Chapter 10

Question 1

___: trade today
___: trade tomorrow
___: might trade tomorrow

Answer 1

spot; forward/future; option

Question 2

intertemporal securities which ‘derive’ their value from the underlying asset

Answer 2

derivatives

Question 3

An agreement between two parties to exchange a standard quantity of an asset at a predetermined price at a specified date in the future.

Answer 3

derivative security

Question 4

agreement made between a buyer and a seller at time 0 for the seller to deliver the asset immediately and the buyer to pay for the asset immediately

Answer 4

spot contract

Question 5

agreement between a buyer and a seller at time 0 to exchange a non-standardized asset for cash at some future date. the details of the asset and the price to be paid at the forward contract expiration date are set at time 0.

• the price is fixed over the life of the contract

Answer 5

forward contract

Question 6

agreement between a buyer and a seller at time 0 to exchange a standardized asset for cash at some future date. Each contract has a standardized expiration and transactions occur in a centralized market

• the price changes daily as the market value of the asset underlying the futures fluctuates

Answer 6

futures contract

Question 7

Describes the prices on outstanding futures contracts that are adjusted each day to reflect current futures market conditions.

Answer 7

marked to market

Question 8

US treasury futures settlement procedures

Answer 8

settlement

Question 9

A purchase of a futures contract.

Answer 9

long position

Question 10

A sale of a futures contract.

Answer 10

short position

Question 11

The unit that oversees trading on the exchange and guarantees all trades made by the exchange traders.

Answer 11

clearinghouse

Question 12

___ requirements on futures that act as a security bond should a counterparty default

Answer 12

margin

Question 13

A deposit required on futures trades to ensure that the terms of any futures contract will be met

Answer 13

initial margin

Question 14

The margin a futures trader must maintain once a futures position is taken. If losses on the customer’s futures position occur and the level of the funds in the margin account drop below the maintenance margin, the customer is required to deposit additional funds into their margin account, bringing the balance back up to the initial margin.

Answer 14

maintenance margin

Question 15

An investment in which traders post and maintain only a small portion of the value of their futures position in their accounts. The vast majority of the investment is borrowed from the investor’s broker.

Answer 15

leveraged investment

Question 16

if losses on the customer’s futures position occur and the level of the funds in the margin account drops below a stated level, the customer receives a ___ ___

Answer 16

margin call

Question 17

a long position in the futures market produces a profit when the value of the underlying T-bond ___

Answer 17

increases

Question 18

a short position in the futures will produce a profit when the value of the underlying t-bond ___

Answer 18

decreases (i.e. interest rates rise)

Question 19

the amount of the margin varies according to the type of contract traded and the ___ of futures contracts traded (e.g. 5% margin of the value of the underlying asset)

Answer 19

quantity

Question 20

A contract that gives the holder the right, but not the obligation, to buy or sell the underlying asset at a specified price within a specified period of time.

Answer 20

option

Question 21

An option that gives a purchaser the right, but not the obligation, to buy the underlying security from the writer of the option at a prespecified exercise price on or before a prespecified date.

Answer 21

call option

• owner is long the underlying, writer is short

Question 22

if, as the option expires, the price of the stock underlying the option, the buyer makes a profit
–> which is the difference between the __ __ and the ___ ___ of the option ___ the ___ ___ ___ to the writer of the option

Answer 22

stock’s price; exercise price; minus; call premium paid

Question 23

the higher the underlying sock’s price at expiration, the ___ the profit on the exercise of the option

Answer 23

larger

(as the underlying stock’s price rises, the call option buyer has a large profit potential)

Question 24

buying a call option is an appropriate position when the underlying asset’s price is expected to ___

Answer 24

rise

Question 25

if the underlying sock's price at expiration is ___ the exercise price, the call buyer is not obligated to exercise the option the buyers losses are limited to the amount of the __ __ payment made to purchase the call option

Answer 25

below; up-front premium

Question 26

in writing a call option on a stock, the writer or seller receives an up-front fee or premium and must stand ready to ___ the underlying stock to the purchaser of the option at the exercise price

Answer 26

sell

Question 27

as the underlying stock's price falls, the potential for a call option writer to receive a positive payoff (or profit) ___

Answer 27

increases

Question 28

as the underlying stock's price ___, the call option writer has unlimited loss potential

Answer 28

rises

Question 29

if the underlying stock's price is ___ than the exercise price at expiration, the call option buyer will exercise the option, forcing the option writer to __ the underlying stock at its high market price and then ___ it to the call option buyer at the lower exercise price

Answer 29

greater; buy; sell

Question 30

An option that gives a purchaser the right, but not the obligation, to sell the underlying security to the writer of the option at a prespecified price on or before a prespecified date.

