Sample Questions and Answers
Which of the following is the primary purpose of using derivatives in risk management?
A) Speculation
B) Hedging
C) Arbitrage
D) Tax avoidance
Answer: B
What does a futures contract represent?
A) An agreement to exchange an asset at a future date at a pre-determined price
B) A bond that pays interest in the future
C) A type of option to purchase stocks
D) A contract to borrow money
Answer: A
What type of derivative is a call option?
A) A contract that obligates the buyer to buy an asset
B) A contract that obligates the seller to buy an asset
C) A contract that gives the buyer the right to buy an asset
D) A contract that gives the seller the right to sell an asset
Answer: C
Which of the following is the most common use of swaps?
A) Hedging against currency fluctuations
B) Gaining leverage in the stock market
C) Speculation in commodities
D) Tax avoidance
Answer: A
A “long position” in futures refers to:
A) The expectation that the price of the underlying asset will fall
B) The purchase of a futures contract with the expectation that the price will rise
C) The selling of a futures contract with the expectation that the price will rise
D) The borrowing of money to purchase futures contracts
Answer: B
The Black-Scholes model is used to calculate the value of which type of derivative?
A) Futures contracts
B) Bonds
C) Stock options
D) Forward contracts
Answer: C
Which of the following is true regarding options contracts?
A) The buyer of a put option is obligated to sell the underlying asset
B) The seller of a call option has the right, but not the obligation, to sell the underlying asset
C) The seller of a put option has the right, but not the obligation, to buy the underlying asset
D) The buyer of a call option is obligated to buy the underlying asset
Answer: A
A “swap” involves:
A) A series of option contracts
B) The exchange of cash flows between two parties based on underlying financial instruments
C) Buying and selling assets in different markets
D) The borrowing and lending of securities
Answer: B
Which of the following is NOT typically associated with risk management using derivatives?
A) Hedging
B) Speculation
C) Arbitrage
D) Margin trading
Answer: D
In the context of risk management, what is meant by “hedging”?
A) Accepting risks in the hope of gaining higher returns
B) Investing in high-risk assets for higher returns
C) Reducing potential financial losses from adverse market movements
D) Diversifying investments to increase overall market exposure
Answer: C
What is the primary risk management advantage of using options?
A) Leverage to increase potential returns
B) No risk of loss if the market moves unfavorably
C) The ability to limit losses while maintaining the potential for unlimited gains
D) Obligating another party to buy or sell an asset at a fixed price
Answer: C
Which of the following is an example of a credit derivative?
A) Futures contract
B) Interest rate swap
C) Credit default swap (CDS)
D) Currency forward contract
Answer: C
Which of the following would be a reason for a company to use an interest rate swap?
A) To lock in current borrowing rates
B) To speculate on the future direction of interest rates
C) To hedge against currency fluctuations
D) To gain tax advantages
Answer: A
A “short position” in a futures contract refers to:
A) The expectation that the price of the underlying asset will fall
B) The purchase of a futures contract with the expectation that the price will rise
C) The holding of a futures contract with no intention to trade it
D) The borrowing of funds to purchase the asset
Answer: A
What is the “strike price” in an option contract?
A) The price at which the option expires
B) The price at which the underlying asset can be bought or sold
C) The amount paid to the seller of the option
D) The price paid for the derivative contract
Answer: B
Which of the following best describes the relationship between risk and return in derivative trading?
A) Derivatives always reduce risk
B) Derivatives provide no returns but increase risk
C) Derivatives can help reduce risk but also introduce new risks
D) Derivatives reduce returns without changing risk
Answer: C
What does a “collar” strategy in options involve?
A) The purchase of both a call and a put option with the same strike price
B) The simultaneous purchase of a call and the sale of a put option
C) The simultaneous purchase of a put and the sale of a call option to limit the potential loss
D) A strategy where an investor holds both a short and long position in an asset
Answer: C
Which of the following is considered a major risk in derivatives trading?
A) Risk of liquidity
B) Risk of taxes
C) Risk of margin calls
D) Political risk
Answer: A
Which of the following is true about forwards contracts?
A) They are standardized contracts traded on exchanges
B) They can be customized to the needs of the parties involved
C) They are typically settled in cash rather than physical delivery
D) They are short-term instruments with fixed maturity dates
Answer: B
A “delta” in options trading measures:
A) The rate of change of the option price with respect to the price of the underlying asset
B) The potential return of the option contract
C) The intrinsic value of the option contract
D) The probability of the option expiring in-the-money
Answer: A
What is the main objective of using commodity derivatives in risk management?
A) To speculate on price movements of underlying assets
B) To hedge against price fluctuations in commodities
C) To create a diversified investment portfolio
D) To take advantage of arbitrage opportunities in international markets
Answer: B
Which of the following is a key feature of a credit default swap (CDS)?
A) It protects against the risk of default on a bond or loan
B) It is a contract to buy or sell an asset at a future date
C) It involves the exchange of interest rate payments
D) It is only used in foreign exchange risk management
Answer: A
What is a “zero-coupon bond”?
A) A bond that does not pay interest during its life and is issued at a discount
B) A bond that pays regular interest payments
C) A bond whose value fluctuates based on the interest rate changes
D) A bond that is sold in small increments
Answer: A
In a “covered call” strategy, the investor:
A) Sells call options without owning the underlying stock
B) Sells call options while owning the underlying stock
C) Buys call options to hedge against a short position
D) Buys put options to protect a long position
Answer: B
What is the term “counterparty risk” referring to in derivatives transactions?
A) The risk that one party will fail to fulfill its obligations under a contract
B) The risk of losing money due to market movements
C) The risk that a government will impose new regulations
D) The risk associated with currency fluctuations
Answer: A
In which situation would a company most likely use a currency forward contract?
A) To speculate on the direction of interest rates
B) To hedge against future currency exchange rate fluctuations
C) To trade stock options
D) To buy foreign equities
Answer: B
What is the term “implied volatility” in options trading?
A) The historical volatility of the underlying asset
B) The market’s forecast of future volatility of the underlying asset
C) The change in volatility over the life of the option
D) The actual realized volatility of an asset
Answer: B
A “straddle” option strategy involves:
A) Buying both a call and a put option with different strike prices
B) Selling both a call and a put option with the same strike price
C) Buying both a call and a put option with the same strike price and expiration date
D) Selling both a call and a put option with different expiration dates
Answer: C
What does “liquidity risk” refer to in derivative markets?
A) The risk that an asset cannot be sold or bought quickly without affecting its price
B) The risk of default by the issuer of a derivative
C) The risk that the underlying asset does not exist
D) The risk that the derivative will not expire on time
Answer: A
The risk of changes in the value of an option due to a change in the underlying asset’s price is measured by which of the following Greek letters?
A) Gamma
B) Delta
C) Theta
D) Vega
Answer: B
31. Which of the following best describes the use of a “put option” in risk management?
A) To bet on the rising price of an asset
B) To lock in a minimum price for selling an asset
C) To purchase an asset at a discounted price
D) To reduce margin requirements
Answer: B
32. In a derivative transaction, the party who agrees to buy an underlying asset at the contract’s expiration is called:
A) The issuer
B) The holder
C) The buyer
D) The seller
Answer: C
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