Derivatives

Question 1

____ contracts are marked to market daily whereas ____ contracts are not.

Answer 1

a) Future
b) Forward

Question 2

What does 1 x 3 FRA means?

Answer 2

To borrow for 2 months after 1 month

Question 3

While calculating currency forward valuation, rf is taken of which currency?

Answer 3

Price currency

Question 4

How is price expressed for the following-
a) T Bills
b) Coupon bonds
c) FRA
d) Currency forward

Answer 4

a) Annualised percentage discount from fair value
b) YTM
c) Annualised MRR
d) currency exchange rate

Question 5

What is delivery option?

Answer 5

Bond futures contracts often allow the short an option to deliver any of several bonds, which will satisfy the delivery terms of the contract. This is called a delivery option and is valuable to the short.

Question 6

What is the SOFR rate?

Answer 6

The lending rate on dollar-denominated loans between banks is based on the secured overnight funding rate.

Question 7

To exploit arbitrage using delta ratio, which position do we take?

Answer 7

Long delta shares and call seller.

Question 8

When are American options more valuable than European options?

Answer 8

a) When put is deep in the money i.e. downtick is more than uptick.
b) Call dividend

Question 9

What does N(d2) means?

Answer 9

It is the risk neutral probabilty that call option will expire in the money.
Also, this the number of short position on bonds.

Question 10

What does N(d1) means?

Answer 10

It is the delta of options.

Question 11

What is geometric Brownian motion process?

Answer 11

It is an assumption of BSM model where it states that the continuous compounded return is normally distributed.

Question 12

Which greek term explains change in delta due to change in spot price?

Answer 12

Gamma
Gamma captures the curvature of the option-value-versus-stock-price relationship. Gamma is highest for at-the-money options.

Question 13

What does delta close to -
a) 1
b) 0.5
c) 0 means for call option?

Answer 13

a) In the money
b) At the money
c) Out the money

Question 14

What is the relationship between delta and call/put options?

Answer 14

Call option is positively related and put option is negatively related.
For gamma both are positively related.

Question 15

Which greek terms helps in hedging and creating and neutral portfolio?

Answer 15

Delta and Gamma

Question 16

When is volatility high for call and put options?

Answer 16

When the option is near the money.

Question 17

What is the gamma risk of delta hedged portfolio?

Answer 17

When price of stock abruptly jumps, the delta will change leaving the previously hedged position unhedged.
The risk of no rebalancing due to change in stock.
A delta-hedged portfolio with a long position in stocks and a short position in calls will have negative net gamma exposure.

Question 18

If market implied volatility is higher then what should we do to our call/put options?

Answer 18

This implies that the Call/Put prices are higher than expected. Hence, sell.

Question 19

What is the black model?

Answer 19

The model represents call and put options on interest rate.
Call option = Right to borrow at fixed rate.

Question 20

Long Call + Put Sell in interest rate implies?

Answer 20

Long FRA - Pay fixed, receive floating
vice versa

Question 21

Series of interest rate call option?

Answer 21

Interest rate Cap, helps in hedging against floating rate loan.
Interest rate put option - interest rate floor - hedge against floating rate investment.

Question 22

If volatility is higher for lower strike prices than for higher strike prices then out of the money put options will be ?

Answer 22

Generally more expensive than out of the money call options.

Question 23

Synthetic European Put Options?

Answer 23

Long Call + Long bond - short stock

Question 24

What is implied volatility?

Answer 24

It is a measure of future estimated volatility which varies across both exercise price and time to expiration for various options. It is a measure of market price of risk.

Question 25

True or False?
Volatility skew tends to steepen whenever the market price of hedging is rising, which causes the its shape to be different from volatility smile.

Answer 25

True

Question 26

True or false?
For a deep-in-the money put option, the upside is limited (because the stock price cannot fall below zero). In such cases, the interest on intrinsic value can exceed the option’s time value

Answer 26

True

Question 27

What is the put call parity theory if option pays dividend?

Answer 27

P0 + S0e ^–δT = C0 + e^–rTX

Question 28

The value of an option on a currency can be thought of as being made up of two components, which are?

Answer 28

A bond component and a foreign exchange component

Question 29

What is time decay?

Answer 29

As time passes and a call option approaches maturity, its speculative value declines, all else equal.
Deep in-the-money put options close to maturity may actually increase in value as time passes.

Question 30

What is the relationship between future and bond component for-
a) Long Call (for declining interest rate
b) Long Put (for rising interest rate)

Answer 30

a) Future component – bond component
b) Bond component – Future component