on December 23 it is
24 and on December 24 it is Rs. 22 Calculate the profit or loss from the contract.

Ans. Profit of Rs. 2

Q.11 the premium for a British put pound with an exercise price of dollar $1.70 is dollar $05 what is the
breakeven spot of rate for the buyer of the put

Ans. $1.65

Q.12 Person a has a call option of 10 share of IBM. The time to majority for his contract is 10 months.
Person b also has call option for the same number of IBM shares with the maturity of 6 months.

Ans. Person A will pay more premium than person B

Q.13 The value of n(d) in the black-Scholes-models can take any value between

Ans. 0 and + 1
Q.14 If you grow sugarcane in your farms how will you hedge you risk.

Ans.

Q.15 which of the following statements regarding short selling is not true.

Ans. It is an arbitrage strategy

Q.17 A stock is currently selling for $100 one year from today the stock price could go up by 30% or go
down by 20%. The risk-free interest rate is 10%. Calculate the price of a one-year European call option on
the stock with an exercise price of $100

Ans.

Q.18 Which of the following is not true

A. The simplest type of order for an individual to place is a market order

B. a limited order specifies a particular price

C. a stop order or a stop loss order specifies a particular price

D. is problem it order is a combination of a limit order and stop order

Q.19 if that would like delete the variance of the underlying stock increases then the assume everything
else remaining the same.

Ans.

Q.20 the current value of stock include in portfolio is subtracted from the present value of portfolio to
calculate

Ans. Current option price

Q.21 calculation of the value of dividend paying securities the income is subtracted because

Ans.

Q.22 The higher majority the higher will be premium both call and put options because

Ans.

Q.23 A currency swap broker is a swap Bank who

Ans.

Q.24 ------- try to lock in a profit by involving two or more markets.

Ans. Arbitrageurs

Q.25 The options are said to be either deep in the money or deep out of the money

Ans.

Q.26 A one year long forward contract on a non-dividend paying stock with current price of Rs. 40 was
entered today. The delivery price was set to be Rs. 25 the risk-free rate is 8% per annum in the economy.
The value of forward contract computed will be.

Ans.

Q.27 The situation in financial position in which the strike price is less than the current price of a stock is
classified as

Ans. In the money

Q28. When one stream of future interest payments are exchanged for another based on the same
principal amount.

Ans. Interest rate swap

Q29. The basic aim of the hedger is to.

Ans. Minimize risk

Q30. Currency swap bank is usually

Ans. A financially intermediary

Q.31 A measure of the rate of change in the value of the option portfolio change in the interest rate is

Ans. Rho

Q.32 An investor is trying to determine the price of a forward contract of 9-months maturity on stocks
with the current market price or Rs. 70 assuming risk free rate as 6% per annum also assumes an equal
dividend of Rs. 10 is expected after 6 months and 9 months

Ans.

Q.33 Victoria's stock price is currently $20 in the next six month it will either fall to $10 or rise to $30
what is the current value of option with an exercise price of $12 the 6 months risk free interest rate is 5%
periodic

Ans. 0.86

Q.34 Option premiums consist of

Ans. Intrinsic value, time value, and volatility

Q35. whenever the price of the underlying asset such that exercising the option will provide gain the
option is said to be

Ans.

Q36. in order to gain profit from an identified arbitrage apart unity the future price of the commodity
should be the spot price

Ans. Less than or more than

Q.37 the type of option which cannot be exercised before the expiry date is classified as

Ans. European option

Q38. The second step in binomial approach of option pricing is to define range of values

Ans. At expiration

Q.39 Take offsetting positions in two or more instruments to lock in a profit

Ans. Arbitrageurs

Q.40 The premium for British put found with an exercise prize of $1.70 is $05 what is the break-even spot
rate for the buyer of the put

Ans. $1.65

Q.41 For a futures contract entered into a January 15 the maintenance margin is Rs.1500 and the initial
margin is Rs. 4000. The balance in the margin account fall to Rs. 1000 the contract holder must

Ans. Add Rs. 3000 to the account

Q.42 Option trading is regulated by the

Ans. Securities and Exchange commission

Q.43 A combination of two calls and one put is

Ans. Straddle

Q.44 At the time to majority increases fall and put option become

A. Call option is not valuable

B. Put option is not valuable

C. Both call and put this option tended to become valuable

D. neither of the two type option is valuable

Q.45 None of the below is incorrect accept

A. minimum levels for initial and maintenance margin are set by the mutual consent of parties

B. maintenance margin is usually 75% of the initial

C. margin requirement on short futures positions are same as long one future position

D. To satisfy initial margin requirements investors can deposit securities with broker

Q.46 Which off the following is true

A. Forward contracts generally require delivery of assets in exchange for U.S. dollar

B. forward contract is an agreement to buy or sell a specified asset at a certain time in the future for a
market

C. Currency forward contracts are the contract for buying and selling a foreign currency on a future date
for an exchange rate that is fixed today

D. potential forward contract are the contract for buying and selling a Indian currency

Q.47 Spot rate of Canadian dollar is $0.08. A 90 day forward the rate of Canadian dollar is $0.079
Canadian interest rate is 4%- and 90-day US interest rate it's 2.5% if the initial investment is $1,000,000
what would be the percentage return to us investor

Ans.

Q.48 A ----- is a combination of a bullish call spread with exercise price and put spread using puts with
same exercise price

Ans.

Q.49 in the binomial approach of option pricing model the value of stock is subtracted from call option
obligation value to calculator.

Ans.

Q.50 The binomial options pricing model is based on the principle of no-arbitrage pricing which is also
known

Ans.

Q.51 The increase in value of option leads to low present value of exercise cost only if

Ans. Interest rates are high

Q.52 as per black Scholes option pricing model while determining effect of changes in variables on call
and put values if the underlying price increases, then call value and put value.

Ans.

Q.53 A call option has an exercise price of $48 and a premium of $2 per share what is the break-even
price of the underlying stock on the expiration date

Ans.

Q.54 A basis with respect to hedging using future contracts is defined as

Ans.

Q.55 According to the Black Scholes model, the purchaser can borrow fraction of security at risk free
interest rate. Which is?

Ans. Short term

Q.56 Interest rate swaps involves counter parties. Who wants to?

Ans.

Q.57 An order that should be executive immediately at the best possible price.

Ans. Market order

Q.58 If there are more traders with ------ Offers than ------ Offers for a particular contact. The futures price
will ----- until this imbalance is

Ans.

Q.59 Is an agreement to buy or sell an asset

Ans. Forward contract

Q.60 The option that gives investors the right to sell a stock at a predefined. Prize is classified as.

Ans. Put Option

Q.61 In short selling

A. a person takes long position in spot market and short position in forward contract

B. a person takes short position in spot market and long position in forward contract

C. short selling cannot be done in forward contracts

D. None of these

Q.62 The type of contracts in which the contract holder has the right to sell an asset at specific period for
predetermine price is classified as.

Ans. Option

Q.63 Axis Bank shares are selling in January 1 at INR 2500. Put options are available on Axis Bank shares
with expiry on January 29. And exercise price of INR 2600. These options are priced at INR 160. The
contract size is 132. These are American options and these options are not expected to pay any dividends
during January. What will be gain or lose is for the put buyer if Axis Bank shares prices INR 2400.

Ans.
Q.64 Relative to the underlying stock a call option always has.

Ans. A higher beta and a higher standard deviation of return

Q.65 The above situation deals with

Ans. A. (Swaps) B. (Hedging through future) c. (Hedging through options) D. (Hedging through forward)

Q.66 How many future contracts will you have to take?

Ans. A. (4.2) B. (4.5) C. (5.2) D. (5.5)

Q.67 If the price in the spot market drops by 10% what will be the amount of gain or loss?

Ans. A. (Loss Rs. 9,000) B. (Gain Rs. 9,000) C. (Loss Rs. 18,000) D. (Gain Rs. 18,000)

Q.68 If the price increases by 5%, what will be the amount of gain or loss?

Ans. A. (Loss Rs. 9,000) B. (Gain Rs. 9,000) C. (Loss Rs. 18,000) D. (Gain Rs. 18,000)
 FIN601-FRM

1. The value of the option which is considered as its worth as soon as it is expired is classified as?
a. Minimum option value
b. Minimum value
c. Maximum value
d. Exercise value

2. Calculation of the value of dividend paying on securities, the income is subtracted because?
a. We own the asset
b. We own the current income
c. We will receive it at the maturity
d. All of these

3. Victoria’s stock price is currently $50. In the next sixth months it will either fall to $10 or rise to $30.
What is the current value of put option with an exercise price of $12. The six-month risk-free interest
rate is 5% (periodic rate).
a. 9.78
b. 2
c. 0.86
d. 9.43

4. A stock is currently selling for $50. The stock price could go up by 10% or fall by 5% each month. The
monthly interest rate 1% (periodic rate). Calculate the price of a European call option on the stock with
an exercise price of $48 and a maturity of 2 months
a. 3.96
b. 2.77
c. 1.98
d. None of these

5. ______ is the minimum level by which an investor’s equity position may fall as result of unfavourable
price movements before the investor is required to deposit additional amount.
a. Initial amount
b. Variation amount
c. Maintenance margin
d. Deposit amount
6. The binomial options pricing model is based on the principle of no-arbitrage pricing, which is also
known as
a. Law of same price
b. Law of high price
c. Law of different price
d. Law of one price
7. A call option has an exercise of $48 and a premium of $2 per share. What is the break even price of
the underlying stock on the expiration date?

a. 50
b. 48
c. 46
d. None of these

8. For a futures contract entered into January 15, the maintenance margin is Rs 1500 and the initial
margin is Rs 4000. The balance in the margin amount fall to Rs 1000. The contract holder must
a. Add Rs 3000 to the account
b. Add Rs 500 to the account
c. No action required
d. The balance is adjusted on the end period only

9. An order that should be executed immediately at the best possible price is

a. Market order
b. Limit order
c. Stop-loss order
d. Immediate order

10. Risk management is

a. Determining positions to settle
b. Setting position limits on the basis of……..
c. Funds settlement is allowed at present
d. Each clearing members is required to … amount of money

11. ________ risk refers to fluctuations in the value of the instrument as a result of market conditions
a. Market
b. Liquidity
c. Credit
d. Basic

12. An investor is trying to determine the price of a forward contract of 9 month maturity on a stock
with current market price of Rs 70. Assume risk free rate as 6% per annum. Also assume an equal
dividend of Rs 10 is expected after 6 months and 9 months
a. Rs 73.22
b. Rs 56.76
c. Rs. 53.07
d. None of these

13. Which of the following best describes the term spot price
a. The price for immediate delivery
b. the price for delivery at a future time
c. the price of an assets that has been damaged
d. the price for renting an asset

14. The major type of risk in derivatives trading are

a. Credit
b. Liquidity
c. Settlement
d. All of these

15. Binomial approach of option pricing, the fourth step is to create

a. Equalize the domain of payoff
b. Equalize the ending price
c. Riskless investment
d. High risky investment

16. The higher the maturity, the higher will be the premium of both call and put option because
a. The option holder has more time in exercise the option
b. The option holder has less time to exercise the option
c. The extra time decreases the probability of profit for option holder and loss for option writer
d. None of these
17. A stock is currently selling for $100. One year from today the stock price could go up by 30% or go
down by 20%. The risk-free interest rate is 10% [apr]. calculate the price of a one-year European call
option on the stock with an exercise price of $100
a. 30
b. 16.36
c. 15.67
d. None of these

18. As per Black-Scholes option pricing model while determining effect of changes in variables on Call
and Put values, if the underlying price increase, than call value__ and put value___
a. Increase, decrease
b. Decrease, increase
c. Increase, increase
d. Decrease, decrease

19. ________ are transactions for which there are at present no contract or agreements between
parties
a. Backlog exposure
b. Quotation exposure
c. Anticipated exposure
d. None of these

20. When there is increase in future price broker of parties with________ positions pay money to
exchange
a. Long position
b. Short position
c. Long as well as short position
d. None of these

21. A palm oil trader wants to enter into a forward contract on May 1, for delivery on june 1, The spot
price of palm oil is INR 120 per litre, and the trader wants to buy 5000 items of oil, if the cost of carry is
5% pm of the spot price. What will be the forward price?
a. INR 114
b. INR 120
c. INR 122
d. INR 126
22. Person a entered long in futures contract for corn on December 21. The locked price for the contract
is Rs. 20. On December 22 the futures price at the close of the trading is Rs. 22 and on December 23 it is
Rs. 24 and on December 24 it is Rs. 22. Calculate the profit or loss from the contract?
a. Profit of Rs. 2
b. Loss of Rs. 2
c. Profit of Rs. 4
d. Loss of Rs. 4
23. Which of the following is true?
a. Forward Contract generally require delivery…..
b. Forward contract is an agreement to buy or sell a specified asset at a certain time in the future for a
market price
c. Currency forward contracts are the contracts for buying or selling a foreign currency on a future
date for an exchange rate that is fixed today.
d. Currency forward contracts are the contracts for buying or selling a Indian currency on a future date for an
exchange rate that is fixed today.

24. You purchase a call option on British pounds for a premium of $0.04 per unit with an exercise price of
%1.65. The option will not be exercised until the expiration date, if at all. If the spot rate on the expiration
date is $1.67, your net profit or net loss will be
a. Profit $0.04
b. Profit of $0.02
c. Loss of -$0.02
d. Loss of -$0.04

25. Whenever the price of the underlying asset is such that exercising the option will provide a gain, the
option is said to be
 At-the-money
 In-the-money
 Out-of-the-money
 Either At-the-money or in-the money

26. When the future price is above the expected spot price, the situation is referred to as
 Normal Backwardness
 Cantago
 Speculative profits
 Settlement price

27. When the future price is below the expected spot price, the situation is referred to as

Normal backwardness
28. Which of the following is correct?

a. Minimum levels for initial & maintenance margins are set by mutual consent of parties
b. Maintenance margin is usually 75% of the initial
c. Margin requirement on short futures positions are same as on long future positions
d. To satisfy initial margin requirement investor can deposit securities with broker.

29. In order to gain profit an identified arbitrage opportunity, the future price of the commodity would
be______ the spot price
a. Less than
b. More than
c. Equal to
d. Less than or more than

30. The risk of price changes in input and outputs that have an impact on a business cash flow is
a. Operational or business risk
b. Event risk
c. Price risk
d. Credit risk

31. The volatility (variance) of the underlying stock increases then

Volatility of both the put option and call option increases

32. ________ take offsetting position in two or more instruments to lock in a profit
a. Hedgers
b. Arbitragers
c. Speculators
d. None of these

33. If an investors provides funds of INR 500000 at a normal rate of 7% for one year. If the inflation
during the year is 5%,the increase in the purchasing power of an investor can be
a. 461750
b. 490654
c. 509524
d. 561750
34. Option premiums consist of
a. Intrinsic value, time value and current value
b. Intrinsic value, time value and volatility
c. Current value, time value and volatility
d. Time value, intrinsic value and historical value

35. The basic aim of the hedger is to

 Maximize profits
 Eliminate risk
 Minimize risk
 None of These

36. If you grow sugarcane in your farms, how will you hedge your risk:
 By taking contracts to sell at spot price
 By taking contracts to buy at spot price
 By taking contract to sell at per agreed forward price
 By taking contract to buy at pre agreed forward price

37. The option that gives investors the right to sell a stock at predefined price is classified as

 Put option
 Call option
 Money back options
 Out of Money options

38. If there are more traders with____ offers than ___ offers for a particular contract, the futures price
will ____ until this imbalance is removed
a. Sell, Buy, rise
b. Buy , sell, fall
c. Buy, sell, rise
d. None of these
39. Spot rate of Canadian dollar is $0.80. A 90 day forward rate of Canadian dollar is $0.79. 90-day
Canadian interest rate is 4% and 90-day US interest rate is 2.5%. If the initial investment is $1000000
what would be the percentage return to a US investor

a. 0.025
b. 0.027
c. 0.023
d. 0.029

40. The current value of stock included in portfolio is subtracted from present value of portfolio to
calculate :
Current option price
41. A measure of the rate of change in the value of the option portfolio to change in the interest rate is
 Rho
 Vega
 Theta
 Gamma

42. The type of contract in which the contract holder has the right to sell an asset at specific period for
predetermine price is classified as

 Option
 Written Contract
 Determined Contract
 Featured Contracts

43. A one year long forward contract on a non-dividend paying stock with current price of Rs. 40 was
entered today. The delivery price was set to be Rs. 25. The risk free rate is 8% per annum in the
economy. The value of forward contract computed will be
a. Rs 17.37
b. Rs. 44.2
c. Rs. 20.65
d. Rs. 30.13

44. A short forward contract is profitable until

a. St<e
b. St>e
c. St=e
d. None of these

45. None of the below is incorrect except

a. Minimum levels for initial & maintenance margins are set by the mutual consent of parties
b. Maintenance margin is usually 75% of the initial
c. Margin requirement on short futures positions are same as on long futures position
d. To satisfy initial margin requirements investor can deposit securities with broker

46. Black-Schole model uses the following variables to value non-dividend paying call option except
a. Current stock price
b. Exercise price of a call
c. Quality of call option
d. The variability of the underlying asset price
47. Which of the following is not true [ to be answered]
a. The simplest type for order for an individual to place is a market order
b. A limited type of order specifies a particular price
c. A stop order or a stop-loss order specifies a particular price
d. A stop-limit order is a combination of a limit order and a stop order

48. The options are said to be either deep in money or deep out money
a. If the difference between the share price and exercise price is very large
b. If the difference between the share price and exercise price is very low
c. If the stock price is close to exercise price
d. If the stock price is above the exercise price

49. An investor expects a stock to increase in value from its current price of $23 per share. The investor
purchases a call option on the stock that has an exercise price of $27 per share. The option premium is
$3 per share. On the expiration date, the stock [Part which is not given--- trades for $29. If the investor
exercises the option and immediately sells the purchased shares, his net gain per share is]--
http://www.swlearning.com/finance/madura/fmi6e/quiz14/quiz14.html

a. Loss of $1
b. Profit of $1
c. Loss of $3
d. Profit of $2

50. A stock is currently selling for $50. One month from today the stock price could go up by 10% or fall
by 50%. If the monthly interest rate is 1% (periodic rate). Calculate the price of a European call option on
the stock with an exercise price of $48 and a maturity of one month
a. 2.77
b. 2
c. 1.98
d. None of the above
51. A stock is currently selling for $50. The stock price could go up by 10% or fall by 5% each month. The
monthly interest rate is 1% (periodic rate). Calculate the price of a European call option on the stock
with an exercise price of $48 and a maturity of 2 month
a. 3.96
b. 2.77
c. 1.98
d. None of these

52. In Binomial approach of option pricing model, the value of stock is subtracted from the call option
obligation value to calculate

a. Current value of portfolio

b. Future value of portfolio
c. Put option value
d. Call option value

53. If the volatility (variance) of the underlying stock increases then the (assume everything else
remaining the same)
a. Value of the put option increases and that of the call option decreases
b. Value of the put option decreases and that of the call option increases
c. Value of both the put option and the call option increases
d. Value of both the put option and the call option decreases

54. Call swaptions are attractive when interest rates are expected to__________
a. Fall
b. Rise
c. Stay the same
d. None of these

55. The increase in value of option leads to low present value of exercise cost only if
a. Low volatility
b. Interest rates are high
c. Interest rate are low
d. High volatility

56. According to exercise value and option price the market value of the option will be zero when
a. Stock price is maximum
b. Option price is zero
c. Stock price is zero
d. Stock price is minimum

57. Interest rate forward is also called

a. forward agreement
b. Rate agreement
c. Forward rate agreement
d. MIBOR

58. To liquidate a futures position by entering an equivalent, but opposite transaction which eliminates
the delivery obligation is called as
a. Open interest
b. Offsetting
c. Delivery
d. Maintenance margin

59. This type of contract in which the contract holder has the right to sell an asset at specific period for
predetermine price is classified as:
Option

60. The premium for a put pound with an exercise price of $1.70 is $0.05. What is the breakeven spot
rate for the buyer of the put?
a. $1.70
b. $1.65
c. $1.75
d. $1.60

61. When one stream of future interest payments are exchanged for another based on the same
principle amount
a. Interest rate swap
b. Currency swap
c. Commodity swap
d. Equity swap

62. Options trading is regulated by the _________

a. Options clearing corporation (OCC)
 b. Federal Reserve
c. Securities and Exchange Commission
d. U.S. Treasury

63. Today is 30th of November and you have entered a long future contract to buy 300 ounces of
silver that settles on 20th of February. The future price is Rs. 800 per ounces. On 1st December
the current market is Rs, 827 per ounce. You are having
a. A loss of Rs. 8100
b. A gain of Rs. 8100
c. After entering the contract, profit and losses do not occur
d. No profit, no loss

64. Axis Bank shares are selling in January 1 at INR 2500. Put options are available on Axis Bank
shares with expiry on January 29 and exercise price of INR 2600. These options are price at INR
160. The contract size is 132. These are American option and these options are not expected to
pay any dividend during January. What will be gain or loss for the put buyer if Axis Bank share
price is INR 2400 ?
a. 40
b. 5280
c. 7920
d. 2240

65. Ann’s stock price is currently $25. In the next six months it will either fall to $15 or rise to
$40. What is the current value of a six month call option with an exercise with an exercise price
of $20? The six month risk free interest rate is 5% (periodic rate)
a. 20
b. 8.57
c. 9.52
d. 131

66. A combination of two calls and one put is

a. Strip
b. Straddle
c. Strap
d. Strangle
67. Interest rate swap involve counterparties who want to _______
a. Exchange a floating rate commitment for a fixed rate loan
b. Exchange debt for stock
c. Exchange a short term loan for a long term loan
d. None of these

68. Margin level are determined by

a. Investor credibility
b. Time period to maturity
c. Negotiation power
d. Variation in prices of underlying asset

69. In put call parity relationship, the present value of exercise price is added to call option which is
equal to
a. Put option stock
b. Call option + stock
c. Call option + market price
d. Put option + market price

70. A ___ is a combination of a bullish call spread with exercise price and put spread using puts with the
same exercise price
a. Calendar spread
b. Butterfly spread
c. Box spread
d. Irin Condor Spread

71. Carol’s stock price is currently $20. In the next six months it will either fall to $10 or rise to $40.
What is the current value of a six month call option with an exercise price of $12? The six month risk
free interest rate (periodic rate) is 5%
a. 9.78
b. 10.28
c. 16.88
d. 13.33

72. In short-selling
a. A person takes long position in spot market and short position in forward market
b. A person takes short position in spot market and long position in forward market
c. Short selling cannot be done in forward contracts
d. None of these

73. Which of the following statements regarding short selling is not true
a. It is an arbitrage strategy
b. Assets involved are not owned
c. Is possible for all investment assets
d. None of these

74. A currency swap broker is a swap bank who

a. Uses his or her own account in completing transactions
b. Is strictly agent to take orders from her client
c. A currency speculator
d. All of these

75. Person A has a call option of 10 shares of IBM. The time to maturity for his contract is 10 months.
Person B also has a call options for the same number of IBM shares with the maturity of 6 months
a. Person A will pay more premium than person B
b. Person B will pay more premium than person A
c. Both will pay the same premium
d. None of these

76. The value n(d) in the Black-Scholes model can take any value between
a. 1 and -1
b. 0 and +1
c. -1 and 0
d. None of these

77. The movement of price or the rise or fall of prices of options is classified as
a. Option lattice
b. Pricing movement
c. Price change
d. Binomial lattice

78. As the time to maturity increases, call and put option become
a. Call option is not valuable
b. Put option is not valuable
c. Both call and put option tend to become valuable
d. Neither of the two types options is valuable
 79. Stock volatility refers to
a. Uncertainty in future stock price
b. Certainty in forward stock price
c. Certainty in future stock price
d. Certainty in current price

CASE STUDY
Consider the following data relating to NM stock. NM has a beta of 0.7 with Nifty. Each Nifty contract is
equal to 200 units. NM now quotes at Rs. 150 and the Nifty futures is 1400 index points. You expects
price to fall and have gone short on 1200 shares of NM in the spot market.
80. How many future contracts will you have to take
a. 4.2
b. 4.5
c. 5.2
d. 5.5

81. If the price increase by 5%, what will be the amount of gain or loss?
a. Loss Rs 9000
b. Gain Rs 9000
c. Loss Rs 18000
d. Gain Rs 18000

82. If the price in the spot market drops by 10%, what will be the amount of gain or loss?
a. Loss Rs 9000
b. Gain Rs 9000
c. Loss Rs 18000
d. Gain Rs 18000

83. The above situation deals with

a. Swaps
b. Hedging through future
c. Hedging through options
d. Hedging through forward
 84. A currency swap bank is usually
a. An end user
b. A financial intermediary
c. A currency speculator
d. All of these

85. A basis with respect to hedging using future contracts is defined as

 Basis=Spot price of the asset to be hedged(-) Future price of the contract used
 Basis=Spot price of the asset to be hedged(+) Future price of the contract used
 Basis=Spot price of the asset to be hedged(x) Future price of the contract used
 Basis=Spot price of the asset to be hedged(/) Future price of the contract used

86. The type of option which cannot be exercised before the expiry date is classified as

 European option
 American option
 Australian option
 Money option

87. Difference between the futures market and forward market provide [ to be answered]
a. Price range
b. Maturity
c. Credit risk
d. All of these

88. Under _____ option the buyer/holder gets the right to sell the underlying asset
 Put
 Call
 Both of these
 None of These

89. _______ try to lock in a profit by involving two or more markets

Reference Course Hero
 Speculators
 Hedgers
  Arbitrageurs
 Investor

90. According to the Black Scholes model, the purchaser can borrow fraction of security at risk free
interest rate which is
Solution Reference- https://mympsc.com/Share.aspx?ArticleID=BC310189-0B98-4982-8B5F-
3D645261A517

 Short term
 Long term
 Transaction cost
 No transaction cost

91. ________ is an agreement to buy or sell an asset today.

