Derivatives Futures, Options, And Swaps Test Bank Docx Ch.9

Student name:__________

1) As the chapter points out, there have been many cases where derivatives have led to a lot of abuse. If this is the case, why do derivatives exist?

2) Explain how an interest rate futures contract differs from an outright purchase of a bond.

3) What are the three main ways to categorize derivatives?

4) Explain why a forward contract may actually carry more risk than a futures contract.

5) Explain why the two parties in a futures contract technically do not make a bilateral agreement with each other.

6) Explain how the clearing corporation reduces the risk it faces in the futures market through the use of margin accounts and marking to market.

7) We have a futures contract for the purchase of 10,000 bushels of wheat at $3.00 per bushel. If the price of wheat were to increase to $3.50, explain what happens to the parties involved in the contract in terms of marking to market. Be sure to identify who is long and short and specifically how much is transferred.

8) A lender obtains funds from depositors by offering short-term interest rates on savings accounts. The lender uses these funds to make longer-term installment loans. Explain how the lender might make use of the futures market to hedge the risk taken.

9) How is the lack of futures markets in poor countries linked to the fact that farmers in poor countries are likely to remain poor?

10) What is the process that makes sure the market price of an underlying asset equals the price of a futures contract at the settlement date? Provide an example.

11) Consider a call option. In terms of the option writer and option holder, who is the buyer? Who is the seller? Finally, who has the option? Explain.

12) With a put option, what specifically does the option holder receive for the price paid for the option?

13) Suppose an investor is considering different options as described here. Answer the questions by filling in the table as directed.

a. The investor could purchase a futures contract to buy a share of stock at some point in the future for $200. Fill in column A in the table to show the profit/loss at various prices on the settlement date.
b. The investor could buy a call option at a strike price of $200, giving her the right to buy the stock for$200. She pays $1 for the right to make this purchase. Including this time value of the option, fill in column B in the table to show the profit from buying this call at the various prices in the table.

c. The investor could sell a put option, which obligates her to buy the stock at a price of $200 if the buyer of the put exercises the option before the expiration date.Assume she receives $1 from the buyer of the put when she initially sells it.Including this put premium, fill in column C in the table to show the profit from selling this put at the various prices in the table.

d. Compare your answers for profit from the futures contract with your answers for the profit from the options. What conclusion can you draw? What does this illustrate about derivatives?

14) Describe the condition that would have a call option in the money. Now describe the condition that has a put option out of the money.

15) Explain the difference between American and European options.

16) If the option holder is the individual with the options, why is anyone an option writer?

17) a. What are the four attributes on which the time value of any financial instrument depends? (Hint: The answer was first presented in Chapter 3.)

b. Recalling that Option value = Intrinsic value + Time value, fill in the following table with “increase” or “decrease” to summarize how an increase in each factor affects the call (right to buy) and put (right to sell).

18) Suppose you purchase a call option to purchase General Motors common stock at $80 per share in March. The current price of GM stock is $83 and the time value of the option is $5. What is the intrinsic value of the option? As the expiration date approaches, what will happen to the size of the time value of the option?

19) Suppose you purchase a put option to sell General Motors common stock at $80 per share in March. The current price of GM stock is $83 and the time value of the option is $1. What is the intrinsic value of the option?

20) Why does the time value of the option tend to vary directly with the time to expiration?

21) What would be the value of an option on a stock that sells at a fixed price with a standard deviation of zero? Explain.

22) Identify four factors that will cause the value of call options to increase.

23) Identify four factors that will cause the value of put options to decrease.

24) If the current closing price of the stock of XYZ, Inc. is $87.50 and the July expiration call options with a strike price of $80 are selling for $9.45, what is the intrinsic value of the option? What is the time value of the option?

25) If the current closing price in the stock of XYZ, Inc. is $87.50 and the July expiration put options with a strike price of $80 are selling for $1.05, what is the intrinsic value of the option? What is the option premium?

26) Why do government debt managers often use interestrate swaps?

27) Explain the concept of notional principal used in swaps.

