INTRODUCTION TO DERIVATIVES AND RISK
MANAGEMENT 10TH EDITION EXAM
QUESTIONS AND SOLUTIONS GRADED A+
◉ Purpose of Derivatives.
Answer: To transfer or reallocate risk between participants; hedgers
use derivatives to protect against losses, while speculators use them
to profit from price movements.
◉ Leverage.
Answer: Small initial margin → large exposure to price changes.
◉ Forward Contract.
Answer: Customized agreement to buy/sell at a future date and
price; over-the-counter (OTC) and subject to counterparty/default
risk.
◉ Futures Contract.
Answer: Standardized forward contract traded on exchanges (e.g.,
CME, CBOT) that requires initial margin deposit and daily marking-
to-market.
◉ Long Position.
,Answer: Buying futures; profits if prices rise.
◉ Short Position.
Answer: Selling futures; profits if prices fall.
◉ Call Option.
Answer: Gives the holder the right to buy an underlying asset at a set
strike price before or at expiration; profits when price ↑.
◉ Put Option.
Answer: Gives the holder the right to sell an underlying asset at a set
strike price before or at expiration; profits when price ↓.
◉ American Options.
Answer: Options that are exercisable anytime.
◉ European Options.
Answer: Options that are exercisable only at maturity.
◉ Intrinsic Value (IV).
Answer: Immediate profit if exercised.
, ◉ Time Value.
Answer: Chance the option becomes profitable before expiration.
◉ Option Premium.
Answer: Price of an option, calculated as Intrinsic Value + Time
Value.
◉ Interest Rate Swap.
Answer: Agreement to exchange fixed-rate for floating-rate
payments to manage exposure to interest rate movements.
◉ Currency Swap.
Answer: Agreement to exchange cash flows in different currencies to
hedge foreign exchange risk.
◉ Credit Default Swap (CDS).
Answer: Buyer pays periodic premiums to seller for protection
against default; if default occurs, seller pays par value of the
loan/bond.
◉ Cap.
Answer: Call on interest rates that hedges against rising rates; seller
pays difference when rates > cap rate.
MANAGEMENT 10TH EDITION EXAM
QUESTIONS AND SOLUTIONS GRADED A+
◉ Purpose of Derivatives.
Answer: To transfer or reallocate risk between participants; hedgers
use derivatives to protect against losses, while speculators use them
to profit from price movements.
◉ Leverage.
Answer: Small initial margin → large exposure to price changes.
◉ Forward Contract.
Answer: Customized agreement to buy/sell at a future date and
price; over-the-counter (OTC) and subject to counterparty/default
risk.
◉ Futures Contract.
Answer: Standardized forward contract traded on exchanges (e.g.,
CME, CBOT) that requires initial margin deposit and daily marking-
to-market.
◉ Long Position.
,Answer: Buying futures; profits if prices rise.
◉ Short Position.
Answer: Selling futures; profits if prices fall.
◉ Call Option.
Answer: Gives the holder the right to buy an underlying asset at a set
strike price before or at expiration; profits when price ↑.
◉ Put Option.
Answer: Gives the holder the right to sell an underlying asset at a set
strike price before or at expiration; profits when price ↓.
◉ American Options.
Answer: Options that are exercisable anytime.
◉ European Options.
Answer: Options that are exercisable only at maturity.
◉ Intrinsic Value (IV).
Answer: Immediate profit if exercised.
, ◉ Time Value.
Answer: Chance the option becomes profitable before expiration.
◉ Option Premium.
Answer: Price of an option, calculated as Intrinsic Value + Time
Value.
◉ Interest Rate Swap.
Answer: Agreement to exchange fixed-rate for floating-rate
payments to manage exposure to interest rate movements.
◉ Currency Swap.
Answer: Agreement to exchange cash flows in different currencies to
hedge foreign exchange risk.
◉ Credit Default Swap (CDS).
Answer: Buyer pays periodic premiums to seller for protection
against default; if default occurs, seller pays par value of the
loan/bond.
◉ Cap.
Answer: Call on interest rates that hedges against rising rates; seller
pays difference when rates > cap rate.
