CHAPTER 32
HJM, LMM, and Multiple Zero Curves
Practice Questions
Problem 32.1.
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
only o

CHAPTER 30
Convexity, Timing, and Quanto Adjustments
Practice Questions
Problem 30.1.
Explain how you would value a derivative that pays off 100R in five years where R is
the one-year interest rate (annually compounded) observed in four years. What differ

CHAPTER 10
Mechanics of Options Markets
Practice Questions
Problem 10.1.
An investor buys a European put on a share for $3. The stock price is $42 and the strike price
is $40. Under what circumstances does the investor make a profit? Under what
circumstan

CHAPTER 5
Determination of Forward and Futures Prices
Practice Questions
Problem 5.1.
Explain what happens when an investor shorts a certain share.
The investors broker borrows the shares from another clients account and sells them in the
usual way. To cl

CHAPTER 29
Interest Rate Derivatives: The Standard Market Models
Practice Questions
Problem 29.1.
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 4
Interest Rates
Practice Questions
Problem 4.1.
A bank quotes you an interest rate of 14% per annum with quarterly compounding. What is
the equivalent rate with (a) continuous compounding and (b) annual compounding?
(a) The rate with continuous c

CHAPTER 26
Exotic Options
Practice Questions
Problem 26.1.
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 3
Hedging Strategies Using Futures
Practice Questions
Problem 3.1.
Under what circumstances are (a) a short hedge and (b) a long hedge appropriate?
A short hedge is appropriate when a company owns an asset and expects to sell that asset in the
fut

CHAPTER 6
Interest Rate Futures
Practice Questions
Problem 6.1.
A U.S. Treasury bond pays a 7% coupon on January 7 and July 7. How much interest
accrues per $100 of principal to the bond holder between July 7, 2014 and August 8, 2014?
How would your answe

CHAPTER 28
Martingales and Measures
Practice Questions
Problem 28.1.
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 31
Interest Rate Derivatives: Models of the Short Rate
Practice Questions
Problem 31.1.
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 1
Introduction
Practice Questions
Problem 1.1.
What is the difference between a long forward position and a short forward position?
When a trader enters into a long forward contract, she is agreeing to buy the underlying asset
for a certain price

CHAPTER 11
Properties of Stock Options
Practice Questions
Problem 11.1.
List the six factors affecting stock option prices.
The six factors affecting stock option prices are the stock price, strike price, risk-free interest
rate, volatility, time to matur

CHAPTER 15
The Black-Scholes-Merton Model
Practice Questions
Problem 15.1.
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
probability dist

CHAPTER 13
Binomial Trees
Practice Questions
Problem 13.1.
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

CHAPTER 34
Energy and Commodity Derivatives
Practice Questions
Problem 34.1.
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 w

CHAPTER 33
Swaps Revisited
Practice Questions
Problem 33.1.
Calculate all the fixed cash flows and their exact timing for the swap in Business Snapshot
33.1. Assume that the day count conventions are applied using target payment dates rather
than actual p

CHAPTER 24
Credit Risk
Practice Questions
Problem 24.1.
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 25
Credit Derivatives
Practice Questions
Problem 25.1.
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 35
Real Options
Practice Questions
Problem 35.1.
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 27
More on Models and Numerical Procedures
Practice Questions
Problem 27.1.
Confirm that the CEV model formulas satisfy putcall parity.
It follows immediately from the equations in Section 27.1 that
p c Ke rT S0e qT
in all cases.
Problem 27.2.
Use

CHAPTER 2
Mechanics of Futures Markets
Practice Questions
Problem 2.1.
Distinguish between the terms open interest and trading volume.
The open interest of a futures contract at a particular time is the total number of long positions
outstanding. (Equival

Chapter 9
OIS Discounting, Credit Issues, and Funding Costs
Practice Questions
Problem 9.1.
Explain what is meant by (a) the 3-month LIBOR rate and (b) the 3-month OIS rate.
Which is higher? Why?
The 3-month LIBOR rate is the rate at which a AA-rated bank

Chapter 8
Securitization and the Credit Crisis of 2007
Practice Questions
Problem 8.1.
What was the role of GNMA (Ginnie Mae) in the mortgage-backed securities market of the
1970s?
GNMA guaranteed qualifying mortgages against default and created securitie

CHAPTER 7
Swaps
Practice Questions
Problem 7.1.
Companies A and B have been offered the following rates per annum on a $20 million
five-year loan:
Company A
Company B
Fixed Rate
5.0%
6.4%
Floating Rate
LIBOR+0.1%
LIBOR+0.6%
Company A requires a floating-r

CHAPTER 16
Employee Stock Options
Practice Questions
Problem 16.1.
Why was it attractive for companies to grant at-the-money stock options prior to 2005? What
changed in 2005?
Prior to 2005 companies did not have to expense at-the-money options on the inc

CHAPTER 12
Trading Strategies Involving Options
Practice Questions
Problem 12.1.
What is meant by a protective put? What position in call options is equivalent to a protective
put?
A protective put consists of a long position in a put option combined with

CHAPTER 14
Wiener Processes and Its Lemma
Practice Questions
Problem 14.1.
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 17
Options on Stock Indices and Currencies
Practice Questions
Problem 17.1.
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 18
Futures Options
Practice Questions
Problem 18.1.
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 th