28) How does trading in over-the-counter markets increase systemic risk?

29) What is a credit default swap?

30) How did credit default swaps contribute to the financial crisis of 2007–2009?

31) Imagine a baker who has the opportunity to bid on a contract to supply a local military base with bread for an entire year. The problem is the baker must commit to a price today and hold to that price for the entire year. Identify the risk faced by the baker, and explain how the use of a futures contract could transfer the risk.

32) A futures contract is a forward contract with some important differences. Explain these.

33) Explain the popularity of options in the context of the potential gains and losses they offer.

34) Explain why, for speculation, the purchase of an option may be more attractive than a futures contract or the outright purchase of the underlying asset.

35) What questions should an employee ask before accepting options as a part of or instead of a salary?

36) A derivative is a financial instrument whose value is

A) intrinsic to the instrument itself.
B) determined by the value of its underlying asset.
C) based on the outright purchase of a financial asset.
D) based on the value of a positive-sum game between two parties.

37) Derivatives are financial instruments that

A) present high levels of risk and should only be used by the wealthy.
B) when used correctly can actually lower risk.
C) should only be used by people seeking high returns from low risk.
D) represent the outright purchase of a bond.

38) Why would a farmer routinely use derivatives?

A) to transfer risk from the buyer of her crop to herself
B) to pay for transaction costs of getting her crop to market
C) to increase transparency about her financial transactions
D) to insure herself against fluctuations in the market price of her crop

39) The value of a derivative is determined by

A) the Federal Reserve.
B) SEC regulation.
C) the value of the underlying asset.
D) the risk-free rate.

40) In a derivative transaction,

A) the dollar amount of the transaction increases as the contract date approaches.
B) the risk is less than if actually purchasing the underlying asset.
C) what one person gains is what the other person loses.
D) there is always a futures contract.

41) The purpose of derivatives is to

A) increase the risk so the return is larger.
B) eliminate risk for both parties in the transaction.
C) postpone the risk for both parties in the transaction.
D) transfer the risk from one person to another.

42) An investor has his own biases and emotions that influence decision making, particularly when there are market losses due to an event such as the 2020 COVID-19 global pandemic. Fraudsters can target investors who are trying to recoup losses, and derivative markets could be fertile ground in some respects because participants tend to be

A) willing to accept risk.
B) unconcerned with managing risk.
C) straightforward in their market strategies.
D) conservative in their investment strategies.

43) Forward contracts are

A) an agreement between more than two parties.
B) contracts usually involving the exchange of a commodity or financial instrument.
C) always standardized.
D) easily resold.

44) The short position in a futures contract is the party that will

A) deliver a commodity or financial instrument to the buyer at a future date.
B) suffer the loss.
C) accept the risk.
D) benefit from increases in price of the underlying asset.

45) The long position in a futures contract is the party that will

A) benefit from decreases in the price of the underlying asset.
B) agree to make delivery of a commodity or financial instrument at a future date.
C) benefit from increases in the price of the underlying asset.
D) accept the greater share of the risk.

46) With a futures contract,

A) payment is made when the contract is created.
B) no payment is made until the settlement date.
C) the short position agrees to purchase the underlying asset.
D) the risk is eliminated for both parties.

47) The key difference between a forward and a futures contract is

A) a forward contract is customized where a futures contract is not.
B) a forward contract is bought and sold on organized exchanges.
C) only the forward contracts have settlement dates.
D) the amount of time involved.

48) The clearing corporation's main role in the futures market is to

A) set the market price of the contract.
B) act as the counterparty to both sides of the transaction, thereby guaranteeing payment.
C) provide the underlying assets so the contracts can be created.
D) act as a mediator to settle differences between the seller and buyer.

49) The process of marking to market

A) is done by the clearing corporation to reduce risk in futures contracts.
B) involves the margin accounts of only the buyers of future contracts.
C) involves the margin accounts of only the sellers of future contracts.
D) usually requires margin accounts to be adjusted weekly by the clearing corporation.

