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Southern College Kolej Selatan

Final Examination Semester 1 / Year 2011


Instructions to Candidates: 1) The question paper consists of 9 pages and two sections. 2) The paper is divided into two sections: Section A: ALL 20 questions are to be attempted Section B: Answer any two (2) questions. 3) Return the question paper with your answer booklet.

DERIVATIVES SECTION A This section is made up of 20 Multiple Choice Questions (MCQs). Each question is worth 3 marks. 1. Three derivatives that may be used to manage financial risk are as follows: 1. Futures contracts 2. Forward contracts 3. Swaps Which of the above may be traded on an organised exchange? A B C D 1 only 1 and 2 2 only 2 and 3

2. Which of the following is true? A As the majority of futures contracts are never taken to delivery a futures contract is not legally binding B The quantity in a futures contract is agreed between the buyer and seller C Delivery dates on futures contracts are specified by the futures exchange and not by the buyer and seller D The margin requirement is a purchase cost of a future. 3. Consider the following statements concerning currency risk hedges: 1. A currency swap may be used to hedge for a longer period than that offered by forward exchange contracts. 2. A futures contract can be customised to fit the particular needs of the client. Which one of the following combinations (true/false) concerning the above statements is correct? Statement 1 2 A True True B True False C False True D False False


DERIVATIVES 4. An investor has a call option on 10,000 ordinary shares in LHT Bhd. The option premium was 40 cents per share and the strike price is 650 cents per share. At the expiry date of the option the share price was 680 cents. Should the option be exercised and what is the net gain (loss) for the investor? Exercised No Yes Yes No Net gain (loss) (RM1,000) (RM1,000) RM3,000 RM4,000


5. Wyoming Inc, a US-based company, expects to receive 800,000 in two months time for consultancy services provided to the Spanish government. It wishes to be certain of the amount to be received and will use the derivatives market to achieve this. Which one of the following actions should the company take NOW to hedge the risk? A Buy euro futures B Buy US dollar options C Sell euro futures D Sell US dollar futures 6. Consider the following statements concerning futures contracts. 1. Futures contracts are tailor-made for the needs of the client 2. Futures contracts can be traded on a futures exchange 3. A short position on a futures contract can be closed by buying an equal number of the contracts for the same settlement date. 4. A long position on a futures contract can be closed by buying an equal number of contracts for the same settlement date. Which two of the above statements are correct? A 1 and 3 B 1 and 4 C 2 and 3 D 2 and 4


DERIVATIVES 7. Assume that a 100 share short position is opened in ordinary shares of JFY Bhd at the bid ask prices of $32.00 - $32.50. When the position is closed the bid-ask prices are $32.50 - $33.00. A commission of 0.5% is also charged. What would be the profit or loss on the short investment? A $32.50 gain B $16.25 loss C $132.50 loss D $100 gain 8. Inches Ltd wishes to fix the interest rate for a six-month period on a 20 million loan that it plans to take out in three months time. The company decides to use a forward rate agreement (FRA) to hedge the interest rate risk and a bank quotes the following rates: Bid Offer 3v6 6.60 6.56 3v9 6.65 6.61 The company can borrow at 60 basis points above LIBOR and, at the fixing date, the relevant LIBOR is 6.4%. What is the amount of interest (in percentage terms) that the company will pay to, or receive from, the bank as a result of the forward rate agreement? A B C D 020% paid to bank 025% paid to bank 035% received from bank 039% received from bank

9. The following exchange rates of sterling against the Singapore dollar have been quoted in a financial newspaper: Spot 1 = Singapore $2.3820 Three months forward 1 = Singapore $2.3540 The interest rate in Singapore is 6% per year for a three-month deposit or borrowing. What is the annual interest rate for a three-month deposit or borrowing in the UK? A 2.71% B 7.26% C 8.71% D 10.83%


DERIVATIVES 10. Polaris plc, a UK-based business, has recently exported antique furniture to a US customer and is due to be paid $500,000 in three months time. To hedge against foreign exchange risk, Polaris plc has entered into a forward contract to sell $500,000 in three months time. The relevant exchange rates are as follows: Spot 1 = $1.5535 1.5595 Three months forward 0.30 0.25 cents premium

How much will Polaris plc receive in sterling at the end of three months? A 321,130 B 321,234 C 322,373 D 322,477.

