CHAPTER 28
Interest Rate Derivatives: The Standard Market Models
Practice Questions
Problem 28.1.
A company caps three-month LIBOR at 10% per annum. The principal amount is $20
million. On a reset date, three-month LIBOR is 12% per annum. What payment wou
CHAPTER 17
Futures Options
Practice Questions
Problem 17.1
Explain the difference between a call option on yen and a call option on yen futures.
A call option on yen gives the holder the right to buy yen in the spot market at an exchange
rate equal to the
CHAPTER 21
Value at Risk
Practice Questions
Problem 21.1.
Consider a position consisting of a $100,000 investment in asset A and a $100,000
investment in asset B. Assume that the daily volatilities of both assets are 1% and that the
coefficient of correla
FIN 641 Lecture 4
Forward and Futures Prices
Consumption vs Investment Assets
Investment assets are assets held by significant
numbers of people purely for investment purposes
(Examples: gold, silver)
Consumption assets are assets held primarily for
consu
FIN641 Exam II Sample Questions
Part I. Multiple Choices
1) Which of the following creates a bull spread?
A) Buy a low strike price call and sell a high strike price call
B) Buy a high strike price call and sell a low strike price call
C) Buy a low strike
NEW JERSEY INSTITUTE OF TECHNOLOGY
School of Management
Course Title: Corporate Finance II
Instructor: Dr. George Li, CFA
Email: leeyzz@hotmail.com
Class Timing: Distance Learning
Course Number: FIN 624
Semester: Fall, 2014
Prerequisites:
An introductory
FIN 641 Lecture 1
Derivatives Markets
An Introduction to Forwards, Futures and Options
Objective :
Basic derivatives contracts
o Forward/Future contracts
o Call/Put options
Types of positions
o Long position
o Short position
Graphical representation
o
FIN 641 Lecture 3
Interest Rates
Types of Rates
Treasury rates
LIBOR rates
Repo rates
2
Treasury Rates
Rates on instruments issued by a
government in its own currency
http:/online.wsj.com/mdc/public/page/mdc_bonds.html?m
od=mdc_topnav_2_3000
3
LIBOR and L
FIN 641 Lecture 5
Interest Rate Futures
Day Counts
Day count conventions:
Accrued interest
= coupon ( # of days from last coupon to the settlement
date)/ (# of days in coupon period)
2
Day Count Conventions in the U.S. (Page 129)
Treasury Bonds:
Actual/Ac
FIN 641 Lecture 2
Hedging Strategies Using Futures
Long & Short Hedges
A long futures hedge is appropriate when
you know you will purchase an asset in the
future and want to lock in the price
A short futures hedge is appropriate when
you know you will sel
CHAPTER 30
Interest Rate Derivatives: Models of the Short Rate
Practice Questions
Problem 30.1.
What is the difference between an equilibrium model and a no-arbitrage model?
Equilibrium models usually start with assumptions about economic variables and de
CHAPTER 34
Real Options
Practice Questions
Problem 34.1.
Explain the difference between the net present value approach and the risk-neutral valuation
approach for valuing a new capital investment opportunity. What are the advantages of the
risk-neutral va
CHAPTER 33
Energy and Commodity Derivatives
Practice Questions
Problem 33.1.
What is meant by HDD and CDD?
A days HDD is max(0, 65 A) and a days CDD is max(0, A 65) where A is the average
of the highest and lowest temperature during the day at a specified
CHAPTER 29
Convexity, Timing, and Quanto Adjustments
Practice Questions
Problem 29.1.
Explain how you would value a derivative that pays off 100 R in five years where R is
the one-year interest rate (annually compounded) observed in four years. What diffe
CHAPTER 31
Interest Rate Derivatives: HJM and LMM
Practice Questions
Problem 31.1.
Explain the difference between a Markov and a non-Markov model of the short rate.
In a Markov model the expected change and volatility of the short rate at time t depend on
CHAPTER 32
Swaps Revisited
Practice Questions
Problem 32.1.
Calculate all the fixed cash flows and their exact timing for the swap in Business Snapshot
32.1. Assume that the day count conventions are applied using target payment dates rather
than actual p
CHAPTER 27
Martingales and Measures
Practice Questions
Problem 27.1.
How is the market price of risk defined for a variable that is not the price of an
investment asset?
The market price of risk for a variable that is not the price of an investment asset
CHAPTER 26
More on Models and Numerical Procedures
Practice Questions
Problem 26.1.
Confirm that the CEV model formulas satisfy putcall parity.
It follows immediately from the equations in Section 26.1 that
p c = Ke rT S 0e qT
in all cases.
Problem 26.2.
CHAPTER 25
Exotic Options
Practice Questions
Problem 25.1.
Explain the difference between a forward start option and a chooser option.
A forward start option is an option that is paid for now but will start at some time in the
future. The strike price is
CHAPTER 20
Basic Numerical Procedures
Practice Questions
Problem 20.1.
Which of the following can be estimated for an American option by constructing a single
binomial tree: delta, gamma, vega, theta, rho?
Delta, gamma, and theta can be determined from a
CHAPTER 22
Estimating Volatilities and Correlations
Practice Problems
Problem 22.1.
Explain the exponentially weighted moving average (EWMA) model for estimating volatility
from historical data.
Define ui as ( Si Si 1 ) / Si 1 , where Si is value of a mar
CHAPTER 23
Credit Risk
Practice Questions
Problem 23.1.
The spread between the yield on a three-year corporate bond and the yield on a
similar risk-free bond is 50 basis points. The recovery rate is 30%. Estimate the average
hazard rate per year over the
CHAPTER 24
Credit Derivatives
Practice Questions
Problem 24.1.
Explain the difference between a regular credit default swap and a binary credit default
swap.
Both provide insurance against a particular company defaulting during a period of time. In a
cred
CHAPTER 18
The Greek Letters
Practice Questions
Problem 18.1.
Explain how a stop-loss trading rule can be implemented for the writer of an out-of-themoney call option. Why does it provide a relatively poor hedge?
Suppose the strike price is 10.00. The opt
CHAPTER 19
Volatility Smiles
Practice Questions
Problem 19.1.
What volatility smile is likely to be observed when
(a) Both tails of the stock price distribution are less heavy than those of the lognormal
distribution?
(b) The right tail is heavier, and th
CHAPTER 16
Options on Stock Indices and Currencies
Practice Questions
Problem 16.1.
A portfolio is currently worth $10 million and has a beta of 1.0. An index is currently
standing at 800. Explain how a put option on the index with a strike of 700 can be
CHAPTER 14
The Black-Scholes-Merton Model
Practice Questions
Problem 14.1.
What does the BlackScholesMerton stock option pricing model assume about the
probability distribution of the stock price in one year? What does it assume about the
continuously com
CHAPTER 13
Wiener Processes and Its Lemma
Practice Questions
Problem 13.1.
What would it mean to assert that the temperature at a certain place follows a
Markov process? Do you think that temperatures do, in fact, follow a Markov process?
Imagine that you
CHAPTER 12
Binomial Trees
Practice Questions
Problem 12.1.
A stock price is currently $40. It is known that at the end of one month it will be either $42 or
$38. The risk-free interest rate is 8% per annum with continuous compounding. What is the
value of