50) Marking to market is a process that

A) involves a transfer of risk.
B) ensures that the buyers and sellers receive what the contract promises.
C) always requires the sellers of contracts to transfer funds to the buyers of contracts.
D) buyers and sellers can request for an additional fee when the contract is created.

51) There is a futures contract for the purchase of 100 bushels of wheat at $2.50 per bushel. At the end of the day when the market price of wheat increases to $3.00 per bushel,

A) the buyer (long position) needs to transfer $50 to the seller (short position).
B) the seller (short position) needs to transfer $50 to the buyer (long position).
C) nothing happens since with a futures contract all payments are made at the settlement date.
D) nothing happens since marked to market adjustments only take place when the market price falls below the contract price.

52) There is a futures contract for the purchase of 1,000 bushels of corn at $3.00 per bushel. At the end of the day when the market price of corn falls to $2.50,

A) the buyer (long position) needs to transfer $500 to the seller (short position).
B) the seller (long position) needs to transfer $500 to the buyer (short position).
C) nothing happens since marked to market adjustments only occur if the market price rises above the contract price.
D) nothing happened since no funds are transferred until the settlement date.

53) A U.S. Treasury bond dealer with a large portfolio who sells a futures contract for U.S. Treasury bonds is

A) taking on additional risk in hopes of getting a larger return.
B) ensuring the sales price of the bond through hedging.
C) not likely to find a buyer for this transaction.
D) should see the value of the futures contract increase as bond prices rise.

54) A pension fund manager who plans on purchasing bonds in the future

A) wants to insure against the price of bonds falling.
B) can offset the risk of bond prices rising by selling a futures contract.
C) will take the long position in a futures contract.
D) will take the short position in a futures contract.

55) A baker of bread has a long-term fixed-price contract to supply bread. Which one of the following would not reduce her risk?

A) taking the long position in a wheat futures contract
B) hedging this risk in the wheat futures market
C) forgoing the act of posting margin
D) finding a wheat farmer who will take the long position in a wheat futures contract

56) A wheat farmer who must purchase his inputs now but will sell his wheat at a market price at a future date

A) faces a market risk that cannot be offset.
B) is a good example of a speculator.
C) would hedge by taking the short position in a wheat futures contract.
D) is unable to hedge risk by participating in a futures contract.

57) Users of commodities are

A) usually not participants in futures contracts.
B) speculators preferring to get the large returns that result from large risk.
C) likely to take the short position in a futures contract.
D) buyers of futures.

58) Speculators differ from hedgers in the sense that

A) speculators do not like risk.
B) hedgers seek to transfer risk.
C) speculators seek to transfer risk.
D) speculators have a profit motive.

59) A possible explanation about why farmers in poor countries remain poor is that

A) they know very little about farming techniques needed for the crop they are growing.
B) they are poor assessors of the risks they face.
C) risk taking is a deterrent to growth.
D) poor farmers in many countries lack access to commodity futures markets.

60) Futures markets and derivatives contribute to economic growth by

A) decreasing speculation.
B) increasing the risk-taking capacity of the economy.
C) deterring the transfer of risk.
D) forcing people to accept the risk their decisions create.

61) On the settlement date of a futures contract, the future’s price

A) is always above the price of the underlying asset.
B) is always below the price of the underlying asset.
C) is equal to the price of the underlying asset.
D) may be above or below the price of the underlying asset but not equal to it.

62) As the time of settlement gets closer, the price of the

A) futures contract will diverge from the price of the underlying asset.
B) futures contract will always be above the price of the underlying asset.
C) underlying asset and the future's price will show no correlation at all.
D) futures contract will move in lockstep with the price of the underlying asset.

63) Tom buys a futures contract for U.S. Treasury bonds and, on the settlement date, the interest rate on U.S. Treasury bonds is lower than Tom expected. Tom will have

A) lost money on his long position.
B) gained money on his long position.
C) lost money on his short position.
D) gained money on his short position.

64) Sue sells a futures contract for U.S. Treasury bonds and, on the settlement date, the interest rate on U.S. Treasury bonds is lower than Sue expected. Sue will have

A) lost money on her short position.
B) gained money on her long position.
C) gained money on her short position.
D) lost money on her long position.

