FINC 306 FINAL EXAM QUESTIONS &
ANSWERS(RATED A+)
Derivative - ANSWERA financial instrument that has a value determined by the price of
the underlying. An agreement between two parties
Underlying assets - ANSWERthe most common include stocks, bonds, commodities,
currencies, interest rates and market indexes
Types of Derivatives - ANSWERForwards, futures, options, swaps
Use of derivatives - ANSWERrisk management, speculation, reduce transaction costs,
regulatory arbitrage
Measures of market size - ANSWER1. Market value: # units of claims x price of claims
2. Notional value: #units of claims x # of underlying assets/units x price of underlying
assets
3. Trading volume: # units of claims (exchanged over a certain period)
4. Open interest= # units of claims (that have not been exercised which are help by
market participants at the end of the day)
Two types of markets - ANSWEROTC and exchange-traded
Forward contract - ANSWERa binding agreement to buy/sell an underlying asset in the
future, at a price set today
Forward contract payoff - ANSWERLong: Vt=St-Ft,T
Short: Vt=Ft,T -ST
Call option - ANSWERa non-binding agreement to buy an asset in the future, at a price
set today, becomes more profitable when the underlying asset appreciates in value
Call option payoff - ANSWERlong, purchased call: CT=max(ST-K,0)
short, written call: CT= - max (ST-K,0)
Put option - ANSWERa non-binding agreement to sell an underlying asset at a
predetermined price during a predetermined period, becomes more profitable when the
underlying asset depreciates in value
Put option payoff - ANSWERLong, purchased put: PT=max(K-ST,0)
Short, written put: PT=-max(K-ST,0)
6 main points of futures - ANSWER1. Standardized structure
2. publicly traded on an exchange
, 3. Settle marked-to-market daily
4. low counterparty/credit risk
5. used for speculation
6. high liquidity
6 main points of forwards - ANSWER1. Customized structure
2. privately traded on OTC
3. only one settlement date
4. high counterparty/credit risk
5. used for hedging
6. low liquidity
Floor - ANSWERinsuring a long position, put option is combined with a long position in
the underlying asset, to insure against an increase in the price of the underlying: ST+PT
Cap - ANSWERinsuring a short position, call option is combined with a short position in
the underlying asset, to insure against an increase in the price of the underlying: -
ST+CT
two strategies to sell insurance - ANSWERnaked and covered writing
naked writing - ANSWERwriting an option when the writer does not have a position in
the asset
covered writing - ANSWERwriting an option when there is a corresponding long position
in the underlying asset
covered call - ANSWERwriting a call is covered by a long position in the underlying
asset: -CT+ST to insure against an increase in the price of the call option
covered put - ANSWERwriting a put option is covered with a short position in the
underlying asset: -PT-ST to insure an increase in the price of the put option
synthetic long forward - ANSWERbuying a call and selling a put on the same underlying
asset, with each option having the same strike price and time to expiration: CT(K)-PT(K)
two main differences between synthetic forward and actual forward - ANSWERforward
contract has zero premium, synthetic pays net option premium
forward contract pays forward price (Ft,T), synthetic pays strike price (K)
Static replication - ANSWERthe units of securities and replicating derivatives will not be
changed at any time before maturity date. the portfolio has the same CF's as the
reference asset. Long a stock and short a bond with a face value of K
dynamic replication - ANSWERunits of securities and replicating derivatives will change
dynamically before maturity. does not have the same CF's as the reference asset
ANSWERS(RATED A+)
Derivative - ANSWERA financial instrument that has a value determined by the price of
the underlying. An agreement between two parties
Underlying assets - ANSWERthe most common include stocks, bonds, commodities,
currencies, interest rates and market indexes
Types of Derivatives - ANSWERForwards, futures, options, swaps
Use of derivatives - ANSWERrisk management, speculation, reduce transaction costs,
regulatory arbitrage
Measures of market size - ANSWER1. Market value: # units of claims x price of claims
2. Notional value: #units of claims x # of underlying assets/units x price of underlying
assets
3. Trading volume: # units of claims (exchanged over a certain period)
4. Open interest= # units of claims (that have not been exercised which are help by
market participants at the end of the day)
Two types of markets - ANSWEROTC and exchange-traded
Forward contract - ANSWERa binding agreement to buy/sell an underlying asset in the
future, at a price set today
Forward contract payoff - ANSWERLong: Vt=St-Ft,T
Short: Vt=Ft,T -ST
Call option - ANSWERa non-binding agreement to buy an asset in the future, at a price
set today, becomes more profitable when the underlying asset appreciates in value
Call option payoff - ANSWERlong, purchased call: CT=max(ST-K,0)
short, written call: CT= - max (ST-K,0)
Put option - ANSWERa non-binding agreement to sell an underlying asset at a
predetermined price during a predetermined period, becomes more profitable when the
underlying asset depreciates in value
Put option payoff - ANSWERLong, purchased put: PT=max(K-ST,0)
Short, written put: PT=-max(K-ST,0)
6 main points of futures - ANSWER1. Standardized structure
2. publicly traded on an exchange
, 3. Settle marked-to-market daily
4. low counterparty/credit risk
5. used for speculation
6. high liquidity
6 main points of forwards - ANSWER1. Customized structure
2. privately traded on OTC
3. only one settlement date
4. high counterparty/credit risk
5. used for hedging
6. low liquidity
Floor - ANSWERinsuring a long position, put option is combined with a long position in
the underlying asset, to insure against an increase in the price of the underlying: ST+PT
Cap - ANSWERinsuring a short position, call option is combined with a short position in
the underlying asset, to insure against an increase in the price of the underlying: -
ST+CT
two strategies to sell insurance - ANSWERnaked and covered writing
naked writing - ANSWERwriting an option when the writer does not have a position in
the asset
covered writing - ANSWERwriting an option when there is a corresponding long position
in the underlying asset
covered call - ANSWERwriting a call is covered by a long position in the underlying
asset: -CT+ST to insure against an increase in the price of the call option
covered put - ANSWERwriting a put option is covered with a short position in the
underlying asset: -PT-ST to insure an increase in the price of the put option
synthetic long forward - ANSWERbuying a call and selling a put on the same underlying
asset, with each option having the same strike price and time to expiration: CT(K)-PT(K)
two main differences between synthetic forward and actual forward - ANSWERforward
contract has zero premium, synthetic pays net option premium
forward contract pays forward price (Ft,T), synthetic pays strike price (K)
Static replication - ANSWERthe units of securities and replicating derivatives will not be
changed at any time before maturity date. the portfolio has the same CF's as the
reference asset. Long a stock and short a bond with a face value of K
dynamic replication - ANSWERunits of securities and replicating derivatives will change
dynamically before maturity. does not have the same CF's as the reference asset