 Forward contract
 Future contract
 Spot contract
 Option contract

92. The Excess of actual price of option over the exercise value of option is classified as

 Time value of option

 Actual options
 Estimated options
 Optional pricing

93. The situation in financial options in which the strike price is less than current price of stock is
classified as
 In-the-money
 Out-of-the-money
 Out-of-the-portfolio
 In-the-portfolio

94. A measure of sensitivity of a bond price to change in yield is

 Modified duration
 Convexity
 Bond var
 Yield spread
95. In put call parity relationship, the put option minus call option plus stock is equal to
 Exercise price present value
 Exercise price future value
 Time line value
 Time value of bond

96. The ________ rate indicates the rate at which a currency can be exchanged in the future.
Solution: Reference( https://courses.lumenlearning.com/boundless-economics/chapter/exchange-
rates/)

 Spot exchange
 Forward
 Cross exchange
 None of the above

97. The black-Scholes opm is dependent on which five parameters?

Solution: Reference(E-Book)

 Stock price, exercise price, risk free rate, beta, and time to maturity
 Stock price, risk free rate, beta, time to maturity, and variance
 Stock price, risk free rate, probability, variance and exercise price
 Stock price, exercise price, risk free rate, variance, and time to maturity

98. The Situation in call options in which the strike price is greater than current price of stock is classified
as
Solution: Reference (https://upscgk.com/upsc-gk/408fbef3-4fa6-45be-bb53-031080ae39ee/the-
situation-in-call-options-in-which-the-strike-price-is-greater-than-current-price-of-stock-is-classified-as)

 Out-of-the-portfolio
 In-the-portfolio
 In-the-money
 Out-of-the-money

99. Which of the following statements regarding American puts is/are true?

 An American put can be exercised any time before expiration

 An American put is always more valuable than an equivalent European put
 Mutli-period binomial model can be used to value an American put
 All of these
100. Options are traded in ______
Solution: Reference Wikipedia

 Exchanges
 Over-the-counter market
 Exchanges as well as OTC market
 No where

101. A Call option has an exercise price of $48 and a premium of $2 per share. What is the break even
price of the underlying stock on the expiration date?

Solution: BEPcall = strike price + premium paid, BEPput = strike price - premium paid

 50
 48
 46
 None of these

102. The third step in binomial approach of option pricing is to:

Solution: Reference(https://upscgk.com/upsc-gk/31ff10a4-f420-4a50-b35b-b4b22cd54b5b/the-third-
step-in-binomial-approach-of-option-pricing-is-to) and https://epolylearning.com/Financial-
Management-and-Financial-Markets/Financial-Options/discuss/62941

 Equalize the beginning price

 Equalize the range of payoffs
 Equalize the domain of payoff
 Equalize the ending price

103 The second step in binomial approach of option pricing is to define range of values

 At expiration
 At buying date
 At exchange closing time
 At exchange opening time
104. The major types of risk in derivatives trading are

 Credit
 Liquidity
 Settlement
 All of these

105. If Strike price is more than the spot price of the asset the call option is known as

 Out-of-money Call option

106. If the strike price increase then the:

 Puts increase in value while calls decrease in value

107. The Last day at which the European and American option can be exercised is classified as

 Expiration date

108. A stock is currently selling for $50. The stock price could go up by 10% or go down by 5% each
month. The monthly interest rate is 1%[periodic rate]. Calculate the price of American put option on the
stock with an exercise price of $55 and a maturity of two months.

 $5.10

Multiple Choice Questions

1. Financial swap markets have emerged in recent years because of the following reasons:
[Exam 18 Sep 2021]
A. exchange rates fluctuate widely
B interest rates fluctuate widely
C forward markets may not function properly
D currency futures are available only for selected currencies
E all of these
2. Financial swaps are used by the following organizations:
A. multinational companies
B. commercial banks
C. world organizations
D. sovereign governments
E. all of the above

3. The origins of the swap market are usually regarded as an outgrowth of the following financial
instruments:
A. parallel loans
B. back to back loans
C. commercial paper
D. treasury bills
E. A and B

4. Parallel and back to back loans attained prominence in the 1970s when .
A. the U.S. had trade deficits
B. Japan had trade surpluses
C. the British government imposed taxes on foreign currency transactions
D. the British government devalued its currency
E. none of the above

5. Typically, parallel loans involve the following parties .

A. two multinational firms
B. three multinational firms
C. two subsidiary firms
D. five multinational firms
E. A and C

6. A back-to-back loan usually involves companies in different countries.

A. two, two
B. four, four
C. three, three
D. A and B
E. all of the above

7. The shortcomings of parallel and back to back loans are .

A. difficulty of finding counterparties
B. a non-compliance by one of the parties
C. difficulty of finding exact matching needs
D. A and B
E. A, B, and C

8. Currency swaps overcome the shortcomings of parallel and back-to-back loans because of .
A. specialized swap dealers and brokers
B. their simplicity
C. their cost effectiveness
D. A and B
E. A, B, and C

9. Which of the following is not part of the new Financial Accounting Standards Board and the
Securities and Exchange Commission’s rules regarding off balance sheet transactions:
A. all off balance sheet transactions must stop effective January 1, 2004.
B. the benefits of off balance sheet transactions must be reported.
C. companies are required to tell investors about the nature and purpose of off balance sheet
transactions.
D. companies must add transactions to their balance sheet when they strand to absorb a majority
of the expected benefits or losses from the bulk of expected returns.
E. the potential risk of any off balance sheet transactions must be told to investors.

10. The first currency swap between the World Bank and IBM was arranged in 1981 by _____.
A. Citicorp
B. BankAmerica
C. Solomon Brothers
D. Merrill Lynch
E. none of the above

11. The amount of outstanding interest rate swaps is ___ than that of outstanding currency swaps.
A. smaller
B. neither larger nor smaller
C. larger
D. two times larger
E. two times smaller

12. A currency swap bank is usually .

A. an end user
B. a financial intermediary
C. a currency speculator
D. A and B.
E. all of the above

13. A currency swap broker is a swap bank who .

A. uses his or her own account in completing transactions
B. is strictly an agent to take orders from her client
C. a currency speculator
D. A and B.
E. all of the above

14. Interest rate swaps involve counterparties who want to .

A. exchange a floating rate commitment for a fixed rate loan
B. exchange debt for stock
C. exchange a short-term loan for a long-term loan
D. A and B
E. none of the above

15. Currency swaps involve .

A. one currency
B. two currencies
C. foreign stocks
D. B and C
E. none of the above Financial Swaps1 0 2
16. Call swaptions are attractive when interests are expected to .
A. fall
B. rise
C. stay the same
D. A and B
E. none of the above

17. An interest rate floor in currency swaps sets .

A. a maximum rate on floating interest rate payments
B. a maximum rate on fixed interest rate payments
C. a minimum rate on floating interest rate payments
D. a minimum rate on fixed interest rate payments
E. none of the above

18. The basic motivations for swaps are shown below .

A. to provide protection against future changes in exchange rates
B. to eliminate interest rate risks arising from normal commercial operations
C. to reduce financing costs
D. A and B
E. all of the above

19. Mortgage companies may use interest rate swaps mainly because .
A. they have short-term liabilities and long-term assets
B. they have long-term debt
C. they have mortgage loans
D. A and B.
E. none of the above

20. Interest rate swaps are usually possible because international financial markets in different
countries are .
A. efficient
B. perfect
C. imperfect
D. A and B
E. none of the above

21. Comparative advantages usually exist because:

A. market imperfections.
B. US banks may not have the same information as British banks have
C. differences in risk
D. foreign borrowers may be treated differently from domestic borrowers
E. all of the above

22. Proper risk management involves a three-stage process. Which of the following is one of those
stages:
A. identify where the risks lie
B. select the right tools to execute the strategy
C. design an appropriate strategy for managing risks
D. both A and C
E. A, B, and C

Use the following information to answer the next three questions:

Assume that you are a swap dealer and have just acted as a counterparty in an interest rate swap. The
notional principal for the swap was $7.5 million and you are now obligated to make five annual
payments of 8 percent interest. The floating rate that you will receive is 8.2 percent, and the floating
payments to you are annual as well.
23. If interest rates do not change over the next five years, what will be your annual net inflow?
A. $10,000
B. $15,000
C. $25,000
D. $40,000
E. $55,000

24. What is the net present value of your swap agreement at a discount rate of 8 percent?
A. $10,000
B. $25,993
C. $55,883
D. 59,895
E. $60,666

25. If the floating rate stays the same for the first two years and then falls by 1.5 percent, what will be
your net payments for the five years?
A. $ 75,000
B. $ 90,000
C. $100,000
D. -$150,900
E. -$262,500
Use the following information to answer the next five questions:

Two counterparties agree to enter a foreign currency swap between American dollars and Swiss
francs. One dollar is currently worth 1.4 francs. The American dollar payor will provide $500,000.
The interest rate on the dollar is 9 percent, and the Swiss franc rate is 8 percent. The swap calls for
a life of three years with annual payments.

26. How much will the provider of the dollar pay at the outset?
A. SFr700,000
B. SFr500,000
C. SFr357,143
D. SFr200,000
E. SFr125,000

27. If the interest rates do not change, what is the annual dollar interest payment for the foreign
borrower of dollars?
A. $34,000
B. $40,000
C. $45,000
D. $50,000
E. $55,000

28. If a net payment is recorded for interest in year one and exchange rates do not change, what will
be the net payment?
A. $1,000
B. $2,000
C. $3,000
D. $5,000
E. $7,000

29. What will be the total payment in francs by the borrower of dollars for year 3?

A. SFr756,000
B. SFr500,000
C. SFr400,000
D. SFr350,000
E. SFr 53,500

30. What will be the total payment in dollars by the borrower of francs for year 3?
A. $150,000
B. $245,000
C. $540,000
D. $545,000
E. $600,000

Answers
Multiple Choice Questions
1. E
2. E
3. E
4. C
5. E
6. A
7. E
8. A
9. A
10. C
11. C
12. B
13. B
14. A
15. B
16. B
17. C
18. E
19. A
20. C
21. E
22. E
23.
24. B
25. D
26. E
27. A
28. C
29. D
30. A
31. D

Solutions
Case Study - Consider following data relating to NM stocks. NM Stock has beta of 0.7 with nifty.
Each nifty contract is equal to 200 units. NM now quotes a 150 –
Answer: Gain of 18000 (drops by 10%) | loss of 9000 (prices increases by 5%) | 4.2 | hedges
through futures

1. A one-year forward contract is an agreement where - One side has the obligation to buy an
asset for a certain price in one year’s time.
2. Which of the following is approximately true when size is measured in terms of the
underlying principal amounts or value of the underlying assets - The over-the-counter
market is ten times as big as the exchange-traded market.
3. Which of the following best describes the term “spot price” - The price for immediate
delivery
4. An investor sells a futures contract an asset when the futures price is $1,500. Each contract
is on 100 units of the asset. The contract is closed out when the futures price is $1,540.
Which of the following is true - The investor has made a loss of $4,000
5. A company knows it will have to pay a certain amount of a foreign currency to one of its
suppliers in the future. Which of the following is true - A forward contract can be used to
lock in the exchange rate
6. Which of the following best describes a central counterparty - It stands between two
parties in the over-the-counter market
7. Forward contracts are generally _________ in nature – OTC
8. Futures contracts are preferred to forward contracts because of_______ - High liquidity
9. An equity index comprises of ______ - basket of stocks
10. Changes in interest rates is an example of – Price Risk
11. Which of the following is true - Futures contracts are traded on exchanges, but forward
contracts are not.
12. Which of the following is NOT true - Futures contracts nearly always last longer than
forward contracts
13. The frequency with which margin accounts are adjusted for gains and losses is – Daily
14. Margin accounts have the effect of - Reducing the risk of one party regretting the deal and
backing out
15. For a futures contract trading in April 2012, the open interest for a June 2012 contract,
when compared to the open interest for Sept 2012 contracts, is usually – Higher
16. Clearing houses are - Sometimes used in both futures markets and OTC markets
17. With bilateral clearing, the number of agreements between four dealers, who trade with
each other, is – 6
18. Which of the following best describes central clearing parties - Perform a similar function
to exchange clearing houses
19. Which of the following are cash settled – None of the above
20. A limit order - Is an order that can be executed at a specified price or one more favorable to
the investor
21. Which of the following is a consumption asset? – Copper
22. An investor shorts 100 shares when the share price is $50 and closes out the position six
months later when the share price is $43. The shares pay a dividend of $3 per share during
the six months. How much does the investor gain? - $400
23. The spot price of an investment asset that provides no income is $30 and the risk-free rate
for all maturities (with continuous compounding) is 10%. What is the three-year forward
price? – $40.50
24. The spot price of an investment asset is $30 and the risk-free rate for all maturities is 10%
with continuous compounding. The asset provides an income of $2 at the end of the fi rst
year and at the end of the second year. What is the three-year forward price? - $35.84

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 1

 25. An exchange rate is 0.7000 and the six-month domestic and foreign risk-free interest rates
are 5% and 7% (both expressed with continuous compounding). What is the six-month
forward rate? – 0.6930
26. Which of the following is true? - The convenience yield is always positive or zero.
27. A short forward contract that was negotiated some time ago will expire in three months
and has a delivery price of $40. The current forward price for three-month forward
contract is $42. The three month risk-free interest rate (with continuous compounding) is
8%. What is the value of the short forward contract? - −$1.96
28. The spot price of an asset is positively correlated with the market. Which of the following
would you expect to be true? - The forward price is less than the expected future spot price.
29. Which of the following describes the way the futures price of a foreign currency is quoted? -
The number of U.S. dollars per unit of the foreign currency
30. Which of the following describes the way the forward price of a foreign currency is quoted?
- Some forward prices are always quoted as the number of U.S. dollars per unit of the
foreign currency and some are always quoted the other way round
31. Which of the following is true - Futures contracts are traded on exchanges, but forward
contracts are not.
32. Which of the following is NOT true - Futures contracts nearly always last longer than
forward contracts
33. In the corn futures contract a number of different types of corn can be delivered (with price
adjustments specified by the exchange) and there are a number of different delivery
locations. Which of the following is true - This flexibility tends decrease the futures price
34. A company enters into a short futures contract to sell 50,000 units of a commodity for 70
cents per unit. The initial margin is $4,000 and the maintenance margin is $3,000. What is
the futures price per unit above which there will be a margin call? – 72 cents
35. A company enters into a long futures contract to buy 1,000 units of a commodity for $60
per unit. Th e initial margin is $6,000 and the maintenance margin is $4,000. What futures
price will allow $2,000 to be withdrawn from the margin account? - $62
36. One futures contract is traded where both the long and short parties are closing out
existing positions. What is the resultant change in the open interest? - Decrease by one
37. Who initiates delivery in a corn futures contract - The party with the short position
38. You sell one December futures contracts when the futures price is $1,010 per unit. Each
contract is on 100 units and the initial margin per contract that you provide is $2,000. The
maintenance margin per contract is $1,500. During the next day the futures price rises to
$1,012 per unit. What is the balance of your margin account at the end of the day? - $1800
39. A hedger takes a long position in a futures contract on a commodity on November 1, 2012
to hedge an exposure on March1, 2013. The initial futures price is $60. On December 31,
2012 the futures price is $61. On March 1, 2013 it is $64. Th e contract is closed out on
March 1, 2013. What gain is recognized in the accounting year January 1 to December 31,
2013? Each contract is on 1000 units of the commodity - $4000
40. A speculator takes a long position in a futures contract on a commodity on November 1,
2012 to hedge an exposure on March 1, 2013. Th e initial futures price is $60. On December
31, 2012 the futures price is $61. On March 1, 2013 it is $64. The contract is closed out on
March 1, 2013. What gain is recognized in the accounting year January 1 to December 31,
2013? Each contract is on 1000 units of the commodity - $3000
41. The basis is defined as spot minus futures. A trader is hedging the sale of an asset with a
short futures position. The basis increases unexpectedly. Which of the following is true? -
The hedger’s position improves
42. Futures contracts trade with every month as a delivery month. A company is hedging the
purchase of the underlying asset on June 15. Which futures contract should it use? – The
July Contract

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 2

 43. On March 1 a commodity’s spot price is $60 and its August futures price is $59. On July 1
the spot price is $64 and the August futures price is $63.50. A company entered into futures
contracts on March 1 to hedge its purchase of the commodity on July 1. It closed out its
position on July 1. What is the effective price (aft er taking account of hedging) paid by the
company? $59.50
44. On March 1 the price of a commodity is $1,000 and the December futures price is $1,015.
On November 1 the price is $980 and the December futures price is $981. A producer of the
commodity entered into a December futures contracts on March 1 to hedge the sale of the
commodity on November 1. It closed out its position on November 1. What is the effective
price (after taking account of hedging) received by the company for the commodity? -
$1014
45. Suppose that the standard deviation of monthly changes in the price of commodity A is $2.
Th e standard deviation of monthly changes in a futures price for a contract on commodity
B (which is similar to commodity A) is $3. The correlation between the futures price and
the commodity price is 0.9. What hedge ratio should be used when hedging a one month
exposure to the price of commodity A? – 0.60
46. A company has a $36 million portfolio with a beta of 1.2. The futures price for a contract on
an index is 900. Futures contracts on $250 times the index can be traded. What trade is
necessary to reduce beta to 0.9? - Short 48 contracts
47. A company has a $36 million portfolio with a beta of 1.2. The futures price for a contract on
an index is 900. Futures contracts on $250 times the index can be traded. What trade is
necessary to increase beta to 1.8? - Long 96 contracts
48. Which of the following is true? - The optimal hedge ratio is the slope of the best fit line
when the change in the spot price (on the y-axis) is regressed against the change in the
futures price (on the x-axis).
49. Which of the following describes tailing the hedge? - None of the above
50. A company due to pay a certain amount of a foreign currency in the future decides to hedge
with futures contracts. Which of the following best describes the advantage of hedging? - It
leads to a more predictable exchange rate being paid
51. A company can invest funds for five years at LIBOR minus 30 basis points. The five-year
swap rate is 3%. What fixed rate of interest can the company earn by using the swap? –
2.7%
52. Which of the following is true? - The principal amounts usually flow in the opposite
direction to interest payments at the beginning of a currency
53. Which of the following is a way of valuing interest rate swaps where LIBOR is exchanged
for a fixed rate of interest? - Assume that floating payments will equal forward LIBOR rates
and discount net cash flows at the risk-free rate
54. Which of the following describes the five-year swap rate? - The average of A and B
55. Which of the following is a use of a currency swap? - All of the above
56. Which of the following is usually true - OIS rates are less than the corresponding LIBOR
rates
57. Which of the following describes an interest rate swap? - All of the above
58. Which of the following is true for an interest rate swap? - A swap is usually worth close to
zero when it is first negotiated
59. Which of the following is true for the party paying fixed in an interest rate swap? - There is
more credit risk when the yield curve is upward sloping than when it is downward sloping
60. Since the 2008 credit crisis - OIS has replaced LIBOR as the discount rate for swaps
61. Which of the following is true? - An employee stock option tends to be exercised earlier
than an OTC option with the same terms
62. Which of the following is NOT usually true about employee stock options? - They can be
sold to other employees