65) Tom buys a futures contract for U.S. Treasury bonds and, on the settlement date, the interest rate on U.S. Treasury bonds is higher than Tom expected. Tom will have

A) gained money on his short position.
B) lost money on his long position.
C) gained money on his long position.
D) lost money on his short position.

66) Sue buys a futures contract for U.S. Treasury bonds and, on the settlement date, the interest rate on U.S. Treasury bonds is higher than Sue expected. Sue will have

A) gained money on her short position.
B) gained money on her long position.
C) lost money on her long position.
D) lost money on her short position.

67) If market participants believe next year’s corn crop is likely to be unusually large,

A) the current spot market price of corn is likely to be below the futures price of corn.
B) the current spot market price of corn is likely to be above the futures price of corn.
C) it would be impossible to find someone to take the short position in a futures contract.
D) it will be impossible to find someone to take the long position in a futures contract.

68) An arbitrageur is someone who

A) always takes the long position in a futures contract.
B) always takes the short position in a futures contract.
C) seeks the high returns that come from the high risk inherent in futures markets.
D) simultaneously buys and sells financial instruments to benefit from temporary price differences.

69) If a futures contract for U.S. Treasury bonds increases by "12" in the financial page listings with a conversion factor of 1/32, the value of the contract increased by

A) $120.00.
B) $1,200.00.
C) $375.00.
D) $240.00.

70) If a futures contract for U.S. Treasury bonds decreases by "17" in the financial page listings with a conversion factor of 1/32, the price of the contract decreased by

A) $531.25.
B) $170.00.
C) $340.00.
D) $1700.00.

71) A price of a futures contract for U.S. Treasury bonds listed as "111-15" is measured in

A) 32nds.
B) 12ths.
C) 4ths.
D) dollars; it stands for $111.15 but a dash is used instead of a period.

72) The user of a commodity who is trying to insure against the price of the commodity rising would

A) take the short position in a futures contract.
B) take the long position in a futures contract.
C) be better off speculating on price movements and earning higher profits.
D) want to hedge by selling a futures contract.

73) An individual who neither uses nor produces a commodity but sells a futures contract for the asset is

A) speculating that the price of the commodity is going to fall.
B) betting that the price is going to increase.
C) hedging trying to transfer risk.
D) using arbitrage to earn profits without taking a risk.

74) An individual who neither uses nor produces a commodity but buys a futures contract for the asset is

A) betting that the price is going to fall.
B) speculating that the price of the commodity is going to increase.
C) is using arbitrage to earn profits without taking a risk.
D) is hedging and transferring risk.

75) The option holder is

A) the seller of an option.
B) another name for the clearinghouse used in futures contracts.
C) the buyer of an option.
D) always a speculator.

76) The option writer is the

A) seller of an option.
B) buyer of an option.
C) underlying asset of the option.
D) individual who obtains the rights.

77) The right to buy a given quantity of an underlying asset at a predetermined price on or before a specific date is called a(n)

A) put option.
B) option writer.
C) call option.
D) arbitrage contract.

78) A call option is an option

A) written more than sixty days into the future.
B) giving the holder the right to buy a given quantity of an asset at a specific price on or before a specified date.
C) giving the seller the right to sell a given quantity of an asset at a specific price on or before a specified date.
D) where all rights are granted to the seller of the option.

79) The strike price of an option is

A) the market price at the time the option is written.
B) the market price at the time the option is exercised.
C) the price at which the option holder has the right to buy or sell.
D) always above the market price.

80) With a call option, the option holder

A) has the right to sell the asset.
B) has the right to buy the asset.
C) can buy or sell, it is their option.
D) can buy the asset but only after the date specified.

81) With a put option, the option holder

A) has the right to buy the asset.
B) can buy or sell the asset, it is their option.
C) has the right to sell the asset.
D) can buy the asset but only on the date specified.

