Q1. Which of these is best classified as a forward commitment?

A. A convertible bond
B. A call option
C. A swap agreement

Q2. Which of the following statements best describes a feature of an option contract? In an option contract:
A. both the long and the short can default.
B. only the short can default.
C. only the long can default.

Q3. A perfectly hedged position consisting of a derivative and its underlying asset will most likely yield a return that is:
A. equal to the risk-free rate.
B. smaller than the risk-free rate.
C. greater than the risk-free rate.

Q4. What is the most likely reason why arbitrage will not completely eliminate all pricing discrepancies for derivatives?
A. Differences in risk aversion
B. Transaction costs
C. Inaccurate forecasts

Q5. Knowledge about the degree of risk aversion of investors is most likely needed for:
A. the pricing of assets, but not for the pricing of derivatives.
B. both the pricing of assets and of derivatives.
C. the pricing of derivatives, but not for the pricing of assets.

Q6. Replication is most likely used to:

A. reduce portfolio risk.
B. increase leverage.
C. exploit pricing differentials.

Q7. The price of a forward contract most likely:

A. decreases as the price of the underlying goes up.
B. is constant and set as part of the contract specifications.
C. increases as market risk increases.

Q8. The value of a long position in a forward contract at expiration is best defined as:
A. forward price agreed in the contract minus spot price of the underlying.
B. spot price of the underlying minus forward price agreed in the contract.
C. value of the forward at initiation minus spot price of the underlying.
Q9. Exercise of a European put option is most likely justified if:
A. the option is out of the money.
B. the exercise price exceeds the value of the underlying.
C. the exercise value is negative.

Q10. Holding other factors constant, the value of a European put option will most likely decrease as the:
A. risk-free interest rate increases.
B. volatility of the underlying increases.
C. value of the underlying decreases.

Q11. If dividends paid by the underlying increase, the value of a European call option will most likely:
A. not change.
B. increase.
C. decrease.
Q12. Relative to spot markets, one key feature of derivatives markets is:
A. high transaction costs.
B. low capital requirements.
C. restrictions on short selling.

Q13. Which of the following attributes is least likely to be a requirement for the existence of riskless arbitrage? The
underlying security:
A. can be sold short.
B. is a financial asset.
C. is relatively liquid.

Q14. If the implied volatility for options on a broad-based equity market index goes up, then it is most likely that:
A. the broad-based equity market index has gone up in value.
B. the general level of market uncertainty has gone up.
C. market interest rates have gone up.

Q15. There are two forward contracts, contract 1 and contract 2, on the same underlying. The underlying makes no cash
payments, does not yield any nonfinancial benefits, and does not incur any storage costs. Contract 1 expires in one year,
and contract 2 expires in two years. It is most likely that the price of contract 1:
A. is equal to the price of contract 2.
B. is less than the price of contract 2.
C. exceeds the price of contract 2.

Q16. A high convenience yield is most likely associated with holding:

A. bonds.
B. equities.
C. commodities.

Q17. A forward rate agreement most likely differs from most other forward contracts because:
A. positions cannot be closed out prior to maturity.
B. it involves an option component.
C. its underlying is not an asset.

Q18. Which of the following statements is least accurate concerning differences in the pricing of forwards and futures?
A. Differences in the pattern of cash flows of forwards and futures can explain pricing differences.
B. Pricing differences can arise if futures prices and interest rates are uncorrelated.
C. Interest rate volatility can explain pricing differences.

Q19. Valuation of a swap during its life will least likely involve the:
A. application of the principle of no arbitrage.
B. use of replication.
C. investor’s risk aversion.

Q20. For a call option, if the underlying asset’s value is less than the option’s exercise price, the option is said to be:
A. at the money.
B. out of the money.
C. in the money.

Q21. For a stock that pays no dividends, the value of an American call option is most likely:
A. the same as the value of a European call option with otherwise identical features.
B. greater than the value of a European call option with otherwise identical features.
C. less than the value of a European call option with otherwise identical features.

Q22. In an efficient market, it is more likely that fundamental value will be reflected in the:
A. underlying spot market before the derivative market.
B. derivatives market and the underlying spot market at the same time.
C. derivatives market before the underlying spot market.

Q23. A corporation issues five-year fixed-rate bonds. Its treasurer expects interest rates to decline for all maturities for at
least the next year. She enters into a one-year agreement with a bank to receive quarterly fixed-rate payments and to
make payments based on floating rates benchmarked on three-month Libor. This agreement is best described as a:
A. futures contract.
B. forward contract.
C. swap.

Q24. Conceptually, a forward rate agreement most likely allows a company that wants to invest money in the future to
lock in a rate by making a:
A. variable payment and receiving a fixed payment.
B. fixed payment and receiving a different fixed payment.
C. fixed payment and receiving a variable payment.

Q25. When valuing a call option using the binomial model, an increase in the probability that the underlying will go
up most likely implies that the current price of the call option:
A. increases.
B. remains unchanged.
C. decreases.

Q26. In the binomial model, the difference between the up and down factors best represents the:
A. volatility of the underlying.
B. moneyness of an option.
C. pseudo probability.

Q27. The underlying in a forward rate agreement is most likely a(n):

A. growth rate of an equity index.
B. interest rate.
C. exchange rate.

Q28. Using put–call parity, a long call can best be replicated by going:
A. long the put, short the asset, and long the bond.
B. short the put, long the asset, and short the bond.
C. long the put, long the asset, and short the bond.