Unit 3 - Extra Flashcards
What position will the writer of a call on a future be in if the option is exercised?
A Delivery of the underlying asset B Long-future C Short-future D Short-put
Short-future
Explanation
Selling the right to buy a future will leave the writer of the option delivering the futures contract if the option is exercised against them.
Which of the following best describes how easy it is for a trader to open or close a position without incurring excessive trading costs?
A Liquidity B Basis C Trade/Cost profile D Gearing
Liquidity
Explanation
Liquidity is a term used to describe how easy it is to trade without incurring excessive trading costs
Which of the following best describes hedging?
A
Taking an opposite position in futures to your position in the underlying asset
B
Buying and selling futures or options
C
Taking a matching position in futures to your position in the underlying asset
D
Buying futures in anticipation of a rise in the value of the underlying asset
Taking an opposite position in futures to your position in the underlying asset
Explanation
Hedging requires adopting a position in the derivatives market that will generate a profit if the underlying position makes a loss. If you own wheat (long underlying) and are worried about the price falling, a short-futures position would profit from a fall in the underlying price to compensate for your losses.
How would you describe the risk associated with buying a futures contract?
A Unlimited B Limited to initial margin C Limited to the value of the underlying D Limited to the futures price
Limited to the futures price
Explanation
When entering into a futures contract, the potential downside, although large, is limited to the futures price. You could take delivery of an underlying asset worth nothing, and still be contractually bound to pay the futures price.
Which of the following is NOT true of a put contract?
A
The holder has the right to sell a specified quantity of a specified asset at a given price
B
If the option is exercised, the writer will buy a specified quantity of a specified asset at a given price
C
The writer can choose not to buy the specified asset
D
A put with a strike price below the price of the underlying has no intrinsic value
The writer can choose not to buy the specified asset
Explanation
The holder of a put contract (long-put) has the right, but not the obligation, to sell the asset at the strike price. The writer must buy the asset if the contract is exercised - therefore ‘the writer can choose not to buy the specified asset’ is the correct answer.
Which organisation has been given the responsibility for the administration of LIBOR?
A British Banking Association B ICE Benchmark Administration C Thomson-Reuters D FCA
ICE Benchmark Administration
Explanation
BBA used to be involved in the administration but since 31st January 2014, this has been passed onto ICE benchmark administration. Thomson-Reuters are still involved but they simply collect the submissions, calculate and then publish LIBOR. Setting LIBOR is now a regulated activity and so FCA are involved from a regulatory aspect.
Banks accepting deposits in the inter bank market use which of the following as the average rate quote?
A LISTIR B LIBOR C LIBID D LIMEAN
LIBID
Explanation
London inter-bank bid (LIBID) is the rate that banks uses to accept deposits. LIBOR is what banks use to lend funds.
In relation to warrants, which of the following is FALSE?
A They can exercise on a daily basis B They must be exercised on expiry C They are convertible into ordinary shares D They do not carry the right to vote at an AGM
They must be exercised on expiry
Explanation
The exercise dates are stated upfront, and may have the capability of exercising daily. Warrants never carry the right to vote in meetings. A warrant is similar to a call option, where there is a right, but not an obligation to buy new shares, and therefore does not have to be exercised at expiry.
An investor will receive a semi-annual interest payment of how much in the following situation?
The investor purchases five 6% $1,000 par value bonds. They are selling at a discount and have a yield to maturity of 8%.
A $150 B $225 C $300 D $60
$150
Explanation
The investor will receive semi-annual payments of $150. The bond pays 6% interest based on $1,000 par value. There are five bonds = $5,000 par value. 6% of $5,000 = $300 / year in interest. Since the interest is paid semi-annually, the payment would = $150.
Which of the below is the best description of a Hybrid derivative?
A
Combining a call option together with a put option
B
Combining a security and a derivative packaged together to create an investment product
C
Combining two different derivatives in creating a synthetic trade
D
Combining two different types of derivatives in one contract
Combining two different types of derivatives in one contract
Explanation
A Hybrid derivative incorporates two different types of risk into a single derivative contract. It allows investors to take a view on a combination of asset classes in a single contract.
A describes a combination trade, B describes a structured product and C is a synthetic trade.
