2019 CFA level 3 qbank reading 33 risk management applications of option strategies questions

10/12/2018 Learning Management System Question #1 of 33 All of the following are conditions that make the second-order gamma e ect more important to a manager delta-hedging an option EXCEPT when the: A) delta is near zero B) option is near expiration .in C) option is at-the-money en tre Question #2 of 33 Assume that the current price of a stock is $100 A call option on that stock with an exercise price of $97 costs $7 A call option on the stock with the same expiration and an exercise price bo ok c of $103 costs $3 Using these options what is the cost of entering into a long bull spread on this stock? A) $4 B) $1 w w o m C) $0 w Question #3 of 33 Which of the following is equivalent to a pay- xed interest rate swap? A) Selling a cap and buying a oor B) Buying a cap and selling an interest rate collar C) Buying a cap and selling a oor Question #4 of 33 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448104/print 1/12 10/12/2018 Learning Management System An option dealer is delta hedging a short call position on a stock As the stock price increases, in order to maintain the hedge, the dealer would most likely have to: A) buy T-bills B) buy more shares of the stock C) sell some the shares of the stock .in Question #5 of 33 An investor believes that a stock they own will continue to oscillate in price and may trend A) sell call options on the stock B) buy put options on the stock en tre downward in price The best course of action for them to take would be to: m Question #6 of 33 bo ok c C) enter into both a covered call and protective put strategy A) $25 w B) -$25 w w stock price is $125? o What is the expiration payo of a long straddle, with an exercise price $100, if the underlying C) $0 Linda Morgan is in a training program at a large investment bank Currently, she is spending three months at her rm's Derivatives Trading desk One of the traders, Jason Gover, CFA, asks her to compare di erent option trading strategies Gover would like Morgan to pay particular attention to strategy costs and their potential payo s Morgan is not very comfortable with option models and must rst investigate how to properly price European and American style equity options Gover has given her software that provides a variety of analytical information Morgan has decided to begin her analysis using two di erent scenarios to evaluate option https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448104/print 2/12 10/12/2018 Learning Management System behavior Her scenarios are illustrated in Exhibit and Exhibit Note that all of the rates and yields are on a continuous compounding basis Exhibit Exhibit Stock Price (S) $100 Call Strike Price (X) $100 Price $5.51 in Exhibit $100 Put Strike Price (X) $100 Price $5.68 bo ok c Stock Price (S) en tre Exhibit Gover instructs Morgan to consider using a straddle in which a at-the-money call and put option would be purchased Assume all other variables remain identical m Question #7 of 33 o Jason explains to Linda that the volatility of returns of the underlying stock has the most in uence over the price of an option Following his explanation he queries Linda on how exactly w w does volatility a ect option values If the volatility were to increase would the price of the option change? w A) Yes, the option price will increase B) Yes, the option price will decrease C) It depends whether the option is a call option or a put option Question #8 of 33 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448104/print 3/12 10/12/2018 Learning Management System After computing the maximum loss of the straddle Linda wonders why an investor would want to set up a straddle Under what circumstances would an investor want to purchase a straddle? When the investor expects: A) Prices to stay close to the exercise price of the options B) Prices to increase or decrease substantially C) Prices to increase .in Question #9 of 33 en tre Linda returns her attention to the straddle using the information in Exhibits and She computes the minimum payo of the straddle at expiration Which of the following is closest to Linda's answer? bo ok c A) $0.00 B) -$4.42 m C) -$11.31 .o Question #10 of 33 w w Linda now wants to compute the breakeven points for the straddle using the options and underlying stock in Exhibits and Which of the following are the closest to the breakeven w points for the straddle? A) $88.81, $111.19 B) $95.58, $104.42 C) $93.11, $106.89 Question #11 of 33 A stock's value on the date of option expiration is $88.50 For a call purchased with a $2.20 premium and an exercise price of $85, what is the breakeven price? https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448104/print 4/12 10/12/2018 Learning Management System A) $86.30 B) $87.20 C) $88.50 Question #12 of 33 Assume that the current price of a stock is $100 A call option on that stock with an exercise price of $97 costs $7 A call option on the stock with the same expiration and an exercise price in of $103 costs $3 Using these options what is the pro t for a long