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Derivative Markets. Summative Assessment - Multiple Choice Quiz

Time: 6 December 2022 (Wednesday), 1:00pm – 2:00pm, Online

Guidance for students

The test will have 30 multiple choice questions. Each question has only one correct answer out of the three answer choices (A, B, or C). All questions are equally weighted and there is no penalty for an incorrect answer. This is an open-book online test. You are allowed to use any type of electronic calculator as well as any software available at the University (e.g., Excel). You will have 60 minutes to complete the test from the time you start the test. The test will be available, and you can start it at 1pm or shortly after 1pm. The test will automatically close either 60 minutes after you started or at 2:15pm (whichever occurs first).

Software

Some questions will require you to do calculations. All calculations can be completed in Excel. You are also allowed to use scientific calculators and other software to perform calculations.

Topics relevant for the quiz

1. Futures and forwards

a. Differences between futures and forwards

b. Long and sort positions.

c. Pricing by arbitrage.

d. Valuations of previously entered contracts.

e. Margin accounts and marking to market.

f. Closing out positions.

g. Short and long hedges.

h. Basis risk and hedging.

i. Stack and roll.

2. Hedging with futures and forwards

a. Choice of a hedging instrument.

b. Choice of the number of contracts to minimize variance.

c. Hedging an equity portfolio.

d. Changing the beta of a portfolio.

e. Reasons for hedging a portfolio.

3. Pricing of forward contracts

a. Costs of carry.

b. Convenience yield.

c. Contango vs backwardation.

d. Pricing formula for already existing contracts.

e. Contracts on currencies.

f. Covered interest rate parity.

4. Calculations involving Bonds

a. Being able to convert interest rates from one compounding frequency to another (e.g., from continuous to semi-annual compounding and vice versa)

b. Deriving the Treasury yield curve (zero/spot rates) from existing bond prices by bootstrapping.

c. Calculating the price of bonds by cashflow discounting.

d. Calculating forward rates.

e. Calculating the par yield of different maturities.

f. Calculating the yield to maturity (YTM) of bonds.

g. Calculating the duration and convexity of bonds.

h. Calculating the G-spread and the Z-spread of corporate bonds.

i. Know the theories of term structure of interest rates.

j. Being able to determine the arbitrage free forward rate in a forward rate agreement.

k. Being able to value already existing forward rate agreements.

5. Swaps

a. Understand the comparative advantage argument.

b. Know how the fixed and floating payments are determined in an interest rate swap.

c. Being able to determine the swap fixed rate of a fixed-for-floating interest rate swap.

d. Being able to estimate the cashflows and determine the value of an already existing interest rate swap.

e. Know how to determine the payments and how to value currency swaps.

6. Options

a. Know the payoffs of call and put options.

b. Know the difference between European and American options.

c. Understand the arbitrage principle.

d. Being able to derive the upper and lower bounds of call and put options.

e. Know the put call parity.

7. Binomial trees

a. Being able to value options using a binomial tree.

b. Being able to replicate an option using the underlying asset and the risk-free bond.

c. Being able to replicate the risk-free bond using the option and its underlying asset.

d. Being able to price options by arbitrage using a binomial tree.

e. Being able to use the risk neutral valuation method for option pricing.

f. Being able to value options with a multiple step binomial tree.

g. Understand the concept of delta hedging.

h. Being able to use the Cox-Ross-Rubinstein model for matching volatility.

8. Stochastic processes and the Black-Scholes model

a. Understand the Markov, Wiener, and Ito processes.

b. Being able to identify a Geometric Brownian motion as a stochastic process.

c. Understand and be able to use the Black-Scholes option pricing formula.