82) There's a call option written for 100 shares of GM stock for $85.00 a share, prior to the third Friday of October 2020. The option writer

A) has the option but not the requirement of selling 100 shares of GM for $85.00.
B) will sell 100 shares of GM for $85.00 on the third Friday of October 2020.
C) has the option to back out of this contract prior to the third Friday of October 2020.
D) is required to post margin.

83) There's a call option written for 100 shares of GM stock for $85.00 a share, prior to the third Friday of October 2020. The option writer:

A) has the requirement to sell 100 shares of GM for $85 a share on or before the third Friday of October 2020 if the option holder wants to exercise the option.
B) has the option to sell 100 shares of GM for $85 a share on or before the third Friday of October 2020.
C) can cancel the option before the third Friday of October 2020.
D) does not have to post margin while the option holder does.

84) With a call option that is described as in the money, the market price of the stock

A) is below the strike price.
B) equals the strike price.
C) is above the strike price.
D) no higher than the strike price.

85) A put option that is described as in the money would find that the

A) market price of the stock is above the strike price.
B) strike price is above the market price of the stock.
C) market and strike prices are the same.
D) option has been exercised.

86) A call option described as at the money would find that the

A) market price of the stock is above the strike price.
B) market price of the stock is below the strike price.
C) option has been exercised.
D) market price of the stock equals the strike price.

87) A put option described as out of the money would find that the

A) strike price is below the market price of the stock.
B) market price of the stock and the strike price are equal.
C) market price of the stock is below the strike price.
D) option has expired.

88) A call option described as out of the money would find that the

A) market price of the stock is above the strike price.
B) option has been exercised.
C) option has expired.
D) strike price is above the market price of the stock.

89) The main difference between European and American options is that

A) holders of European options have more options than holders of American options.
B) American option holders have more options than European option holders.
C) European option holders can exercise the option prior to expiration.
D) European options cannot be resold.

90) One key difference between options contracts and futures contracts is that

A) in a futures contract, one part has more rights than the other.
B) with an options contract, both parties have equal rights.
C) in an options contract, the rights belong to one party.
D) in a futures contract, all rights are held by just one party.

91) Which one of the following can be sold prior to expiration?

A) Call options can be sold prior to expiration but put options cannot.
B) Put options can be sold prior to expiration but call options cannot.
C) No option can be sold prior to expiration.
D) Both American and European options can be sold prior to expiration.

92) The seller of a put option

A) is transferring the risk of a price decrease of the stock to the buyer of the option.
B) is transferring the risk of a price increase of the stock to the buyer of the option.
C) cannot transfer risk.
D) is not transferring risk because only sellers of call options are transferring risk.

93) Someone who purchases a call option is really buying insurance to protect against

A) the stock not being available when they want to purchase it.
B) the price of the stock falling.
C) a seller not being able to deliver the stock.
D) the price of the stock rising.

94) Comparing an option to a futures contract, it would be correct to say that

A) the risk involved in each is equal.
B) a futures contract carries more risk than the option contract.
C) an option contract carries more risk than the futures contract.
D) neither involves risk since they are tools to eliminate risk.

95) An investor who purchases a call option is

A) highly leveraged for a gain but is limited in losses.
B) limited in his or her gain but is highly leveraged in losses.
C) highly leveraged for both gains and losses.
D) limited in both gains and losses.

96) Options are popular because of all of the following except that

A) stock prices are volatile.
B) they offer a tool to transfer risk.
C) they present a tool to limit losses but also limit gains.
D) they offer opportunities for high leverage.

97) The two parts that make up an option's price are the

A) extrinsic value and the time value of the option.
B) commission and the time value of the option.
C) intrinsic value and the time value of the option.
D) price of the underlying asset and the time value of the option.

98) The intrinsic value of an option

A) is the amount the investor believes the option will be worth on the expiration date.
B) is the amount the option is worth if it is exercised immediately.
C) is equal to price of the underlying asset.
D) cannot be determined without knowing the future price of the underlying asset.

99) As an option approaches its expiration date, the value of the option approaches

A) the intrinsic value.
B) the price of the underlying asset.
C) zero.
D) infinity.

