CFA LEVEL III PRACTICE QUESTIONS (LOS # 28) Question - #92609 In 90 days, a firm wishes to borrow $10 million for 180 days The borrowing rate is LIBOR plus 200 basis points The current LIBOR is 4% The firm 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% The call premium is $9,000 What is the effective annual rate of the loan if at expiration LIBOR = 4%? A) 0.0637 B) 0.0619 C) 0.0787 Question - #91698 In delta-hedging, gamma would be important if the price of the underlying asset: A) had a large move upward only B) remained constant C) had a large move upward or downward Question - #92358 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 of $103 costs $3 Using these options what is the cost of entering into a long bull spread on this stock? A) $1 B) $4 C) $0 Question - #93027 A manager would delta hedge a position to: A) earn extra “dividend” income on a given position B) place a floor on the position while leaving the potential for upside risk C) earn the risk-free rate Question - #92744 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 of $103 costs $3 Using these options what is the expiration profit of a bear call spread if the stock price is equal to $110? A) -$6 B) $2 C) -$2 Question - #91625 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) sell some the shares of the stock C) buy more shares of the stock Question - #92538 In 30 days, a firm wishes to borrow $15 million for 90 days The borrowing rate is LIBOR plus 250 basis points The current LIBOR is 3.8% The firm 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 effective annual rate the firm can anticipate paying? A) 0.0671 B) 0.0687 C) 0.0603 Question - #92676 What is the expiration payoff of a long straddle, with an exercise price $100, if the underlying stock price is $125? A) -$25 B) $0 C) $25 Question - #92914 Assume a stock has a value of $100 Using at the money call and put options on that stock with 0.5 years to expiration and a constant interest rate of percent, what is the necessary amount that needs to be invested in a zero coupon risk-free bond in order to synthetically replicate the underlying stock Which of the following is closest to the correct answer? A) $97.04 B) $103.00 C) $100.00 Question 10 - #92926 Linda Morgan is in a training program at a large investment bank Currently, she is spending three months at her firm's Derivatives Trading desk One of the traders, Jason Gover, CFA, asks her to compare different option trading strategies Gover would like Morgan to pay particular attention to strategy costs and their potential payoffs Morgan is not very comfortable with option models and must first 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 different scenarios to evaluate option behavior Her scenarios are illustrated in Exhibits and Note that all of the rates and yields are on a continuous compounding basis Exhibit Stock Price (S) $100 Call Strike Price (X) $100 Price $5.51 Exhibit Stock Price (S) $100 Put Strike Price (X) $100 Price $5.68 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 Part 1) Jason explains to Linda that the volatility of returns of the underlying stock has the most influence over the price of an option Following his explanation he queries Linda on how exactly does volatility affect option values If the volatility were to increase would the price of the option change? A) It depends whether the option is a call option or a put option B) Yes, the option price will increase C) Yes, the option price will decrease Part 2) 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 C) Prices to increase or decrease substantially Part 3) Linda returns her attention to the straddle using the information in Exhibits and She computes the minimum payoff of the straddle at expiration Which of the following is closest to Linda's answer? A) -$11.31 B) -$4.42 C) $0.00 Part 4) 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 points for the straddle? A) $95.58, $104.42 B) $88.81, $111.19 C) $93.11, $106.89 Question 11 - #92910 Which of the following best explains put-call parity? No arbitrage requires that using any three of the four instruments (stock, call, put, bond) the A) fourth can be synthetically replicated No arbitrage requires that only the underlying stock can be synthetically replicated using at B) the money call and put options and a zero coupon bond with a face value equal to the strike price of the options C) A stock can be replicated using any call option, put option and bond Question 12 - #92852 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 of $103 costs $3 Using these options what is the profit for a long bull spread if the stock price at expiration of the options is equal to $110? A) -$2 B) $6 C) $2 Question 13 - #92415 An investor makes the following transactions in calls on a stock: (1) buys one call with a premium of $3.50 and exercise price of $20, (2) buys one call with a premium of $1.00 and 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)? A) $21 only B) $20.50 and $24.50 C) $21 and $26 Question 14 - #93134 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 profit and loss for this position? A) maximum profit = $2.00 and maximum loss = -$3.00 B) infinite profit and maximum loss = -$4.00 C) maximum profit = $3.00 and maximum loss = -$4.00 Question 15 - #92150 A firm purchases a collar with floor rate of 3% and a cap rate of 4.4% The cap and floor have quarterly settlement and a notional principal of $10 million The maximum outflow and inflow the buyer can expect on a given settlement is (assume equal settlement periods): A) $75,000 and maximum inflow = infinite B) $110,000 and maximum inflow = $140,000 C) $75,000 and maximum inflow = $140,000 Question 16 - #93111 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 effective annual rate of the loan if at expiration LIBOR = 4.1%? A) 0.0648 B) 0.0619 C) 0.0640 Question 17 - #92847 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 five 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 way to deliver performance is to, whenever possible, combine the fund’s stock portfolio with option positions on equity Part 1) Given the following scenario: Performance to Date: Up 3% Client Objective: Stay positive Austin's scenario: Low stock price volatility between now and end of year Which is the best option strategy to meet the client's objective? A) Bull call B) Protective put C) Long butterfly Part 2) Given the following scenario: Performance to Date: Up 16% Client Objective: Earn at least 15% Austin's scenario: Good chance of large gains or large losses between now and end of year Which is the best option strategy to meet the client's objective? A) Long butterfly B) Long straddle C) Short straddle Part 3) 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) Long put options B) Short call options C) Long call options Question 18 - #92288 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 April 1, July 1, October 1, and the following January Given the indicated LIBOR rates on those dates in the table below, what is the maximum payoff and on what date did it occur on? (The days in each settlement period have been provided.) Date Dt Payoff Jan 6.15% Apr 6.15% 90 ? July 6.15% 91 ? Oct 6.10% 92 ? Jan 6.10% 92 ? $189,583 on July A) $191,666 on Oct B) $187,500 on C) April Question 19 - #92248 Which of the following is equivalent to a pay-fixed interest rate swap? A) Buying a cap and selling an interest rate collar B) Selling a cap and buying a floor C) Buying a cap and selling a floor Question 20 - #93141 The buyer of a straddle on a stock is most likely to benefit: A) if the volatility of the underlying asset’s price decreases B) if the volatility of the underlying asset’s price increases C) under all conditions because the straddle is guaranteed a risk-free rate of return Question 21 - #92662 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? A) $86.30 B) $88.50 C) $87.20 Question 22 - #91692 In delta-hedging a call position, which of the following pairs of conditions would lead to the gamma effect being the most important? The call is: A) at-the-money and has a long time until expiration B) out-of-the-money and near expiration C) at-the-money and near expiration Question 23 - #93054 All of the following are conditions that make the second-order gamma effect more important to a manager delta-hedging an option EXCEPT when the: A) delta is near zero B) option is at-the-money C) option is near expiration  ... price of $1 03 costs $3 Using these options what is the profit for a long bull spread if the stock price at expiration of the options is equal to $110? A) -$2 B) $6 C) $2 Question 13 - #92415 An... $21 only B) $20.50 and $24.50 C) $21 and $26 Question 14 - # 931 34 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) $95.58, $104.42 B) $88.81, $111.19 C) $ 93. 11, $106.89 Question 11 - # 9291 0 Which of the following best explains put-call parity? No arbitrage requires that using any three of the four instruments