A floor broker working on an open outcry exchange carries out trades on behalf of another brokerage house. Once the trade is done, the floor broker passes the trade back to the originating firm. This is called:
A Assignment B Give-up C Dual brokerage D Cross trading
Give-up
Explanation
Note: ‘giving-up’ trades is also called ‘allocating’. Small brokerage houses that do not have floor brokers themselves often employ floor brokers to execute their business. Once the trade is completed, the floor broker gives up the trade to the originating firm.
In a trade registration system, when is a trade considered to be registered?
A When the trade has been allocated B When the trade has been removed from the default account C When it is ready for clearing D When the trade has been matched
When it is ready for clearing
Explanation
This is a difficult question; the best answer is C, as a trade will be considered registered when it is ready to be passed into the clearing system.
On which of the following US exchanges would you find oil derivatives?
A COMEX B CBOT C PHLX D NYMEX
NYMEX
Explanation
Both crude and heating oil futures (no options) are available on the New York Mercantile Exchange (NYMEX).
CBOT trades agriculturals and financial contracts.
COMEX trades metals.
PHLX trades financial contracts.
EFP arrangements occur:
A Ex pit B Ante pit C In pit D Under pit
Ex pit
Explanation
EFP arrangements take place outside the trading pit (or the normal trading mechanism). This could also be called ‘Ex pit’.
Which of the following systems allows a firm to allocate trades to the correct account?
A UCP B CPS C EDSP D PPS
UCP
Explanation
The Universal Clearing Platform (UCP) is used by ICE Futures Europe and Euronext Derivatives for firms to allocate trades to the correct account. The LME uses the LME matching and clearing system.
What needs to be reported on an execution of a block trade?
I Time II Price III Volume IV Client details
I, II and III
Explanation
Client details are not required in a trade report for a block trade.
Which of the following contracts is physically delivered?
A Euro future B STIR future C FTSE 100 index future D FTSE 100 index option
Euro future
Explanation
A euro future to buy 125,000 euros at a fixed price on a fixed date will result in 125,000 euros actually being delivered. This is a physically delivered future. The others are all settled by paying or receiving the difference between the price at which the position was opened and the price that it was closed at, i.e. a contract for difference.
Which of the following is the best definition of exchange traded?
A
On an Recognised Investment Exchange (RIE)
B
On a Designated Investment Exchange (DIE)
C
On an Recognised Investment Exchange or Designated Investment Exchange
D
On any exchange
On any exchange
Explanation
A deal on any exchange would be exchange traded (as opposed to ‘over the counter’).
Which of the following is a benefit of a block trade?
A
They can be executed for any size
B
Prices can be agreed away from the order book
C
There is no need for trades to be reported
D
There is never any publication of block trades
Prices can be agreed away from the order book
Explanation
The exchange sets the size requirements; they must be reported and publication may be delayed. The block trade facility allows members of ICE Futures and their wholesale clients to transact business of significant size as bilaterally agreed transactions on-exchange, without delay and with certainty of price and execution.
What is shown in the touch strip on electronic/screen-based trading systems?
A Current bid/offer prices B Best bid/offer price C Details of the day's trades D Best three bid/offer prices
Best bid/offer price
Explanation
The touch strip shows the best bid and offer currently available. The touch strip is sometimes referred to as Level 1.
Level 2 shows all the available buy and sell orders currently available - sometimes referred to as the market in depth.
Universal Trading Platform is used on which of the following exchanges?
A CME B EUREX C Euronext Derivatives D LSE Derivatives
Euronext Derivatives
Explanation
Universal Trading Platform is the electronic order-driven trading platform used by Euronext Derivatives.
Which of the following matches and carries registered trades between UK exchanges and UK Clearing houses?
A CPS B SPAN C UCP D UTP
UCP
Explanation
The details of the trade will be reported into the administration system that is used by the exchange, such as the Universal Clearing Platform (UCP) for ICE Futures Europe. These systems will ensure that the trade inputs are matched - in other words, that both a purchase and a sale exist on the same terms. This process is particularly important when the exchange uses open outcry, where there is more scope for human error than in an electronic order-matching system.
When acting as an agent on behalf of a principal, an agent may:
I Enter into contracts on behalf of their principal II Settle contracts using their own funds III Charge the principal commission IV Allocate a proportion of trades to their own account
I, II, III, IV
Explanation
An agent acting on behalf of a principal is, for example, where a broker acts for a client.
