FINC 306 Exam Questions and Answers Fully Solved
Define Derivarive - Answers a financial instrument that has a value determined by the value of
something else (underlying)
Examples of Derivatives - Answers Stocks, bonds, commodities, currencies, interest rates
Types of Derivatives - Answers Forwards, futures, options, swaps
Why use derivatives - Answers Risk management
Speculation
Reduce transaction costs
Regulatory Arbitrage
Difference between Market value and Notional value - Answers market value is the sum of the market
value of all the claims that could be traded
notional value measures the scale of a position, usually with reference to some underlying asset
Define Forward contract - Answers A binding agreement (obligation) to buy or sell an underlying asset in
the future, at a price set today
Payoff of Forward (long) - Answers Vt = ST - FtT
Payoff of Forward (short) - Answers Vt = FtT - ST
Today, 2 parties enter a 1 year forward contract to buy and sell a stock. The current price of the stock is
St = 90. The agreed forward price is FtT = 100. In 1 year the spot price is ST = 110.
What is the payoff of the long position? - Answers VT = ST - FtT
VT = 110 - 100
VT = 10
Today, 2 parties enter a 1 year forward contract to buy and sell a stock. The current price of the stock is
St = 90. The agreed forward price is FtT = 100. In 1 year the spot price is ST = 110.
What is the payoff of the short position? - Answers VT = FtT - ST
VT = 100 - 110
VT = -10
,List the key differences between Forwards and Futures - Answers Futures are standardised, so are
publicly traded on an exchange and have low counter-party risk with high liquidity.
Forwards are customised to the customer, so are privately traded (OTC) and have high counter-party risk
with low liquidity.
Define Call option - Answers A non-binding agreement (a right but not an obligation) to buy an
underlying asset in the future, at a price set today
Payoff of a call (long) - Answers CT = max (ST - K, 0)
or
{ST - K , ST>K
{0 , ST<K
So profit when stock price > strike price (ST > K)
Payoff of a call (short) - Answers CT = -max (ST - K, 0)
Today, t, the spot price is St = 90. 2 parties longs a call option with strike K = 100 which matures in 1
year.
If the spot price in 1 year is ST = 110, what is the payoff of the long position? - Answers CT = max (ST - K,
0)
CT = max (110 - 100, 0)
CT = max (10, 0)
CT = 10
Today, t, the spot price is St = 90. 2 parties shorts a call option with strike K = 100 which matures in 1
year.
If the spot price in 1 year is ST = 110, what is the payoff of the short position? - Answers CT = - max (ST -
K, 0)
CT = - max (110 - 100, 0)
, CT = - max (10, 0)
CT = - 10
If we are given St, ST, T, t and K, show the formula for profit of a call - Answers Profit = max (ST - K, 0) -
CT
Define Put option - Answers A non-binding agreement (right but not an obligation) to sell an underlying
asset in the future, at a price set today
Payoff of a put option (long) - Answers PT = max (K - ST, 0)
Payoff of a put option (short) - Answers PT = - max (K - ST, 0)
Draw the payoff diagram of VT = 10CT(100) - 10PT(100) - 5ST + 500 - Answers Check A
Check B and find payoff of diagram, replicated with European calls with different strikes and find price is
prices are for strikes 10 ,20,30,40,50,60,70 are 60,45,35,25,7,3,1 - Answers Check B
What are Floors and what are they used for?
And give the payoff and diagram - Answers Used to protect against falls in the price of the underlying to
insure long positions.
So is buying something which goes up when the price of the underlying goes down eg buy a put and a
stock
Check 0.5
What are Caps used for?
And give the payoff and diagram - Answers To protect against rises in the price of the underlying to
insure short positions.
Check 0.5
Covered call payoff - Answers Covered call = -CT + ST
Covered put payoff - Answers Covered put = - PT - ST
Define Derivarive - Answers a financial instrument that has a value determined by the value of
something else (underlying)
Examples of Derivatives - Answers Stocks, bonds, commodities, currencies, interest rates
Types of Derivatives - Answers Forwards, futures, options, swaps
Why use derivatives - Answers Risk management
Speculation
Reduce transaction costs
Regulatory Arbitrage
Difference between Market value and Notional value - Answers market value is the sum of the market
value of all the claims that could be traded
notional value measures the scale of a position, usually with reference to some underlying asset
Define Forward contract - Answers A binding agreement (obligation) to buy or sell an underlying asset in
the future, at a price set today
Payoff of Forward (long) - Answers Vt = ST - FtT
Payoff of Forward (short) - Answers Vt = FtT - ST
Today, 2 parties enter a 1 year forward contract to buy and sell a stock. The current price of the stock is
St = 90. The agreed forward price is FtT = 100. In 1 year the spot price is ST = 110.
What is the payoff of the long position? - Answers VT = ST - FtT
VT = 110 - 100
VT = 10
Today, 2 parties enter a 1 year forward contract to buy and sell a stock. The current price of the stock is
St = 90. The agreed forward price is FtT = 100. In 1 year the spot price is ST = 110.
What is the payoff of the short position? - Answers VT = FtT - ST
VT = 100 - 110
VT = -10
,List the key differences between Forwards and Futures - Answers Futures are standardised, so are
publicly traded on an exchange and have low counter-party risk with high liquidity.
Forwards are customised to the customer, so are privately traded (OTC) and have high counter-party risk
with low liquidity.
Define Call option - Answers A non-binding agreement (a right but not an obligation) to buy an
underlying asset in the future, at a price set today
Payoff of a call (long) - Answers CT = max (ST - K, 0)
or
{ST - K , ST>K
{0 , ST<K
So profit when stock price > strike price (ST > K)
Payoff of a call (short) - Answers CT = -max (ST - K, 0)
Today, t, the spot price is St = 90. 2 parties longs a call option with strike K = 100 which matures in 1
year.
If the spot price in 1 year is ST = 110, what is the payoff of the long position? - Answers CT = max (ST - K,
0)
CT = max (110 - 100, 0)
CT = max (10, 0)
CT = 10
Today, t, the spot price is St = 90. 2 parties shorts a call option with strike K = 100 which matures in 1
year.
If the spot price in 1 year is ST = 110, what is the payoff of the short position? - Answers CT = - max (ST -
K, 0)
CT = - max (110 - 100, 0)
, CT = - max (10, 0)
CT = - 10
If we are given St, ST, T, t and K, show the formula for profit of a call - Answers Profit = max (ST - K, 0) -
CT
Define Put option - Answers A non-binding agreement (right but not an obligation) to sell an underlying
asset in the future, at a price set today
Payoff of a put option (long) - Answers PT = max (K - ST, 0)
Payoff of a put option (short) - Answers PT = - max (K - ST, 0)
Draw the payoff diagram of VT = 10CT(100) - 10PT(100) - 5ST + 500 - Answers Check A
Check B and find payoff of diagram, replicated with European calls with different strikes and find price is
prices are for strikes 10 ,20,30,40,50,60,70 are 60,45,35,25,7,3,1 - Answers Check B
What are Floors and what are they used for?
And give the payoff and diagram - Answers Used to protect against falls in the price of the underlying to
insure long positions.
So is buying something which goes up when the price of the underlying goes down eg buy a put and a
stock
Check 0.5
What are Caps used for?
And give the payoff and diagram - Answers To protect against rises in the price of the underlying to
insure short positions.
Check 0.5
Covered call payoff - Answers Covered call = -CT + ST
Covered put payoff - Answers Covered put = - PT - ST
