Hedge, Straddle, Notional Principal Contract - DOC

							FIN 353 Financial Institutions
2006 Spring Semester
Sample Final Exam                                                    Name:
_________________

Multiple Choice: Choose the One That is the Most Correct (4 points each)

1. Which of the following statements about the Black-Scholes model is not true?
   a. decreasing the volatility lowers the call price
   b. the expected future stock price plays a role in determining today’s call price.
   c. the risk-free rate is continuously compounded
   d. the model is consistent with put-call parity
   e. none of the above

2. Which of the following assumptions of the Black-Scholes model is correct?
   a. the stock volatility is constant
   b. the stock return follows a random walk
   c. there are no transaction costs
   d. there are no taxes
   e. none of the above

The following quotes were observed for options on a given stock on November 1 of a
given year. These are American calls except where indicated. Use the information to
answer questions 3 and 4.


                              Calls                                      Puts
  Strike        Nov              Dec         Jan           Nov           Dec            Jan
   105          8 3/8            10         11 ½           5/16          1 1/4           2
   110          4 3/8         7 1/8          8¼           15/16          2 1/2          3 3/4
   115          1 1/2         3 7/8          5¼          2 13/16         4 3/4          4 3/4

The stock price was 113 1/4. Assume no dividends unless indicated.

3. What is the intrinsic value of the November 105 put?
   a. 0.3125
   b. 8.25
   c. 8.375
   d. 0.00
   e. none of the above

Solution: Since the spot price is higher than the exercise price on the put, Intrinsic Value
= $0.
4. What is the time value of the December 105 put?
   a. 1.25
   b. 8.25
   c. 0.00
   d. 7.00
   e. none of the above

Solution:       Intrinsic value = 0
                Time value = $1.25 - $0 = $1.25


Consider a stock priced at $30. There are put and call options available at exercise prices
of 30 and a time to expiration of six months. The calls are priced at $2.89 and the puts cost
$2.15. Assume that all transactions consist of 100 shares or one contract (100 options).
Use this information to answer questions 5 through 7.

5. What is your profit if you sell a put, hold it to expiration and the stock price at expiration
   is $27?
     a. -$515
     b. -$85
     c. $215
     d. $300
     e. none of the above

Solution:       profit = ($30 - $27) * 100 = $300

6. What is the breakeven stock price at expiration on the transaction described in problem
   5?
   a. $32.89
   b. $27.00
   c. $27.85
   d. $32.15
   e. there is no breakeven

Solution:       BE = $30 - $2.15 = $27.85

7. What is the maximum profit on the transaction described in problem 5?
    a. $215
    b. infinity
    c. zero
    d. $270
    e. $300

Solution:       Max profit = $2.15 * 100 = $215
8. Which of the following statements is true about the purchase of a protective put at a
   higher exercise price relative to a lower exercise price?
   a. the breakeven is lower
   b. the maximum loss is greater
   c. the insurance is less costly
   d. the insurance is more costly
   e. none of the above

The following prices are available for call and put options on a stock priced at $50. The
March options have 90 days remaining and the June options have 180 days remaining.
The Black-Scholes model was used to obtain the prices.

                                    Calls                                  Puts
      Strike             March               June               March               June
        45                 6.84               8.41               1.18               2.09
        50                 3.82               5.58               3.08               4.13
        55                 1.89               3.54               6.08               6.93

Assume that each transaction consists of one contract (100 options) unless otherwise
indicated.

Answer questions 9 through 11 about a long straddle constructed using the March 45
options.

9. What will the straddle cost?
   a. $566
   b. $684
   c. $802
   d. $118
   e. none of the above

Solution:      ($6.84 + $1.18)*100 = $8.02*100 = $802

10. What are the two breakeven stock prices at expiration?
    a. $38.16 and $51.84
    b. $43.82 and $46.18
    c. $39.36 and $51.64
    d. $36.98 and $53.02
    e. none of the above

Solution:      BE1 = $45 + $6.84 + $1.18 = $53.02
               BE2 = $45 - $6.84 - $1.18 = $36.98
11. What is the profit if the stock price at expiration is at $43?
    a. -$602
    b. $802
    c. $1,002
    d. $200
    e. none of the above

Solution:      Profit = [($45 - $43) - $6.84 - $1.18 ] * 100 = -$602

12. Two stocks are identical in terms of volatility and current price, but one pays a
higher dividend rate. We would expect identical call options on the stock with the higher
dividend rate
    a. to have a higher price because of the higher potential dividend.
    b. to have a lower price because the expected dividend payment will reduce the
       underlying stock price.
    c. to have a longer maturity so that the actual dividend payment can be determined.
    d. to have a lower risk-free interest rate because of the higher expected cash flow.

