INDE4412 - Sample Midterm Questions

The following are the midterm questions from the past iteration of the course. The questions are of multiple-
choice type since the campus was closed following the February earthquake and the course was delivered
online at the time of the test. While the upcoming midterm exam will be of classical type with quantitative
problem-solving questions, the content and style herein is representative of the questions that will be asked.

1. The volatility instilled into asset prices by economic, social, or political influences that exert an influence
on the business prospects of all profit-making entities is referred to as _______

A Diversifiable Risk
B Financial Risk
C Idiosyncratic Risk
D Business Risk
E Systematic Risk

2. Which of the following choices best describes the potential uses of derivatives?
A Diversification, Arbitrage, and Hedging
B Speculation, Hedging, and Arbitrage
C Diversification, Arbitrage, and Speculation
D Speculation, Hedging, and Diversification
E Hedging and Diversification

3. When compared to a futures contract with identical terms, a forward contract has an advantage in terms
of its ______ and a disadvantage in terms of its ________

A liquidity, flexibility
B risk, flexibility
C flexibility, risk
D risk, liquidity
E flexibility, liquidity

4. The party with the short position in a forward contract ______

A has the right to buy the underlying asset at a fixed price on the settlement date.
B has the right to sell the underlying asset at a fixed price until the settlement date.
C has the right to buy the underlying asset at a fixed price until the settlement date.
D is obliged to sell the underlying asset at a fixed price on the settlement date.
E is obliged to buy the underlying asset at a fixed price until the settlement date.

5. Which of the following is an example of hedging a risk exposure?

A A corn producer taking a short position in corn futures.

B An iron frame manufacturer taking a short position in iron futures.
C A stock fund manager taking a long position in index futures.
D A coffee shop taking a short position in coffee bean futures.
E A bond fund manager taking a short position in interest rate futures.
6. Which of the following is false about the basis in futures contracts?
A It is the difference between the initial futures price and the current futures price of the asset.
B It may hurt the party at the short end and benefit the party at the long end.
C It may hurt the party at the long end and benefit the party at the short end.
D It may be caused by a mismatch in settlement dates.
E It may be caused by a mismatch in the asset to be hedged and the underlying asset

7. The per unit price of a commodity is $10. If the standard size of futures contracts on this commodity is
10,000 units and the initial and maintenance margin requirements for these contracts are 10% and 5%,
respectively, how much do you need to provide as margin to initiate a single long futures position?
A $100,000
B $50,000
C $10,000
D $5,000
E $1,000

8. To hedge its product price and currency risk exposures, a Turkish mining firm that plans to sell a large
amount of silver in three months to a European client (payment to be made in Euros) should take…
A a long position in silver futures and a long position in EURTRY futures.
B a long position in silver futures and a short position in EURTRY futures.
C a short position in silver futures and a long position in EURTRY futures.
D a short position in silver futures and a short position in EURTRY futures.
E a long position in silver futures and no position in EURTRY futures.

9. What would be the optimal hedge ratio if the correlation of price changes in 0.75 for the hedged asset
and the hedge instrument, and the variance of former is four times greater than the variance of latter?
A 0.75
B 1.50
C 2.00
D 3.00
E 4.00

10. Your bond portfolio's duration will be equal to half of the duration of the futures contract you are using
at the end of the contract's settlement period. The standard size of the future contract is 1/10 of your
portfolio value. To completely eliminate interest rate risk from your portfolio, you should _____
A take a short position in 20 futures contracts.
B take a short position in 10 futures contracts.
C take a short position in 5 futures contracts.
D take a long position in 10 futures contracts.
E take a long position in 20 futures contracts.
11. Your stock portfolio is worth $2,000,000 and it is twice as risky as the market as measured by its beta.
Futures contracts on a broad market index are available at a standard size of 250 times the index. The index
is currently at 1,000. To completely eliminate market risk from your portfolio, you should …

A take a long position in 8 contracts.

B take a short position in 8 contracts.
C take a long position in 12 contracts.
D take a short position in 16 contracts.
E take a long position in 16 contracts.

12. Which of the following is FALSE about futures and forward contracts?
A Futures contracts are more liquid than forward contracts.
B Futures contracts are less risky than forward contracts.
C Futures contracts are more flexible than forward contracts.
D Futures contracts trade on organized exchanges.
E Forward contracts trade on the over-the-counter market.