bull spread if the stock price en tre at expiration of the options is equal to $110? A) $6 B) -$2 m Question #13 of 33 bo ok c C) $2 An investor makes the following transactions in calls on a stock: (1) buys one call with a o premium of $3.50 and exercise price of $20, (2) buys one call with a premium of $1.00 and w w exercise price of $25, and (3) sells two calls with a premium of $2.00 each and an exercise price of $22.50 What is (are) the breakeven price(s)? w A) $20.50 and $24.50 B) $21 only C) $21 and $26 Dennis Austin works for O'Reilly Capital Management and manages endowments and trusts for large clients The fund invests most of its portfolio in S&P 500 stocks, keeping some cash to facilitate purchases and withdrawals The fund's performance has been quite volatile, losing over 20 percent last year but reporting gains ranging from percent to 35 percent over the previous ve years O'Reilly's clients have many needs, goals, and objectives, and Austin is called upon to design investment strategies for their clients Austin is convinced that the best https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448104/print 5/12 10/12/2018 Learning Management System way to deliver performance is to, whenever possible, combine the fund's stock portfolio with option positions on equity Question #14 of 33 Given the following scenario: Performance to Date: Up 3% Client Objective: To maintain a positive stock position and retain upside potential Which is the best option strategy to meet the client's objective? en tre A) Protective put .in Austins scenario: Expect low stock price volatility between now and the end of year B) Long butter y Question #15 of 33 m Given the following scenario: bo ok c C) Bull call Performance to Date: Up 16% o Client Objective: Earn at least 15% w w Austin's scenario: Good chance of large gains or large losses between now and end of year w Which is the best option strategy to meet the client's objective? A) Long straddle B) Long butter y C) Short straddle Question #16 of 33 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448104/print 6/12 10/12/2018 Learning Management System Given the following scenario: Performance to Date: Up 16% Client Objective: Earn at least 15% Austin's scenario: Good chance of large losses between now and end of year Which is the best option strategy to meet the client's objective? A) Short call options B) Long put options en tre in C) Long call options Question #17 of 33 A rm purchases a cap with two semi-annual payo s, a strike rate of 4%, a notional principal of bo ok c $3 million, and semiannual settlement The reference rate at the initiation of the cap is 5%, falls to 4.5% at the next settlement and then to 4% one year after the cap's initiation The total payo s (without discounting) over the maturity of the cap would be: B) $7,625 w w o C) $22,500 m A) $22,792 w Question #18 of 33 A rm purchases a collar with oor rate of 3% and a cap rate of 4.4% The cap and oor have quarterly settlement and a notional principal of $10 million The maximum out ow and in ow the buyer can expect on a given settlement is (assume equal settlement periods): A) $110,000 and maximum in ow = $140,000 B) $75,000 and maximum in ow = $140,000 C) $75,000 and maximum in ow = in nite https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448104/print 7/12 10/12/2018 Learning Management System Question #19 of 33 A manager would delta hedge a position to: A) place a oor on the position while leaving the potential for upside risk B) earn the risk-free rate C) earn extra “dividend” income on a given position .in Question #20 of 33 en tre Suppose that a 1-year cap has a cap rate of percent and a notional amount of $500 million The frequency of settlement is quarterly, and the reference rate is 3-month LIBOR The contract begins on January and the settlements are on July 1, October 1, and the following January Given the indicated LIBOR rates on those dates in the table below, what is the maximum payo Dt Date Jan 6.15% Apr 6.15% July 6.15% Oct Payo ? 6.10% 92 ? 6.10% 92 ? o m 91 w w Jan bo ok c and on what date did it occur on? (The days in each settlement period have been provided.) A) $187,500 on April w B) $127,778 on Jan C) $191,666 on Oct Question #21 of 33 A short position in naked calls on an asset can be delta hedged by: A) shorting the underlying asset B) buying the put https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448104/print 8/12 10/12/2018 Learning Management System C) buying the underlying asset Question #22 of 33 The buyer of a straddle on a stock is most likely to bene t: A) under all conditions because the straddle is guaranteed a risk-free rate of return B) if the volatility of the underlying asset’s price increases en tre in C) if the volatility of the underlying asset’s price decreases Question #23 of 33 bo ok c In delta-hedging a call position, which of the following pairs of conditions would lead to the gamma e ect being the most important? The call is: A) out-of-the-money and near expiration B) at-the-money and near expiration w w o m C) at-the-money and has a long time until