Derivatives and Risk-Neutral Valuation

Question 1

What two spot interest rates imply the value of a six-month forward contract from a six-month Treasury bill?

Answer 1

The current six-month and 12-month spot rates are needed to find the six-month forward contract for a six-month Treasury bill.

Question 2

What is the relationship between a forward interest rate and its expected value at settlement under the unbiased expectations hypothesis.

Answer 2

Under the unbiased hypothesis, forward bond prices are predictors of subsequent spot prices.

Question 3

What are the carryin costs and benefits of physical inventory

Answer 3

costs - interest and storage

benefit - convenient yield

Question 4

What does it mean when a future is marked to market?

Answer 4

Cash is transferred through the life of the contract when prices change.

Question 5

What is a maintenance margin?

Answer 5

A maintenance margin is collateral put up by the investor on an ongoing basis until the position is closed out.

Question 6

What two assets form a long straddle

Answer 6

A long call and a long put with the same strike rate

Question 7

What is the equation for a put-call parity?

Answer 7

Call + bond - Put = Underlying assets.

Question 8

What are the five variables that determine the price of an option on a non-divident stock according to the Black-Scholes option pricing model?

Answer 8

• The price of the underlying asset
• The strike price
• The return volatility of the underlying asset
• The time to the option’s expiration
• The riskless rate

Question 9

What are the names of the first and second derivatives of an option price with respect to the price of the option’s underlying asset?

Answer 9

Delta and gamma