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 3

 63. What term is used to describe losses shareholders experience because the interests of
managers are not aligned with their own? – Agency Costs
64. Which of the following are true of employee stock options? - They are commonly valued as
though they are regular European options but with a reduced life.
65. Which of the following was true about employee stock options prior to 1995? - Options
which were at-the-money when issued did not affect a company’s financial statements
66. Which of the following was true about employee stock options between 1996 and 2004? -
The value of options which were at-the-money when issued had to be reported in the notes
to the financial statements
67. Which of the following was true after 2005? - The value of options which were at-the-
money when issued had to be expensed on the income statement
68. Which of the following is true about employee stock options after they have been issued? -
They never have to be revalued
69. Which of the following is true about the practice of backdating a stock options grant? - It is
illegal
70. A company surprises the market with an announcement that it has granted stock options to
senior executives. The options are exercised four years later. When does dilution take
place? - Dilution takes place on the announcement date
71. A one-year forward contract is an agreement where - One side has the obligation to buy an
asset for a certain price in one year’s time
72. Which of the following is NOT true - An call option will always be exercised at maturity if
the underlying asset price is greater than the strike price
73. A one-year call option on a stock with a strike price of $30 costs $3; a one-year put option
on the stock with a strike price of $30 costs $4. Suppose that a trader buys two call options
and one put option. Th e breakeven stock price above which the trader makes a profit is -
$35
74. A one-year call option on a stock with a strike price of $30 costs $3; a one-year put option
on the stock with a strike price of $30 costs $4. Suppose that a trader buys two call options
and one put option. Th e breakeven stock price below which the trader makes a profit is -
$26
75. Which of the following is approximately true when size is measured in terms of the
underlying principal amounts or value of the underlying assets - The over-the-counter
market is ten times as big as the exchange-traded market
76. Which of the following best describes the term “spot price” - The price for immediate
delivery
77. Which of the following is true about a long forward contract - The contract is worth zero if
the price of the asset declines after the contract has been entered into
78. Which of the following describes European options? - Calls (there are no puts)
79. Which of the following is NOT true - The holder of a forward contract is obligated to buy or
sell an asset
80. Which of the following creates a bull spread? - Buy a low strike price call and sell a high
strike price call
81. Which of the following creates a bear spread? - Buy a high strike price call and sell a low
strike price call
82. Which of the following creates a bull spread? - Buy a low strike price put and sell a high
strike price put
83. Which of the following creates a bear spread? - Buy a high strike price put and sell a low
strike price put
84. What is the number of different option series used in creating a butterfly spread? – 3
85. A stock price is currently $23. A reverse (i.e short) butterfly spread is created from options
with strike prices of $20, $25, and $30. Which of the following is true? - The gain when the
stock price is greater that $30 is the same as the gain when the stock price is less than $20
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 4
 86. Which of the following is correct? - A calendar spread can be created by buying a call and
selling a call when the strike prices are the same and the times to maturity are different
87. What is a description of the trading strategy where an investor sells a 3-month call option
and buys a one-year call option, where both options have a strike price of $100 and the
underlying stock price is $75? - Bullish Calendar Spread
88. Which of the following is correct? - A diagonal spread can be created by buying a call and
selling a call when the strike prices are different and the times to maturity are different
89. Which of the following is true of a box spread? - All of the above
90. How many nodes are there at the end of a Cox-Ross-Rubinstein five-step binomial tree? – 5
91. Which of the following cannot be estimated from a single binomial tree? – theta
92. Which of the following is true for u in a Cox-Ross-Rubinstein binomial tree? - It depends on
the interest rate and the volatility
93. How many different paths are there through a Cox-Ross-Rubinstein tree with four-steps? –
12
94. When we move from assuming no dividends to assuming a constant dividend yield, which
of the following is true for a Cox, Ross, Rubinstein tree? - Neither p nor u changes
95. When the stock price is 20 and the present value of dividends is 2, which of the following is
the recommended way of constructing a tree? - Draw a tree for an initial stock price of 20
and subtract the present value of future dividends at each node
96. What is the recommended way of making interest rates a function of time in a Cox, Ross,
Rubinstein tree? - Make u and p a function of time
97. What is the recommended way of making volatility a function of time in a Cox, Ross,
Rubinstein tree? - Make u and p a function of time
98. The chapter discusses an alternative to the Cox, Ross, Rubinstein tree. In this alternative,
which of the following are true: - None of the above
99. Which of the following is acquired (in addition to a cash payoff) when the holder of a put
futures exercises? - A short position in a futures contract
100. Which of the following is acquired (in addition to a cash payoff) when the holder of
a call futures exercises? - A long position in a futures contract
101. The risk-free rate is 5% and the dividend yield on the S&P 500 index is 2%. Which
of the following is correct when a futures option on the index is being valued? - The futures
price of the S&P 500 is treated like a stock paying a dividend yield of 5%.
102. Which of the following is NOT true? - Black’s model can be used to value an
American-style option on futures
103. Which of the following is true when the futures price exceeds the spot price? - A call
on futures is always worth at least as much as the corresponding call on spot
104. Which of the following describes a futures-style option? - A futures on an option
payoff
105. A futures price is currently 40 cents. It is expected to move up to 44 cents or down
to 34 cents in the next six months. The risk-free interest rate is 6%. What is the probability
of an up movement in a risk-neutral world? – 0.6
106. A futures price is currently 40 cents. It is expected to move up to 44 cents or down
to 34 cents in the next six months. The risk-free interest rate is 6%. What is the value of a
six-month put option with a strike price of 37 cents? – 1.16 cents
107. A futures price is currently 40 cents. It is expected to move up to 44 cents or down
to 34 cents in the next six months. The risk-free interest rate is 6%. What is the value of a
six month call option with a strike price of 39 cents? – 2.91 cents
108. Which of the following are true? - Futures options are usually American
109. A call option on a stock has a delta of 0.3. A trader has sold 1,000 options. What
position should the trader take to hedge the position? - Buy 300 shares
110. What does theta measure? - The rate of change of the portfolio value with the
passage of time
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 5
 111. What does gamma measure? - The rate of change of delta with the asset price
112. What does vega measure? - None of the above
113. What does rho measure? - The sensitivity of a portfolio value to interest rate
changes
114. Which of the following is true? - The gamma of a European put equals the gamma of
a European call
115. A portfolio of derivatives on a stock has a delta of 2400 and a gamma of –10. An
option on the stock with a delta of 0.5 and a gamma of 0.04 can be traded. What position in
the option is necessary to make the portfolio gamma neutral? - Long position in 250
options
116. A trader uses a stop-loss strategy to hedge a short position in a three-month call
option with a strike price of 0.7000 on an exchange rate. The current exchange rate is
0.6950 and value of the option is 0.1. The trader covers the option when the exchange rate
reaches 0.7005 and uncovers (i.e., assumes a naked position) if the exchange rate falls to
0.6995. Which of the following is NOT true? - The hedge works reasonably well
117. Maintaining a delta-neutral portfolio is an example of which of the following -
Dynamic hedging
118. Which of the following could NOT be a delta-neutral portfolio? - A short position in
call options plus a short position in the underlying stock

119. an excess of actual price of option over an exercise value of option is classified as? –
Time Value
120. Limit order specifies? – Specific price
121. the variability of stock price option term to maturity and the risk free rate are
dependents of? An Option
122. the third step in binomial approach of option pricing is to? Equalize range of payoffs
123. in order to gain profit from an identified arbitrage opportunity the? Less than or
more than
124. A one year long forward contract on a non dividend paying stock with current price
of Rs 40 was entered today. The delivery price was set to be Rs 25. The risk free rate is 8 %
per annum in the economy. The value of forward contract computed will be? – 44.2
125. Person A has a call option of 10 shares of IBM. The time to maturity for his contract
is 10 months. Person B also has call option for the same number of IBM shares... Person A
will pay more premium than person B
126. The current value of stock included in portfolio is subtracted from present value of
portfolio to calculate – Current Option Price
127. the second step in binomial approach of option pricing is to define range of value –
Value at Expiration
128. in calculation of the value of dividend paying securities the income is subtracted
because" All of the above
129. take offsetting positions in two or more instruments to lock in a profit -
Arbitrageurs
130. if u grow sugarcane in your farm how will you hedge your risk By taking contract to
sell at per agreed forward price
131. Which of the following statements regarding short selling is not true it is an
arbitrage strategy
132. "option premium consist of" Intrinsic value, time value and volatility
133. in put call parity relationship the put option minus call option plus stock is equal to
Future value
134. the value of n(d) in the black Scholes model can take any value between 0 and +1
135. a currency swap bank is usually A financial intermediary
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 6
 136. call swaption are attractive when interest rates are expected to rise
137. If an investor provides fund of INR 500000 at a nominal rate of 7%.. inflation is 5%
- 509524 (500000*1.07/1.05)
138. An investor is trying to determine the price of a forward contract of 9 month
maturity on stock with current market price of 70. Assuming risk free rate as 6% per
annum. Also assume an equal dividend of 10 is expected after 6 months and 9 months –
73.22
139. In cross-hedging, when the futures contract is highly correlated with the portfolio
being hedged, the value of future contract changes by – Either the hedge percentage …
percentage.. same percentage
140. Black-Scholes model uses the following variable to value non-dividend call option
except – Quality of call option
141. The binomial options pricing model is based on the principle of no-arbitrage
pricing, which is also known as – Law of One price
142. If strike price is more than the spot price of the asset the call option is known as
Out-the-money call option
143. The movement of price or rise or the fall of prices of option classified as Binomial
Lattice
144. The_______ rate indicate the rate at which currency can be exchanged in future The
forward exchange rate.
145. The higher the maturity the higher will be the premium the higher will be the
premium of both call and put option because? C, the extra time
146. The last day at which the European and American can be exercise is classified as
Expiration Date
147.

S.no Q (FINC601) A
___ is used a major means of reducing risk in letter of credit
1 international transactions
______ is one of the important instruments (d)
for “Risk aversion”? The “Currency Options” are intended to suffice
the risk aversion aspect of a firm and not for
2 liquidity needs.
_________ act as a critical link between the (c)
derivatives market and the cash market so Arbitrageurs try to profit from market price
that both the markets synchronize to the differences in two different markets or
extent that there cannot be much exchanges. For instance, in the futures market,
disequilibrium in the markets. arbitrageurs by their activities tend to reduce
or eliminate the price differences that exist
between the cash market and the futures
market, by buying and selling till the price
3 difference does not yield any profits.
_________ is the currency of the b)
environment in which an entity generates Functional currency is an entity’s currency of
and expends cash. the primary economic environment in
which it operates. i.e., the currency of the
environment in which an entity primarily
generates and expends cash. Reporting
currency is the currency in which an entity
4 prepares
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 7
 its financial statements. Local currency is the
currency of a particular country being
referred to. Foreign currency is the currency of
a foreign entity. Hence (b)
is the answer.
Hence (c) is false.
______is the value of the march 482 call on 18.55
futures contract on December 25, 2014. the
futures price is 465.75 and strike price is
$482. the risk free interest rate is 8% per
year. the last trading day for the futures call
is March 15, 2015. the standard deviation is
5 30%
______is used a major means of reducing letter of credit
6 risk in international transactions
‘American options’ are those (b)
Alternative (b) is correct because, an American
Option can be exercised on any business
day within the life of an option including the
7 expiration date.
‘Covered Call Writing’ means (e)
The statement given under (e) is true. The
strategy of covered call writing involves
buying the underlying asset and writing a call
8 on that asset.
‘European options’ are (b)
The statement given under (b) is true and is
self
-
explanatory (they c
an be exercised on
9 expiry date only).
A _______ is created by going short on both c)
put and call options, and the strike price and The definition given under option (c) is the
time to expiration of both the options are definition of a short straddle. A straddle
the same. nvolves a call and a put option with the same
exercise price and the same expiration date.
In a short straddle, the seller sells a call and a
put option at the same exercise price and the
same expiration date. In a long straddle, the
buyer buys a call and a put option at the same
10 exercise price and the same expiration date.
A bank who is a party to a swap transaction (e)
can be termed as Swap facilitators and swap dealers are parties
to any swap transactions. Swap brokers
are intermediaries who help in identifying the
potential counterparties to a swap
11 transaction.
A binomial tree prices an American option at 3.08
12 $3.12 and the
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 8
 corresponding European option at $3.04. Th
e Black-Scholes
price of the European option is $2.98. What
is the control variate
price of the American option?
A buyer of a straddle will profit if d)
The buyer of a straddle will profit only if the
price of the underlying asset changes
substantially
-
either up or down, i.e., there should be a wide
13 variation in prices
A call option on a stock has a delta of 0.3. A Buy 300 shares
trader has sold
1,000 options. What position should the
trader take to hedge
14 the position?
A call option with strike price of 35 has a (b)
premium of 2. A call option with strike price For a call option, the premium is inversely
of 36 may have a premium of proportional to the strike price. Therefore, if
the strike price increases, the premium
decreases. In this case the premium will be
less than
15 Rs.2. Therefore answer is (b)
A cash market is (a)
A cash market is the market for a commodity
at present, based on which the options or
16 futures contract is based.
A company can invest funds for five years at 0.027
LIBOR minus 30
basis points. The five-year swap rate is 3%.
What fixed rate of
interest can the company earn by using the
17 swap?
A company due to pay a certain amount of a It leads to a more predictable exchange rate
foreign currency being paid
in the future decides to hedge with futures
contracts. Which
of the following best describes the
18 advantage of hedging?
A company enters into a long futures 62
contract to buy 1,000
units of a commodity for $60 per unit. The
initial margin is
$6,000 and the maintenance margin is
$4,000. What futures
price will allow $2,000 to be withdrawn
19 from the margin account?
A company enters into a short futures 72 cents
20 contract to sell 50,000
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 9
 units of a commodity for 70 cents per unit.
Th e initial margin
is $4,000 and the maintenance margin is
$3,000. What is the
futures price per unit above which there will
be a margin call?
A company has a $36 million portfolio with a Long 96 contracts
beta of 1.2. The futures price for a contract
on an index is 900. Futures contracts on
$250 times the index can be traded. What
trade is
21 necessary to increase beta to 1.8?
A company has a $36 million portfolio with a Short 48 contracts
beta of 1.2. The futures price for a contract
on an index is 900. Futures contracts on
$250 times the index can be traded. What
trade is
22 necessary to reduce beta to 0.9?
A company has sold HDD index, and if the (a)
days, remain hot then it would If a company expects the coming month to b
e hot and sells HDD indices in winter, and
if the days turn out to be hot as expected then
the company will earn good revenues. Thus,
23 the company would make an overall gain
A company knows it will have to pay a A forward contract can be used to lock in the
certain amount of a exchange
foreign currency to one of its suppliers in rate
the future. Which of
24 the following is true
A company surprises the market with an Dilution takes place on the announcement
announcement that date
it has granted stock options to senior
executives. Th e options
are exercised four years later. When does
25 dilution take place?
A company which is expecting hot days in d)
summer should A company expecting hot days in summer
should buy a call option of the HDD in
26 winter. Thus (d) is the answer.
A covered call is A covered call involves buying the underlying
asset and writing a call, i.e., long on asset and
short on call. So none of the options is true.
27 Thus the answer is (e).
A covered call is Buying a call option with a short position in
28 the underlying asset
A credit balance in comprehensive income (c)
represents A credit balance in comprehensive income
29 represents a deferred gain
30 A currency call option gives the buyer the right to buy the underlying currency

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 10

 A currency swap involves (e)
All the statements given are the characteristics
31 of currency swaps.
A financial swap helps in overcoming (e)
Statements under options (a) and (c) are the
main reasons for counterparties to enter into
32 swaps.
A firm having floating rate liabilities has (a)
decided to invest in floating rate assets, Loss control management involves various
such a type of risk management is called measures to limit or reduce the risks. A firm
having floating rate liabilities can keep a better
balance between the payables and
receivables by investing in floating rate assets,
rather than fixed rate assets, as the variations
in the interest rates will affect both the assets
and liabilities simultaneously keeping a
33 proper balance of the same.
A forward market hedge involves the future spot rate
34 following except
A futures contract on bonds is now selling at (a)
92.50 and any of the following bonds can be Cheapest
delivered under the contract. Which of the -
bonds is the cheapest to deliver? to
-
deliver bond is the bond with the lowest cost
of delivering.
Cost of delivering = Quoted price
–
(Current Futures price x Conversion factor)
Cost of Bond 1 = 98.50
–
(92.50 x 1.0292) = 3.299
Cost of Bond 2 = 101.50
–
(92.50 x 1.0401) = 5.29
Cost of Bond 3 = 136.00
–
(92.50 x 1.3453) = 11.5598
Cost of Bond 4 = 120.75
–
(92.50 x 1.2595) = 4.24
Since Bond 1 has lowest cost of delivering, it is
35 the cheapest to deliver bond.
A futures price is currently 40 cents. It is 0.6
expected to move upto 44 cents or down to
34 cents in the next six months. The risk-free
interest rate is 6%. What is the probability of
36 an up movement in a risk-neutral world?

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 11

 A futures price is currently 40 cents. It is 2.91 cents
expected to move upto 44 cents or down to
34 cents in the next six months. The risk-free
interest rate is 6%. What is the value of a six
month call option with a strike price of 39
37 cents?
A futures price is currently 40 cents. It is 1.16 cents
expected to move upto 44 cents or down to
34 cents in the next six months. The risk-free
interest rate is 6%. What is the value of a
six-month put option with a strike price of
38 37 cents?
A futures trader can square up his position (e)
only by dealing in contracts which are All the above mentioned are the
similar to the one he bought or sold in characteristics of the contracts, except for the
characteristics like delivery
39 terms which may be different.
A good rule of thumb regarding futures is to (d)
choose a delivery month that is as close as This rule is good because the farther away the
possible to, but later than the expiration delivery month is, the lower will be the
date of the hedge. The basis of this rule is price and if the delivery month is later than
based on the assumption that the expiration date, the basis will be negative.
commodity in all the maturities and the holder
does not want to take the delivery of the
asset, but go for a settlement
This is a good option subject that there is a
40 good liquidity in the contracts of the said
A hedger takes a long position in a futures 4000
contract on a commodity
on November 1, 2012 to hedge an exposure
on March
1, 2013. Th e initial futures price is $60. On
December 31, 2012
the futures price is $61. On March 1, 2013 it
is $64. Th e contract
is closed out on March 1, 2013. What gain is
recognized
in the accounting year January 1 to
December 31, 2013? Each
41 contract is on 1000 units of the commodity.
A limit order Is an order that can be executed at a specified
price or one
42 more favorable to the investor
A long straddle involves (c)
The statement given under (c) is true and is
self
-
43 explanatory.
A medium term swap has a tenure of d)
44 Swaps can be divided into short
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 12
 -
term, medium
-
term, and long
-
term swaps. Short
-
term
swaps have maturity periods of less than three
years, medium
-
term swaps mature between
three and five years and long
-
term swaps have a life extending beyond five
years. Therefore
(d) is the answer.
A modest risk taking speculator who expects e)
wide variation in the exchange rates can Whenever
a speculator is expecting a wide variation in
the stock prices, he can either
sell a butterfly or buy a straddle. Here the
45 answer is (e).
A one-year call option on a stock with a 35
strike price of $30
costs $3; a one-year put option on the stock
with a strike price
of $30 costs $4. Suppose that a trader buys
two call options
and one put option. The breakeven stock
price above which
46 the trader makes a profit is
A one-year call option on a stock with a 26
strike price of $30
costs $3; a one-year put option on the stock
with a strike price
of $30 costs $4. Suppose that a trader buys
two call options
and one put option. The breakeven stock
price below which
47 the trader makes a profit is
A one-year forward contract is an One side has the obligation to buy an asset for
agreement where a certain
48 price in one year’s time.
A particular portfolio having a VaR of X at (b)
95% confidence level implies VaR is the measurement of loss which has a
chance over a certain pre
-
decided
49 confidence level of being exceeded. If the
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 13
 confidence level is 95%, the chance that the
loss
may be exceeded is 5%
A portfolio of derivatives on a stock has a Long position in 250 options
delta of 2400 and a
gamma of –10. An option on the stock with
a delta of 0.5 and
a gamma of 0.04 can be traded. What
position in the option is
necessary to make the portfolio gamma
50 neutral?
A protective put strategy is a long put plus a long position in the
51 underlying asset
A put option was written at a premium of d)
Rs.400. The current market price of the Assuming a put option. Exercise Price Rs.3,500
stock is Rs.38 and the exercise price of the –
contract is Rs.35. After a period of two Premium Rs.400 = Total outgo of
months the price of the stock is Rs.30. The Rs.3,100. After 2 months if the share price is
amount of the profit made by the option Rs.3,000, the net profit is Rs.100 (Rs.3,100
holder is Rs.______. (Assume that the –
52 contract is for 100 shares) Rs.3,000).
A risk manager normally tries to cover the (e) A corporate’s aim is to create wealth for its
risk to shareholders. This is done by maximizing
profits, reducing known and expected losses
and reducing the uncertainty of cash flows. A
risk manager is appointed in order to calculate
53 the expected risk and minimize it.
A short hedge occurs when c)
Short hedge, also known as selling hedge
occurs when the hedger sells the futures
contracts in order to hedge the cash
54 commodity against declining prices.
A short forward contract that was −$1.96
negotiated some time ago
will expire in three months and has a
delivery price of $40.
The current forward price for three-month
forward contract is
$42. Th e three month risk-free interest rate
(with continuous
compounding) is 8%. What is the value of
the short forward
55 contract?
A software which measures the level of risk b)
of a bond portfolio is known as Risk Manager is software, which measures the
56 level of risk of a bond portfolio
A speculator takes a long position in a 3000
futures contract on a
commodity on November 1, 2012 to hedge
57 an exposure on
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 14
 March 1, 2013. Th e initial futures price is
$60. On December
31, 2012 the futures price is $61. On March
1, 2013 it is $64.
Th e contract is closed out on March 1,
2013. What gain is
recognized in the accounting year January 1
to December 31,
2013? Each contract is on 1000 units of the
commodity.
A stock index currently stands at 350. The 354.7
risk-free interest rate is 8% per annum (with
continuous compounding) and the dividend
yield on the index is 4% per annum. What
should the futures price for a four-month
58 contract be?
A stock price is currently $23. A reverse (i.e The gain when the stock price is greater that
short) butterfly $30 is the
spread is created from options with strike same as the gain when the stock price is less
prices of $20, $25, than $20
59 and $30. Which of the following is true?
A straddle consists of buying a call and a put with identical strike and
60 expiration date
a strangle involves buying a call and put with same expiration
61 date and different exercise price
A swap quote of Libor/fixed 5 year swap at Bank is willing to pay 5 year treasury + 85bp
85/95 over 5 year treasury by a bank means and receives LIBOR
62 that
a swap quote of LIBOR/fixed 5 year swap at bank is willing to pay and receive fixed rate to
85/95 over 5 year treasury by a bank means be determined
63 that
A swap quote of LIBOR/fixed 5 year swap at A swap quote of LIBOR/fixed 5 year swap at
85/95 over 5 year treasury by a bank means 85/95 over 5 year treasury by a
that bank means that the bank is willing to pay 5
year treasury+ 85 basis points and receive
Libor. The bank is willing to receive 5 year
treasury +95 basis points and pay LIBOR. So,
64 the correct answer is option “c”.
A swap which gives the seller the option to d)
terminate swap at any time before its A putable swap gives the seller of the swap to
maturity terminate the swap at any time before its
maturity. A callable swap gives the holder the
right to terminate the swap at any
time before
its maturity. A swap, in which a stream of
floating interest rates are exchanged for
another
stream of floating interest rates, is known as
basis swap. Vanilla swap is an interest rate
65 swap, which can be defined as an agreement
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 15
 between two
or more parties who agree to
exchange interest payments over a specific
period on agreed terms. Accreting swaps can
be
used to convert floating rate payments into
fixed rate payments if the principal amount
increases every time additional loan is
availed.
A synthetic long call is a combination of (a)
A synthetic long call option can be created by
purchasing a long call option and going
66 short on the underlying asset.
a tool for managing risk? (e)All the above mentioned tools are used to
manage risk, either individually or in
67 combinations.
A trader is long in the spot market and short (a)
in the futures market. If the basis is positive A trader is long in the spot market means
and widens, the trader stands to that he has bought the security. He is short
on the futures market, it means that he has
sold futures contract. The basis is positive
means. Current spot price > futures price.
The positive basis widens and so the trader
incurs
a loss in the spot market while he gains in the
68 futures market. Therefore answer is (a).
A trader is short in the spot market and long (b)
in the futures market. If the basis is positive A trader is long in the futures market means
and narrows, the trader stands to that he has bought the futures. He is short
on the spot
market; it means that he has sold the security.
The basis is positive means
Current spot price > futures price. The positive
basis narrows and so the trader incurs a
relative gain which is more than the relative
loss. The end result is a gain and the answer is
69 (b).
A trader uses a stop-loss strategy to hedge a The hedge works reasonably well
short position in
a three-month call option with a strike price
of 0.7000 on an
exchange rate. Th e current exchange rate is
0.6950 and value
of the option is 0.1. Th e trader covers the
option when the
exchange rate reaches 0.7005 and uncovers
(i.e., assumes a naked
position) if the exchange rate falls to 0.6995.
Which of the
70 following is NOT true?
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 16
 according to a survey by Bank of America, translation exposure
the type of foreign exchange risk most often
71 hedged by firms is ______
According to Black Scholes model, purchaser short term
can borrow fraction of security at risk free
72 interest rate which is
According to Black Scholes model, short full cash proceeds
73 term seller receives today price which
According to Black Schools model, stocks no dividends
74 with call option pays the
According to FAS-133, what is/are the (d)
cause(s) of changes in the fair values of the The statements under (a), (b) and (c) identity
derivatives changes in the fair values of the
75 derivatives
according to the black scholes model, the short term
purchaser can borrow fractions of security
76 at risk free interest rate which is
77 All else equal call option values are lower for high dividend payout policies
All of the following factors affect the price of the expected rate of return on the stock
78 a stock option except
Among the instruments listed below, which (c)
is/are option like instruments? i. Rights ii. A warrant is an instrument t
Warrrants iii. Puttable and Callable bonds. hat gives the owner an option to purchase a
fixed number of
shares of stock at a designated price over a
79 specific time period.
An asset swap is (c)
An asset swap is a variant of interest rate
swap, where there is exchange of interest
income. An interest rate swap is defined as an
agreement between two or more parties who
agree to exchange interest payments over a
specific period on agreed terms. It should be
remembered that the exchange of principle is
80 notional
an be covered to a large extent. (c)
Primary risks are those, that are an essential
part of the business. They can be minimized
but cannot be covered fully or even to a very
81 large extent, but only covered partly.
82 An equity index comprises of ______. basket of stocks
An equity swap involves e)
An equity swap means an exchange of
dividends earned and capital gains on a
portfolio,
which is based on a stock index against
periodic interest payments. Hence all the
statements
83 are true. Therefore (e) is the answer.

