11. Which of the following is true about stress testing?

A. It is used to evaluate the potential impact on portfolio values of unlikely, although plausible, events or movements in a set of financial variables.

B. It is a risk-management tool that directly compares predicted results to observed actual results. Predicted values are also compared with historical data.

C. Both A and B above are true

D. None of the above are true

12. You have entered into a currency swap in which you receive 4% per annum in yen and pay 6% per annum in dollars once a year. The principals in the two currencies are 100 million yen and 10 million dollar. The swap will last for another two years, and the current exchange rate is 115 yen for 1 dollar. Suppose that the annualized spot rates (with continuous compounding) are given as in the table below, what is the value of the swap to you in million dollars?

A. -1.270.

B. -0.447.

C. 0.447.

D. 1.270.

13. The dividend yield of an asset is 10% per annum. What is the delta of a long forward contract on the asset with 6-month to maturity?

A. 0.95

B. 1.00

C. 1.05

D. Can not be determined without further information.

14. Two comparable (same credit rating, maturity, liquidity, rate) U.S. callable corporate bonds are being analyzed by you. The following data is available for the nominal spread over the U.S. Treasury yield curve and Z spread and option adjusted spread relative to the U.S. Treasury spot curve 

The nominal spread on the comparable option free bonds in the market is 100 basis points. Which of the following statements is correct?

A. X is undervalued. 

B. Y is undervalued.

C. X and Y both are undervalued. 

D. Neither X nor Y is undervalued.

15. Which one of the following statements on hedging exotic options is incorrect?

A. Asian options are more difficult to hedge because they have more extreme gamma towards expiration.

B. Barrier options are more difficult to hedge because delta is liable to be discontinuous at the barrier.

C. The approach of static options replication is to find a portfolio of regular options whose value matches the value of the exotic option on some boundary.

D. The portfolio constructed using static option replication must be unwound when any part of the boundary is reached.

11. Which of the following is true about stress testing?

A. It is used to evaluate the potential impact on portfolio values of unlikely, although plausible, events or movements in a set of financial variables.

B. It is a risk-management tool that directly compares predicted results to observed actual results. Predicted values are also compared with historical data.

C. Both A and B above are true

D. None of the above are true

Correct answer is A

A is correct as it describes 'stress testing'.fficeffice" />

B is incorrect as it is not about 'stress testing'.

C is not correct, as B is incorrect.

D is incorrect as A is correct.

12. You have entered into a currency swap in which you receive 4% per annum in yen and pay 6% per annum in dollars once a year. The principals in the two currencies are 100 million yen and 10 million dollar. The swap will last for another two years, and the current exchange rate is 115 yen for 1 dollar. Suppose that the annualized spot rates (with continuous compounding) are given as in the table below, what is the value of the swap to you in million dollars?

A. -1.270.

B. -0.447.

C. 0.447.

D. 1.270.

Correct answer is A

Calculation

(1)    The value BY of yen-denominated bond:

BD = 40 e-(2%)1 + 1040 e -(2.5%) 2 = 1028.487

(2)    The value BD of dollar-denominated bond:

BD = 0.6 e-(4.5%) 1 + 10.6 e -(4.75%) 2 = 10.213

(3)    The value CY of yen-denominated coupons:

CY = 40 e -(2%) 1 + 40 e -(2.5%) 2 = 77.257

(4)    The value CD of dollar-denominated coupons:

CD = 0.6 e -(4.5%) 1  + 0.6 e -(4.75%) 2 = 1.119

A is correct. Value = BY / 115 ? BD = 1028.487/115 ? 10.213 = -1.270.

B is incorrect. It's derived by missing to account for the principals:

77.257/115 ? 1.119 = -0.447

C is incorrect. It mixes up the values of paying vs. receiving.

D is incorrect. It mixes up the values of paying vs. receiving and does not account for the principals.

Reference: John Hull, Options, Futures, and Other Derivatives, 6th ed. (ffice:smarttags" />New York: Prentice Hall, 2006), Chapter 7.

13. The dividend yield of an asset is 10% per annum. What is the delta of a long forward contract on the asset with 6-month to maturity?

A. 0.95

B. 1.00

C. 1.05

D. Can not be determined without further information.

Correct answer is A

Calculation:

The value of a long forward contract

? = S0 e -qT ? K e -rT,

where S0 , q, T, K, and r are the asset price, dividend yield, time to maturity,

delivery price, and risk-free rate, respectively.

It follows that the delta of the forward = e -qT.

Given q = 10% and T = 1/2, we have delta =e -10% / 2 = 0.95

A is correct, as shown from the calculations above.

B is incorrect, derived erroneously by not accounting for the dividend.

C is incorrect, derived erroneously by mixing up the sign of exponential.

D is incorrect. It can be determined with the given information as shown above.

Reference: John Hull, Options, Futures, and Other Derivatives, 6th ed. (New York: Prentice Hall, 2006), Chapter 15.

14. Two comparable (same credit rating, maturity, liquidity, rate) U.S. callable corporate bonds are being analyzed by you. The following data is available for the nominal spread over the U.S. Treasury yield curve and Z spread and option adjusted spread relative to the U.S. Treasury spot curve 

The nominal spread on the comparable option free bonds in the market is 100 basis points. Which of the following statements is correct?

A. X is undervalued. 

B. Y is undervalued.

C. X and Y both are undervalued. 

D. Neither X nor Y is undervalued.

Correct answer is B

A is incorrect. The OAS of X bond is equal to the comparable option free bond while the option cost is also higher than the Y bond.

B is correct. The OAS of the bonds should be compared with the nominal spread on comparable option free bonds. Bonds with higher OAS and low option cost are undervalued and should be bought. 

C is incorrect. X is not undervalued with a comparable OAS to the nominal spread of the option free bonds.

D is incorrect. Y is undervalued and should be bought.

Reference: Tuckman, Chapter 21

15. Which one of the following statements on hedging exotic options is incorrect?

A. Asian options are more difficult to hedge because they have more extreme gamma towards expiration.

B. Barrier options are more difficult to hedge because delta is liable to be discontinuous at the barrier.

C. The approach of static options replication is to find a portfolio of regular options whose value matches the value of the exotic option on some boundary.

D. The portfolio constructed using static option replication must be unwound when any part of the boundary is reached.

Correct answer is A

A is correct. Asian options are easier to hedge because the payoff becomes progressively more certain as we approach maturity.

B is incorrect. Barrier options are more difficult to hedge because delta is liable to be discontinuous at the barrier.

C is incorrect. The approach of static options replication is to find a portfolio of regular options whose value matches the value of the exotic option on some boundary.

D is incorrect. The portfolio constructed using static option replication must be unwound when any part of the boundary is reached.

Reference: John Hull, Options, Futures, and Other Derivatives, 6th ed. (New York: Prentice Hall, 2006), Chapter 22 Exotic Options.