Derivatives & Risk Management

QUIZ
Time :1hours Marks:50
Roll Number: _____________________________
Name____________________________________
1. Which of the following are always positively related to the price of a European call
option on a stock?
(a) The stock price
(b) The strike price
(c) The time to expiration
(d) The volatility
(e) The risk-free rate
(f) The magnitude of dividends anticipated during the life of the option

2. A call and a put on a stock have the same strike price and time to maturity. At 10:00am
on a certain day, the price of the call is $3 and the price of the put is $4. At 10:01am
news reaches the market that has no effect on the stock price or interest rates, but
increases volatilities. As a result, the price of the call changes to $4.50. What would
you expect the price of the put to change to?
5.50 _ _ _ _ _
3. The Black-Scholes-Merton model assumes (circle one)
(g) The return from the stock in a short period of time is lognormal
(h) The stock price at a future time is lognormal
(i) The stock price at a future time is normal
(j) None of the above

Questions: 4 to 7

A portfolio manager in charge of a portfolio worth $10 million is concerned that the market
might decline rapidly during the next six months and would like to use options on the S&P
100 to provide protection against the portfolio falling below$9.5 million. The S&P 100
index is currently standing at 500 and each contract is on 100 times the index.

4. If the portfolio has a beta of 1, how many put option contracts should be purchased?

_ _ 200_ _ _ _

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5. If the portfolio has a beta of 1, what should the strike price of the put options be?
_ _475 _ _ _ _

6. If the portfolio has a beta of 0.5, how many put options should be purchased?

100_ _ _ _ _ _

7. If the portfolio has a beta of 0.5, what should the strike prices of the put options be?
Assume that the risk-free rate is 10% and the dividend yield on both the portfolio and
the index is 2%. _ _ 410_ _ _ _

Questions: 8 to 10

A futures price is currently 40 cents. It is expected to move up to 44 cents or down to 34

cents in the next six months. The risk-free interest rate is 6%.

8. What is the probability of an up movement in a risk-neutral world? _ _ 0.6_ _ _ _

9. What is the value of a six-month put option with a strike price of 37 cents? (Give two
decimal places) _ _1.16 _ _ _ _

10. What is the value of a six-month call with a strike price of 33 cents? (Give two
decimal places) 6.79 _ _ _ _ _

11. What is the delta of a short position in 1,000 European call options on silver futures?
The options mature in eight months, and the futures contract underlying the option
matures in nine months. The current nine-month futures price is $8 per ounce, the
exercise price of the options is $8, the risk-free interest rate is 12% per annum, and
the volatility of silver is 18% per annum.

We have solved in the class

Questions: 12 to 13

A call option on an asset has a delta of 0.4. A trader has sold 2000 options and wants to
create a delta-neutral position

12. Should the trader take a long or short position in the asset_ _ _ Long _ _

13. How many units of the asset should be bought or sold_ _ _800 _ _ _

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 Questions: 14 to 15

A portfolio of derivatives on a stock has a delta of 2400 and a gamma of –100. An option
on the stock with a delta of 0.6 and a gamma of 0.04 can be traded.

14. What position in the option creates a portfolio that is gamma neutral? Give size of
position and state whether it is long or short _ _ 2500 long _ _ _

15. After this position has been taken what position in the stock is then necessary for delta
neutrality? Give size of position and state whether it is long or short
_ _ 3900 short_ _

16. Theta measures (circle one)

(a) The rate of change of delta with the asset price
(b) The rate of change of the portfolio value with the passage of time
(c) The sensitivity of a portfolio value to interest rate changes
(d) None of the above

17. Gamma measures (circle one)

(a) The rate of change of delta with the asset price
(b) The rate of change of the portfolio value with the passage of time
(c) The sensitivity of the portfolio value to interest rate changes
(d) None of the above

18. Vega measures (circle one)

(a) The rate of change of delta with the asset price
(b) The rate of change of the portfolio value with the passage of time
(c) The sensitivity of the portfolio value to interest rate changes
(d) None of the above

19. A European call and European put have the same strike price and time to maturity
Which two of the following are true (circle two)
(a) The gamma of a call is the same as the gamma of a put
(b) The delta of a call is the same as the delta of a put
(c) The vega of a call is the same as the vega of a put
(d) The theta of a call is the same as the theta of a put

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20. A trader uses a stop–loss strategy to hedge a short position in a three-month call option
with a strike price of 0.7000 on an exchange rate. The trader covers the option when
the exchange rate is 0.7005 and assumes a naked position when the exchange rate is
0.6995. The value of the option is 0.1. Estimate the expected number of times the trader
covers the position during the life of the option _ 100 _ _ _ _ _

Questions: 21 to 22

Suppose that the cumulative default probability for a company for years one, two, three
and four are 3%, 6.5%, 10%, and 14.5%.

21. What is the unconditional default probability for year four_ _ _ _ _?

22. What is the default probability for year four conditional on no default in earlier
years__ _ _ _ _ _ _? We have solved in the class

Questions: 23 to 25
Company A, a U.S. firm, and Company B, a European firm, have 5 years’ debt
exposures equivalent to $50 million. As on January 1, 2010, the exchange rate is
$1.25 per euro. The dollar-denominated interest rate is 7.25%, and the euro-
denominated interest rate is 4.5%.

23. Draw the Currency Swap diagram

24. Arrange a Currency Swap and decide the interest payment after one year

25. End of one year decide the principal exchange if the exchange rate is $1.40 per euro
as on Jan 1, 2011.

We have solved in the class

Rough Works

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