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 17

 An exchange rate is 0.7000 and the six- 0.693
month domestic and foreign
risk-free interest rates are 5% and 7% (both
expressed with
continuous compounding). What is the six-
84 month forward rate?
an external hedging technique? (e)
Netting is the standard practice followed by a
multinational company in order to reduce
the transaction costs during the flow of funds
from one subsidiary to the other or from the
parent company to the subsidiaries or vice
-
versa. Through netting the difference between
the receivables and payables in foreign
exchange is estimated and hedging is done for
the
85 net amount. This is an internal technique.
An increase in volume associated with a a)
decrease in open interest on futures This is true of any exchange. If the operators
exchange indicates that start squaring off their positions and
booking profits, the volume will increase and
there wi
86 ll be decreased interest in new deals.
An index fund means management b)
strategies investing in the same stocks and The description given in (b) is the definition of
in the same proportions as those that an index fund.
87 comprise the selected market index
An investor buys 100 6 month call of (a)
Reliance Industries at a strike price of The investor will not exercise the option. Since
Rs.200, when the current market price is the stock price is less than the exercise
Rs.180 per share. The call price is Rs.5 per price. The maximum loss will be 100 x Rs.5 =
share, at the end of six months the Rs.500.
88 maximum loss to the investor will be
An investor buys a call option contract for a (c)
premium of Rs.200. The exercise price is Assuming a call option. Premium Rs.200 +
Rs.20 and the current market price of the Exercise Price Rs.2,000 = Total outgo of
share is Rs.17. If the share price after three Rs.2,200. After 3 months if the share price is
months reaches Rs.25, what is the profit Rs.2,500, the net profit is Rs.300 (Rs.2,500
made by the option holder on exercising the –
option. Contract is for 100 shares. Ignore the Rs.2,200).
89 transaction charges.
An investor buys a call option contract for a a)
premium of Rs.300. The exercise price is Premium Rs.300 + Exercise Price Rs.3,000 =
Rs.30 and the current market price of the Total outgo of Rs.3,300. After 3 months
share is Rs.26. If the share price after three if
months reaches Rs.30, the amount of loss to the share price is Rs.3,300, the net loss is
the investor will be ______.Rs Rs.300 (Rs.3,000
–
90 Rs.3,300).
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 18
 An investor goes long on Nifty future b)
contract at Rs.1,225. Initial margin was 5000 Rs.(1,225
with maintenance margin of 4500. If index –
closes at Rs.1,125 and multiple associated 1,125) x 100 = Rs.10,000.
with the contract is 100, calculate the call
91 money.
An investor is short on put at strike price of a)
Rs.200. Determine his profit/loss, if closing 100 x Rs.5 = Rs.500.
price is 200 and premium charged was Rs.5
92 and trading lot for put is 100.
An investor sells a futures contract an asset The investor has made a loss of $4,000
when the futures
price is $1,500. Each contract is on 100 units
of the asset. Th e
contract is closed out when the futures price
is $1,540. Which
93 of the following is true
An investor sells a futures contract an asset Exercisable only at maturity
when the futures
price is $1,500. Each contract is on 100 units
of the asset. Th e
contract is closed out when the futures price
is $1,540. Which
94 of the following is true
An investor shorts 100 shares when the 400
share price is $50 and
closes out the position six months later
when the share price is
$43. Th e shares pay a dividend of $3 per
share during the six
95 months. How much does the investor gain?
an investor wrote a naked call option. the 620
premium was Rs. 2.50per share and the
market price and the exercise price of the
same are Rs. 37 and Rs41 respectively._____
is the amount that is required to be
deposited with the clearing house(the
96 contract is for 100 shares)
An option dealer took a short position in a d)
call and put options on dollar at strike price The total option premium received by the
of Rs.43.00. He received a premium of dealer is Rs.5.00.
Rs.2.50 for each option. For dealer to make If the price is Rs. 38 the call is not exercised
a gain in this option strategy price should but
remain in the range of the put sold is exercised leading to a loss
of Rs.5.00 which is offset by the option
premium. Therefore net profit/loss is 0.
If the price is Rs.48 the call is exercised leading
to a loss of Rs.5.00 but the put is not
exercised. The option premium of Rs.5.00
97 makes good the loss
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 19
 an option market hedge in foreign exchange covered hedge
98 risk management is a form of a(an)
Anticipating a in significant change from the e)
spot price, a dealer buys two calls on dollars It is a butterfly spread and X
1
,X
2
,X
3
are related as X
1
>X
2
>X
3
or X
1
<X
2
<X
3
.
Therefore both statements (a) and (
99 b) are true. Thus answer is (e).
Any component excluded from the c)
computation of the effectiveness of the Any component excluded from the
derivative instrument is reported in computation of the effectiveness of the
derivative
instrument is reported in earnings. Hence (c) is
100 the answer.
Arbitrage means (a)
The description given in (a) is the definition of
101 arbitraging.
102 A short hedge occurs when a firm that owns or plans to purchase
Asset liability management can be used to (e)
manage ALM is used to manage both the interest rate
risk exchange risk and liquidity risk. It
aims at minimizing the exposure to price risk
by holding the appropriate combination of
assets and liabilities so as to meet the firm’s
objectives and simultaneously minimizing the
103 firm’s risk. Therefore (e) is the right choice.
At any given time the clearing house net (c)
position will be equal to The clearing corporation settles the positions
of all the members and matches the same
on a daily basis. So its net position is always
zero, as for every purchase there must be an
104 equal and opposite sale.
Backwardation occurs when (c)
105 If the futures price is less than the cash price,
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 20
 the basis is positive. T
his condition
prevails only if the futures price is determined
by some other factors than the cost
-
of
-
carrying. This is known as backwardation.
Basis risk arises in c)
Basis risks take place mostly in floating
-
to
-
floating rate swaps, when both the sides are
pegged to two different indices and both the
indices are fluctuating and there is no proper
correlation between both. Hence (c) is the
106 answer
Basis risk can be reduced by e)
Options (a), (b) and (c) are the ways of
107 reducing the basis risk
Basis swap involve sating and floating (d)
interest in same currency A swap in which a stream of floating interest
rates is swapped against another stream of
floating interest rates is known as a basis
108 swap.
Business event risk may be (e)
All of the above mentioned are types of risks
109 related to business.
Buy in and selling call or put option with the horizontal option spread
same strike price but different expiration
110 dates is called
Buying a range forward implies a)
The statement in (a) above is the definition of
111 range forward.
Buying and selling call or put option with the (c)
same strike price but different expiration This is also known as a time spread. It consists
dates is called of buying and selling of call or put
options with the same strike price and
112 different expiration dates.
Calculate the present value of bond a whose 1000
113 coupon rate is 7%
114 changes in interest rates is an example of: Price Risk
Clearing houses are Sometimes used in both futures markets and
115 OTC markets
Combination of two fixed floating currency a)
swaps to form a fixed to fixed currency swap Two fixed
is -
floating currency swaps are combined to form
116 a fixed to fixed currency
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 21
 swap, which is known as circus swap. It can be
created by combining a currency swap and
an interest rate swap with floating rate or both
having LIBOR pricing. Hence (a) is the
answer.
Company ‘A’ borrows $1 million for 5 years c)
at fixed rate of 12% and company ‘B’ The differential savings is 14%
borrows $1 million for 5 years at floating –
rate of LIBOR + 3.5% from the market. ‘A’ 12%
can also borrow at a floating rate of LIBOR + –
2.5% from the market and ‘B’ can also LIBOR + 2.5%
borrow at a fixed rate of 14% from the –
market. The two companies agree to a swap (LIBOR + 3.5%) = 1% which
in which ‘B’ would pay ‘A’ a fixed rate of can be divided equally by both the parties i.e.
13.5% and ‘A’ would pay ‘B’ a floating rate 0.5% each savings. So, A will be paying
of LIBOR + 3.5%. if ‘A’ and ‘B’ enter the swap LIBOR + 2.5%
contract, the effective interest ‘A’ would be –
117 paying each year 0.5% = LIBOR + 2%.
Company ‘A’ borrows $1 million for 5 years b)
at fixed rate of 12% and company ‘B’ B would be paying 14%
borrows $1 million for 5 years at floating –
rate of LIBOR + 3.5% from the market. ‘A’ 0.5% = 13.5%
can also borrow at a floating rate of LIBOR +
2.5% from the market and ‘B’ can also
borrow at a fixed rate of 14% from the
market. The two companies agree to a swap
in which ‘B’ would pay ‘A’ a fixed rate of
13.5% and ‘A’ would pay ‘B’ a floating rate
of LIBOR + 3.5%. The effective interest rate
118 ‘B’ would be paying each year
Company ‘A’ borrows $1 million for 5 years (a)
at fixed rate of 12% and company ‘B’ Each party stands to gain 0.5%
borrows $1 million for 5 years at floating
rate of LIBOR + 3.5% from the market. ‘A’
can also borrow at a floating rate of LIBOR +
2.5% from the market and ‘B’ can also
borrow at a fixed rate of 14% from the
market. The two companies agree to a swap
in which ‘B’ would pay ‘A’ a fixed rate of
13.5% and ‘A’ would pay ‘B’ a floating rate
of LIBOR + 3.5%. What does ‘B’ save by
doing the swap and not borrowing from the
119 market at 14%
Company ‘A’ borrows $1 million for 5 years (c)
at fixed rate of 12% and company ‘B’ Each party stands to gain 0.5%.
borrows $1 million for 5 years at floating
rate of LIBOR + 3.5% from the market. ‘A’
can also borrow at a floating rate of LIBOR +
2.5% from the market and ‘B’ can also
120 borrow at a fixed rate of 14% from the
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 22
 market. The two companies agree to a swap
in which ‘B’ would pay ‘A’ a fixed rate of
13.5% and ‘A’ would pay ‘B’ a floating rate
of LIBOR + 3.5%. What does ‘A’ save by
doing the Swap and not borrowing from the
market at LIBOR + 2.5% floating rate?
Consider a one year maturity call option and 6.23
a one year put option on the same stock,
both with striking price $45. If the risk-free
rate is 4%, the stock price is $48, and the put
sells for $1.50, what should be the price of
121 the call?
consider a one-year maturity call option and $6.23
one year put option on the same stock, both
with striking price $45. if the risk-free rate is
4%, the stock price is $48, and the put sell
for $1.50, what should be the price of the
122 call?
Consider the following information (e)
Company Objective T-bill rate Libor Total gain from swap = 2.5% bank’s share =
rate Alpha T-bill based funds T-bill + 2.5% 0.4 x 2.5%=1.00%. Gain to each party
Libor + 1.0% Beta Libor based funds T-bill + =0
0.5% Libor + 1.5% if a bank acts as an .75%. Hence, option “e” is correct.
intermediary for arranging swap between
Alpha and Beta, and if bank’s share is 40% of
the gain from swap, then gain to each party
if rest of the gain is shared equally between
123 them is
Consider the following information (e)
Company Objective T-bill rate Libor Max gain = (T
rate Alpha T-bill based funds T-bill + 2.5% -
Libor + 1.0% Beta Libor based funds T-bill + bill+2.5% ) + (Libor + 1.5%)
0.5% Libor + 1.5% Maximum possible gain –
from arranging swap between two parties is (T
-
bill + 0.5%)
–
(Libor + 1.0%)=2.5%
124 So the correct option is “e”.
Consider the following information. (e)
Company Objective Fixed Floating X Floating The cost of borrowing for X is lower than that
8% Libor Y Fixed 10% Libor + 1% Which of of Y in both fixed and floating markets.
the following statements is false? Therefore, X enjoys absolute advantage in
both the markets. The cost of funds for Y is
higher in fixed rate by 2% whereas the same is
higher by 1% in floating market
. This
advantage is known as comparative
advantage. Hence, Y has comparative
125 advantage in
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 23
 floating rate market. Therefore statements (a)
and (d) are true and statements (b) and (c) are
false. Hence (e) is the answer.
Consider the following information. (b)
Company Objective Fixed Floating X Floating 10%
8% Libor Y Fixed 10% Libor + 1%. The quality –
spread that exists is equal to 8% + LIBOR
–
(LIBOR
126 + 1%) = 1%
Cooling Degree Days (CDD) index is used to a)
measure warmth in The CDD index is used to measure warmth in
summer months. Higher the index,
warmer the day and vice
-
127 versa
Creation of exposures in the normal course a)
of business which offset the existing Exposure netting refers to creation of
exposures is called exposures in the normal course of business
which
offset the existing exposures.
Loading refers to advancing a payment and
hagging refers to postponing a payment.
Hedging refers to simultaneously buying and
setting exactly correlated assets. Therefore
128 (a) is the answer.
day value at risk is about _______ times the b)
9 day value at risk. 3
2
= 9 and 6
2
129 = 36. So, 6/3 = 2 times.
Derivatives are classified based on (e)
All the above mentioned options are the ways
130 of classifying derivatives.
Due to mark-to-market, profits and losses everyday
131 are settled at the end of
132 Economic exposure management ______ . both of the above
Effective Date is the date (c)
Effective date is the date when the initial fixed
and floating payments begin. It is also
133 called value date
Estimating the relation between changes in (b)
futures price and changes in the spot price According to the principle of delta hedging,
of the underlying asset relates to the changes in futures price and changes in
the spot price of the underlying asset can be
estimated. Here, Delta can be defined as the
ratio of the change in the price of the stock
option or futures contract to the change in the
134 price of the underlying asset.
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 24
 Example(s) of deferred delivery contract c)
is/are i. Futures contract ii. Option contract An option and forward contract can be termed
iii. Forward contract as deferred delivery contracts, because
they usually end up in the delivery of th
e underlying asset, unlike the future and
forward
contracts which end up in settlement of
135 differences.
Fair value is (a)
Fair value is defined as the amount at which
the asset can be bought or sold. Firm
commitment is an agreement legally
enforceable, specifying all significant terms.
Forecasted transaction gives no present rights
or obligations. An underlying is a specified
price or rate such as a stock price, interest
rate, currency rate, commodity price or
related
136 index. Hence (a) is the answer.
First currency futures was traded in (b)
Chicago Mercantile Exchange (CME) is the first
to introduce futures in 1972 in the
137 form of financial futures.
For a futures contract trading in April 2012, Higher
the open interest
for a June 2012 contract, when compared to
the open interest
138 for Sept 2012 contracts, is usually
For which of the following options, the time b)
value will be maximum? An option whose exercise price is equal to the
current spot price is said to be at
-
the
-
139 money and it has the highest time value.
Forward contracts are generally _________ OTC
140 in nature.
Futures contracts are preferred to forward High liquidity
contracts because
141 of_______
Futures contracts trade with every month as The July contract
a delivery month.
A company is hedging the purchase of the
underlying asset on
June 15. Which futures contract should it
142 use?
futures is not easy to understand. (b)
Index futures are obligations to deliver at
settlement, an amount equal to ‘x’ times the
143 stock index value on the expiration day of the
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 25
 contract at the price at which the contract was
struck. Given the fact that the index value is
widely understood,
it is easier to understand
the index futures as compared to options.
Given N(d) = 0.5080 and N(d) = 0.3707,the a)
hedge ratio is The hedge ratio is N(d
1
144 )
Given that riskless portfolio can be (a)
constructed by combining 202 long calls The gives portfolio is a riskless portfolio.
with a short position of 100 units of The value of the long calls = Value of the
underlying asset. Which of the following underlying assets.
statements is is 2.02. No. of long calls x Unit price = No. of
underlying assets x Unit price.
202 x Unit price = 100 x Unit price
Unit Price of long call 100
=
Unit
Price of underlying 202
145 Hedge ratio or Delta = 0.4950.
Going long on a currency and short on a call (b)
option results in the pay-off profile of a The type of option mentioned here is synthetic
put option. A short call option when
combined with a long position in the asset
(here currency), it results in a synthetic short
put
option. i.e., it results in the pay
-
off of a put option writer. Therefore
(b) is the correct
146 answer.
Going long on currency and long on a put put option buyer
147 option results in the payoff profile of a
Going long on currency and long on put c)
option results in the pay off profile of The type of option mentioned here is
Synthetic call option. A long put option when
combined with a short position in the asset
(here currency), it results in a synthetic long
cal
l
option. i.e., it results in the pay
-
off of a call option buyer. Therefore (c) is the
correct
148 answer.
Going short on a currency and long on a call (a)
option results in the pay The type of option mentioned here is synthetic
put option. A long call option when
149 combined with a short position in the asset
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 26
 (here currency), it results in a synthetic long
put
option. i.e., it results in the pay
-
off of a put option buyer. Therefore (a) is the
correct
answer.
Going short on a currency and long on a call Call option buyer
150 option results in the pay off profile of a
going short on a currency and long on a call put option buyers
151 option results in the pay-off profile of a
Heating Degree Days (HDD) index is used to a)
measure cold waves in The HDD index is used to measure c
old waves during winter months. Higher the
index,
colder the day and vice
-
152 versa.
High volume trading in a futures contract b)
indicates High volume in any exchange implies the
existence of a large number of buyers and
153 sellers in the market.
Higher the volatility of the price of d)
underlying asset, higher would be the price Both the options given under (b) and (c) are
of true. A higher volatility of the price of
underlying asset results in higher values of
both ca
154 ll and put options.
How many different paths are there through 12
a Cox-Ross-Rubinstein
155 tree with four-steps?
How many nodes are there at the end of a 5
Cox-Ross-Rubinstein
156 five-step binomial tree?
Hybrid debt instruments can be tied up with (e)
Hybrid debt instruments are debt securities
combined with any other type of derivatives.
They can be tied to any of the markets
157 mentioned above.
identify the correct statement e)
The interest rate on convertible debentures or
debentures with warrants tends to be
lower than in the case of simple debentures,
because simple debentures do not carry the
option of earning more in future when the
conversion takes place into shares. A call
option
is an option given by the writer to the buyer of
the option to purchase from him the
158 underlying asset. As such, it cannot be
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 27
 a negative amount. Equity shareholders carry
the
risks of the firm as they are the true owners. If
the risk of the firm cannot be assessed
accurately, investment in debentures is a wiser
step, as they carry a fixed rate of interest that
Identify the FALSE statement amount (b)
The degree of risk present in a particular
situation depends on the nature of the
situation
and the need not be an absolute or
independent amount but will depend on the
type of risk
159 and the gravity of the situation.
if A and B enter the swap contract, the LIBOR +2%
effective interest A would be paying each
160 year
If a bank enters into a swap with an offering (c)
company, without finding a counterparty to Warehousing means to enter into a swap with
the swap and hedge the interest risk is one counterparty by the bank, then
known as hedging the interest rate risk until a
counterparty wanting to take an opposite
position is
161 found.
If a company expects the coming month to (e)
be hot, it can If a company expects the coming month to be
hot, it should either sell CDD indices in
summer or buy the HDD indices in winter.
162 Hence (e) is the answer.
if a days average temperature is 40 F, then (b)
the Cooling Degree Days (CDD) index is The temperature is taken as 0 if it
is below 65
o
163 under the CDD
if a foreign currency depreciates, exchange receipts are greater than exposed payments
164 losses will occur when exposed
If a related commodity on which a future is e)
traded is used for hedging an asset on which This is mostly used by those companies that
no futures contract is traded it is called a want to hedge their future positions on
commodities on which there is no futures
contract being traded. E.g.: Air
-
line fuel futures
contracts are not traded. In order to hedge the
position, an airline company
may have to use
future contracts of gasoline, crude oil or
165 heating oil for the hedging

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 28

 If an investor is long on a call option at a b)
strike price of Rs.400, he will make profit The investor will make profits when the price
only when the stock price is is above Rs.400, since it is a call option.
In case of a call option, a trader makes profi
t if the current stock price is more than the
166 exercise price.
If an investor wants to trade in forwards A broker
167 contract he can do so through/with
If annualized volatility of an asset is 15%, d)
then daily volatility is (Assume 250 working 15%/
168 days in a year) 250= 0.9487%
If at the time making a contract, no Forward Premium contract
transaction is recorded in the books because
delivery and payment are yet to take place,
169 the transaction is called as a/an
If c and C represent prices of European and a)
American call options and S represents the The call option of an American option is
current stock price, then usually equal or lower
than the underlying
170 stock price.
If in an interest rate swap, interest rate risks c)
can be shifted by converting a floating rate Amortizing swaps are useful for managing the
liability to a fixed rate liability, then it is associated interest rate risk arising from
called Coaster swap mortgage loans. Accreting swaps can be used
to convert floating rate payments into fixed
rate payments if the principal amount
increases every time additional loan is availed.
Roller
coaster swap can be used to shift the interest
rate risk by converting a
floating rate liability
to a fixed rate liability, or vice versa. In an
extendible swap, the fixed rate payer gets the
right to extend the swap maturity date. Hence
171 (c) is the answer.
If the average daily price change is Rs.25 and (a)
the standard deviation of the price changes Rs.25 x 100 + 3 x Rs.3 x 100 = Rs.3,400.00.
is Rs.3.00, the initial margin will be ______.
Assume that there are 100 units per
172 contract.
if the condition is such that the forward sell forward contract
price is more than the spot price which
173 strategy is best
If the mean value of an asset is Rs.100 and b)
its standard deviation is 3, then If the distance from the mean is 2 Standard
Deviations, then the 95.5% of values are
contained within (100 + 2 x 3) and (100
–
174 2 x 3), i.e., 106 and 94

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 29

 If the previous day payment date and 0.5
forthcoming fixed day payment date are
04/09/2014 and 04/03/2015 then fixed day
175 count fraction is calculated as
If the previous fixed day payment date and (d)
forthcoming fixed day payment date are Fixed day count can be calculated under the
01.02.2001 and 01.08.2001, then fixed day Actual/360 convention. Here, the previous
count fraction will be fixed day payment date is included and the
forthcoming fixed payment date is excluded.
Hence total number = 28 + 31 + 30 + 31 + 30 +
176 31 = 181/360.
If the previous fixed day payment date and c)
forthcoming fixed day payment date are Here 30/360 convention is used. (27 + 30 x 5
04/09/1999 and 04/03/2000 then fixed day +3) /360 = 0.5.
177 count fraction is calculated as
if the transaction costs are ignored, being short on forward
simultaneous sale of a call and purchase of
put at same strike price and expiry gives a
178 pay-off profile identical to
if the transaction costs are ignored, selling a put option
simultaneous sale of a call and purchase of
put at same strike price and expiry gives a
179 pay-off profile identification
If the value of the option is zero on the e)
expiry date, then All the statements given above are true and
self
-
explanatory. The action is opposite for
180 call and put options
If the volatility per trading day of a stock is (c)
given by 1.5 and if the number of trading 225x1.5
181 days is 225 then the volatility per annum is = 15 x 1.5 = 22.5.
If you are an exporter expecting to receive c)
$1,00,000 after three months, you can Whenever there is a foreign currency
hedge by receivable, a put option should be bought,
because
it gives the option buyer a right to sell the
underlying asset at a predetermined price, so
that
he is not affected even if the exchange rates
182 move adversely. Thus (c) is the right answer.
If you are an Indian importer, needing to (a)
remit $1,000,000 after three months, you Whenever there is a foreign currency payable,
can hedge exposure by a call option should be bought, because it
gives the option buyer a right to buy the
underlying asset at a predetermined price, so
that
he is not affected even if the exchange rates
183 move adversely. Thus (a) is the right answer.

