Derivatives Markets, 3e (McDonald)

Chapter 1 Introduction to Derivatives

1.1 Multiple Choice
1) Which of the following is not a derivative instrument?
A) Contract to sell corn
B) Option agreement to bu land
C) !nstallment sales agreement
") Mortgage bac#ed securit
Answer$ C
%) Who from the following list would be considered a speculator b entering into a futures or
options contract on commodities?
A) &armer
B) Corn deliver truc# driver
C) &ood manufacturer
") 'one of the above
Answer$ B
() A mutual fund is engaged in the short term and temporar purchase of inde) futures* for
purposes of minimi+ing its cash e)posures. Which ,use, most closel e)plains their actions?
A) -is# management
B) .peculation
C) -educed transaction costs
") -egulator arbitrage
Answer$ C
/) "uring the growing season* a corn farmer sells short corn futures contracts in an amount e0ual
to her crop. !f upon harvesting and selling her crop she maintains the contracts* she is then
considered a1n)$
A) 2edger
B) .peculator
C) Arbitrager
") 'one of the above
Answer$ B
3) All of the following are financiall engineered products* e)cept$
A) Mortgage
B) Mortgage bac#ed securit
C) !nterest onl
") 4rincipal onl
Answer$ A
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8) .elect the famil member who is offering the most diversification to the rest of the famil.
A) "ad wor#s for 9eneral Motors
B) Mom wor#s for 9oodear
C) "aughter wor#s for :iff ;ube
") .on wor#s for 7li ;ill < Compan
Answer$ "
=) What is the cost of 166 shares of :iff* !nc. stoc# given that the bid>as# prices are
?(1.%3 > ?(%.66 and a ?13.66 commission per transaction e)ists?
A) ?(%13
B) ?(1/6
C) ?(1%3
") ?(%66
Answer$ A
@) Assume that ou purchase 166 shares of :iff* !nc. common stoc# at the bid>as# prices of
?(%.66 > ?(%.36. When ou sell* the bid>as# prices are ?(%.36 > ?((.66. !f ou pa a commission
rate of 6.3A* what is our profit or loss?
A) ?6
B) ?18.%3 loss
C) ?(%.36 gain
") ?(%.36 loss
Answer$ "
B) Assume that ou open a 166>share short position in :iff* !nc. common stoc# at the bid>as#
price of ?(%.66 > ?(%.36. When ou close our position* the bid>as# prices are ?(%.36 > ?((.66. !f
ou pa a commission rate of 6.3A* what is our profit or loss on the short investment?
A) ?(%.36 gain
B) ?18.%3 loss
C) ?1(%.36 loss
") ?166.66 gain
Answer$ C
16) Assume that ou open a 166>share short position in :iff* !nc. common stoc# at the bid>as#
prices of ?(%.66 > ?(%.36. When ou close our position* the bid>as# prices are ?(%.36 > ?((.66.
Cou pa a commission rate of 6.3A. Dhe mar#et interest rate is 3.6A and the short rebate rate is
(.6A. What is our additional gain or loss due to leasing the asset?
A) ?8/.66 loss
B) ?186.66 loss
C) ?B8.66 gain
") ?6
Answer$ A
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11) Assume that an investor lends 166 shares of :iff* !nc. common stoc# to a short seller. Dhe
bid>as# prices are ?(%.66 > ?(%.36. When the position is closed* the bid>as# prices are
?(%.36 > ?((.66. Dhe commission rate is 6.3A. Dhe mar#et interest rate is 3.6A and the short
rebate rate is (.6A. Calculate the gain or loss to the lender. Assume the lender is not subEect to a
bid>as# loss or commissions.
A) ?18/.66 gain
B) ?18/.66 loss
C) ?166.66 gain
") ?166.66 loss
Answer$ A
1%) According to trading volume data tabulated b the Wall .treet :ournal for April 13* %616*
which inde) futures contact e)perienced the highest total open interest?
A) ": !ndustrial Average
B) .<4 366 !nde)
C) Mini .<4 366
") Mini 'asda0 166
Answer$ C
1() A firm provides a service that benefits from decreasing emploment. Dhis firm has a ris#
e)posure to macro event. All other variables being e0ual* which of the following derivative
securities is the firm most li#el use to hedge its e)posure?
A) .hort position in an economic futures
B) ;ong position in an economic futures
C) .hort position in an interest rate futures
") ;ong position in an interest rate futures
Answer$ B
1.% .hort Answer 7ssa Fuestions
1) Wh might a variable rate mortgage be considered a ,derivative, and a fi)ed rate mortgage
not?
Answer$ Dhe pure definition of a derivative is one in which its value is determined b the price
of another item. A-Ms often use ;!BO- to determine their value* thus have their values
,derived, from another securit. Dhis answer ma* of course* be splitting hairs.
%) Wh would a corn farmer* who maintains a short futures contract after harvesting and selling
her crop* be considered a speculator?
Answer$ Dhe farmer was a hedger until she sold her crop. 2er perspective then changed since
she no longer had an asset to hedge. 2er na#ed contract is now a speculation.
() &or families emploed and living in ,compan towns, 1i.e.* where the maEor emploer owns
all homes* retail stores* etc.)* e)plain the lac# of diversification.
Answer$ .ince the large local emploer owns all retail establishments* the demise of the
compan will cause the demise of the entire town. "istribution of ownership would reduce the
impact of a compan failure.
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/) "escribe the concept of a bid>as# spread and how that impacts the cash flows of an investor.
Answer$ !n some mar#ets* especiall ODC* dealers complete transactions. Buers of stoc# pa
the higher of the spread and sellers receive the lower price in the spread. Dhe difference is the
dealerGs profit.
3) What would cause the spread between the mar#et rate of interest and the repo rate to be small?
Answer$ !f there is a low demand to short sell a securit or a large suppl of the securit repo
rates will be higher due to lac# of demand for short instruments.
1.( Class "iscussion Fuestion
1) "iscuss the origins of derivatives in terms of ris# reduction using the concept of evolution to
integrate the additional uses of derivatives into the discussion. Conclude b as#ing students to
list methods b which third parties could ma#e fees b interEecting themselves into the process.
/
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