expiration Question #24 of 33 w In 60 days, a bank plans to lend $10 million for 180 days The lending rate is LIBOR plus 200 basis points The current LIBOR is 4.5% The bank buys an interest-rate put that matures in 60 days with a notional principal of $10 million, days in underlying of 180 days, and a strike rate of 4.3% The put premium is $4,000 What is the e ective annual rate of the loan if at expiration LIBOR = 4.1%? A) 0.0648 B) 0.0640 C) 0.0619 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448104/print 9/12 10/12/2018 Learning Management System Question #25 of 33 Which of the following statements regarding covered call options on an underlying stock is most correct? A) The maximum loss is equal to the purchase price of the stock less the call premium B) The breakeven price is equal to the strike price of the stock less the call premium C) The strategy is used to generate additional portfolio income by speculating that the in underlying stock price will change signi cantly en tre Question #26 of 33 In 50 days, Munro Co (Munro) will be borrowing $10 million for 120 days based on a rate of LIBOR plus 200 basis points LIBOR is currently 3% Munro purchases an interest rate call for bo ok c $10,000 that has a 50-day maturity with a notional principal of $10 million, 120 days in underlying, and a strike rate of 4% Based on the information provided, which of the following statements is correct? A) If LIBOR is 6%, then the e ective annual rate of the loan at expiration is 8.67% m B) If LIBOR is 3%, then the call option is in-the-money because the total borrowing cost of 5% exceeds the 4% strike rate w w w o C) If LIBOR is 6%, then the e ective annual rate of the loan at expiration is 6.53% Question #27 of 33 Joe purchases a stock for $55 and simultaneously purchases a put for $2 that has a strike price of $45 Which of the following statements is correct? A) The maximum pro t is unlimited B) The maximum loss is $8 C) The breakeven price is $47 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448104/print 10/12 10/12/2018 Learning Management System Question #28 of 33 In delta-hedging, gamma would be important if the price of the underlying asset: A) had a large move upward or downward B) had a large move upward only C) remained constant .in Question #29 of 33 en tre An investor purchases a stock for $38 and a put for $0.50 with a strike price of $35 The investor sells a call for $0.50 with a strike price of $40 What is the maximum pro t and loss for this position? A) maximum pro t = $2.00 and maximum loss = -$3.00 bo ok c B) in nite pro t and maximum loss = -$4.00 m C) maximum pro t = $3.00 and maximum loss = -$4.00 .o Question #30 of 33 w w In 90 days, a rm wishes to borrow $10 million for 180 days The borrowing rate is LIBOR plus 200 basis points The current LIBOR is 4% The rm buys an interest-rate call that matures in 90 days with a notional principal of $10 million, 180 days in underlying, and a strike rate of 4.1% w The call premium is $9,000 What is the e ective annual rate of the loan if at expiration LIBOR = 4%? A) 0.0637 B) 0.0619 C) 0.0787 Question #31 of 33 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448104/print 11/12 10/12/2018 Learning Management System In 30 days, a rm wishes to borrow $15 million for 90 days The borrowing rate is LIBOR plus 250 basis points The current LIBOR is 3.8% The rm buys an interest-rate call that matures in 30 days with a notional principal of $15 million, 90 days in underlying, and a strike rate of 4% The call premium is $4,000 What is the maximum e ective annual rate the rm can anticipate paying? A) 0.0603 B) 0.0671 .in C) 0.0687 en tre Question #32 of 33 Assume that the current price of a stock is $100 A call option on that stock with an exercise price of $97 costs $7 A call option on the stock with the same expiration and an exercise price stock price is equal to $110? A) -$6 B) $2 w w o m C) -$2 bo ok c of $103 costs $3 Using these options what is the expiration pro t of a bear call spread if the w Question #33 of 33 Jason has written 150 call options (delta of 0.81) on Stock A and has taken the appropriate steps with Stock A within his investment portfolio to delta hedge his overall exposure In the following week, the price volatility of Stock A increases sharply What is the impact on the value of his investment portfolio as a result of the change in volatility? A) Unchanged B) Decrease C) Increase https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83448104/print 12/12 ... m C) -$2 bo ok c of $1 03 costs $3 Using these options what is the expiration pro t of a bear call spread if the w Question #33 of 33 Jason has written 150 call options (delta of 0.81) on Stock... https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice /qbank/ 24 038 518/quiz/ 834 48104/print 9/12 10/12/2018 Learning Management System Question #25 of 33 Which of the following statements regarding covered call options on an... Question #31 of 33 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice /qbank/ 24 038 518/quiz/ 834 48104/print 11/12 10/12/2018 Learning Management System In 30