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Hull: Options, Futures, and Other Derivatives, Ninth Edition Chapter 17: Options on Stock Indices and Currencies Multiple Choice Test Bank: Questions with Answers 1. Which of the following describes what a company should do to create a range forward contract in order to hedge foreign currency that will be received? A. Buy a put and sell a call on the currency with the strike price of the put higher than that of the call B. Buy a put and sell a call on the currency with the strike price of the pu
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  Hull: Options, Futures, and Other Derivatives, Ninth EditionChapter 17: Options on Stock Indices and Currencies Multiple Choice est !ank: uestions #ith $ns#ers 1.Which of the following describes what a company should do to create a range forward contract in order to hedge foreign currency that will be received?A.Buy a put and sell a call on the currency with the strike price of the puthigher than that of the callB.Buy a put and sell a call on the currency with the strike price of the putlower than that of the callC.Buy a call and sell a put on the currency with the strike price of the puthigher than that of the callD.Buy a call and sell a put on the currency with the strike price of the putlower than that of the call Answer B !he company wants to ensure that the price received for the foreign currency will be between  K  1 and  K  . #t does this by buying a put option withstrike price  K  1  and selling a call option with strike price  K  . .Which of the following describes what a company should do to create a range forward contract in order to hedge foreign currency that will be paid?A.Buy a put and sell a call on the currency with the strike price of the puthigher than that of the callB.Buy a put and sell a call on the currency with the strike price of the putlower than that of the callC.Buy a call and sell a put on the currency with the strike price of the puthigher than that of the callD.Buy a call and sell a put on the currency with the strike price of the putlower than that of the call Answer D !he company wants to ensure that the price paid for the foreign currency will be between  K  1 and  K  . #t does this by selling a put option with strike price  K  1  and buying a call option with strike price  K  .$.What should the continuous dividend yield be replaced by when options on an e%change rate are valued using the formula for an option on a stock paying a continuous dividend yield?A.!he domestic risk&free rateB.!he foreign risk&free rateC.!he foreign risk&free rate minus the domestic risk&free rateD.'one of the aboveAnswer B   !he continuous dividend yield( q ( should be replaced by the foreign risk rate( r   f  .).*uppose that the domestic risk free rate is r and dividend yield on an inde% is +. ,ow should the put&call parity formula for options on a non&dividend&payingstock be changed to provide a put&call parity formula for options on a stock inde%? Assume the options last ! years.A.!he stock price is replaced by the value of the inde% multiplied by e%p-+!B.!he stock price is replaced by the value of the inde% multiplied by e%p-r!C.!he stock price is replaced by the value of the inde% multiplied by e%p-&+!D.!he stock price is replaced by the value of the inde% multiplied by e%p-r!Answer C S  /  is replaced by S  / e -qT  .0.A portfolio manager in charge of a portfolio worth 1/ million is concerned that stock prices might decline rapidly during the ne%t si% months and would like to use put options on an inde% to provide protection against the portfolio falling below 2.0 million. !he inde% is currently standing at 0// and each contract is on 1// times the inde%. What position is re+uired if the portfolio has a beta of 1?A.*hort // contractsB.3ong // contractsC.*hort 1// contractsD.3ong 1// contracts Answer A !he number of contracts re+uired is 1/(///(///4-0//51//6 //. A short position is re+uired because the contracts must provide a positive payo7 when the market declines.8.A portfolio manager in charge of a portfolio worth 1/ million is concerned that the market might decline rapidly during the ne%t si% months and would like to use put options on an inde% to provide protection against the portfolio falling below 2.0 million. !he inde% is currently standing at 0// and each contract is on 1// times the inde%. What should the strike price of options on the inde% be the portfolio has a beta of 1?A.) 0B.)0/C.)90D.0// Answer C  When the portfolio declines in value by 0:( the inde% can be e%pected to decline in value by 0:. !he strike price should therefore be /.2050//6)90.9.A portfolio manager in charge of a portfolio worth 1/ million is concerned that the market might decline rapidly during the ne%t si% months and would like to use put options on an inde% to provide protection against the portfolio falling below 2.0 million. !he inde% is currently standing at 0// and each contract is on 1// times the inde%. What position is re+uired if the portfolio has a beta of /.0?A.*hort // contractsB.3ong // contractsC.*hort 1// contractsD.3ong 1// contracts Answer C  !he number of contracts re+uired is /.051/(///(///4-0//51//61//. A short position is re+uired because the contracts must provide a positive payo7 when the market declines.;.A portfolio manager in charge of a portfolio worth 1/ million is concerned that the market might decline rapidly during the ne%t si% months and would like to use put options on an inde% to provide protection against the portfolio falling below 2.0 million. !he inde% is currently standing at 0// and each contract is on 1// times the inde%. What should the strike price of options on the inde% be the portfolio has a beta of /.0? Assume that the risk&free rate is 1/: per annum and there are no dividends.A.)//B.)1/C.) /D.) 0 Answer D  !he risk&free rate per si% months is 0:. When the portfolio declines by 0: its return is per si% months is 1/: below the risk&free rate. !he return on the inde% is therefore /: below the risk&free rate. #ts return is therefore <10:. !he portfolio therefore declines to 0//5/.;0 6 ) 0. 2.=or a >uropean put option on an inde%( the inde% level is 1(///( the strike price is 1/0/( the time to maturity is si% months( the risk&free rate is ): per annum( and the dividend yield on the inde% is : per annum. ,ow low can theoption price be without there being an arbitrage opportunity?A.0/.//B.)$.11  C. 2. 1 D.$2.18 Answer DA lower bound for the put option price is  Ke -rT  -S  / e -qT  . #n this case(  K  61/0/( S  / 61///( T  6/.0( r  6/./) and q 6/./ . !he lower bound is therefore 1/0/e &/./)5/.0 <1///e &/./ 5/.0 6$2.18. !he put price cannot fall below this without there being an arbitrage opportunity.1/.=or a >uropean call option on a currency( the e%change rate is 1.////( the strike price is /.21//( the time to maturity is one year( the domestic risk&free rate is 0: per annum( and the foreign risk&free rate is $: per annum. ,ow lowcan the option price be without there being an arbitrage opportunity?A./.1/);B././2//C./.1$))D./.1 11 Answer AA lower bound for the call option price is rT T r   KeeS   f    −− − 0   . #n this case(  K  6/.21//( S  / 61.////( T 6 1( r  6/./0 and r   f 6/./$. !he lower bound is therefore 1.//e &/./$51 </.21e &/./051 6/.1/);. !he call price cannot fall below this without there being an arbitrage opportunity.11.#nde% put options are used to provide protection against the value of the portfolio falling below a certain level. Which of the following is true as the betaof the portfolio increases?A.!he cost of hedging increasesB.!he re+uired options have a higher strike priceC.!he number of options re+uired increasesD.All of the above Answer DAs beta increases A( B( and C are all true. 1 .Which of the following is '! true about a range forward contract?A.#t ensures that the e%change rate for a future transaction will lie between two valuesB.#t can be structured so that it costs nothing to set upC.#t re+uires a forward contract as well as two options
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