100) The time value of the option can best be defined as the

A) commission earned by a broker.
B) fee earned for the potential benefits from buying the option.
C) service fee charged by the SEC for regulating the option market.
D) fee paid for the potential benefits from buying an option (excluding its intrinsic value).

101) Assume we have a stock currently worth $100. We also assume the interest rate is zero, and we can buy options for this stock with a strike price of $100. If the stock can rise or fall by $20 with equal probability over the option period, and the option cannot be exercised until the expiration date, what is the time value of the option?

A) $20
B) $0
C) $10
D) $100

102) Assume we have a stock currently worth $100. We also assume the interest rate is zero, and we can buy options for this stock with a strike price of $100. If the stock can rise or fall by $5 with equal probability over the option period, and the option cannot be exercised until the expiration date, what is the time value of the option?

A) $10.00
B) $5.00
C) $2.50
D) $0

103) Assume we have a stock currently worth $50. We also assume the interest rate is zero, and we can buy options for this stock with a strike price of $50. If the stock can rise or fall by $10 with equal probability over the option period, and the option cannot be exercised until the expiration date, what is the time value of the option?

A) $5
B) $10
C) $50
D) $40

104) As the volatility of the stock price increases, the time value of the option

A) decreases.
B) is zero.
C) increases.
D) doesn't change.

105) An option's value will never be less than zero because

A) the intrinsic value is always less than zero.
B) the option seller is required to make up any shortfall faced by the option buyer.
C) an option holder will never make an additional payment to exercise the option.
D) the time value of the option is always less than zero.

106) The intrinsic value of a call option

A) is the difference between the option price and the interest rate.
B) must be less than or equal to zero.
C) is the greater of zero or the difference between the price of the underlying asset and the strike price.
D) will be negative if the time value of the option is negative.

107) At expiration, the value of an option is

A) greater than the intrinsic value.
B) less than the intrinsic value.
C) equal to the time value of the option.
D) equal to the intrinsic value.

108) At expiration, the time value of an option is

A) equal to the intrinsic value.
B) greater than the intrinsic value.
C) zero.
D) less than the intrinsic value.

109) The time value of the option should

A) decrease the longer the time to expiration.
B) increase the longer the time to expiration.
C) not change with time to expiration.
D) approach infinity at expiration.

110) If the price of an underlying asset has a standard deviation of zero, then

A) options for this asset would likely not exist.
B) options for this asset would be highly valued.
C) the intrinsic value of options for this asset would equal the asset's price.
D) options for this asset would have a time value of the option equal to the price of the asset.

111) Considering a put option; if the price of the underlying asset increases, then the

A) value of the put option also increases.
B) intrinsic value of the option increases.
C) value of the option decreases.
D) time value of the option decreases.

112) Considering a call option, if the price of the underlying asset decreases, then the

A) intrinsic value of the option decreases if it is above zero.
B) intrinsic value of the option increases if it is above zero.
C) strike price decreases.
D) value of the option increases.

113) Options

A) allow investors to get rid of the risks they do not want and keep the ones they do want.
B) can be used for hedging but not for speculation.
C) obligate the holder to sell the underlying asset at a predetermined price on or before a fixed date.
D) allow investors to bet that the price of an underlying asset will rise but not that it will fall.

114) Considering a put option, an increase in the strike price

A) causes the intrinsic value of the option to decrease if it is above zero.
B) causes the intrinsic value of the option to increase if it is above zero.
C) causes the value of the option to decrease.
D) makes the option worthless.

115) If we have a stock selling for $95.00 and a call option for this stock has a strike price of $82.00 and an option price of $13.60, then the intrinsic value

A) of the option is $0.60 and the time value of the option is $13.00.
B) is $82.00 and the time value of the option is $13.60.
C) of the option is $13.00 and the time value of the option is $0.60.
D) is $0 since the option is out of the money.