Answer 30

put option - owner is short the underlying, writer is long

Question 31

The difference between an option’s exercise price and the underlying asset’s price. - payoff if the option was exercised right now

Answer 31

intrinsic value of an option

Question 32

The difference between an option’s price (or premium) and its intrinsic value. - value in excess of intrinsic, from time to expiration

Answer 32

time value of an option

Question 33

An option that can be exercised at any time before and on the expiration date.

Answer 33

American option

Question 34

An option that can be exercised only on the expiration date.

Answer 34

European option

Question 35

the underlying asset on a ______ is the value of a major stock market index (e.g. the DJIA or the S&P 500 index)

Answer 35

stock index option

Question 36

the difference between a stock option and a stock index option is that at expiration, the stock index option holder ___ settle the option contract with the actual purchase or sale of the underlying stock index, instead they are settled in ___

Answer 36

cannot; cash

Question 37

the underlying asset on a ___ ___ contract is the stock of a publicly traded company

Answer 37

stock option

Question 38

one option generally involved ___ shares of the underlying company's stock

Answer 38

100

Question 39

regulates all securities traded on national securities exchanges, including several exchange-traded derivates

Answer 39

SEC

Question 40

has exclusive jurisdiction over all exchange-traded derivative securities and regulates all national futures exchanges, as well as all future and options contracts

Answer 40

Commodities Futures Trading Commission (CFTC)

Question 41

An agreement between two parties to exchange a series of cash flows for a specific period of time at a specified interval.

Answer 41

swap

Question 42

An exchange of fixed-interest payments for floating-interest payments by two counterparties.

Answer 42

interest rate swap

Question 43

By convention, a party that makes the fixed-rate payments in an interest rate swap transaction.

Answer 43

swap buyer

Question 44

By convention, a party that makes the floating-rate payments in an interest rate swap transaction.

Answer 44

swap seller

Question 45

A swap used to hedge against exchange rate risk from mismatched currencies on assets and liabilities.

Answer 45

currency swap

Question 46

fastest-growing types of swaps have been those developed to better allow financial institutions to hedge their credit risk

Answer 46

credit default swap

Question 47

the ___ ___ __ was an important factor leading to the global financial crisis of 2008, which witnessed the after-effects of poor loan underwritting, shoddy documentation and due diligence, failure to monitor borrower activity, and fraudulent activity on the part of both lenders and borrowers

Answer 47

loosening of incentives

Question 48

A call option on interest rates, often with multiple exercise dates.

Answer 48

cap

Question 49

buying a cap means buying a call option or a succession of call options on ___ ___

Answer 49

interest rates

Question 50

A put option on interest rates, often with multiple exercise dates.

Answer 50

floor

Question 51

buying a floor is similar to buying a ___ ___ on interest rates

Answer 51

put option

Question 52

A position taken simultaneously in a cap and a floor.

Answer 52

collar (the idea is that the firm wants to hedge itself against rising rates but wants to finance the cost of the cap)

Question 53

you can 'offset' a futures contract by entering into an ___ ___

Answer 53

opposite contract (both contracts expire at the same time, the gold purchased from the 'long' contract is sold to the 'short' contract)

Question 54

- owner/buyer of the contract chooses if future trade happens - writer/seller of the contract has no choice - everything else is fixed - owner buys the option from the writer, paying them a premium

Answer 54

option to trade

Question 55

option to trade (call vs. put): - transaction price: - expiration date: - quantity:

Answer 55

- transaction price: strike/exercise price - expiration date: 3rd friday of the month - quantity: 100 shares