All are permitted, provided any related FCA rules are adhered to: e.g. settle contracts, using own funds, would require prior written consent from a retail client.
The price at which an exchange of futures for physical (EFP) is agreed is:
A The currently traded futures price B The price determined by the exchange C The price agreed by the counterparties D The settlement price at the end of the day
The price agreed by the counterparties
Explanation An EFP (exchange future for physical) is between two members, but ex-pit (off exchange). Members agree between themselves what price the EFP is to be done at.
If the fair value of a future is at a discount to the future’s price, which of the following would generate profit?
A Long future B Short future C Cash and carry D Reverse cash and carry
Cash and carry
Explanation Buy cheap (the underlying) and sell the expensive (future).
In a screen-based market, the exchange has a responsibility to provide prices to which of the following people?
A Quote vendors B Exchange members C The public D The clearing house
The public
Explanation
Exchanges must publish trading information giving everyone access to price and volume information. This publication of trade details is a requirement for all ‘on exchange’ transactions, whether they occur through screen trading or not.
Which of the following is TRUE of basis?
A Basis always equals the cost of carry B Basis is calculated by deducting the future's price from the cash price C When the future's price increases relative to cash, the basis is said to strengthen D Basis risk can be avoided by hedging
Basis is calculated by deducting the future’s price from the cash price
Explanation
Basis is not always the cost-of-carry, as the future may trade away from its fair value. Choice ‘When the future’s price increases relative to cash, the basis is said to strengthen’ describes basis weakening and basis risk cannot be hedged against.
‘Basis is calculated by deducting the future’s price from the cash price’ is the correct answer.
When is gearing highest for an option?
A When it is at-the-money B When it is in-the-money C When it is out-of-the-money D When the exercise price equals the cash price
When it is out-of-the-money
Explanation
An option’s gearing refers to its profit/loss potential compared to that of owning the underlying asset. The smaller the premium, the higher the gearing. Out-of-the-money options have the lowest premiums due to the fact that there is no intrinsic value. They are therefore the most highly geared.
Per put-call parity, which of the following combinations creates a synthetic short call?
A Long asset and short put B Short asset and short put C Long asset and long put D Short asset and long put
Short asset and short put
Explanation
Rearrange put-call parity formula, C - P = S - K / (1 + r)^t to get C on its own using ‘- C’ as a short call.
- P - S + K / (1 + r)t = - C . Therefore, shorting the asset and selling the put gives you a synthetic short call.
Which of the following options would have the greatest time value if the underlying is trading at 71?
A June 90 call B June 70 call C June 110 call D June 50 call
June 70 call
Explanation
If everything else is constant the time value of an option is greatest when it is at-the-money.
The index is currently at 3,800 points. The dividend yield is 2% and interest rates are 5%. What is the fair value of the 29 day future?
A 3,791 B 3,800 C 3,914 D 3,809
3,809
Explanation
This is calculated as:
Index value + index value(Interest rate - dividend yield pro-rated for 29 days)
3,800 + 3,800 x ((5% - 2%) x 29 / 365) = 3,809
The rate of change of delta (assuming long positions) for a given change in the underlying is:
A Positive for calls, negative for puts B Positive for calls, positive for puts C Negative for calls, negative for puts D Negative for calls, positive for puts
Positive for calls, positive for puts
Explanation
The rate of change of delta - gamma - is positive for both long calls and long puts.
In June, a farmer is concerned about falling wheat prices and takes out a hedge by selling a December wheat contract. His wheat is ready for sale in November and he lifts the hedge by selling the wheat in the cash market and closing-out his futures contract.
From which of the following is the farmer at risk?
A
A change in the future’s price from June to November
B
A change in the price of wheat from June to November
C
A change in basis from June to November
D
A change in the future’s price from November to December
A change in basis from June to November
Explanation
As the farmer has lifted his hedge early he is susceptible to ‘basis risk’. Basis risk can arise because the relationship between the cash price and future’s price is unpredictable and can change between setting-up the hedge and lifting it early. If basis has weakened, the farmer’s profits in the futures market will not be sufficient to offset the loss in the cash market.
Gamma:
A Decreases as an option approaches expiry B Measures the volatility in an option C Always moves in the same direction as Delta D Is negative for short options
Is negative for short options
Explanation
Gamma is the sensitivity of delta relative to a change in the price of the underlying asset. It increases for ATM options as time to expiry falls. It is positive for long options and negative for short options.
