Introduction to Derivative Securities By Robert A. Jarrow – Test Bank

Introduction to Derivative Securities By Robert A. Jarrow – Test Bank

CHAPTER 7: Financial Engineering and Swaps

MULTIPLE CHOICE

1. The holder of the following security gives an option to the issuer:
a. a callable bond
b. a convertible bond
c. an employee stock option
d. a stock
e. a warrant

ANS: A DIF: Easy REF: 7.2
TOP: The Build and Break Approach MSC: Factual

2. The holder of the following security gets an additional option embedded within the bond:
a. a callable bond
b. a convertible bond
c. an employee stock option
d. a stock
e. a warrant

ANS: B DIF: Easy REF: 7.2
TOP: The Build and Break Approach MSC: Factual

3. Hybrids:
a. are bonds with repayment pegged to the stock’s price
b. are derivative securities that combine swaps with options
c. are derivative securities that combine calls with puts
d. are derivatives whose payoffs are tied to exchange rates
e. are combinations of options and futures

ANS: A DIF: Easy REF: 7.3 TOP: Financial Engineering
MSC: Factual

Your company is planning to buy euros in six months time. The spot price is $1.25 per euro. Boldman Bankers Inc. (fictitious name) designs a “fancy derivative” that provides protection against an appreciation in the euro, but it also limits your benefits if the euro declines. After six months, by the terms of this “range forward,” (1) if the spot exchange rate for the euro is above $1.30, then you pay $1.30; (2) if the spot exchange rate for the euro is below $1.20, then you pay $1.20; and (3) if the spot exchange rate lies between this range, then you buy euros at the prevailing market price.

4. Your cousin, who is studying derivatives at college, says “This is no big deal,” and breaks down this range forward into basic building blocks. His breakdown is:
a. long zero-coupon bond with a face value $1.20, long call with strike price $1.20, and short call with strike price $1.30
b. long zero-coupon bond with a face value $1.20, short call with strike price $1.20, and short call with strike price $1.30
c. short zero-coupon bond with a face value $1.20, short call with strike price $1.20, and long call with strike price $1.30
d. short zero-coupon bond with a face value $1.30, short call with strike price $1.20, and long call with strike price $1.30
e. long zero-coupon bond with a face value $1.30, short call with strike price $1.20, and short call with strike price $1.30

ANS: A DIF: Moderate REF: 7.3 TOP: Financial Engineering
MSC: Applied

5. Another cousin, who is also studying derivatives at university, said your portfolio must include a long spot position in euros, because you are planning to buy euros. Her breakdown is:
a. long spot, short put with strike price $1.30, and short call with strike price $1.20
b. short spot, long put with strike price $1.30, and short call with strike price $1.20
c. long spot, long put with strike price $1.20, and short call with strike price $1.30
d. short spot, long put with strike price $1.20, and short call with strike price $1.30
e. long spot, long put with strike price $1.30, and long call with strike price $1.20

ANS: C DIF: Moderate REF: 7.3 TOP: Financial Engineering
MSC: Applied

6. The following is NOT a feature of plain vanilla interest rate swap contracts:
a. interest rate risk
b. counterparty risk
c. early termination of the swap with the consent of all counterparties
d. existence of swap facilitators
e. the Swap Trading Corporation (STC) overseeing all swap transactions

ANS: E DIF: Easy REF: 7.4 TOP: An Introduction to Swaps
MSC: Factual

7. A typical commodity swap involves:
a. a payment of the difference between two different commodities’ prices on the expiration date
b. an exchange of a fixed payment for the daily average of a commodity’s price over a time period
c. an exchange of a fixed payment for a floating payment that depends on one of the counterparty’s fluctuating commodity need during the month
d. payments in two different currencies
e. None of these answers are correct.

ANS: B DIF: Easy REF: 7.5
TOP: Applications and Uses of Swaps MSC: Factual

8. The following is NOT a characteristic feature of a plain vanilla interest rate swap:
a. cash flows in the same currency
b. counterparty risk
c. exchange of principal at the beginning and at the end
d. a net payment by one of the parties
e. notional principal

ANS: C DIF: Easy REF: 7.6 TOP: Types of Swaps
MSC: Factual