13. The forward price will be higher than the futures price for assets whose prices are _____ correlated with
_____ and lower than the futures price for assets whose prices are _____ correlated with _____.
A positively, market returns, negatively, market returns
B negatively, market returns, positively, market returns
C positively, interest rates, negatively, interest rates
D negatively, interest rates, positively, interest rates
E positively, market returns, negatively, interest rates

14. If the settlement price on a USDTRY futures contract happens to be greater than its theoretical value, a
local arbitrageur can take a ______ position in the futures contract and finance an investment in ______ by
borrowing funds at _______ to generate zero-investment arbitrage profits.

A long, U.S. dollars, Turkish interest rate

B long position, Turkish lira, U.S. interest rate
C short position, U.S. dollars, Turkish interest rate
D short position, Turkish lira, U.S. interest rate
E short position, Turkish lira, Turkish interest rate

15. If the futures settlement price of an investment asset increases in the absence of a change in its spot
price, a likely explanation based on the absence of arbitrage would be that _____
A the risk premium on the asset must have increased.
B the risk premium on the asset must have declined.
C the risk-free rate of return must have increased.
D the risk-free rate of return must have declined.
E the risk premium on the asset must have turned negative.
16. The futures price of a commodity will increase if the convenience yield of holding that commodity in
the inventory ______, if the cost of storing the commodity _____, or if the risk-free rate of return _____.

A declines, increases, increases.

B increases, declines, increases.
C declines, increases, declines.
D increases, increases, declines.
E declines, declines, increases.

17. For two stocks that have equal spot prices, the futures price should be ____.

A greater for the stock with the larger expected return.

B greater for the stock that will make larger dividend payments until the settlement date.
C exactly equal to one another.
D smaller for the stock that will make larger dividend payments until the settlement date.
E smaller for the stock with lower expected return.

18. What is the nine-month forward price of a stock that is currently valued at $20 if the stock will make a
dividend payment of $2 per share six months from today and the continuously compounded annual risk-
free rate that applies to all future horizons is flat at 10%?
A 19.51
B 19.56
C 21.56
D 23.56
E 23.61

19. The current bid and ask prices for a non-dividend paying stock are $25 and $26. respectively, and the
continuously compounded annual risk-free rate is 15% for lending and 18% for borrowing over a 16-month
horizon. Which of the following prices would create an arbitrage opportunity?

A $33.00
B $32.00
C $31.50
D $31.00
E $30.00

20. What is the 7-month forward price of a bond that is currently valued at $90 if the bond will make interest
payments with a coupon rate of 5% expressed in continuously compounded annual frequency and the
continuously compounded annual risk-free rate that applies to all future horizons is flat at 12%?
A $91.69
B $93.21
C $93.75
D $95.57
E $146.91
21. Which of the following would lead to an increase in the futures price of an asset?
A The announcement of an unexpectedly high dividend with the settlement period.
B An increase in the per unit storage cost of the underlying asset.
C An increase in the convenience yield of the underlying asset.
D A decline in the interest rate that applies to the contract’s settlement horizon.
E An unexpected increase in the risk premium expected on the underlying asset.

22. Which of the following is true for a risky asset with no storage costs or convenience yield?

A The forward price today should be equal to the price expected on the settlement date.
B The forward price today should be greater than the price expected on the settlement date.
C The forward price should be less than the spot price expected on the settlement date.
D The forward price today is unrelated to the spot price expected on settlement date.
E The forward price today should be zero regardless of the price on the settlement date.

23. The spot price of a stock is $34. The settlement price observed on futures contracts with 15-month until
delivery is $39.75. If the stock is not expected to pay any cash dividends over the next 15 months, what is
the implied 15-month rate on the risk-free security in continuously compounded annual terms?

A 10.00%
B 12.50%
C 13.52%
D 15.63%
E 19.53%

24. The six-month forward rate that applies to the period between nine months from today and fifteen
months from today is observed today as 10%. If the current nine-month spot rate is 15%, what should be
the current fifteen-month spot rate? (All rates given in continuously compounded frequency.)
A 11.00%
B 13.00%
C 15.00%
D 17.00%
E 21.67%

25. What is the value today of a one-year forward rate agreement where an investor has agreed to receive a
fixed effective annual rate of 13.2% on a notional principal of 1,000,000 liras over a one-year period that
starts twelve months from today if the currently observed forward rate that applies to the same future period
is 11% in effective annual frequency and the current one-year spot rate is 10%?

A -₺22,000
B -₺20,000
C ₺0
D +₺22,000
E +₺20,000