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 30

 If, at the time of making a contract, no (d)
transaction is recorded in the books because A forward contract is an agreement to buy or
delivery and payment are yet to take place, sell an asset at a certain future time and
the transaction is called as a/an future price, which can be at premium,
discount or par. It is not normally traded in the
exchange. Under this both delivery and
payment take place at
184 future date.
In a put swaption a)
In a put swaption the buyer is a floating rate
185 payer.
In a standard normal distribution _______ of (c)
the values are contained within plus or The Normal Distribution is a be
minus 2 standard deviations of mean. ll
-
shaped perfectly symmetrical distribution and
has the
following characteristics:
Standard Deviation from Mean Confidence
Level
1 68.3%
1.65 90.0%
2 95.5%
3 99.7%
186 Hence (c) is the answer.
In an extendible swap e)
In an extendible swap, the floating rate payer
gets the right to extend the swap maturity
date. If the interest rates rise and are expected
to rise further then such an extendible swap
works to the advantage of the fixed rate payer
since h
e is required to pay less than the
187 current rates. Hence (e) is the answer.
In case of buying the call options, the loss the total investment made in the call option
188 incurred will be equal to contract
In case of futures contract by marking to unaffected
189 market the value of contract
In future the guarantee to fulfill the contract The buyer of the futures contract
190 is given by
In futures contract tick size refers to b)
The minimum price change in the exchange is
called ‘tick’. It varies from currency to
191 currency.
In futures the guarantee to fulfill the (d)
contract is given by The clearing corporation which could be a
separate institution or part of the stock
exchange clears all the transactions
undertaken in the respective exchange and
192 settles the
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 31
 amount due to or from the members. As such,
it takes the guarantee to ensure that the
contracts are fulfilled.
In futures trading, the margin is to be c)
deposited by Every member has to deposit margins with the
exchange, whether he is buying or
193 selling.
In Monte Carlo Simulation techniques VaR is a)
calculated as The result of Monte Carlo Simulations is a
random distribution o
f market prices or
rates, on which a cut
-
off point has to be assumed as the confidence
level. The difference
between the cut
-
off point and the current value of the portfolio
is the VAR. hence (a) is the
194 answer.
In non acceptable risks (c)
Non
-
acceptable risks are those major risks that may
affect the profitability or even
standing of the company. These risks have
195 potential for major losses
In options ‘out-trades’ are referred to as c)
In order to have a trade the bid and ask prices
must match. In case there are unmatched
trades due to difference in price or volume or
196 demand, unmatched trades take place
In the corn futures contract a number of This flexibility tends decrease the futures price
different types of
corn can be delivered (with price
adjustments specified by the
exchange) and there are a number of
different delivery locations.
197 Which of the following is true
In which of the following contracts will there a)
be no need to prove the insurable interest? It is not required as there is always an interest
of the parents to protect their children
198 from any kind of accidents
In which of the following convention the e)
actual number of days are counted between Under the Actual/360 convention, the actual
previous fixed day payment date and number of days is counted between
forthcoming fixed day payment date, previous fixed day payment date and
including previous fixed date and excluding forthcoming fixed day payment date, including
forthcoming fixed day? previous fixed date and excluding f
199 orthcoming fixed date. Actual/365 is also
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 32
 similar to
Actual/360, but the denominator is taken as
365. Hence (e) is the answer.
In which of the following forms can d)
members of an exchange maintain the All the options given above represent the
margin relating to transactions in futures? methods in which the members can keep their
margin relating to transactions in the futures
200 market.
In which of the following futures contracts, (e)
the holding cost can be negative? Holding costs can be either 0 or a positive
number which is the cost of holding the
201 stock. Negative costs are usually not there.
in which option does the buyer get the right American option
to buy the underlying asset any time during
202 the contract period?
In which option does the buyer get the right (a)
to buy the underlying asset? A call option is an option given to the buyer to
203 purchase the underlying asset.
Initial margin is also referred to as (c)
The initial margin is also known as the
performance margin as it is kept with the
exchange till the completion of all the
obligations of the contract are fulfilled or as
long as
204 the investor wants to trade in the market.
Insurance is a _________ technique for (e)
managing risk. Insurance is a method of risk transfer, under
which a third party (an insurance company)
is arranged to pay for the losses if they occur.
This is also referred to as risk financing.
205 Therefore answer is (e).
Insurance policy for vehicles covering third (c)
party risk is a ________ technique for An insurance policy for vehicles covering third
managing risk. party loses. Under this, payment is made
to the third party without actually transferring
the risk is a transfer technique for managing
the risk without actual transfer of the asset or
206 liability to the third party.
Insuring one’s business covers the (a)
Pure risks are those risks whose outcome can
only be a loss. Insurance policy covers
207 only losses, and thus, pure risks.
Logistics Manager may expose a firm to (a)
Logistics means the careful organization of
complex busi
ness activities so that they
happen in a successful and effective way.
Logistics managers may expose the firm to
price
208 risks when they fix the input prices or agree to
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 33
 a specific input
-
price adjustment clause.
Long strangle strategy involves d)
A strangle is a combination of a call and put
with the same expiration date and different
strike prices. Under a long strangle, a call and
put options are bought on a particular
underlying asset with different strike prices
and same expiration period. The exercise price
of the call is higher than that of put. Thus (d) is
209 the correct alternative.
Maintaining a delta-neutral portfolio is an Dynamic hedging
example of which
210 of the following
211 Margin accounts have the effect of All of the above
Margins are imposed on the writers of the e)
option to provide immunity to Immunity can be provided to all the parties
mentioned above by putting margins in
212 options trades.
Minimum tick size of a weather derivative in a)
CME is Minimum tick size of a weather derivative
(futures or options) in CME is 1 degree
-
day
213 index point ($100).
Ms. Priya has bought a call option on MTNL (c)
at strike price of Rs.175 by paying premium Rs.185
of Rs.10. She is short on a call option on –
MTNL at a strike price of Rs.185 for Rs.6. Rs.6 = Rs.179 or Rs.175 + Rs.10
Calculate at what price of MTNL, Ms. Priya’s –
214 position will break even. Rs.6 = Rs.179.
off profile of a ‘fence’ strategy is equivalent d)
to that of a A fence involves buying a call option at a
higher strike price and selling a put option at
a lower strike price simultaneously. The
hedger will be protected from any rise in the
underlying asset since he will exercise his call.
The pay
-
off of a fence is similar to a bull
215 spread.
On March 1 a commodity’s spot price is $60 59.5
and its August
futures price is $59. On July 1 the spot price
is $64 and the
August futures price is $63.50. A company
entered into futures
contracts on March 1 to hedge its purchase
216 of the commodity
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 34
 on July 1. It closed out its position on July 1.
What is the
effective price (after taking account of
hedging) paid by the
company?
On March 1 the price of a commodity is 1014
$1,000 and the
December futures price is $1,015. On
November 1 the price
is $980 and the December futures price is
$981. A producer of
the commodity entered into a December
futures contracts on
March 1 to hedge the sale of the commodity
on November 1.
It closed out its position on November 1.
What is the effective
price (aft er taking account of hedging)
received by the company
217 for the commodity?
One basis point is equal to c)
1 basis point is one hundredth of 1% or one
218 thousandth of 10%.
One futures contract is traded where both Decrease by one
the long and short
parties are closing out existing positions.
What is the resultant
219 change in the open interest?
One of the following is a substitute for (d)
physical delivery while settling futures Normally, in the futures exchange, physical
obligation. delivery is not done and instead cash
payments at the time of expiration of the
contract are done to settle any gain or loss,
without taking delivery. Therefore alternative
220 (d) is the answer.
221 options are traded in Exchanges as well as OTC
Options/Futures are __________ techniques b)
for managing risk. Through options/futures, one can finance
one’s risk by hedging the position before the
222 risk takes place
Plain vanilla interest rate swaps involved (b) Plain vanilla swaps are those which swaps
where fixed rate obligations are exchanged for
floating rate obligations over a specific period
of time on a notional principal. Hence (b) is
223 the answer
Pure risks are the type of (c)
Static risks are those risks that do not depend
on various scenarios. Pure risks a
224 re types of static risks.

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 35

 Put call parity theorem states that b)
According to put
-
call parity, P = C + Xe
-
rt
–
225 S
Quality spread exists because of (e)
Quality spread is the difference between the
borrowing power of two parties in the
market. This difference in t
he interest rates arises because of the
difference in credit ratings
of the two firms, market saturation and
financial leverage of a firm. Thus (e) is the
226 answer.
risk at the minimal level. (d)
The main aim of risk management is to
maintain the risk level at an acceptable level
that
need not always be th
227 e minimum.
Risk can be defined as (b) Risk is the possibility that the actual
outcome may be different from the expected
outcome. So variance in the value of assets,
liabilities and operating income due to
228 unanticipated changes in some factors is risk.
Risk included (d)
Certain losses are not included in risk because
risk includes uncertainty whereas in
certain losses there is no uncertainty.
Therefore both statements (a) and (b) are
true. Thus
229 the answer is (d).
Risk of the assets of a firm being readily (b)
marketable is called Marketable or marketability risk is the risk of
the assets of the firm not being readily
marketable, whenever there is an urgent need
for funds. The non
-
marketability may lead to
liquidity risk. Marketing risks can also take
place because of selling at lower than
expected
prices due to existence of competition, change
230 in fashion or taste of the consumers, etc
Risk grades is a b)
231 Risk Grades is a da

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 36

 ta engine for risk management developed by J
P Morgan
Risk metrics consists of d)
Risk metrics employs a comprehensive set of
daily re
-
estimated volatilities and
correlations across a broad range of
instruments as input to estimate market risks.
It
consists of all the given parts. Hence (d) is the
232 answer.
s1 and f1 represent spot and future prices at a)
time t1 and s2 and f2 represent spot and If the basis has strengthened between time t
future prices at time t2. if the basis has 1
strengthened between time t1 and t2 and t
(t1<t2), then 2
, the spot price S
2
and the futures
price F
2
are bound to be greater than the spot price S
1
and the futures price F
1
. The
difference between F
2
and F
1
is equal to the difference between S
2
and S
1
, in order to attain
an equilibrium position between the futures
and the spot
233 prices.
Since the 2008 credit crisis OIS has replaced LIBOR as the discount rate for
234 swaps
Speculation on derivatives is an integral part c)
of ___________. Speculation on derivatives is a way of earning
profits and of maintaining the prices of
the derivative instruments under control, so it
can be termed as a treasury function
235 .
236 Speculators in currency futures markets are: greatly exposed to exchange rate risk

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 37

 Standardization of futures contracts in case (e)
of commodities is/are in terms of All the options mentioned above are the
237 standard features of a futures contract.
Stochastic process d)
A reasonably strict definition of this (also
called a random process) is a family of
random variables indexed by t, where t
belongs to some index set T (which may
denote
time, space, or whatever else one wishes). A
more intuitive definition might call this the set
of all possible outcomes of an experiment (this
set also being called the ensemble)
inherently involving some degree of
randomness along with the mechanism by
which
individual outcomes, or realizations, selected.
Thus, it includes both (b) and (c). Therefore
238 answer is (d).
Suppose a June call option on a stock X is (b)
currently trading at Rs.31 with a strike price A call option is said to be out
Rs.35. On the expiration date the price of -
the stock is Rs.32. Then, which of the of
following -
the
-
money when the strike price is above the spot
price
239 of the underlying asset.
Suppose a put option has an underlying c)
asset of Rs.102 and the exercise price is If the put is exercised, the value of the put will
Rs.100. What will be the value of the put in be 0, as nothing will be received by way
the following cases? i. If the put is exercised of premium. If the stock is trading at Rs.100,
ii. If the stock trades at Rs.100 iii. If the stock the put value will be 0 as it will not be
trades at Rs.94. exercised. If the stock trades at Rs.94, the
value of the put will be Rs.(100
–
240 94) = Rs.6.
Suppose that the standard deviation of 0.6
monthly changes in
the price of commodity A is $2. The
standard deviation of
monthly changes in a futures price for a
contract on commodity
B (which is similar to commodity A) is $3.
The correlation
between the futures price and the
commodity price is 0.9.
241 What hedge ratio should be used when

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 38

 hedging a one month
exposure to the price of commodity A?
Suppose the price of a share of Google stock increased to $506
is $500. An April call option on Google stock
has a premium of $5 and an exercise price of
$500. Ignoring commission, the holder of
the call option will earn a profit if the price
242 of the share
Swap coupon is the (c)
Swap coupon is the fixed rate of interest on
243 the swap
Synthetic long put can be created by which (c)
of the following combinations? A synthetic long put can be created by
purchasing a long call option and going short
on
244 the underlying asset.
Temperature derivatives are traded in c)
Chicago Mercantile Exchange in multiples of In CME, the temperature derivatives are
245 traded in multiples of $100
The basis is defined as spot minus futures. A The hedger’s position improves
trader is hedging the sale of an asset with a
short futures position. The basis increases
unexpectedly. Which of the following is
246 true?
The chapter discusses an alternative to the None of the above
Cox, Ross, Rubinstein tree. In this
247 alternative, which of the following are true:
The risk-free rate is 5% and the dividend The futures price of the S&P 500 is treated like
yield on the S&P 500 index is 2%. Which of a stock
the following is correct when a futures paying a dividend yield of 5%.
248 option on the index is being valued?
The spot price of an asset is positively The forward price is less than the expected
correlated with the market. Which of the future spot price
249 following would you expect to be true?
The spot price of an investment asset is $30 35.84
and the risk-free rate for all maturities is
10% with continuous compounding. The
asset provides an income of $2 at the end of
the first year and at the end of the second
250 year. What is the three-year forward price?
The spot price of an investment asset that 40.5
provides no income is $30 and the risk-free
rate for all maturities (with continuous
compounding) is 10%. What is the three-
251 year forward price?
The above graph represents pay off profile (a)
for a Alternative (a) is correct, since in the case of a
call option, the trader makes a profit
whenever the current stock price is greater
252 than the exercise price. The graph shows that
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 39
 th
e
upside potential associated with the strategy
is unlimited. Therefore, it represents the pay
-
off of long call option. Also, if X is the strike
price and S
T
is the final price of the
underlying asset, the pay
-
off from a long position in a European cal
l option is max (S
T
–
X,
0). i.e., the option will be exercised if S
T
> X and it will not be exercised if S
T
< X.
The above graph represents pay off profile (b)
for a Alternative (b) is correct, in the case of a call
option, the trader makes a profit whenever
the current stock price is greater than the
exercise price and since the graph shows that
the
downside risk is unlimited, it represents a
short
-
call position. Also, if X is the strike price
and S
T
is the final price of the underlying asset, the
pay
-
off from a long position in a
European c
all option is
–
max (S
T
–
X, 0) or
–
min (X
–
S
T
253 , 0). i.e., the option will be
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 40
 exercised if S
T
< X and it will not be exercised if S
T
> X.
The above graph represents pay off profile (a)
for a Alternative (a) is correct, because the pay
-
off to the holder of a long position in a
European put
option is max(X
–
S
T
254 , 0).
The above graph represents pay off profile (b)
for a Alternative (b) is correct, because the pay
-
off to the holder of a short position in a
European put option is
–
max(X
–
S
T
, 0) or min(S
T
–
255 X, 0).
The aim of risk management is to (d)
Unsystematic risk is the risk pertaining to the
individual company. Corporate risk
management is
the science of identifying such risks, managing
to keep them to the
minimum with minimum costs of
256 management.
The assets that can be delivered against a d)
futures contract are called Most of the contracts in the futures market
end up in settlement by either cash delivery
or any other method, without resorting to
physical delivery. Very few assets that are
carried
forward for delivery are known as deliverable
257 assets.
The Beta (β) c-efficient is measured by (e)
Beta (
β
) measures the non
258 -
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 41
 diversifiable risk in relation to the market
portfolio. Non
-
diversifiable risk is also known as market risk
or systematic risk, so options (a), (b) and (c)
are correct. Hence (e) is the answer.
The beta of a portfolio is 1.1. The investor (e)
who holds this portfolio foresees a bearish The investor can follow all the ways given
phase for the market in the short run and for controlling beta by using stock index
wants to reduce the beta of the portfolio to futures. The product of the beta and the value
0.6. Which of the following strategies can be of futures on the stock give the position
adopted for achieving the desired level of taken. This when compared with the exposure
beta? i. Sell a part of the equity portfolio will give profit or loss to the investor
and invest the proceeds in debentures. ii.
Sell high beta stocks and buy low beta
259 stocks. iii. Short sell high beta stocks.
The binomial option-pricing model uses a)
________ time whereas the Black Scholes The binomial option
model uses _________ time and further -
assumes that the underlying asset’s volatility pricing model uses discrete time whereas the
is_______ and that _______ computational Black
methods are used to derive the option -
prices. Scholes model
uses continuous time and further assumes
that the underlying asset’s volatility is
constant
and that closed
-
form
computational methods are used to derive the
option price. Hence, the
260 answer choice (a) is correct.
The call option delta is b)
The Delta of a call option has an upper bound
261 of 1 and a lower bound of ‘0’
The cash price of a ton rice on January 1, (e)
2000 was Rs.1,500. The annualized Settlement price = 1500 + 1500 x 0.12x (10/12)
borrowing rate on the same day was 12%. + 50 x 10 = 2150. Therefore, answer is (e).
The cost of storing the rice is Rs.50 per
month. Calculate the following with the help
of the above information. What is the
settlement price of November 1, 2000 rice
262 futures contract?
The change of an option’s price with respect (a)
to change in the price of the underlying The statement given under (a) is the definition
263 asset is of delta.
The concept of Value at Risk (VaR) is closely (e)
linked to concepts of VaR is a proba
bilistic statistical measure to know the level of
264 risk in numerical terms. It
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 42
 involves the normal distribution curve, which
is based on the mean and the standard
deviations from the mea
The costs, which are incurred to take (a)
precautions and limits on the chances of Loss control costs are the increased
recurrence of risks is called precautions and limits on the risk activities in
order
to reduce the chances of recurrence of the
265 risks.
The date on which the interest accrual stops (d)
266 is called On maturity date the interest accrual stops.
The date on which the parties agree to swap (a)
is called It can also be defined as the date in which the
267 parties enter into the swap.
The Derivative Financial Instruments (DFI) (e)
include Derivative Financial Instruments (DFIs) include
Option contracts, Interest rate caps,
Interest rate floors, Fixed
-
rate loan commitments, Note issuance
facilities, Letters of credit,
Forward contracts, Forward rate agreements,
Interest rate collars, Futures and Swaps. DFIs
exclude Mortgage
-
backed securities, Interest only obligations,
Principal only obligations
and Indexed obligations. Hence (e) is the
268 answer.
The determinants of the option values is/are (e)
All the options given above are determinants
of option values as evident in Black
269 Scholes model.
The distance between the actual price of the (e)
warrant and its lower limit is a function of The price difference between the actual price
which of the following factors? of the warrant and the price of issue
depends on the following factors: The variance
in the returns that are earned in the stock
price, the time to expiration of the warrant
and the risk
-
free rate of interest or the rate at
which the government securities are being
offered to the public(c) Depending on these
factors the warrant will command a price in
270 the market.
the effective interest 'B' would be paying 13.5
271 each year.
The firm producing and selling in domestic (a)
272 market may face _______ risk when the Operating risk may be increased for a
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 43
 domestically operating country when the
economy is opened up to foreign multinational
companies.
The first contract on weather derivatives in e)
the Chicago Mercantile exchange was The first transaction on weather derivatives
executed by took place in 1997 in the CME and was
executed by Aquila Energy of the USA as a
weather option embedded in a power
273 contract.
The frequency with which margin accounts Daily
are adjusted for
274 gains and losses is
The Internal/Intrafirm factors, which (d)
contribute to the growth of Financial Intra
Engineer are: i. Agency Costs. ii. Accounting -
Benefits. iii. Tax Asymmetries. iv. firm factors include liquidity needs, risk
Quantitative sophistication aversion among managers and owners,
agency costs, greater levels of quantitative
sophistication among investment managers,
and
more formal training of senior level personnel.
275 Tax asymmetries is an environmental factor.
The inverse floating rate note issued by (c)
Sallie Mae in 1986 was a hybrid to manage As the interest rates were falling in the US,
Sallie Mae, in 1986 introduced an inverse
276 floating rate note to hedge the risks.
The job of a Risk Manager involves (e)A risk manager is an expert appointed in
identification of order to identify the nature of the expected
risks, the remedial measures available to
manage the expected risks thus identified and
to compute the costs of managing the
identified risks, in order to ensure that the
cost of managing the risk is not higher than
the possible costs to be incurred in case of
277 loss.
The lifetime high and low figures in the the highest and lowest prices for each contract
278 currency futures quotation table mean month during its life time
The major difference between exchange (c)
traded and OTC derivatives is in respect to The credit risk on OTC derivatives is more than
on the exchange traded ones, as the
transactions are ad hoc and not legalized.
There is no intermediary or clearing agent
between the two parties and this may lead to
increased credit risks. The products of the beta
and the value of
futures on the stock gives the position taken.
This when compared with the
exposure will give profit or loss to the
279 investor.

