Derivatives Pricing Quiz

Which of the following statements is most accurate? In derivatives pricing:

• investors are assumed to be risk averse.

• expected payoffs of the derivative can be discounted at the risk-free rate.

• a portfolio consisting of the underlying and the derivative must earn the risk-free rate plus a risk premium.

Replication is most likely used to:

• increase leverage.

• reduce portfolio risk.

• exploit pricing differentials.

Convenience yield is primarily associated with which of the following assets?

• High-yield bonds

• Dividend-paying stocks

• Commodities in short supply

Which of the following statements best describes the relationship between the costs of carry and the forward price?

• If the costs of carry exceed the benefits, the forward price would be lower

• If the costs of carry exceed the benefits, the forward price would be higher

• If the benefits exceed the costs of carry, the forward price would be higher

An increase in the risk-free rate, r, following the inception of a forward contract will cause which of the following to the forward contract’s MTM value to the forward seller if other parameters remain unchanged.

• The forward contract‘s MTM value to the forward seller will be unchanged.

• The forward contract’s MTM value to the forward seller will increase.

• The forward contract‘s MTM value to the forward seller will decrease.

Which of the following statements about a forward rate agreement is accurate?

• The underlying is a currency exchange rate

• The short position hedges against an increase in interest rates

• The contract is closely tied to the term structure of interest rates

Which of the following statements regarding the gains or losses of a long forward contract position compared to a long futures contract position is most correct? Assume that the underlying is identical on both contracts and that both contracts have the same time until maturity.

• The daily realized gain or loss of the forward contract position and the futures contract position are equivalent.

• Before the contracts mature, the cumulative realized gains or losses of the forward contract position and the futures contract position are equivalent.

• At contract maturity, the cumulative realized gains or losses of the forward contract position and the futures contract position are approximately equivalent.

For an investor with a long position, the price of a futures contract will most likely be higher than the price on a forward contract on the same asset with the same expiration date if there is a:

• negative correlation between the futures price and interest rates.

• zero correlation between the futures price and interest rates.

• positive correlation between the futures price and interest rates.

A swap is most likely similar to a series of forward contracts when:

• the combined value of all forward contracts is zero.

• all the forward contracts have the same maturity date.

• the value of the long forward contracts are matched with the value of the short forward contracts at each swap payment date.

Which of the following statements is most accurate?

• The value of a swap fluctuates as market conditions change

• The price and the value of a swap are the same at expiration

• The price of a swap at initiation is zero as there is no initial outlay of cash