Option/Swap Practice Problems:

1. If a trader simultaneously purchases a call and writes a put at the same strike price and same maturity, the trader has created a ______.

A. bull spread B. synthetic long forward C. synthetic short forward D. bear spread

2. Modern day swap contracts evolved from prior contracting agreements commonly called ______.

A. parallel loans B. perpendicular loans C. notional swaps D. contango arrangements

3. A trader has written a call option at strike price of $45. At contract expiration the underlying asset price is $52. The trader’s payoff from this position is ______.

A. $52 B. $45 C. $7 D. -$7

4. The swap rate or swap price is always a weighted average of ______on the same asset over the same time horizon.

A. call option prices B. put option prices C. forward prices D. spot prices

5. A ______option can come into existence when the underlying stock price touches or crosses a specific dollar value.

A. knock-in barrier B. knock-out barrier C. gap D. exchange

6. The payoff and profit of a written put option contract ______as the spot price at expiration of the underlying asset increases above the strike price, all else constant.

A. increases B. decreases C. does not change D. changes randomly

7. A firm is choosing to compensate their management team with options that payoff only if the stock of their firm increases more than the S&P500 index. The firm is most likely to select ______options to provide this form of compensation.

A. Asian B. Barrier C. Compound D. Exchange

8. A key assumption common to both the binomial and Black Scholes methods of option pricing is that the ______.

A. probability of an increase in underlying stock price equals the probability of a decrease in the underlying stock price B. existence of arbitrage opportunities will be widely available C. volatility of the underlying asset is constant during the life of the option D. all human traders and market participants are risk-averse

9. A geometric average price Asian call option will be priced ______than an otherwise similar call option, and the Asian option can be priced using ______methods.

A. more; Black-Scholes B. less; binomial C. less; Black-Scholes D. more; binomial

10. A financial reporter recently broadcast that: “The current price of oil is $99.60 per barrel, yet the 5-year swap price of oil is $91.40 per barrel. This implies that it is certainly much cheaper to buy oil through the swap market than through the spot or forward markets.” What would be a reasonable argument noting that he is incorrect or misleading?

11. Suppose you simultaneously buy a 1-year call option with strike=$45 on XXM stock at a price of $4.52, and write a 1-year call option with strike=$55 on XXM stock at a price of $2.24 What is the smallest payoff and profit you can earn on this position in 1-year if the interest rate is 3%?

12. Prices for 1-year options on an asset with current spot price of $90, valued with a continuously compounded per annum interest rate of 4%.

strike call value put value 85 13.16 4.83 90 10.46 6.93 95 8.19 9.46 100 6.33 12.40 105 4.83 15.71

A. Suppose you sold a put option at a strike of $100 and simultaneously bought a put option at a strike of $90. What will be the payoff and profit of this combined position if the spot price at expiration is $92? B. Suppose you bought a call and bought a put, both at strike=$95. At option expiration, what underlying price ranges will your profit be positive and negative? C. Suppose you bought the underlying stock at the current spot price of $90, and you simultaneously bought a put option at strike = $85 and sold a call option at strike=$105. What is the greatest profit and loss you can take on this combined stock+option position?

13. Givens: S=71.08, K=75, u=1.04, d=0.96, r=0.05, and t=0.5 per play.

A. Using a 3-period binomial model, what is the value of a call option (total life of the option is 1.5 years)?

B. What is the largest payoff to a geometric average price asian call option at expiration if the life of the option is 1.5 years? (No need to calculate the value of the Asian option).

14. GGI is a stock whose value mimics the Global Gold Index, but pays no dividends to the shareholders. The current spot price of stock GGI is $80.85 per share, the current continuously compounded per annum interest rate is 4% and standard deviation is 30%. What is the current value of a 1-year put and call options on GGI with strike=$85/share?

S X r t sigma d1 d2 N(d1) N(d2) 80.85 85 0.04 1 0.3 0.1164 -0.1835 0.5464 0.4272

15. With respect to GGI put option in question #14 above, suppose a market-maker wrote a put option for a client. How could the market maker hedge the position using GGI stock overnight? Suppose the overnight change in the stock price is -$0.32. What is the overnight profit/loss for GGI on the combined put+option position?