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 44

 The major takers of weather derivatives in d)
USA is/are Till date, the major takers of weather
derivatives in US are the utility companies, as
compared to the agro
-
280 based companies
The margin deposited with the broker as a (b)
replenishment is referred to as As the price of the futures contract changes,
gains or losses accrue to the holder of the
contract. The gains or losses are credited or
debited to the margin account. If the price
movements are adverse, the balance in the
account falls. In these circumstances, the
trader
is required to replenish the margin, bringing it
on par with the initial
value whenever the
level or value of funds on deposit with the
broker, reach a certain level. This level is
referred to as the maintenance margin. The
additional amount, which the trader deposits
with the brokerage firm, is called the
281 “Variation Margin”.
The margin paid on long positions is ______. e)
The statement given under (e) is true and is
self
-
282 explanatory.
The market in which the futures price is b)
greater than the cash price is referred to as When the futures prices obtained by full
-
carry relationship are accurately projected, the
basis becomes negative, and the futures price
becomes higher than the cash price. This is
283 known as contango.
The mechanism for determining transaction (c)
prices in futures markets involves: Transaction prices are set in the futures
market by the ‘open outcry’. In open outcry
the
futures brokers seek the highest selling prices
or the lowest buying prices available from all
other brokers in the market at the time. With
this process only the lowest buy prices and
highest sell prices are matched. Hence, the
answer choice (c)
284 is correct.
the minimum margin which a customer maintenance margin
must maintain with the member at all times
285 is known as

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 45

 The minimum size of price movement which (e)
is specified by the London International Tick is the minimum price fluctuation of the
Financial Futures Exchange (LIFFE) is also exchange.
286 known as a/an
The multiple attached with Nifty index (d)
futures S&P CNX Nifty futures have a multiple of 200.
287 Therefore, the answer is “d”
The number of option contracts traded on a d)
company’s stock in an exchange has the The number of shares of a company traded on
following effect: the sto
ck exchange do not affect the
288 company’s performance in any way
The objective function of the risk (e)
management policy of a banking firm is to A banking always tries to minimize its
exposures by matching the price of the
borrowings and lendings, matching the
maturities of various deals to avoid maturity
mismatch and forecast interest rate
movements to reduce the foreign exchange
risks. It is to
be noted that risk cannot be eliminat
289 ed but can be minimized.
The optimal hedge ratio for hedging with (c)
futures will be equal to 1.0 when i. There is In a perfectly positive correlation with an
perfect positive correlation between the equal standard deviation in the changes of
changes in the values of the futures and the values of the asset in the cash and future
assets hedged. ii. There is perfect negative market, the hedge ratio will be 1.00.
correlation between the changes in the
values of the futures and iii. The standard
deviation of the changes in values of the
asset and the futures are equal. iv. The
standard deviation of the changes in values
290 of the asset and the futures are unequal.
The pay off profile of a butterfly spread is a)
A short butterfly is V shaped and a long
291 butterfly is inverse V shaped.
The potential for loss for a put option writer c)
is The maximum loss to the put writer
(seller) is limited to the put option seller loses
if
market price is less than exercise price
difference between the price at which the put
writer
is forced to buy the stock and the market price
at which he could have bought it otherwise
292 stock price at the time of exercise.
The price of a commodity future is quoted (d)
as This is the correct way of reading the futures
quotations as given in the newspapers.
293 1
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 46
 247
4is the opening price on a particular day and it
is not the closing price of the previous
day. 248 is the settlement price on a particular
day. Hence (d) is the answer.
The process of earning abnormal risk by (a)
trading simultaneously in the spot and The statement is the definition of arbitrage in
294 futures market is called the futures market.
The rationale behind the concept of (c) Many a time, when an innovation is
“Financial Engineering” is ________. effected, the market participants face a lot of
difficulty in adapting themselves to these
changing situations. This necessitated a
process to aid the market participants to react
effectively to the changing scenarios. Thus,
295 evolved the concept of financial engineering.
The risks present in the OTC derivatives are (d)
OTC derivatives are not traded in any market
and as such do not come under any
regulatory norms of the stock exchanges. The
risks involved depend on both the parties to
the contract and the chances of high credit risk
296 and counterparty risk of default are present
The selection of suit able methods for risk (d)
management depends upon which of the Methods for risk management depend on
following? various factors. The amount the firm can
afford to spend for risk management, the
degree or extent of risk that is acceptable t
o the
firm, the future outlook of the business, the
297 level of operations of the firm, etc
The seller of an option has: Unlimited liability and limited opportunity for
298 gain
The spot price of ITC is Rs.910. An exchange c)
is trading the following option contracts. In a long strangle, the investor buys a c
all at X
1
and a put at X
2
, in such a way
that X
1
>X
2
299 .
The steps to be undertaken for measuring e)
VaR is/are All the statements given above are the steps
to be taken to measure VaR and are self
-
300 explanatory

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 47

 the stock of X ltd is currently quoted in the 32.08
market at Rs. 195. The company has
declared a dividend of Rs. 8 per share
recently, which will be distributed to the
shareholders after two months. The
volatility of X's stock price is 15% annually.
The Rf rate prevailing bin the economy is
6%p.a. By using black-scholes option
valuation model,______is the price of 6
month put option on the company's stock at
301 an exercise price of Rs. 225.
The strategy of buying an option and selling a)
another option of the same type and time to Under a vertical spread strategy, an option is
expiration but with different exercise price is bought and simultaneously another option
known as is sold. Both the options have the same time
to expiration but different exercise prices.
There are two types of vertical spread: Bull
spread and Bear spread. Under Bull spread, an
option with a lower strike price is bought and
an option with a higher
strike price is sold. Under a bear spread, an
option with a lower strike price is sold and an
option with a higher
302 strike price is bought.
the theory of purchasing power parity says the exchange rate will adjust to reflect
303 that changes in the price levels of two countries
The theta of an option is defined at the rate (c)
of change of The statement given under (c) is the definition
304 of Theta.
The value of a call option e)
All the statements given above are true and
refer to chapter “Sensitivity of Option
305 Premium”
The value of a put option at the time of (a)
expiration is The value of a put option at expiration should
be max (0, E
–
S) where E is the exercise
price and S is the underlying price of the stock
306 at expiration.
The value of an option (b)
The longer the time to maturity, the greater
the opportunity, so the higher the price of
307 the option
the value of forward contract at the time it Zero
308 is first entered is
the value of the forward contract at the both a & c
309 time it is first entered is
The writer of a call swaption is the (e)
310 A call swaption gives the buyer the fight to
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 48
 enter into a swap as a fixed rate payer. The
writer of the call swaptions are floating rate
payer if the option is exercised. Hence (e) is
the
answer.
The writer of the option is also known as a (c)
311 The seller of an option is also know as writer.
the yeild on treasury bill with a maturity is option expiration
classified as risk free rate and must be equal
312 to
There is a put option on a stock trading at d)
Rs.2 its strike price is Rs.35. What would be For a put option, the premium is directly
the price of the put option with a strike proportional to the strike price. If the strike
price of Rs.34 price decreases, the premium also de
313 creases. In this case it will be less than Rs.2.
To change the beta of a portfolio from to (b)
β Option (b) is the formula to be used for the
to change of the beta of a portfolio from
β β
using futures, where S is the spot price of to
the index and F is the futures price, and β
β * using futures, where S is
> the spot price and F is the futures price.
β
314 *,
Top Flight Stock currently sells for $53. A 11.97
one-year call option with strike price of $58
sells for $10, and the risk free interest rate is
5.5%. What is the price of a one-year put
315 with strike price of $58?
316 trading in "exotic options" takes place in the over the counter market
317 trading in exotic option takes place on the new york exchanged
318 transaction costs are relatively same for spot and forward transaction
using the black scholes model,_____is the 24.89
value the following call option for the
following data. stock price rs,210, srike price
rs. 220 time to expiration 167days. risk free
interest rate 10% variance of annual stock
319 returns 20%
Value at Risk (VaR) able to the management d)
As VaR is a numerical measure of the risk level,
it can be used to lay down the policy
for the level of overall risk that is acceptable to
the management. VaR cannot be used to
measure event risk or even the risk to the
business under extreme market conditions,
because it is difficult to model risk under such
320 conditions.

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 49

 Value of a futures contract equals (d)
The value of a futures contract is Price/Unit x
321 No. of Commodity units.
Value of an off market swap can be d)
When the market rates change after the initial
pricing of
the swap, the values of both the
fixed leg and the floating leg will be different.
The cash flows on the fixed leg do not
change but the discounting factor changes and
so the value also changes. On the floating
side, both the values change and hence the
value changes. Therefore, the swap in which
the
present values of the fixed leg and the floating
leg are not equal is called an off
-
market
swap. i.e., the value of an off
-
market swap can be positive or negative and
not zero. Thus
322 (d) is the answer.
Weather derivatives are traded in CME for d)
CME trades the index for a month or part of
323 a month only and never more than that.
What are the motives behind a swap d)
transaction? The following are some of the significant
motives for entering into a swap transaction:
–
quality spreads (lower financing costs)
–
currency risk management
–
interest risk management
Swaps can also be used to
–
enter new markets
–
large
324 r scale of operations.
what does 'B' save by doing the swap and 0.5% each year
not borrowing from the market at 14% fixed
325 rate?
What does gamma measure? The rate of change of delta with the asset
326 price
What does rho measure? The sensitivity of a portfolio value to interest
327 rate changes

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 50

 What does theta measure? The rate of change of the portfolio value with
the passage
328 of time
329 What does vega measure? None of the above
What is a description of the trading strategy Bullish Calendar Spread
where an investor
sells a 3-month call option and buys a one-
year call option,
where both options have a strike price of
$100 and the underlying
330 stock price is $75?
What is the number of different option 3
series used in creating
331 a butterfly spread?
What is the recommended way of making Make u and p a function of time
interest rates a
function of time in a Cox, Ross, Rubinstein
332 tree?
What is the recommended way of making Make u and p a function of time
volatility a function
333 of time in a Cox, Ross, Rubinstein tree?
What is the time value of a put option at the a)
time of maturity if premium = 1, strike price It is 0 because, as the spot price is more than
= 35 and spot price = 35.5? the strike price, the investor will opt to sell
334 the share rather than exercise the put option.
What term is used to describe losses Agency costs
shareholders experience
because the interests of managers are not
aligned with their
335 own?
When a position is over hedged, the profit e)
or loss from the speculative futures position Hedging implies taking the opposite position in
will depend upon order to cover one’s exposure in the
cash market. If over hedging is done, the profit
or loss will depend on how much movement
336 is there in the actual cash price in future.
When a swap gives the holder the right to b)
terminate the swap any time before its A callable swap gives the holder the right to
maturity is called terminate the swap at any time before its
maturity. A swap, in which a stream of floating
interest rat
es are exchanged for another
stream of floating interest rates, is known as
basis swap. A forward swap is one in which
the commencement date is set at a future
date, and it helps in locking the swap rates and
use
them later as and when needed. Forwards
337 swaps are also known as deferred swaps.

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 51

 Hence
(b) is the correct answer.
When futures are used to hedge an d)
exposure, the final price obtained by the The hedger shall receive the futures price at
hedger can be expressed as which the contract was tied
-
up plus the
basis (difference between the futures price
and the cash price), which can be nega
tive or
positive, at the time of settling the contract.
i.e Price = Ft
1
+b
2
where Ft
1
is the sport price
at the time of hedging and basis price at the
338 time of squaring off the hedge
When futures prices are above cash prices, (c)
the algebraic value of the basis Basis is the difference between the cash price
and the futures price. The fu
tures price is
usually above the cash price when the
contract is distant from expiration and the
more
distant the price, the wider the basis and the
lower the algebraic value. Hence, when the
futures price is more than the cash price, the
basis is negat
339 ive.
When the costs/yields of liabilities/assets (a)
are linked to a floating rate and there is no Basis risk is fundamental to hedging. Basis
simultaneous movement in the interest means the difference between the cash price
rates, it leads to and the futures price. When the cash price of
commodities changes and the interest rate risk
does not change simultaneously in the same
direction, the basis equilibr
ium changes and
340 this results in basis risk.
When the price of the stock is less than the (c)
exercise price of the option The statement giv
en under (c) is true. An option is said to be in
-
the
-
money when a
trader makes profit if he exercises it. A call
341 option is said to be in
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 52
 -
the
-
money if the stock
price exceeds the exercise price, and a put
option is said to be in
-
the
-
money if the exercise
price exceeds the stock price. An option is said
to be out
-
of
-
money when a trader makes a
loss if he exercises it. A call option is said to be
out
-
of
-
money if the exercise price exceeds
the current stock price, and a put option is
said to be out
-
of
-
money if the current stock price
exceeds the exercise price. Hence (c) is the
correct answer.
When the price of the stock is same as the (e)
price of the option The statements given under (b) and (c) are
true. An option (call or put) whose exercise
price is equal to the current spot price is said
to be at
-
the
-
342 money options.
When the stock price is 20 and the present Draw a tree for an initial stock price of 20 and
value of dividends subtract the
is 2, which of the following is the present value of future dividends at each node
recommended way of constructing
343 a tree?
When the strike price of an option is equal d)
to the spot price of the underlying asset at An option
the expiration date/exercise date, then the whose exercise price is equal to the current
option is said to be spot price is said to be at
-
344 the
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 53
 -
money.
When there is a counterparty failure in (c)
performing repayment obligation, it gives When one of the counterparties defaults in
rise to low quality assets, which in turn leads repayment, it gives rise to low quality assets,
to as the NPAs start building up. This results in
the other counterparty getting a lower credit
345 rating which in turn can give rise to credit risk.
When we move from assuming no dividends Neither p nor u changes
to assuming a
constant dividend yield, which of the
following is true for a
346 Cox, Ross, Rubinstein tree?
When you buy call option on underlying Rs. 51
asset by paying Rs 3 as premium with strike
at Rs 48 , the price of the underlying asset
347 should be ---- for you to obtain profits
Where is the cash flow hedge included in c)
the FAS-133? FAS 133 requires standardized accounting and
reporting for all derivative instrument
and for hedging activities. The following table
shows where to include the derivative
transactions:
Type of derivative transaction Accounting
treatment
No hedge Included in current income
Fair value hedge Included in current net
income
Cash flow
hedge Included in other comprehensive
348 income
Which among the following innovation was (b) The innovations like money market funds,
intended to suffice the “Liquidity Needs” of money market accounts, sweep
a firm? accounts, electronic funds transfer and
electronic payment systems, commercial
paper, and repos are intended to suffice the
liquidity needs of a firm while stock index
futures is intended to satisfy risk aversion
349 aspect.
Which is the most recently introduced c)
derivatives contract in Indian market? Currency options were introduced in the
350 Indian markets in July/August 2003. Therefore
Which of following statement(s) is/are for c)
the index futures? The cash customers position is not marked
-
to
-
market at the end of the cash settlement
351 period, but settled by cash, as there is usually

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 54

 no delivery of the underlying stocks and stock
certificates.
Which of the below mentioned statement is Both A & C Profits from the future contracts
false ? are not linear, Profits from the option
352 contracts are linear
which of the below mentioned statement is profits from the option contract are not linear
353 false?
Which of the following activities are e)
performed by hedgers? i. Protect a position The options given in (i), (ii) and (iv) are the
or an anticipated position in the spot market main features of hedging activity
by using an opposite position in derivatives
market. ii. Eliminate or minimize or reduce
the risk. iii. Sell futures. iv. Take a
corresponding position in the derivatives
354 market.
which of the following activities of the risk policy formulation
management process are long-term in
nature and dod not require constant
355 review?
356 Which of the following are cash settled All option contracts
Which of the following are features of a)
embedded derivative instruments? i. An Statement (ii) is not true because risks and
embedded derivative instrument should be economic characteristics are not clearly
separated from the best contract and related to those of the contract. Hence (a) is
accounted separately. ii. Risk and economic the answer.
characteristics are not related to those of
the contract. iii. A separate instrument with
the same terms as the embedded derivative
instrument would be accounted for as a
derivative instrument. iv. The hybrid
instrument is to be measured at fair value
357 under GAAP.
Which of the following are risks of writing (e)
call options? All the options given under (a), (b) and (c) are
358 the risks faced by option writers.
Which of the following are true of employee They are commonly valued as though they are
stock options? regular
A. They are commonly valued as though European options but with a reduced life.
they are regular
359 American options
360 Which of the following are true? Futures options are usually American
Which of the following best describes a It stands between two parties in the over-the-
central counterparty counter
361 market
Which of the following best describes Must be used for all OTC derivative
362 central clearing parties transactions
Which of the following best describes the The price for immediate delivery
363 term “spot price”

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 55

 Which of the following best describes the The contract becomes more valuable as the
term “spot price” price of the
364 asset declines
Which of the following can be considered as (e)
the advantages of controlling beta by using All the options given above are the advantages
stock index futures? of controlling beta by using stock index
365 futures.
Which of the following can be identified as (b)
‘Physical Tools’ of a ‘Financial Engineer’? i. Physical tools are used to precisely implement
Bonds. ii. Weather Derivatives. iii. Hedging the financial engineering processes.
Theory. iv. Portfolio Theory. v. Securities. Broadly, the instruments consist of equities,
fixed income securities, derivatives, and a
366 number of variants of these basic forms.
Which of the following cannot be estimated theta
from a single binomial
367 tree?
Which of the following cannotbe designated (b)
as a hedging instrument for a cash flow Only derivative instruments can be designated
hedge as
hedging instruments for a cash flow
368 hedge
Which of the following could NOT be a A short position in call options plus a short
delta-neutral position in
369 portfolio? the underlying stock
Which of the following cover represents the (d)
Act Liability Only Cover? The ‘Act’ Liability only covers the liability of
the vehicle owner/driver required to be
covered compulsorily under the provisions of
the Motor Vehicles Act. It affords the
narrowest protection and attracts the lowest
370 rate of premium. Hence (d) is the answer.
Which of the following creates a bear Buy a high strike price call and sell a low strike
371 spread? price call
Which of the following creates a bear Buy a high strike price put and sell a low strike
372 spread? price put
Which of the following creates a bull Buy a low strike price call and sell a high strike
373 spread? price call
Which of the following creates a bull Buy a low strike price put and sell a high strike
374 spread? price put
Which of the following derivative contracts (d)
is most widely used in India for hedging? Given the fact that futures market is not very
well developed in India, hedging of
currency positions is done through currency
forwards contracts, in order to ensure that
there
are
375 no losses due to price volatility in the future.
Which of the following derivative exchanges (c)
first introduced weather derivatives? The Chicago Mercantile Exchange (CME) was
376 the first exchange to transact in weather
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 56
 derivatives in order to ensure that the
profitability or revenue expectation of a
company are
not adversely affected by the playfulness of
the weather.
Which of the following derivatives are d)
available in India? At present stock index futures, currency
forwards, and interest rate futures are all
available in India. Energy futures are yet to be
377 introduced in India. Therefore answer is (d).
Which of the following describes a futures- A futures on an option payoff
378 style option?
Which of the following describes an interest All of the above
379 rate swap?
Which of the following describes European Calls (there are no puts)
380 options?
Which of the following describes tailing the None of the above
381 hedge?
Which of the following describes the five- The average of A and B
382 year swap rate?
Which of the following describes the way Some forward prices are always quoted as the
the forward price of number
a foreign currency is quoted? of U.S. dollars per unit of the foreign currency
and some are
383 always quoted the other way round
Which of the following describes the way The number of U.S. dollars per unit of the
the futures price of a foreign
384 foreign currency is quoted? currency
which of the following does not come under (d)
the scope of “Financial Engineering”? The Scope of financial engineering is much
wider and includes Corporate Finance,
Trading, Risk Management, Investment and
Money Management, etc. But it does not
include the function of “Ac
385 counting and Bookkeeping.”
Which of the following explains the principle e)
of Uberrimae fides? All the insurance contracts of insurance are
Uberrimae Fides contracts. i.e., these
contracts require utmost good faith on both
the parties which ask for voluntary disclosure
of
all the material facts releva
nt to the subject matter of the contract. Any
material facts that
are not disclosed to the other party having a
386 direct or indirect relationship to the contract
Which of the following (a)
External/Environmental factors contribute The environmental factors include price
to the growth of Financial Engineering? i. volatility, globalization of markets, tax
387 Regulatory Changes and increased asymmetries, technological advances,
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 57
 competition. ii. Transaction costs. iii. advances i
Advances in Financial theory. iv. Liquidity n financial theory, regulatory change and
needs of firm increased competition, and transaction costs.
And the liquidity needs of a firm is an intra
-
firm factor.
Which of the following factors is/are (e)
considered while valuing options on stocks? The following are considered while valuing
options. The value of an option depends
upon:
•
The spot price or current price of the
underlying asset.
•
The exercise price or strike price of the option.
•
The time
-
to
-
maturity or time
-
to
-
expiration.
•
Volatility of the underlying asset or volatility in
the price of underlying asset.
•
The risk
-
free rate of interest.
•
Dividends expected during the life of the
option, in case of dividend
-
388 paying options
Which of the following formulae is required (a)
to describe a general cost of carry price The formula given under (a) is the formula that
relationship between the spot and futures defines the cost
price of any commodity? -
of
-
carry relationship
between the spot and futures price of a
commodity.
Cost of carry = Cash price + financing co
sts + storage costs.
i.e., F
389 t,T
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 58
 =C
t
+C
t
xS
t,T
xR
t,T
+G
t,,T
Which of the following insurance policies is a)
evolved on the principle that variation in the Declaration policy is evolved on
value of insured stock or merchandise the principle that variation in the value of
results in under insurance/over insurance? insured stock
of merchandize results in under
-
insurance and over
-
insurance. Floating policy covers
insurance of all the stocks and goods at more
than one location such that fluctuation of
value of stocks at
all locations will be covered. Reinstatement
value policy is issued when
the insurer is satisfied about the bonafides of
the insured and the subject matter is a
building
and/or machinery. Transit insurance policies
are available under various inland tran
sits like
rail, road, registered post, and air. Liability
insurance policy is a miscellaneous insurance
390 policy. Hence (a) is the answer.
Which of the following insurances come (d)
under the classification of insurance of Fidelity guarantee insurance and guarantee
interest? insurance come under the classification of
391 insurance of interest. Hence (d) is the answer.
Which of the following investment (b)
categories should be less than 40 percent of State government securities, state and central
the total investments of LIC? government guaranteed securities should
not be less be than 40 percent of the total
392 investments of LIC. Hence (b) is the answer.
Which of the following investments do not (d)
have default risk? Treasury bills are gilt
-
edged securities issued by the central bank of
the country or by
the government, and as such they do not hav
393 e default risk, as they are guaranteed by the

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 59

 central government, unless the government
itself goes bankrupt, which is highly illogical.
Which of the following is ‘not’ the reason for (e)
popularity of derivatives? All the above mentioned options are the
394 advantages of derivatives.
Which of the following is a consumption Copper
395 asset?
Which of the following is a default risk? (a)
Whenever there is a risk that the money lent
to outsiders may not be recovered, it is
396 known as a default risk.
Which of the following is a primary risk? (c)
Primary risks are those risks are those are an
essential part of the business. Counterparty
risk affects th
e firm directly, unlike the other types of risks
mentioned, which affect the
397 entire economy.
Which of the following is a shortcoming of (b)
the binomial model? The binomial model is useful when the
possible inflows follow a probabilistic
distribution either increasing or decreasing
and cannot be used for inflows with
continuous
398 changes due to various factors.
Which of the following is a use of a currency All of the above
399 swap?
Which of the following is a way of valuing Assume that floating payments will equal
interest rate swaps forward LIBOR
where LIBOR is exchanged for a fixed rate of rates and discount net cash flows at the risk-
400 interest? free rate
Which of the following is acquired (in A long position in a futures contract
addition to a cash payoff) when the holder
401 of a call futures exercises?
Which of the following is acquired (in A short position in a futures contract
addition to a cash payoff) when the holder
402 of a put futures exercises?
which of the following is an assumption of the option being valued can be exercised
403 black scholes model anytime before the expiration date.
Which of the following is an external (e)
business risk? Machinery breakdown and labor strike are
both internal causes while government policy
and change in customer preferences are
external causes which result in external
business
404 risks.
Which of the following is an internal (c)
business risk Processing risk is an internal business risk as it
has to do with the internal
405 manufacturing process of the firm.
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 60
 Which of the following is approximately true The over-the-counter market is ten times as
when size is big as the
measured in terms of the underlying exchange-traded market
principal amounts or
406 value of the underlying assets
Which of the following is correct? A calendar spread can be created by buying a
call and
selling a call when the strike prices are the
same and the
407 times to maturity are different
Which of the following is correct? A diagonal spread can be created by buying a
call and selling
a call when the strike prices are different and
the times
408 to maturity are different
409 which of the following is exchange traded futures and options
Which of the following is false ? (c)
The intra
-
day spread is the difference in the price
between two different commodities
that are traded in the same futures market,
410 whether they are related to each other or not.
Which of the following is false regarding d)
‘Options’? The value of an option depends on the value
of the underlying asset and options can be
used for hedging i
411 n the commodity markets.
Which of the following is false, if it has to be b)
assumed that there is ineffectiveness in the If it is assumed that there is ineffectiveness
cash flow hedge between an interest s in the cash flow hedge between an interest
bearing financial instrument and an interest bearing financial instrument and an interest
rate swap? rate swap, the principal and the notional
412 amount of the swap must match.
which of the following is not a ‘Conceptual (d)
Tool’ of a financial engineer? Conceptual tools are used to gain familiarity
with the basics of finance. They mainly
guide the financial engineer to conceptualize
the ideas. Some of the conceptual tools
include valuation theory, portfolio
theory, hedging theory, accounting
relationships, and tax
treatment for various businesses. As the
413 equities are physical tools it is the answer.
which of the following is not a reason for the e)
existence of Tax Asymmetries among the Tax asymmetries is an environmental factor
firms? and an individual firm’s ability or inability
to pay taxes on the basis of their earned
414 profits cannot affect it.

