Seminar 10 Questions

1. A put option is out-of-the-money if _______________________________

A. the strike price is equal to the spot price
B. the strike price is higher than the spot price
C. the spot price is higher than the strike price
D. the spot price equals the future price
2. A call option is in-the-money if _______________________________
A. the strike price is equal to the spot price
B. the strike price is higher than the spot price
C. the spot price is higher than the strike price
D. the spot price equals the future price
3. The marking-to-market operation exist in ______________________
A. the forward contracts
B. the option contracts
C. the futures contracts
D. all the above
4. Suppose that at expiration the spot price of the EUR/USD is 1.2345 and the
option has a strike price of EUR/USD is 1.2545 with a premium of EUR/USD is
0.01.
A. the writer of the call option suffers a loss of EUR 0.01 to the USD.
B. the buyer of the put option suffers a loss of EUR 0.01 to the USD.
C. the writer of the put option suffers a loss of EUR 0.01 to the USD.
D. the buyer of the call option gains EUR 0.01 to the USD.
5. When we buy a put option we expect the market to ________
A. increase
B. fall
C. remain stable
D. none of the above as put option is an arbitrage strategy
6. The 3-month Eurodollar future is currently priced at $95. A firm wants to
borrow $1m in 1 month time for 3 months. The firm expects the LIBOR to
increase in 3 months time to 6.5%. What is the position that the firm should take
in the Eurodollar future and how much would be the potential profits/losses from
a single contract, assuming that their expectations came true?
A. long, -$1500
B. long, $3750
C. short, $3750
D. short, -$1500
7. An interest rate floor is an option contract that is exercised when _________
A. when interest rates are higher than the floor rate
B. when the interest rates are equal to the floor rate
C. when the interest rates are lower than the floor rate
D. is always exercised

8. A bank expects an interest rate payment from a client on a floating interest

rate loan. The hedging tool that the bank can use to protect itself from the
downside risk is_______________ in _________ position
A. interest rate cap, long
B. interest rate floor, long
C. Eurodollar futures, short
D. Interest rate floor, short
9. Firm A got a loan of $2m at LIBOR. They enter into a cap agreement with 5%
and premium $10000. In six months LIBOR goes to 5.5%. How much will be the
firms total payment according to the cap contract?
A. $0.080m
B. $0.090m
C. $0.110m
D. $0.100m
3. Which of the following statement is true with regards to floating-rate issues
that have caps and floors?
A. A cap is an advantage to the debt-holder while a floor is an advantage to
the debt-issuer
B. A cap is a disadvantage to the debt-holder while a floor is a disadvantage
to the debt-issuer.
C. A floor is a disadvantage to both debt-issuer and the debt-holder while a
cap is an advantage to both the debt-issuer and the debt-holder.
D. A floor is an advantage to both the debt-issuer and the debt-holder while
a cap is a disadvantage to both the debt-issuer and the debt-holder.
Exercises:
1. Assume that a bank will lend in 6 months $15m to Firm A for 3 months at a
LIBOR. The Eurodollar futures are currently priced at 93.35. The bank expects
that the interest rates will decrease.
a) Which position should the bank take in the Eurodollar futures?
b) Which position should the firm take and under which assumption regarding the
future interest rates?
c) What will be the exposure of the bank if the interest rates were 5.5%, 5% or
4%, in 3 months time? Calculate the profits from the Eurodollar futures contract
for each of the above LIBOR rates and state the number of contracts that are
required by the bank in order to hedge completely the interest rate risk. Can the
bank achieve a perfect hedge?
2. Suppose that the standard deviation of daily changes in the spot prices of a
EUR/GBP over the last 3 months is 22%. The standard deviation in futures prices
on the same exchange rate is 18%. The coefficient of correlation between the
two changes is 0.4. What is the optimal hedge ratio for a three-month futures
contract in the EUR/GBP exchange rate? What does it mean?
3. Based on the above, how many contracts the firm should go long (assuming
that the firm is expected to have a foreign currency outflow) if the exposure is
5,600,000 and the contract size is 125,000? Is this a perfect hedge?

4. Assuming that a firm will take a loan in 6 months of 10m for 1 year on LIBOR.
The firm signs today a 1-year interest rate cap at 7%, with 6 months expiration.
The cost of the option contract is 0.03m. The interest rate payments are annual.
Assuming that the LIBOR rates in 6 months can be 5%, 6%, 7%, 8% and 9%,
calculate the profits/losses of the hedging.
5. Assuming that a bank will provide a loan in 3 months of 15m for 1 year on
LIBOR. The bank signs today a 1-year interest rate floor at 5%, with 3 months
expiration. The cost of the option contract is 0.02m. The interest rate payments
are annual. Assuming that the LIBOR rates in 3 months can be 2%, 3%, 4%, 5%
and 6%, calculate the profits/losses of the hedging.