On an open outcry market, who has the responsibility of price reporting?
A The exchange member B A clearing house official C An exchange official D The client
An exchange official
Explanation
The exchange official is responsible for ensuring price transparency is upheld on the open outcry markets. LME is now the only UK based exchange that still operates open outcry.
Which of the following options would have the highest delta?
A A far-dated deeply out-of-the-money call B A near-dated deeply out-of-the-money put C A near dated at-the-money call D A far-dated deeply in the money put
A far-dated deeply in the money put
Explanation
In the money options have the highest delta.
It is the convention to ignore the sign - therefore -1 and +1 are treated in the same way.
Exchange price feeds provide:
A Delayed prices B Streaming prices C Settlement prices D Closing prices
Streaming prices
Explanation
Exchange price feed provide streaming prices throughout the day.
What would be the equivalent exposure to the UK stock market if an investor bought 7 FTSE 100 futures? The contract is currently at 6,400 points and has a tick value of £5 per half point.
A £32,000 B £64,000 C £224,000 D £448,000
£448,000
Explanation
Total exposure = 6,400 points x £10 per point x 7 contracts = £448,000.
How would a hedger attempt to eliminate basis risk?
A
Hold the derivative investment to expiry
B
Structure the hedge using OTC derivatives
C
Structure the hedge using exchange traded derivatives
D
Create synthetic positions using futures and options
Hold the derivative investment to expiry
Explanation
The best answer here is to hold the derivative until delivery where basis will be zero.
When trading on an order driven sytem, MIT stands for which of the following?
A Market-inside-touch B Market-if-touched C Minimum integral tranche D Mandatory imminent takeover
Market-if-touched
Explanation
A market-if-touched (MIT) order specifies that the order is executed at the best prevailing price once price hits a certain level.
What might you use to determine implied volatility?
A Statistical analysis B Pricing models C Regression studies D Trading estimates
Pricing models
Explanation
Implied volatility refers to the volatility implied in a premium quoted by the market. In order to extract this you would need a pricing formula such as Black-Scholes.
If the Delta of a long-put option is -0.65, what would the Delta of the corresponding long-call position be?
A -0.65 B -0.35 C \+0.65 D \+0.35
+0.35
Explanation
The combined Delta of a put and a call with the same underlying, strikes and expiries equals 1 (ignoring positive or negative signs). Therefore, if the Delta of the put is 0.65, the Delta of the corresponding call must be 0.35. Because it is a LONG-call, the Delta will be +0.35.
As identified by the ISDA credit support documentation, what is the main difference between UK and US law?
A
UK may use cash or collateral as margin whereas the US can use cash only
B
UK may use cash only as margin whereas the US may use cash and collateral
C
Any collateral deposited in the UK remains the legal property of the depositor whereas in the US title transfers to the holder
D
Any collateral deposited in the US remains the legal property of the depositor whereas in the UK title transfers to the holder
Any collateral deposited in the US remains the legal property of the depositor whereas in the UK title transfers to the holder
Explanation
US law dictates that a security interest of any collateral deposited as margin can be created instead of legal transfer of title. In the UK title transfers immediately.
OTC products on the inter-continental exchange (ICE) can be traded: A Bilaterally only B Electronically only C Bilaterally or electronically D There is no OTC facility on ICE
Bilaterally or electronically
Explanation
OTC products on ICE can be traded bilaterally, directly between the two counterparties, or electronically on ICE’s ‘many-to-many’ trading platform.
A bank believes that a single debtor has become too risky for them to continue to take on the risk of their debt. What could the bank do to transfer the risk of the debtor to a third party?
A Enter into a vanilla swap B Enter into a total return swap C Issue a credit linked note D Issue a mortgaged backed security
Issue a credit linked note
Explanation
A credit linked note represents the amount borrowed by the debtor. The institution buying the note will benefit from any payments from the debtor, but is, however, taking on the risk of the debtor defaulting.
Bclear is used for?
A Clearing Brazilian government bonds B Clearing Bloomberg trades C Clearing OTC equity derivatives D Clearing UK government bonds
Clearing OTC equity derivatives
Explanation
Bclear service combines much of the flexibility of the over-the-counter (OTC) market with many of the benefits of an exchange and clearing house environment. Launched initially for OTC equity derivatives, Bclear now also offers commodity contracts.