11. Villa plc is seeking to borrow 50 million for five years at a variable rate of interest and Aston plc is seeking to borrow 50 million for five years at a fixed rate of interest. The amount required by each company can be borrowed at the following interest rates: Variable rate Fixed rate Villa plc LIBOR + 12% 52% Aston plc LIBOR + 14% 60% The two companies enter into a swap arrangement and any benefits are shared equally. What is the net annual interest rate for Villa plc when LIBOR is 5%? A 5.7% B 5.8% C 5.9% D 6.1%. 12. Who from the following would be considered a speculator by entering into a futures or option contract on commodities? A B C D Farmer Lorry driver Food manufacturer None of the above


DERIVATIVES 13. A trader buys 100 European call options with a strike price of $20 and a time to maturity of one year. The cost of each option is $2. The price of the underlying asset proves to be $25 in one year. The profit or loss made by the trader is? A B C D $500 gain $500 loss $300 gain $300 loss

14. Which one of the following is not true? A Futures contracts nearly always last longer than forward contracts. B Futures contracts are standardised; forward contracts are not. C Delivery or final cash settlement usually takes place with forward contracts; the same does not apply to futures contracts. D Forward contracts usually have one specified delivery date; futures contracts often have a range of delivery dates 15. The short-term risk-free rate usually used by derivatives traders is? A B C D The Treasury rate The LIBOR rate The repo rate The commercial paper rate

16. The initial margin for a contract is $2,000 and the maintenance margin requirement is $1,500. The balance on the margin account is currently $1,400. How much will be the variation margin payment? A B C D $100 $500 $600 $1,400


DERIVATIVES 17. The initial margin for a contract is $1,500, the maintenance margin is set at 75% of initial margin, and the balance on the margin account is currently $1,800. What is the maximum amount the investor could withdraw from the margin account? A B C D $1,500 $1,125 $ 675 $ 300

18. Which of the following phrases is used to describe an option where immediate exercise results in a positive payoff? A B C D At-the-money In-the-money Near-the-money Out-of-the-money

19. You sell three December gold futures contracts when the futures price is $410 per ounce. Each contract is on 100 ounces of gold and the initial margin per contract is $2,000. The maintenance margin per contract is $1,500. During the next seven days the futures price rises slowly to $412 per ounce. What is the balance of your margin account at the end of the seven days? A B C D $6,600 $6,000 $5,400 $4,500

20. Which strike price is reflective of an out-of- the-money long call with an asset price of $34? A B C D $32 $34 $36 $38 (Total: 60 marks)


DERIVATIVES SECTION B Question 1 a) When investing in options, what are the four basic positions an investor may take up? (5 marks) b)

(b) (a)



i) What does the above diagram show? ii) Using the above diagram, state what is being shown by: (a) (b) (c), and (d)

(3 marks)

(2 marks) (2 marks) (3 marks) (2 marks)

c) Give three (3) factors that could influence the price of an option

(3 marks)

(Total: 20 marks)


DERIVATIVES Question 2 a) List three types of traders in futures, options and forward markets b) What are the three types of margin? c) Briefly describe the term cost of carry (4 marks) (4 marks) (2 marks)

d) Briefly describe five (5) factors which affect market prices and move them towards or away from full carry (10 marks) (Total 20 marks)


DERIVATIVES Question 3 Briefly describe any five (5) of the following derivative terms: a) European option b) Short sale c) Hedging d) Put option e) Cap f) In the money g) Forward contract h) A floor