A stock price is currently $20. Tomorrow, news is expected to be announced that will either
increase the price by $5 or decrease the price by $5. What are the problems in using
BlackScholes to value one-month opt
Binomial Trees in Practice
Consider an option that pays off the amount by which the final stock price exceeds the
average stock price achieved during the life of the option. Can this be valued from a binomial
The Greek Letters
What does it mean to assert that the theta of an option position is 0.1 when time is measured
in years? If a trader feels that neither a stock price nor its implied volatility will change, what
Suppose you buy a put option contract on October gold futures with a strike price of $900 per
ounce. Each contract is for the delivery of 100 ounces. What happens if you exercise when
Options on Stock Indices and Currencies
Show that the formula in equation (15.9) for a put option to sell one unit of currency A for
currency B at strike price K gives the same value as equation (15.8) for a cal
Valuing Stock Options: The Black-Scholes-Merton Model
A stock price is currently $40. Assume that the expected return from the stock is 15% and its
volatility is 25%. What is the probability distribution for the
Introduction to Binomial Trees
Consider the situation in which stock price movements during the life of a European option
are governed by a two-step binomial tree. Explain why it is not possible to set up a posi
Trading Strategies Involving Options
Use putcall parity to relate the initial investment for a bull spread created using calls to the
initial investment for a bull spread created using puts.
A bull spread using
Properties of Stock Options
Explain why the arguments leading to putcall parity for European options cannot be used to
give a similar result for American options.
When early exercise is not possible, we can argu
Mechanics of Options Markets
A corporate treasurer is designing a hedging program involving foreign currency options.
What are the pros and cons of using (a) the NASDAQ OMX and (b) the over-the-counter
Securitization and the Credit Crisis of 2007
Why did mortgage lenders frequently not check on information provided by potential
borrowers on mortgage application forms during the 2000 to 2007 period?
Explain why a bank is subject to credit risk when it enters into two offsetting swap contracts.
At the start of the swap, both contracts have a value of approximately zero. As time passes, it
is likely that
Determination of Forward and Futures Prices
Is the futures price of a stock index greater than or less than the expected future value of the
index? Explain your answer.
The futures price of a stock index is always
The cash prices of six-month and one-year Treasury bills are 94.0 and 89.0. A 1.5-year bond
that will pay coupons of $4 every six months currently sells for $94.84. A two-year bond that
will pay cou
Hedging Strategies Using Futures
In the Chicago Board of Trades corn futures contract, the following delivery months are
available: March, May, July, September, and December. State the contract that should be
Mechanics of Futures Markets
The party with a short position in a futures contract sometimes has options as to the precise
asset that will be delivered, where delivery will take place, when delivery will take plac
Suppose you own 5,000 shares that are worth $25 each. How can put options be used to
provide you with insurance against a decline in the value of your holding over the next four
You should buy
1. All of the following are characteristics of program trading except
a. it is portfolio trading.
b. it is computerized trading.
c. it is computerized decision making.
d. it is large block trading.
Other Derivative Assets
1. A primary advantage of futures options is that they
a. require no cash outflow when purchased.
b. permit the adjustment of portfolio risk/return exposure.
c. are guaranteed by the Securities Excha
1. You can think of a swap as all of the following except
a. a pair of stocks.
b. a pair of bonds.
c. a series of forward contracts.
d. a pair of options.
You can think of a swap as the combinatio
Swaps and Interest Rate Options
1. The swap fixed rate is also called the swap _.
d. notional value
2. Tenor refers to
a. the underlying currency behind a swap.
b. the length of time as
Futures Contracts and Portfolio Management
1. Immunization strategies deal mostly with _.
a. credit risk
b. market risk
c. convenience risk
d. interest rate risk
2. In a bullet immunization application, the manager
Foreign Exchange Futures
1. Suppose a U.S. investor buys shares on a foreign stock exchange. When the shares are
eventually sold, the holding period return will be
a. greater if the dollar appreciated relative to the foreign cu
Stock Index Futures
1. A characteristic of stock index futures is
a. they have limited risk.
b. they pay dividends monthly.
c. they are settled in cash.
d. they have a beta of zero.
2. If a stock index is 400.00, how
1. Jones and Smith each own 100 shares of ZYX stock (currently selling for $60). Jones writes a
MAY 65 call, while Smith writes a MAY 70 call. These are the only ZYX option positions
the two people have. Which o
The Black-Scholes Option Pricing Model
In the Black-Scholes Option Pricing Model, what is the minimum and maximum
value of N(d1)?
a. minus infinity to plus infinity
b. minus infinity to zero
c. minus one to zero
d. zero to p
1. If a stocks variance of return increases and everything else remains constant, the price of a
call option will
b. remain unchanged.
d. gradually increase.
2. XYZ pays no div
Option Combinations and Spreads
Which of the following is most equivalent to writing a straddle?
a. buy stock, write two calls
b. buy stock, buy one put
c. short stock, buy one call
d. short stock, buy one put
Basic Option Strategies
1. Which of the following strategies most closely resembles the outright purchase of stock?
a. Buy a call, write a call with a higher striking price.
b. Buy a call, write a put.
c. Write a call, write a pu
Basic Principles of Stock Options
A person who buys an option may do any of the following except
a. extend it.
b. exercise it.
c. sell it.
d. allow it to expire.
An option whose striking price is above the stock