Hull: Options, Futures, and Other Derivatives, Ninth Edition Chapter 1: Introduction Multiple Choice Test Bank: uestions !ith "ns!ers 1. A one-year one-year forwar forward d contract contract is an agreement agreement wher where e A. One side has the right to buy buy an asset for a certain price price in one year’s year’s time. B. One side has the obligation to buy an asset asset for a certain certain price in one one year’s time. C. One side has the obligation to buy an asset asset for a certain certain price at some some time during the next year. D. One side has the obligation to buy an asset asset for the maret maret price price in one year’s time. Answer! B A one-year forward contract is an obligation to buy or sell in one year’s time for a predetermined price. By contrast" an option is the right to buy or sell.
#. $hich $hich of the following following is %O& %O& true true A. $hen a CBO' call option on (B) is exercised" exercised" (B) issues more stoc stoc B. An American option can can be exercised exercised at any time during its its life C. An call option will always be exerc exercised ised at maturity maturity if the underlying underlying asset price is greater than the strie price D. A put option will always be exercised exercised at maturity if the strie price is greater than the underlying asset price. Answer! A $hen an (B) call option is exercised the option seller must buy shares in the maret to sell to the option buyer. (B) is not in*ol*ed in any way. Answers B" C" and D are true.
+. A one-yea one-yearr call option option on a stoc stoc with with a stri strie e price price of ,+ costs costs ,+ ,+ a oneoneyear put option on the stoc with a strie price of ,+ costs ,/. 0uppose that a trader buys two call options and one put option. &he breae*en stoc price abo*e which the trader maes a prot is A. ,+2 B. ,/ C. ,+ D. ,+3 Answer! A $hen the stoc price is ,+2" the two call options pro*ide a payo4 of #56+27+8 or ,1. &he put option pro*ides no payo4. &he total cost of the options is #5+9 / or ,1. &he stoc price in A" ,+2" ,+2" is therefore therefore the breae*en stoc price abo*e which the position is protable because it is the price for which the cost of the options e:uals the payo4.
/. A one-year call option on a stoc with a strie price of ,+ costs ,+ a oneyear put option on the stoc with a strie price of ,+ costs ,/. 0uppose that a trader buys two call options and one put option. &he breae*en stoc price below which the trader maes a prot is A. ,#2 B. ,#; C. ,#3 D. ,# Answer! D $hen the stoc price is ,# the two call options pro*ide no payo4. &he put option pro*ides a payo4 of +7# or ,1. &he total cost of the options is #5+9 / or ,1. &he stoc price in D" ,#" is therefore the breae*en stoc price below which the position is protable because it is the price for which the cost of the options e:uals the payo4.
2. $hich of the following is approximately true when si
3. $hich of the following best describes the term =spot price> A. &he price for immediate deli*ery B. &he price for deli*ery at a future time C. &he price of an asset that has been damaged D. &he price of renting an asset Answer! A &he spot price is the price for immediate deli*ery. &he futures or forward price is the price for deli*ery in the future
?. $hich of the following is true about a long forward contract A. &he contract becomes more *aluable as the price of the asset declines B. &he contract becomes more *aluable as the price of the asset rises
C. &he contract is worth
;. An in*estor sells a futures contract an asset when the futures price is ,1"2. 'ach contract is on 1 units of the asset. &he contract is closed out when the futures price is ,1"2/. $hich of the following is true A. &he in*estor has made a gain of ,/" B. &he in*estor has made a loss of ,/" C. &he in*estor has made a gain of ,#" D. &he in*estor has made a loss of ,#" Answer! B An in*estor who buys 6has a long position8 has a gain when a futures price increases. An in*estor who sells 6has a short position8 has a loss when a futures price increases.
@. $hich of the following describes 'uropean options A. 0old in 'urope B. riced in 'uros C. 'xercisable only at maturity D. Calls 6there are no 'uropean puts8 Answer! C 'uropean options can be exercised only at maturity. &his is in contrast to American options which can be exercised at any time. &he term ='uropean> has nothing to do with geographical location" currencies" or whether the option is a call or a put.
1.$hich of the following is %O& true A. A call option gi*es the holder the right to buy an asset by a certain date for a certain price B. A put option gi*es the holder the right to sell an asset by a certain date for a certain price C. &he holder of a call or put option must exercise the right to sell or buy an asset D. &he holder of a forward contract is obligated to buy or sell an asset
Answer! C &he holder of a call or put option has the right to exercise the option but is not re:uired to do so. A" B" and C are correct 11.$hich of the following is %O& true about call and put options! A. An American option can be exercised at any time during its life B. A 'uropean option can only be exercised only on the maturity date C. (n*estors must pay an upfront price 6the option premium8 for an option contract D. &he price of a call option increases as the strie price increases Answer! D A call option is the option to buy for the strie price. As the strie price increases this option becomes less attracti*e and is therefore less *aluable. A" B" and C are true. 1#.&he price of a stoc on uly 1 is ,2?. A trader buys 1 call options on the stoc with a strie price of ,3 when the option price is ,#. &he options are exercised when the stoc price is ,32. &he trader’s net prot is A. ,? B. ,2 C. ,+ D. ,3 Answer! C &he payo4 from the options is 15632-38 or ,2. &he cost of the options is #51 or ,#. &he net prot is therefore 27# or ,+.