116) We have a stock selling for $90.00. There is a put option for this stock with a strike price of $85 and an option price of $1.20. The intrinsic value of this option

A) is $0.00 and the time value of the option is $1.20.
B) is $90.00 and the time value of the option is $1.20.
C) is –$5.00 and the time value of the option is $1.20.
D) and the time value of the option cannot be determined since the strike price is less than the underlying asset price.

117) For a given call option price, which one of the following statements is correct?

A) The closer the strike price is to the current price of the underlying asset, the smaller is the time value of the option.
B) The closer the strike price is to the current price of the underlying asset, the larger is the time value of the option.
C) As the strike price approaches the price of the underlying asset, the time value of the option approaches zero.
D) As the strike price approaches the price of the underlying asset, the intrinsic value of the option increases and the time value of the option decreases.

118) Ceteris paribus, speculators in options markets would prefer stocks with

A) low volatility and options with near-term expiration dates.
B) low volatility and options with long-term expiration dates.
C) high volatility and options with near-term expiration dates.
D) high volatility and options with long-term expiration dates.

119) Which one of the following would tend to decrease the size of the time value of the option?

A) The price volatility of the underlying asset is high.
B) The time to expiration of the contract is far away.
C) The underlying price of the asset approaches the strike price.
D) The time to expiration of the options contract is near.

120) Interestrate swaps are

A) exchanges of equity securities for debt securities.
B) agreements between two parties to exchange periodic interestrate payments over some future period.
C) agreements involving swapping of option contracts.
D) agreements that allow both parties to convert floating interest rates to fixed interest rates.

121) A key use of interestrate swaps is to

A) eliminate risk for both parties involved in the transaction.
B) earn the fees for constructing the swaps.
C) provide a hedge against interestrate risk.
D) manage government revenues.

122) The principal in an interest rate swap is

A) always transferred from the originator to the counterparty of the swap.
B) usually held by a clearinghouse to guarantee payment.
C) usually borrowed from a third party.
D) not borrowed, lent, or exchanged. It just serves as the basis for the calculation of cash flows.

123) The figure illustrates a typical interest rate swap agreement. Which party is the bank and which is the dealer?

A) 1 is the bank, and 2 is the dealer.
B) 1 is the dealer, and 2 is the banker.
C) The bank is the party that agrees to pay the floating rate.
D) The dealer is the party that pays a fixed rate in exchange for payments based on the floating rate.

124) Considering interestrate swaps, the swap rate is

A) the benchmark rate plus a premium.
B) the rate being offered on U.S. Treasury securities of similar maturities.
C) another name for the swap spread.
D) a measure of overall risk in the economy.

125) Considering interestrate swaps, the swap spread is

A) another name for the swap rate.
B) the difference between the benchmark rate and the swap rate.
C) the benchmark rate plus the swap rate.
D) a measure of the time value of the swap.

126) One key difference between swaps and option contracts is that

A) swaps are derivative agreements and options are not.
B) swaps do not involve any risk and options do.
C) options transfer risk, swaps create risk.
D) options trade on organized exchanges and swaps do not.

127) The VIX, constructed from options on S&P 500 Index futures, is technically a measure of what?

A) leverage
B) market liquidity
C) stock valuations
D) implied volatility

128) The primary risk in swaps is that

A) interest rates will not change.
B) one of the parties will default.
C) they are highly liquid and the market price will change.
D) high U.S. government deficits will limit the availability of swaps.

129) Credit default swaps

A) are short-term agreements that do not require collateral.
B) help reduce uncertainty about who bears the credit risk on a given loan.
C) make it more difficult for sellers of insurance to assume and conceal risk.
D) provide a division of labor where one party identifies loan opportunities and collects payments while someone else worries about default risk.

130) Using a credit default swap,

A) a lender can make a loan without facing the possibility of default.
B) lenders cannot insure themselves against the risk that a borrower will default.
C) financial institutions have more transparency about risk.
D) the buyer pays a fee to the seller to accept the risk of default.

131) Standardization of derivative contracts

A) results in increased risk for the parties involved.
B) makes them more difficult to understand and therefore leads to increased misuse.
C) makes the premiums involved with these contracts increase.
D) leads to greater liquidity and lower risk.