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 61

 Which of the following is not a technique for (e) All the 4 options are used for measuring
measuring risk? risk. Variance and SD are computed using the
entire data set and gives a full estimate of the
risk. Semi-variance is calculated for only the
upside and downside movement of the
underlying variable from the mean. Range
gives the full estimate of the extreme values of
the variable compared to a % in SD. Therefore
415 the answer is (e).
which of the following is not an advantage a
of VaR against other risk management )
techniques? The VaR does not sum up the risks but
measures the risk of each event in numerical
416 units of currency terms
which of the following is not an assumption all of the above
417 of black-scholes model?
which of the following is not correct c)
regarding VaR? VaR is based on the past observed data which
418 may not be the same in future.
Which of the following is NOT true Futures contracts nearly always last longer
419 than forward contracts
Which of the following is NOT true An call option will always be exercised at
maturity if the
underlying asset price is greater than the
420 strike price
Which of the following is NOT true The holder of a forward contract is obligated
to buy or sell
421 an asset
which of the following is not true in case of (c)
Swaptions? The swaption is also an option contract and so
422 the correct answer is “c”.
which of the following is not true regarding (b)
a “Financial Engineer”? Even though a financial engineer does financial
analysis in some firms, the major part
of his work starts after the completion of
financial analysis. His work involves the design,
development and implementation of
innovative financial
instruments and processes, and the
formulation of creative solutions to problems
423 in finance.
Which of the following is NOT true? Black’s model can be used to value an
American-style
424 option on futures
Which of the following is NOT usually true They can be sold to other employees
about employee
425 stock options?
which of the following is the part of the risk all of the above
426 management process?

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 62

 which of the following is the part of the risk all of the above
427 management process?
Which of the following is the principal (a)
motivating factor for introduction of deep Deep discount or zero
discount/zero coupon bonds in India? -
coupon bonds do not carry interest rates and
are issued at a
discount to the face value and redeemed at
par. The difference between the issue price
and
the face value is the implied interest yield.
These bonds carry lower interest yield than
the
market and the main attraction is the
428 tax rebate available on them.
Which of the following is true Futures contracts are traded on exchanges,
but forward
429 contracts are not
Which of the following is true about a long The price for immediate delivery
430 forward contract
Which of the following is true about They never have to be revalued
employee stock options
431 after they have been issued?
Which of the following is true about the It is illegal
practice of backdating
432 a stock options grant?
Which of the following is true for an interest A swap is usually worth close to zero when it is
433 rate swap? first negotiated
Which of the following is true for the party There is more credit risk when the yield curve
paying fixed in an is upward
434 interest rate swap? sloping than when it is downward sloping
Which of the following is true for u in a Cox- It depends on the interest rate and the
Ross-Rubinstein volatility
435 binomial tree?
Which of the following is true of a box All of the above
436 spread?
Which of the following is true when the A call on futures is always worth at least as
futures price exceeds much as the
437 the spot price? corresponding call on spot
which of the following is true? an American option can be exercised any time
438 during the life of the contract
Which of the following is true? The convenience yield is always positive or
439 zero
Which of the following is true? The optimal hedge ratio is the slope of the
best fit line
when the change in the spot price (on the y-
axis) is
regressed against the change in the futures
price (on the
440 x-axis).
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 63
 Which of the following is true? The principal amounts usually flow in the
opposite direction
to interest payments at the beginning of a
441 currency
Which of the following is true? An employee stock option tends to be
exercised earlier
442 than an OTC option with the same terms
Which of the following is true? The gamma of a European put equals the
gamma of a
443 European call
Which of the following is usually true OIS rates are less than the corresponding
444 LIBOR rates
Which of the following is/are assumptions of (e)
Black Scholes approach? All the options given above are the
assumptions of Black and Scholes model. The
option under (a) should be read as “Short Sale
of Securities” is allowed with full use of
445 proceeds.
Which of the following is/are feature(s) of (d)
corporate risk management? It is to be noted that all the risks of a corporate
cannot be reduced. A typical example is
pure risks which cannot be reduced in certain
circumstances. Therefore (d) is the right
446 choice
Which of the following is/are Over The (e)
Counter (OTC) derivative? There is no organized exchange for forwards
and swaps, so both of them can be termed
447 as OTC derivatives.
Which of the following is/are true (e)
All the statements mentioned above are true
and self
-
448 explanatory statements.
Which of the following items form the d)
income for LIC? First year premium and income from
investments form the main sources of income
for
449 LIC. Hence (d) is the answer
Which of the following items of uses of a)
funds form the outgoes for LIC? Payment of claims form the major outgoes for
450 the LIC. Hence (a) is the answer.
Which of the following perils are excluded (d)
from the cover of the fire insurance policy? Earthquake and cyclone do not cause fire
directly and as such are excluded from the
451 cover of a fire insurance policy.
which of the following regarding short it is an arbitrage strategy
452 selling is not true?
Which of the following regarding Value at d)
Risk (VaR)? VaR is a statistical measure of the maximum
453 potential loss from uncertain events in the
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 64
 normal business over a particular time
horizon. It is measured in units if currency
through a
probability level. It is basically a loss
measurement consistent with a
confidence limit.
Which of the following relationships (c)
correctly indicates put call parity? The option given under (c) represents the true
put
-
call parity
ratio. It can also be
represented as c + Xe
-
r(T
–
t)
= p + S. If this relationship does not hold,
arbitrage
454 opportunities exist.
Which of the following risks fall under the (e)
category of Interest Rate Risk? All the above mentioned options are types of
455 interest rate risks
Which of the following risks is absent for a (b)
buyer of a futures contract? Counterparty risk is absent from a futures
contract, as the contract is done w
ith the
futures exchange and one party does not have
456 to find another counterparty.
Which of the following risks is related to c)
interest rate swap? There is no question of settlement in an
interest rate swap. At the end of the swap,
both
the counterparties take their principal back
457 and repay the same to the bank
Which of the following risks will affect (d)
exchange risk? Investment risk need not affect the exchange
risk, because investments can be domestic
also, or in the same currency for both the
458 parties.
Which of the following software uses (a)
quantum mechanics and fluid dynamics Numerix is software that uses quantum
related scientific techniques for derivative mechanics and fluid dynamics related scientific
analysis? techniques
for derivatives analysis and risk measurement.
RAROC 2020 is software for
measuring accuracy of risk and is developed by
Bankers Trust, a leading banker in US.
Risk Manager is software, which measures the
459 level of risk of a bond portfolio. Risk Grades
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 65
 is
a data engine for risk management developed
by J P Morgan. Hence (a) is the answer.
which of the following statement are false e)
Arbitrageurs try to identify differences in the
rates of securities or derivative instruments
between two different
markets and make profit out of the same by
buying in one exchange
and selling in the other. They perform a very
valuable economic function by keeping the
derivatives prices and current underlying
assets price closely consistent. Speculators
help in
enhancing liquidity and arbitragers help in
460 price discovery leading to market efficiency.
which of the following statement are true (c)
By hedging, insuring, diversifying, etc., the firm
is trying to minimize its risks, by
transferring the unacceptable risks and
461 accepting other risks that are acceptable to it.
which of the following statement are true (e
)
Systematic or market risk can be priced and
measured through the beta (
β
) and it
influences the rate of return as the investor
can decide whether to invest or not based on
it.
Unsystematic risk or company specific risk
cannot be priced or measured accurately, but
as
it is existent it must be properly managed, or
else it may result in losses that can affect the
462 interests of the shareholders.
Which of the following statement is true ? (i) both (i) and (iii) above
Black-Scholes valuation model gives
identical relationship for valuing options on
dividend paying stocks or currencies. (ii)
Black-scholes model can be used to work
out exact values of American put options.
(iii) The values of put and call options will be
equal at a strike price which is equal to the
463 forward rate for the same maturity.
which of the following statement is/are call option with lower strike price are more
incorrect? 1) call option with lower strike valuable
prices are more valuable. 2) if the current
stock price is above the strike price of a call,
464 the option has some intrinsic value 3) put
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 66
 option with lower strike prices are more
valuable 4) if the strike price is equal to the
current stock price, an option is said to be at
money
which of the following statement is/are true (a)
Alternative (a) is true because the price
difference between two American puts is
always
less than the difference in their exercise
465 prices.
which of the following statement is/are true e)
The longer the time to maturity, the greater
the opportunity, so the higher the price of the
466 call option.
which of the following statement(s) is/are (a)
false ? Only calls and puts that do not accelerate
repayment of principal but require a cash
settlement equal to the option price at the
date of exercise are treated as embedded
467 derivative instruments
which of the following statement(s) is/are c)
false ? All assets and liabilities are to be translated at
the current rate and not at the historical
468 rate
Which of the following statement(s) is/are (e)
reduce the overall risk of the firm. By diversifying one’s activities, overall risk
exposure can be reduced and a go
od way of
risk sharing is by retaining part of it and
469 transferring the rest to some outside party
Which of the following statement(s) is/are (c)
true for index arbitrage? If the price of the index futures contract is out
of line with the theoretical price, then an
arbitrageur can earn abnormal returns by
trading simultaneously in th
e cash and futures
470 markets. Hence alternative (c) is correct.
Which of the following statement/s is/are (e)
example(s) of underlying asset(s) for futures All the options mentioned above are examples
contracts? of under
471 lying assets for futures contracts.
Which of the following statement/s is/are d)
false i. The price of a call option is always The price of a call option need not al
more than the underlying stock price. ii. The ways be more than the underlying stock price.
price of a call option cannot be less than the It
underlying stock price. iii. The price of a put could also be the same as the price of the
option cannot be more than the strike price. underlying stock. Similarly, the price of a put
option can be the same or more than the
472 strike price.

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 67

 Which of the following statement/s is/are only (iii) above
incorrect ? (i) call option with lower strike
prices are more valuable. (ii) If the current
stock price is above the strike price of a call,
the option has some intrinsic value (iii) Put
option with lower strike prices are more
valuable (iv) If the strike prices is equal to
the current stock price, an option is said to
473 be at the money.
Which of the following statement/s is/are only (iii) above
incorrect ? (i) call option with lower strike
prices are more valuable. (ii) If the current
stock price is above the strike price of a call,
the option has some intrinsic value (iii) Put
option with lower strike prices are more
valuable (iv) If the strike prices is equal to
the current stock price, an option is said to
474 be at the money.
Which of the following statement/s is/are (b)
incorrect? A put option is an option given to sell the
underlying asset. So, the higher the premium,
475 the more valuable is the option.
Which of the following statement/s is/are d)
true Derivatives are financial instruments that
derive their value from the value of other,
more basic underlying variables or assets. As
derivatives are bought or sold, they can also
be termed as contracts to exchange payments
between both the p
476 arties involved in the trade.
Which of the following statement/s is/are (e)
true All the statements given above are true
477 characteristics of hedging with futures
Which of the following statement/s is/are (d)
true Both statements (b) and (c) are true
478 characteristics of hedging with futures.
Which of the following statement/s is/are d)
true Both the statements given under (a) and (b)
are true and self
-
explanatory. (c) is false
because in a bear vertical spread, a call with a
lower strike price is sold and a call with a
479 higher strike price is bought.
Which of the following statement/s is/are (a)
true A straddle involves a call and put option with
the same expiration date. This strategy
appeals to investors who want to take a
position in an underlying asset that is volatile
480 but
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 68
 does not have a clue whether it will rise or fall
in the short run. The in
vestor however, only
anticipates a sharp movement in the price of
the asset.
Which of the following statement/s is/are (d)
true Spread positons are generally less volatile
because it protects the spread holder to get a
limited profit or limited loss. If the market
moves either way in an extreme manner, then
in
one end it will gain and in the other end it will
lose and the difference would remain more
481 or less constant in magnitude.
Which of the following statement/s is/are (b)
true Options are referred to as wasting assets as
they will expire if not exercised. The
principal risk associated with the buying of
options is that the investor loses his entire
482 investment if the option is not exercised.
Which of the following statement/s is/are (d)
true i. Black Scholes valuation model gives The explanation for statement (iii) is as
identical relationship for valuing options on —
dividend paying stocks or currencies. ii. Put-call parity is p = c + Xe-rt–S X is the strike
Black Scholes model can be used to work price equal to the forward rate for the same
out exact values of American put options. iii. maturity.
The values of put and call options will be The term e-rt discounts the strike price(i.e.
equal at a strike price which is equal to the forward rate for the same maturity) and brings
X to the spot price i.e. S
483 Therefore Xe-rt= S And so p = c.
Which of the following statement/s is/are (a)
true? Alternative (a) is correct because an option is a
contract in which the seller of the
contract grants the buyer, the right to
purchase from the seller a designated
instrument or an asset at a specific price
which is agreed upon at the time of entering
into the contract.
Therefore, the option buyer has the right but
not an obligation to buy or sell. But the seller
of the option has an obligation to deliver or
take delivery of the underlying asset at the
484 agreed price
Which of the following statements are False (c)
In a financial futures contract, the holder need
not take physical possession of the
underlying security and as such, he will not be
entitled to dividends or interest payments on
the underlying security. This is because in the
485 futures market, the settlement can be either
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 69
 by physical delivery, cash payment of
difference, offsetting or exchange of futures
for
physicals. The holder will only be entitled for
dividends or interest if he takes the physical
delivery of the asset.
Which of the following statements are False e)
The CMO is an innovation, which will suffice
486 the liquidity needs of a firm.
which of the following statements are true (
b)
A gross margining system requires that
margins be posted on all the long and short
positions, and the total amount is kept with
the clearing association. The amount
demanded
by the clearing associations will depend on the
financial characteristics of
the customer and
is a matter of negotiation between the
487 clearing association and the customer.
Which of the following statements defines (e)
risk? Risk can be defined as a specific unexpected
outcome that may happen in the course of
a business. Based on this definition, options (a)
488 and (b) are correct.
Which of the following statements describes d)
a short sellers’ profit? Both the options given under (a) and (b) are
489 true
Which of the following statements is False (a)
The statement is false because profitability has
no relation to liquidity. If the sales are
done through credit, the liquidity risk may
490 arise, while the deals may be very profitable
Which of the following statements is false b)
regarding rate capped swaps? Rate capped swap gives protection to floating
rate payer against interest rate rise (and
491 not fall).
Which of the following statements is false (e)
with respect to Differed Rate Swaps (DRS)? All the statements given above are true and
492 none of them is false.
Which of the following statements is false? a)
A seller of an option is also known as the
493 option writer
Which of the following statements is false? (b)
Both the counterparties and not the share
494 brokers share the net gain from the swap.
Which of the following statements is false? c)
495 The value of the fixed leg of a swap can change

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 70

 if the fixe
d rate drastically falls or rises
which of the following statements is not (b)
correct regarding swap market The swap market is not exchange controlled
and it is an over
-
the
-
496 counter market.
Which of the following statements is true (d)
Because in an increasing interest rate scenario
the value of fixed rate assets ( as it
would be discounted by a higher interest
rate) would go down as the fixed rate is
expected
to be lesser than the increased rate. Therefore
497 statements (a) and (c) are true
Which of the following statements is true, in (a)
the context of intra-commodity spread? The statement given under (a) is the definition
of intra
-
day commodity spread and is
self
-
498 explanatory.
Which of the following statements is true? (e)
Option is “e”. (b) is true because delta of a put
option is negative. (c) is true because for
a call option the premium is inversely
proportional to the strike price. Hence (e) is
the
499 answer.
Which of the following statements is/are (c)
False Statements (a) and (b) are true. Systematic or
market risk is the same to all the
participants in the market. Unsystematic or
firm’s individual risk has no influence on the
discou
nt rate applicable to the industry but will
reduce the expected cash flows, as the
public will stay away from such an investment.
Statements (c) is false because managing
unsystematic risk is essential for a firm to
stabilize its earnings and add value to it’s
500 investor’s wealth.
Which of the following statements is/are (a)
false? In a decreasing interest rate scenario the value
of fixed rate assets at higher
501 rates would

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 71

 appreciate, because they are valued at a lower
(discount) rate of interest. Thus answer is (a).
Which of the following statements is/are (d) Risk is the possibility of the outcome being
TRUE different from the expected, it can be adverse
or favorable though controlling the adverse
outcome is more pronounced. Therefore
statements (b) and (c) are true, and (a) is not
502 entirely true. So option (d) is the answer.
Which of the following statements regarding It is an arbitrage strategy
503 short selling is not true ?
Which of the following statements relate to e)
annuities? An annuity is an investment that can be made
either in a single lump sum or through
installments paid over a certain number of
years, in return for which a specific sum is
received every year, half
-
year, or every month, either for life or
for a fixed number of years.
LIC offers annuities for those who want to
hedge the risk of living longer. In an annuity
contract, the insurer stops paying upon the
504 death of the insured. Hence (e) is the answer.
Which of the following statements relating a)
to the doctrine of subrogation is Doctrine of Subrogation refers to “the right of
indemnification. the insurer to stand in the place of the
insured, after settlement of a claim, in so far
as the insured’s right of recovery from an
alternative source is involved. It ensures that
all rights of the ‘insured subject matter’ are
transferred to the insured on indemnification.
It is not applicable to life insurance contracts.
In life insurance, legal heirs have a right to
recover the perceived loss from a third party,
but
it cannot be subrogated irrespective of the
status of the policy amount that has to be paid
by
505 the insurer. Thus (a) is the answer.
Which of the following strategies involve c)
buying the underlying security? Spread strategies involve only the use of
options, they do not involve buying the
506 underlying securities.
Which of the following techniques expresses (e)
returns as a histogram of hypothetical Historical pattern of observations and Monte
values? Carlo Simulations express returns as a
histogram of hypothetical values. Hence (e) is
507 the answer
Which of the following techniques is used in c)
508 measurement of VaR? Sensitivity analysis is done to measure the
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 72
 changes in the option prices due to change in
the prices of the underlying asset and not for
VaR.
Which of the following was true about The value of options which were at-the-money
employee stock options when
between 1996 and 2004? issued had to be reported in the notes to the
financial
509 statements
Which of the following was true about Options which were at-the-money when
employee stock options issued did not
510 prior to 1995? affect a company’s financial statements
Which of the following was true after 2005? The value of options which were at-the-money
when
issued had to be expensed on the income
511 statement
Which of the methods for measuring VaR d)
is/are suitable for shorter period of study? The Monte Carlo and Historical Pattern of
Observations methods are used for longer
period of study; and the Variance/Co
-
variance methods are better suited for shorter
period
of study. Hybrid models are also applicable to
shorter periods of measurement.
Hence (d) is
512 the answer.
Which one of the following is a (d)
characteristic of “Average Strike Rate The “Average Strike Rate Option” is an
Option?” innovative instrument which is a type of
floating strike option, where the pay
-
off is determined by comparing t
he underlying price at
expiration with a strike computed as the
average of the underlying asset over the pre
-
specified time. Since the option strike is
uncertain and not determinable until
exercised, this
type of option is less expensive than a normal
513 option.
Which one of the following is not an (c)
assumption of Black Scholes model? Black
-
Scholes model states that the option follows
European exercise terms, which
means that it can only be exercised on the
514 expiration day.
515 which one of the following is not true? all of the above

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 73

 Which one of the following is not true? (b)
The price of the put option decreases with the
increase in the price of the underlying
asset, which is just the opposite of the call
516 option.
Which one of the following statements is a (b)
feature of derivatives? Exchange traded transactions tend to be very
liquid as the number of players involved
in
the market is very large. The transaction costs
are also low given the fact that the volumes
517 are very high.
whiich of the following statement is true i. c)
Derivative instruments are assets and Statement (iii) is false because only true assets
liabilities. ii. Only the fair value of the and liabilities are reported and not the
derivative instruments should be considered gains or losses arising from derivative
for reporting purpose iii The gains and losses instruments. Hence (c) is the answer.
arising from the derivative instruments is
518 also reported. +
While taking up an overseas project, a e)
company faces While taking up an overseas project, a
company faces risks which are not there in a
domestic project. Such risks could be political
risks, sovereign risks, inflation risks,
currency risks or a combination of any of the
above, and they solely depend on the country
519 in which the project is undertaken.
Who among the following is a participant in (c)
the derivatives market? Central banks do not usually participate
directly in the derivative markets nor do they
interfere in the derivative markets in order to
control the prices. But India is an exception
the derivative markets are regulated by the
520 derivatives exchanges.
Who initiates delivery in a corn futures The party with the short position
521 contract
Who, among the following, coined the term (d)
Financial Engineering? The word ‘Financial Engineering’ was first
coined in the mid 80s, among London
Investment Banks to build risk management
departments consisting of teams of experts
who would advocate structured solutions to
522 corporate risk exposures.
With bilateral clearing, the number of 6
agreements between
523 four dealers, who trade with each other, is
With regard to vertical spread which of the (b)
following statement(s) is (are) i. Is a non A vertical spread is a directional strategy which
directional strategy which requires the is based on the underlying asset either
524 underlying to rise or fall ii. Is a directional to rise or
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 74
 strategy which requires the underlying to fall over the duration of the option. A bull
rise or fall iii. Can be constructed with only vertical spread can be constructed by
puts iv. Can be constructed with only calls v. using the two calls and a bear vertical spread
Can be constructed with either puts or calls. can be constructed by using two puts with the
same expiry date but different strike prices.
Hence the answer choice (b) is
correct.
You purchased a one month forward dollar 42136
from bank in New York on April 9, 2015
Friday. The one month forward settlement
525 date is
You sell one December futures contracts 1800
when the futures
price is $1,010 per unit. Each contract is on
100 units and the
initial margin per contract that you provide
is $2,000. The
maintenance margin per contract is $1,500.
During the next
day the futures price rises to $1,012 per
unit. What is the balance
of your margin account at the end of the
526 day?
You write one AT&T February 50 put for a 45
premium of $5. Ignoring transaction costs,
527 what is the breakeven price of this position?
You wrote a put option contract for a (e)
premium of Rs.250. The exercise price of Assuming a put option. Exercise Price Rs.5,000
option is Rs.50 and the current market price –
is Rs.45. After a period of four months the Premium Rs.250 = Total outgo of
price of the stock is Rs.53. If the option Rs.4,750. After 4 months if the share price is
holder exercises the option, total loss will be Rs.5,300, the net loss is Rs.550 (Rs.
Rs.______. Ignore the transaction costs and 4,750
the contract is for 100 shares. –
528 Rs.5,300).