1+.&he price of a stoc on ebruary 1 is ,1#/. A trader sells # put options on the stoc with a strie price of ,1# when the option price is ,2. &he options are exercised when the stoc price is ,11. &he trader’s net prot or loss is A. Eain of ,1" B. Foss of ,#" C. Foss of ,#"; D. Foss of ,1" Answer! D &he payo4 that must be made on the options is #561#7118 or ,#. &he amount recei*ed for the options is 25# or ,1. &he net loss is therefore #71 or ,1.
1/.&he price of a stoc on ebruary 1 is ,;/. A trader buys # put options on the stoc with a strie price of ,@ when the option price is ,1. &he options are exercised when the stoc price is ,;2. &he trader’s net prot or loss is A. Foss of ,1"
B. Foss of ,#" C. Eain of ,# D. Eain of ,1 Answer! A &he payo4 is @7;2 or ,2 per option. or # options the payo4 is therefore 25# or ,1. Gowe*er the options cost 15# or ,#. &here is therefore a net loss of ,1. 12.&he price of a stoc on ebruary 1 is ,/;. A trader sells # put options on the stoc with a strie price of ,/ when the option price is ,#. &he options are exercised when the stoc price is ,+@. &he trader’s net prot or loss is A. Foss of ,; B. Foss of ,# C. Eain of ,# D. Foss of ,@ Answer! C &he payo4 is /7+@ or ,1 per option. or # options the payo4 is therefore 15# or ,#. Gowe*er the premium recei*ed by the trader is #5# or ,/. &he trader therefore has a net gain of ,#.
13.A speculator can choose between buying 1 shares of a stoc for ,/ per share and buying 1 'uropean call options on the stoc with a strie price of ,/2 for ,/ per option. or second alternati*e to gi*e a better outcome at the option maturity" the stoc price must be abo*e A. ,/2 B. ,/3 C. ,22 D. ,2 Answer! D $hen the stoc price is ,2 the rst alternati*e leads to a position in the stoc worth 152 or ,2. &he second alternati*e leads to a payo4 from the options of 15627/28 or ,2. Both alternati*es cost ,/. (t follows that the alternati*es are e:ually protable when the stoc price is ,2. or stoc prices abo*e ,2 the option alternati*e is more protable. 1?.A company nows it will ha*e to pay a certain amount of a foreign currency to one of its suppliers in the future. $hich of the following is true A. A forward contract can be used to loc in the exchange rate B. A forward contract will always gi*e a better outcome than an option C. An option will always gi*e a better outcome than a forward contract D. An option can be used to loc in the exchange rate Answer! A A forward contract ensures that the e4ecti*e exchange rate will e:ual the current forward exchange rate. An option pro*ides insurance that the exchange rate will not be worse than a certain le*el" but re:uires an upfront
premium. Options sometimes gi*e a better outcome and sometimes gi*e a worse outcome than forwards. 1;.A short forward contract on an asset plus a long position in a 'uropean call option on the asset with a strie price e:ual to the forward price is e:ui*alent to A. A short position in a call option B. A short position in a put option C. A long position in a put option D. %one of the abo*e Answer! C 0uppose that 0 & is the nal asset price and H is the strie priceIforward price. A short forward contract leads to a payo4 of H70 &. A long position in a 'uropean call option leads to a payo4 of max60 &7H" 8. $hen added together we see that the total position leads to a payo4 of max6" H70 &8" which is the payo4 from a long position in a put option. C can also be seen to be true by plotting the payo4s as a function of the nal stoc price.
[email protected] trader has a portfolio worth ,2 million that mirrors the performance of a stoc index. &he stoc index is currently 1"#2. utures contracts trade on the index with one contract being on #2 times the index. &o remo*e maret ris from the portfolio the trader should A. Buy 13 contracts B. 0ell 13 contracts C. Buy # contracts D. 0ell # contracts Answer! B One futures contract protects a portfolio worth 1#25#2. &he number of contract re:uired is therefore 2""I61#25#28J13. &o remo*e maret ris we need to gain on the contracts when the maret declines. A short futures position is therefore re:uired.
#.$hich of the following best describes a central clearing party A. (t is a trader that wors for an exchange B. (t stands between two parties in the o*er-the-counter maret C. (t is a trader that wors for a ban D. (t helps facilitate futures trades Answer! B A central clearing party 6CC8 is a clearing house that stands between two parties in the o*er-the-counter maret. (t ser*es the same purpose as an exchange clearing house.