13. The reason that the price of a call option tends to increase with the underlying
volatility on a stock is
   a. the call owner must be compensated for the higher underlying stock risk.
   b. There is a higher probability that the stock will go up than down if volatility is
         higher.
   c. The risk-free interest rate is higher on a more volatile stock.
   d. There is a higher probability that the exercise price will be less than the stock
         price at maturity.

14. For a S&L with balance-sheet portfolio consisted of long-term assets with fixed
interest rates, and short-term liabilities which are repriced more frequently, the manager
might choose to:
    a. hedge by becoming the floating-rate payer on a swap
    b. hedge by becoming the fixed-rate payer on a swap
    c. take a naked position as a floating-rate payer
    d. speculate as the floating-rate payer

15. In intermediating swap transactions, banks who serve as dealers might be exposed to
   ____ if their swap positions are _____.
   a. price risk; open
   b. price risk; closed
   c. credit risk; open
   d. liquidity risk; open

16. When arranging fixed-to-floating rate swaps, the basic rule in setting the rates is:
    a. the fixed rate must always start at a higher rate than the floating rate for the swap
       to be profitable.
   b. the starting floating rate can be calculated by using forward rates and then
      applying backward induction.
   c. the fixed rate can be calculated by making sure the expected net present value of
      the swap is zero for both parties.
   d. the fixed rate is set by calculating the series of forward rates in the swap and then
      taking the geometric average.

17. A agrees to pay 8% fixed to B in exchange for a 3-month LIBOR payment on a plain
    vanilla swap with a notional principal of $10 million and interest settlement every six
    months. If the 3-month LIBOR rate for settlement is 9%, for the settlement:
    a. A pays B $50,000
    b. B pays A $50,000
    c. A pays B $100,000
    d. B pays A $100,000
    e. A pays B $800,000 and B pays A $900,000

Solution:      B pays to A = (9% - 8%) * $10m * 6/12 = $50,000

18. A two-year interest rate swap that requires interest settlement every three months to
    pay LIBOR in exchange for 11% fixed rate interest. If the interest rate at the initiation
    and three months after are 12% and 13%, respectively, what would the payment be in
    three months?
    a. fixed-rate payer pays 1/4% to floating-rate payer
    b. fixed-rate payer pays 1/2% to floating-rate payer
    c. floating-rate payer pays 1/4% to fixed-rate payer
    d. floating-rate payer pays 1/2% to fixed-rate payer

Solution:      floating –rate payer pays (12% - 11%) * 3/12 = ¼%

19 Companies X and Y have been offered the following rates per annum on a $ 10
million 10-year loan:



                               Fixed Rate             Floating Rate
Company X                       7.0%                  LIBOR + 0.5%
Company Y                       8.8%                  LIBOR + 1.5%


Company X requires a floating rate loan; company Y requires a fixed rate loan. If X and
Y agree to a swap that X will pay LIOBOR floating in exchange for Y pay 7.1% fixed
rate. What much the cost savings will be to each of X and Y with the swap?
a. X saves 0.5%; Y saves 1.7%
b. X saves 0.1%; Y saves 0.5%
c. X saves 0.6%; Y saves 0.2%
d. X saves 0.2%; Y saves 0.6%
e. X saves 0.4%; Y saves 0.4%

Solution:
Without swap: X pays LIBOR + 0.5% and Y pays 8.8%

With swap:    X issues fixed-rate bond at 7.0% and swaps with Y to receive 7.1% by
              paying LIBOR to Y, X’s all-in-cost = 7% + LIBOR – 7.1% = LIBOR -
              0.1%. Compared to without swap, X saves 0.6%.

              Y issues floating-rate bond at LIBOR + 1.5% and swaps with X to receive
              LIBOR and pay 7.1% to X, Y’s total-all-in-cost = LIBOR + 1.5% + 7.1%
              - LIBOR = 8.6%. Compared to without swap, Y saves 0.2%.

20. Which of the following is not accomplished by asset securitization?
    a. Increases the liquidity of assets.
    b. Provides a new source of funds.
    c. Increases the costs of monitoring.
    d. Decreases the duration of assets.
    e. Decreases the costs of regulation.


Solutions:

1. b          11.     a
2. a          12.     b
3. d          13.     d
4. a          14.     b
5. b          15.     a
6. c          16.     b
7. a          17.     b
8. d          18      c
9. c          19      c
10. d         20.     e