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 a

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

CHAPTER 9
Mechanics of Options Markets
Practice Questions
Problem 9.1.
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
circumstance

CHAPTER 10
Properties of Stock Options
Practice Questions
Problem 10.1.
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 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

CHAPTER 11
Trading Strategies Involving Options
Practice Questions
Problem 11.1.
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 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 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 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 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 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 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 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