1. In a "Future Contract", the obligation to buy or sell the asset at a specified price on a specified date is:
Binding only if the price moves in a favorable direction.
Optional for both parties.
Optional for the buyer but binding for the seller.
Binding on both the buyer and the seller.
Explanation:
Unlike "Options" where the buyer has the right but not the obligation, "Futures" impose a binding obligation on both parties to fulfill the contract on the maturity date.
2. A "Put Option" gives the buyer the right, but not the obligation, to:
Buy an underlying asset at a specified price.
Sell an underlying asset at a specified price.
Swap interest rates.
Receive a dividend.
Explanation:
A Put Option allows the holder to sell the asset at the strike price. They will exercise this option if the market price falls below the strike price, profiting from the decline.
3. Which of the following is a key difference between a "Forward Contract" and a "Futures Contract"?
Forwards are traded on exchanges; Futures are OTC.
Forwards are marked-to-market daily; Futures are settled only at maturity.
Futures carry high counterparty risk; Forwards do not.
Futures are standardized; Forwards are customized.
Explanation:
Futures are standardized contracts traded on exchanges with a central counterparty (clearinghouse), virtually eliminating counterparty risk. Forwards are customized, Over-the-Counter (OTC) contracts between two parties, carrying higher counterparty risk.
4. In an "Interest Rate Swap" (IRS), the principal amount is:
Exchanged only if one party defaults.
Exchanged only at the beginning.
Exchanged at the beginning and end of the contract.
Not exchanged; it is a notional amount used to calculate interest payments.
Explanation:
In an Interest Rate Swap (IRS), the principal is "Notional". It is never exchanged. Only the interest payment streams (e.g., fixed vs. floating) based on this notional principal are exchanged between the counterparties.
5. Other factors remaining constant, an increase in the "Volatility" of the underlying asset price will generally cause the price (premium) of an Option to:
Increase.
Remain unchanged.
Become zero.
Decrease.
Explanation:
Higher volatility increases the probability that the option will end up "In the Money" (profitable). Therefore, sellers demand a higher premium for taking on this higher risk. This applies to both Call and Put options.
6. A "Credit Default Swap" (CDS) acts primarily as:
An equity derivative.
A tool to lower interest rates.
A mechanism to swap currencies.
A form of insurance against the default of a borrower/debt instrument.
Explanation:
In a CDS, the buyer pays a premium to the seller. In return, the seller agrees to compensate the buyer if the underlying debt issuer defaults. It transfers credit risk.
7. A "Forward Rate Agreement" (FRA) is primarily used to hedge against:
Operational Risk
Credit Risk
Foreign Exchange Risk
Interest Rate Risk
Explanation:
An FRA is a forward contract on interest rates. It allows a borrower or lender to lock in an interest rate for a future period, thereby protecting themselves against adverse movements in interest rates.
8. In Options trading, the "Delta" measures:
Sensitivity to interest rate changes.
Sensitivity of the option price to changes in volatility.
Time decay of the option price.
Sensitivity of the option price to changes in the price of the underlying asset.
Explanation:
Delta represents the rate of change of the option premium with respect to the change in the price of the underlying asset.
9. The "Put-Call Parity" relationship applies to:
European Options
American Options
Futures Contracts
Swaps
Explanation:
Put-Call Parity defines the relationship between the price of a European Call option and a European Put option with the same strike price and expiration. It does not strictly hold for American options due to early exercise possibilities.
10. The "Initial Margin" in a Futures Contract is collected by the clearinghouse to:
Pay tax to the government.
Generate profit for the exchange.
Cover potential losses from daily price movements (Credit Risk mitigation).
Pay commission to brokers.
Explanation:
Initial Margin acts as a security deposit (good faith deposit) to ensure that parties fulfill their obligations, covering the maximum probable loss in a single day.