Practice questions

Question 1

what is the delta of an option?

Answer 1

change in call price for a small change in stock price

Question 2

what is inversely related to the value of a call option?

Answer 2

the strike price

Question 3

according to the put call parity which of the following is true:

a) buying a call and selling a put is equivalent to buying a stock and borrowing PV(X)
b) buying a call and selling a put is equivalent to buying a stock and lending PV(X)
c) selling a call and buying a put is equivalent to selling a stock and borrowing PV(X)
d) selling a call and buying a put is equivalent to selling a stock and lending PV(X)

Answer 3

a) buying a call and selling a put is equivalent to buying a stock and borrowing PV(X)

P - C = X - S

Question 4

purchased futures at 349, contract is for 2500 units. margin requirement 10%. sold for 278, what is return on invested capital?
a -255.4%
b -203.4%
c -155.4%
d -103.4%

Answer 4

b -203.4%

Question 5

what is a long stable strategy used for?

Answer 5

a strategy that produces profit when price of underlying move significantly in either direction

Question 6

in almost all cases what is the purpose of a hedge?

Answer 6

to reduce or eliminate risk

Question 7

a put has fundamental value as long as:

a) MV of underlying financial asset has a positive value
b) MV of underlying financial asset is less than strike price
c) strike price of put is greater than it’s time premium
d) strike price of put is less than MV of underlying asset

Answer 7

b) MV of underlying financial asset is less than strike price

P = X - S

Question 8

a deep in the money call option on futures is exercised early because:

a) the intrinsic value is maximised
b) it behaves like a futures but it ties up funds
c) futures price is not likely to rise any further
d) none of the above

Answer 8

b) it behaves like a futures but it ties up funds

Question 9

what is the margin deposits associated with the purchase of a forwards contract for?

Answer 9

its used to cover any losses in market value of contract resulting from adverse price fluctuations

Question 10

spot price of gold = 904
storage cost of carry = 1.5
rf = 7.25%
contract is 4months, what is the price of a futures at equilibrium?

Answer 10

926.84

f(t) = So(1+r)^t/n + cost of carry

Question 11

what does the BS model assume about the probability distribution of stock prices?

Answer 11

that they are log normal

Question 12

what does the BS model assume about the continuously compounded rate of return during the year?

Answer 12

assumes that the continuously compounded rate of return is normally distributed

Question 13

what are the shortcomings of LTCM? 7

Answer 13

• reliance on short term history
• risk concentration
• bias in risk measurement
• strategy was based on relative value
• tiny profits needed leverage to make returns attractive
• leverage ration of 25:1
• market downturn (Russian debt crisis, Asian financial crisis)

Question 14

why did BS fail in LTCM?

Answer 14

• over reliance on mathematical modelling
• non normal market conditions (Russian Debt crisis)
• unexpected events couldn’t be accounted for causing non log-normal returns

Question 15

what is the purpose of margin accounts? why can it be considered an insurance?

Answer 15

limit default risk

because it is marked to market daily, losses and gains are received/deducted throughout the life of the contract not just at expiry

Question 16

how is the margin balance determined?

Answer 16

in Australia its determined using SPAN, deposits amount determined by 16 risk scenarios, each based on loss potentials across 1 day with a 99% CI, the highest risk is then used to determine the initial deposit.