1. Relative to the underlying stock, a call option always has:

A) A higher beta and a higher standard deviation of return
B) A lower beta and a higher standard deviation of return
C) A higher beta and a lower standard deviation of return
D) A lower beta and a lower standard deviation of
return Answer: A Type: Difficult Page: 565

2. A call option has an exercise price of $100. At the final exercise date, the stock price could
be either $50 or $150. Which investment would combine to give the same payoff as the stock?
A) Lend PV of $50 and buy two calls
Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 75
 B) Lend PV of $50 and sell two calls
C) Borrow $50 and buy two calls
D) Borrow $50 and sell two calls
Answer: A Type: Difficult Page: 566
Response: Value of two calls: 2 (150 - 100) = 100 or value of two calls =: 2(0) = 0 (not exercised);
payoff = 100 + 50 = 150 or payoff = 0 + 50 = 50

3. The option delta is calculated as the ratio:

A) (the spread of possible share prices) / (the spread of possible option prices)
B) (the share price) / (the option price)
C) (the spread of possible option prices) / (the spread of possible share prices)
D) (the option price) / (the share price)
Answer: C Type: Medium Page: 567

4. Suppose Ralph's stock price is currently $50. In the next six months it will either fall to $30 or rise
to $80. What is the option delta of a call option with an exercise price of $50?
A) 0.375
B) 0.500
C) 0.600
D) 0.75
Answer: C Type: Medium Page: 567
Response: Option delta = (30 - 0)/(80 - 30) = 30/50= 0.6

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 76

 5. Suppose Waldo's stock price is currently $50. In the next six months it will either fall to $40 or
rise to $60. What is the current value of a six-month call option with an exercise price of $50? The
six-month risk-free interest rate is 2% (periodic rate).
A) $5.39
B) $15.00
C) $8.25
D) $8.09
Answer: A Type: Difficult Page: 567
Response:
Replicating portfolio method: Call option payoff = 60 -50 = 10 and zero;
(60)(A) + (1.02)(B) = 10, (40)(A) + 1.02(B) = 0; A = 0.5 (option delta) &
B = -19.61; call option price (current) = 0. 5(50) - 19.61 = $5.39
Risk- neutral valuation: 50 = [x(60) + (1-x)40]/1.02) ; x = 0. 55; (1-x )= 0.45;
Call option value = [(0.55)(10) + (0.45)(0)]/(1.02) = $5.39

6. Suppose Waldo's stock price is currently $50. In the next six months it will either fall to $40 or
rise to $80. What is the current value of a six-month call option with an exercise price of $50? The
six-month risk-free interest rate is 2% (periodic rate).
A) $2.40
B) $15.00
C) $8.25
D) $8.09
Answer: D Type: Difficult Page: 567
Response:
Replicating portfolio method: Call option payoff = 80-50 = 30 and zero;
(80)(A) + (1.02)(B) = 30, (40)(A) + 1.02(B) = 0; A = 0.75 (option delta) &
B = -29.41; call option price (current) = 0.75(50) - 29.41 = $8.09
Risk- neutral valuation: 50 = [x(80) + (1-x)40]/1.02) ; x = 0.275; (1-x )= 0.725;
Call option value = [(0.275)(30) + (0.725)(0)]/(1.02) = $8.09

7. Suppose Ann's stock price is currently $25. In the next six months it will either fall to $15 or rise
to $40. What is the current value of a six-month call option with an exercise price of $20? The
six-month risk-free interest rate is 5% (periodic rate). [Use the risk-neutral valuation method]
A) $20.00
B) $8.57
C) $9.52
D) $13.10
Answer: B Type: Difficult Page: 567
Response: Method I: 25 = [x(40) + (1-x)15]/1.05 ; x = 0.45 1- x =0.55
Call option price = [(0.45)(20) + (0.71875)(0)]/(1.05) = $8.57

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 8. Suppose Ann's stock price is currently $25. In the next six months it will either fall to $15 or rise
to $40. What is the current value of a six-month call option with an exercise price of $20? The
six-month risk-free interest rate is 5% (periodic rate). [Use the replicating portfolio method]
A) $20.00
B) $8.57
C) $9.52
D) $13.10
Answer: B Type: Difficult Page: 567
Response: 40(A) + 1.05(B) = 20; 15(A) +1.05(B) = 0; A = 0.8; B = -11.43
Call option price = 25(0.8) - 11.43 = $8.57

9. Suppose Carol's stock price is currently $20. In the next six months it will either fall to $10 or rise
to $40. What is the current value of a six-month call option with an exercise price of $12? The
six-month risk-free interest rate (periodic rate) is 5%. [Use the risk-neutral valuation method]
A) $9.78
B) $10.28
C) $16.88
D) $13.33
Answer: A Type: Difficult Page: 567
Response: 20 = [x(40) + (1-x)(10)]/ 1.05 ; x = 0.367; (1-x) = 0.633
Call option price = [(0.367)(28) + (0.633)(0)]/(1.05) = $9.78

10. Suppose Carol's stock price is currently $20. In the next six months it will either fall to $10 or
rise to $40. What is the current value of a six-month call option with an exercise price of $12? The
six-month risk-free interest rate (periodic rate) is 5%. [Use the replicating portfolio method]
A) $9.78
B) $10.28
C) $16.88
D) $13.33
Answer: A Type: Difficult Page: 567
Response: 40(A) + 1.05 (B) = 28; 10(A) + 1.05(B) = 0; A = 0.9333; B = -8.89
Call option price = (0.9333)(25) - 8.89 = 9.78

11. Suppose Victoria's stock price is currently $20. In the next six months it will either fall to $10 or
rise to $30. What is the current value of a put option with an exercise price of $12? The six-month
risk-free interest rate is 5% (periodic rate).
A) $9.78
B) $2.00
C) $0.86
D) $9.43
Answer: C Type: Difficult Page: 568
Response:
Replicating portfolio method: 30(A) + 1.05 (B) = 0; & 10 (A) + 1.05(B) = 2;
A = - 0.1(option delta) & B = 2.86; Put option price = -(0.1)(20) + 2.86 = 0.86;
Risk-neutral valuation: 20 = [x(30) + (1-x)(10)]/1.05; x = 0.55 and (1-x) = 0.45
Put option price = [(0.55)(0) + (0.45)(2)]/(1.05) = 0.86

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 12. The delta of a put option is always equal to:
A) The delta of an equivalent call option
B) The delta of an equivalent call option with a negative sign
C) The delta of an equivalent call option minus one
D) None of the above
Answer: C Type: Difficult Page: 569

13. If the delta of a call option is 0.6, calculate the delta of an equivalent put option
A) 0.6
B) 0.4
C) – 0.4
D) –0.6
Answer: C Type: Difficult Page: 569
Response: 0.6 - 1 = -0.4

14. Suppose Victoria's stock price is currently $20. Six-month call option on the stock with an
exercise price of $12 has a value of $9.43. Calculate the price of an equivalent put option if the
six-month risk-free interest rate is 5% (periodic rate).
A) $0.86
B) $9.43
C) $8.00
D) $12.00
Answer: A Type: Difficult Page: 570
Response: Value of Put = 9.43 - 20 + 12/(1.05) = $0.8

15. If e is the base of natural logarithms, and (ó) is the standard deviation of the continuously
compounded annual returns on the asset, and h is the interval as a fraction of a year, then the quantity
(1
+ upside change) is equal to:
A) e^[(ó)?*SQRT(h)]
B) e^[h*SQRT(ó)]
C) (ó)?e^[SQRT(h)]
D) none of the above.
Answer: A Type: Difficult Page: 574

16. If u equals the quantity (1+ upside change), then the quantity (1 + downside change) is equal to:
A) –u
B) –1/u
C) 1/u
D) none of the above.
Answer: C Type: Medium Page: 574

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 17. If the standard deviation of the continuously compounded annual returns (ó ) on the asset is
40%, and the time interval is a year, then the upside change is equal to:
A) 88.2%
B) 8.7%
C) 63.2%
D) 49.18%
Answer: D Type: Difficult Page: 574
Response: (1 + u) = e^(0.4) = 1.4918 or upside change = 49.18%

18. If the standard deviation for continuously compounded annual returns on the asset is 40% and
the interval is a year, then the downside change is equal to:
A) 27.4%
B) 53.6%
C) 32.97%
D) 38.7%
Answer: C Type: Difficult Page: 574
Response:
(1 + u) = e^[(0.4*1)] =1.4182 ; downside change = 1/1.4182 = 1 + d =0.67032
d = -0.3297 ; down % = 32.97%

19. If the standard deviation of continuously compounded annual returns on the asset is 20% and
the interval is half a year, then the downside change is equal to:
A) 37.9%
B) 19.3%
C) 20.1%
D) 13.2%
Answer: D Type: Difficult Page: 574
Response: (1+ u) = e^[(0.2)*] = 1.152 or d= 1/1.152 = .868 or downside change = 13.2%

20. If the standard deviation of continuously compounded annual returns on the asset is 40% and
the interval is a year, then the downside change is equal to :
A) 27.4%
B) 53.6%
C) 33.0%
D) 38.7%
Answer: C Type: Difficult Page: 574
Response: (1 + u)=e^(0.4) = 1.492 or (1+d)= 1/1.492 = 0.67 or downside change = 33%

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 80

 21. A stock is currently selling for $50. The stock price could go up by 10% or fall by 5% each
month. The monthly interest rate is 1% (periodic rate). Calculate the price of a European call option
on the stock with an exercise price of $50 and a maturity of two months. (use the two-stage binomial
method)
A) $5.10
B) $2.71
C) $4.78
D) $3.62
Answer: B Type: Difficult Page: 574
Response: 50 = [55(x) + 47.5(1-x)]/(1.01) ; x = 0.4; 1-x = 0.6
Payoffs at the end of month-2: $10.5; $2.25 ; and zero; [Exercise price = $50]
End of one month values: [(10.5)(0.4) + 2.25(0.6)]/1.01 = 5.495 and [2.25(0.4) + 0]/1.01 = 0.891
Price of the call option = [5.495(0.4) + (0.891)(0.6)]/1.01 = 2.71

22. An European call option with an exercise price of $50 has a maturity (expiration) of six months,
stock price of $54 and the instantaneous variance of the stock returns 0.64. The risk-free rate is
9.2%. Calculate the value of d2 (approximately).
A) +0.0656
B) –0.0656
C) +0.5656
D) –0.5656
Answer: B Type: Medium Page: 576
Response: d2 = 0.5 - 0.8(0.5^0.5) = - 0.0656

23. An European call option with an exercise price of $50 has a maturity (expiration) of six months,
stock price of $54 and the instantaneous variance of the stock returns 0.64. The risk-free rate is 9.2%.
Then [d1] has a value of (approximately):
A) 0.3
B) 0.7
C) –0.7
D) 0.5
Answer: D Type: Difficult Page: 576
Response: d1= [ln(54/50) + (0.092 + (0.64/2))(0.5)]/[(0.8)(0.7071)] = 0.5

24. Cola Company has call options on its common stock traded in the market. The options have an
exercise price of $45 and expire in 156 days. The current price of the Cola stock is $44.375. The
risk-free rate is $7% per year and the standard deviation of the stock returns is 0.31. The value of [d1]
is (approximately):
A) 0.0226
B) 0.18
C) –0.3157
D) 0.3157
Answer: B Type: Difficult Page: 576
Response: d1 = [ln(44.375/45) + [0.07 +(0.096/2)][165/365]/[(0.31)(0.6538)] = 0.18

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 81

 25. Cola Company has call options on its common stock traded in the market. The options have an
exercise price of $45 and expire in 156 days. The current price of the Cola stock is $44.375. The
risk-free rate is $7% per year and the standard deviation of the stock returns is 0.31. Calculate the value
of d2: (approximately)
A) +0.0227
B) -0.0227
C) +0.2027
D) -0.2027
Answer: B Type: Medium Page: 576
Response: d2 = d1 - [(σ )(SQRT( t)]; d2 = 0.18 (0.31)[ (156/365)^0.5] = -0.0227

26. If the value of d1 is 1.25, then the value of N(d1) is equal to:
A) -0.1056
B) 1.25
C) 0.25
D) 0.844
Answer: D Type: Medium Page: 578
Response: Use the Cumulative Probabilities of the Standard Normal Distribution Table

27. If the value of d2 is -0.5, then the value of N(d2) is:

A) -0.1915
B) 0.6915
C) 0.3085
D) 0.8085
Answer: C Type: Medium Page: 578
Response: Use the Cumulative Probabilities of the Standard Normal Distribution Table

28. If the value of d is –0.75, calculate the value of N(d):

A) 0.2266
B) –0.2266
C) 0.7734
D) –0.2734
Answer: A Type: Medium Page: 578

29. If the strike price increases then the: [Assume everything else remaining the same]
A) Value of the put option increases and that of the call option decreases
B) Value of the put option decreases and that of the call option increases
C) Value of both the put option and the call option increases
D) Value of both the put option and the call option
decreases E)None of the above
Answer: A Type: Medium Page: 578

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 30. If the volatility (variance) of the underlying stock increases then the: [Assume everything else
remaining the same]
A) Value of the put option increases and that of the call option decreases
B) Value of the put option decreases and that of the call option increases
C) Value of both the put option and the call option increases
D) Value of both the put option and the call option
decreases E)None of the above
Answer: C Type: Medium Page: 578

31. The Black-Scholes OPM is dependent on which five parameters?

A) Stock price, exercise price, risk free rate, beta, and time to maturity
B) Stock price, risk free rate, beta, time to maturity, and variance
C) Stock price, risk free rate, probability, variance and exercise price
D) Stock price, exercise price, risk free rate, variance and time to maturity
Answer: D Type: Difficult Page: 578

32. The value of N(d) in the Black-Scholes model can take any value between:
A) –1 and + 1
B) 0 and +1
C) –1 and 0
D) None of the above
Answer: B Type: Medium Page: 578

33. N(d1) in the Black-Scholes model represents

(I) call option delta
(II) hedge ratio
(III) probability
A) I only
B) II only
C) III only
D) I, II, and III
Answer: D Type: Medium Page: 578

34. The term [N(d2)*PV(EX)] in the Black-Scholes model represents:

A) call option delta
B) bank loan
C) put option delta
D) none of the above
Answer: B Type: Medium Page: 578

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 35. Which of the following statements regarding American puts is/are true?
A) An American put can be exercised any time before expiration
B) An American put is always more valuable than an equivalent European put
C) Multi-period binomial model can be used to value an American put
D) All of the above
Answer: D Type: Medium Page: 582

36. A stock is currently selling for $50. The stock price could go up by 10% or fall by 5% each
month. The monthly interest rate is 1% (periodic rate). Calculate the price of an American put
option on the stock with an exercise price of $55 and a maturity of two months. (Use the two-stage
binomial method)
A) $5.10
B) $3.96
C) $4.78
D) None of the above
Answer: A Type: Difficult Page: 582
Response: p=1-(-5)/(10-(-5)) = 0.40 1-p = 0.6
End of one month values: [(0)(0.4) + (2.75)(.6)]/1.01= 1.6337 or zero
And [(2.75)(.4)+(9.875)(0.6)]/1.01 = $6.9555 or $7.5 if exercised;
P = [0.4(1.6337) +(7.5)(0.6)]/1.01 = $5.10

37. Suppose the exchange rate between US dollars and British pound is US$1.50 = BP1.00. If the
interest rate is 6% per year what is the adjusted price of the British pound when valuing a foreign
currency option with an expiration of one year? (Approximately)
A) $1.905
B) $1.4151
C) $0.7067
D) None of the above
Answer: B Type: Difficult Page: 583
Response: Adjusted price = 1.5/1.06 = 1.4151

38. If the interest rate is 10%, the upside change is +25% and the downside change is –20%.
Calculate the risk-neutral probability of upside change.
A) 0.5
B) 0.6667
C) 0.75
D) None of the above.
Answer: B Type: Difficult Page: 584
Response: p = 10-(-20)/(25-(-20)) = 0.6667

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 39. If the interest is 8%, the upside change is +40% and the downside change is –40% calculate the
risk-neutral probability of upside change.
A) 0.50
B) 0.80
C) 0.60
D) None of the above.
Answer: C Type: Difficult Page: 584
Response: p= 8-(-40)/(40-(-40)) = 0.6

40. If the interest rate is 12%, the upside change is 20% and the downside change is –10%, calculate
the risk-neutral probability of upside change.
A) 0.733
B) 0.5
C) 0.1
D) None of the above.
Answer: A Type: Difficult Page: 584
Response: p=12-(-10)/(20-(-10)) = 0.7333

41. A stock is currently selling for $100. One year from today the stock price could go up by 30% or
go down by 20%. The risk-free interest rate is 10%[APR]. Calculate the price of a one-year
European call option on the stock with an exercise price of $100 using the binomial method.
A) $30.00
B) $16.36
C) $15.67
D) None of the above.
Answer: B Type: Difficult Page: 584
Response: p=10-(-20)/(30-(-20)) = 0.60; C = [(0.6)(30)-(.4)(0)]/1.1 = $16.36

42. A stock is currently selling for $50. One month from today the stock price could go up by 10% or
fall by 50%. If the monthly interest rate is 1% (periodic rate) calculate the price of a European call
option on the stock with an exercise price of $48 and a maturity of one month (use the binomial
method). A) $2.77
B) $2.00
C) $1.98
D) None of the above.
Answer: A Type: Difficult Page: 584
Response: p = [1-(-5)]/(10-(-5)) = 0.40; C = [(0.4)(7) + (0.6)(0)]/1.01 = $2.77

Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 85

 43. A stock is currently selling for $50. The stock price could go up by 10% or fall by 5% each
month. The monthly interest rate is 1% (periodic rate). Calculate the price of a European call option
on the stock with an exercise price of $48 and a maturity of two months. (use the two-stage binomial
method)
A) $3.96
B) $2.77
C) $1.98
D) None of the above.
Answer: A Type: Difficult Page: 584
Response: p=1-(-5)/(10-(-5)) = 0.40 1-p = 0.6
End of one month values: [12.5(0.4) + (4.25)(.6)]/1.01= 7.4752
And [(4.25)(.4)+ (0.6)(0)]/1.01 = $1.6832; C = [0.4(7.4752) + (0.6)(1.6832)]/1.01 = $3.96

44. A stock is currently selling for $50. The stock price could go up by 10% or fall by 5% each
month. The monthly interest rate is 1% (periodic rate). Calculate the price of a American put
option on the stock with an exercise price of $55 and a maturity of two months. (Use the two-stage
binomial method)
A) $5.10
B) $3.96
C) $4.78
D) None of the above.
Answer: A Type: Difficult Page: 584
Response: p=1-(-5)/(10-(-5)) = 0.40 1-p = 0.6
End of one month values: [(0)(0.4) + (2.75)(.6)]/1.01= 1.6337 or zero
And [(2.75)(.4)+(9.875)(0.6)]/1.01 = $6.9555 or $7.5 if exercised;
P = [0.4(1.6337) +(7.5)(0.6)]/1.01 = $5.10

45. A stock is currently selling for $50. The stock price could go up by 10% or fall by 5% each
month. The monthly interest rate is 1% (periodic rate). Calculate the price of a European put option
on the stock with an exercise price of $55 and a maturity of two months. (use the two-stage binomial
method)
A) $5.10
B) $2.77
C) $4.78
D) None of the above.
Answer: C Type: Difficult Page: 584
Response: p=1-(-5)/(10-(-5)) = 0.40 1-p = 0.6
End of one month values: [(0)(0.4) + (2.75)(.6)]/1.01= 1.6337 or zero
And [(2.75)(.4)+(9.875)(0.6)]/1.01 = $6.9555 or $7.5 if exercised ;
P = [0.4(1.6337) +(6.9555)(0.6)]/1.01 = $4.78

True/False Questions

T F 46. An option can be valued using the standard discounted cash flow procedure.
Answer: False Type: Medium Page: 565

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Brealey/Myers/Allen, Principles of Corporate Finance, 8/e 87
 T F 47. It is possible to replicate an investment in a call option by a levered investment in the
underlying asset.
Answer: True Type: Medium Page: 566

T F 48. When risk-neutral probabilities are used, the cost of capital is the discount rate
Answer: False Type: Medium Page: 567

T F 49. Option delta for a put option is always positive

Answer: False Type: Difficult Page: 569

T F 50. For an European option: Value of put = Value of call) - share price + PV(exercise price)
Answer: True Type: Medium Page: 570

T F 51. The binomial model is a discrete time model

Answer: True Type: Medium Page: 570

T F 52. The Black-Scholes model is a discrete time model

Answer: False Type: Medium Page: 575

T F 53. N(d1) and N(d2) are probabilities and therefore take values between 0 and 1.
Answer: True Type: Medium Page: 578

T F 54. Multi-period binomial model can be used to evaluate an American put option
Answer: True Type: Medium Page: 582

Essay Questions

55. Briefly explain why discounted cash flow method (DCF) does not work for valuing options?
Type: Difficult Page: 565
Answer:
Discounted cash flow method has two steps. First, estimating cash flows; second, discounting these cash
flows using an appropriate opportunity cost of capital. In case of options, the first part is quite difficult. But
the second step is almost impossible as the risk of an option changes with changes in stock price.
Also, the risk changes over time even without a change in the stock price.

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 56. Briefly explain why an option is always riskier than the underlying stock?
Type: Difficult Page: 566
Answer:
An investment in option can be replicated by borrowing a fraction of the cost of the stock at the risk-free
rate and investing in the stock. Therefore, investing in an option is always riskier than investing only in
the stock. The beta and the standard deviation of returns of an option is always higher than that of
investing in the underlying stock

57. Briefly explain risk-neutral valuation in the context of option valuation.

Type: Difficult Page: 567
Answer:
The valuation method that uses risk-neutral probabilities to evaluate the current price of an option is
known as risk-neutral valuation. The risk-neutral upside probability is calculated as:
p = [risk-free rate – downside change]/[upside change – downside change]

58. Briefly explain what is meant by risk-neutral probability?

Type: Difficult Page: 567
Answer:
Risk-neutral probability provides certainty equivalent expected payoffs. It assumes that the investor does
not need a higher rate of return to invest in a risky asset. The present value of the payoffs are obtained by
discounting at the risk-free rate of return.

59. Briefly explain the term "option delta."

Type: Medium Page: 567
Answer:
Option delta is the ratio of spread of possible option prices to spread of possible share prices. This is also
the hedge ratio.

60. Give an example of an option equivalent investment using common stock and borrowing.
Type: Difficult Page: 567
Answer:
The current price of a stock is $40. Stock price, one period from today, could be either $50 or $30. The
exercise price is also $40. The risk-free rate per period is 2%. The option payoff is $10 in the up state
and is zero in the down state. By borrowing $14.74 today and buying 0.5 of a share of stock, one can
replicate the payoffs from the option. The payoff in the upstate is, the value of the stock $25 minus the
payoff amount of the loan $15, equal to $10. The payoff in the downstate is, the value of the stock is
$15 minus the payoff amount of $15, equal to zero. This is called a replicating portfolio.

61. Briefly explain put-call parity.

Type: Medium Page: 570
Answer:
The relationship between the value of an European option and the value of our equivalent put option is
called put-call parity. If this does not hold, then investors have arbitrage opportunity.

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 62. Briefly explain how to choose the up and down values for the binomial method?
Type: Medium Page: 574
Answer:
[1 + upside change] = eó (SQRT (h)) and [1 + downside change] = 1/[1 + upside change]
Where: ó = standard deviation of the annual returns of the underlying stock. h = time to expiration
expressed in years.

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