1. An investor with a large portfo.lio of fixed-rate bonds could hedge her inter

Question

1. An investor with a large portfo.lio of fixed-rate bonds could hedge her interest rate risk by entering into a fixed for floating rate swap.

True

False

2. The price of a credit default swap (CDS) on a given bond will likely increase if the bond yield decreases.

True

False

3. The price of a Google call option with exercise price 900 expiring in June will be lower than the price of a Google call option with exercise price 900 expiring in April of the same year.

True

False

4. The Facebook call with an exercise price of 170 has a higher price than the Facebook call with an exercise price of $190 if they have the same maturity.

True

False

5. The Facebook put with an exercise price of 170 has a higher price than the Facebook put with an exercise price of $190 if they have the same maturity.

True

False

Explanation / Answer

1)TRUE

An interest rate swap allows one party to exchange its fixed cash flows for floating rate cash flows and floating rate cash flows are determined based on a spread over market benchmark like LIBOR, etc.This effectively means that interest rates move up or down with market.

2)FALSE

CDS is an insurance contract wherein credit protection buyer gets compensated by protection seller on occurance of an credit event.The decrease in bond yield might reflect the market's perception on the bond to be safe investment and hence less protection required against credit event.

3) FALSE

Call options price determined by two factors on is intrinsic value and the other is time value.

intrinsic value=Spot Price-Strike Price (since both the options have same strike price intrinsic value will be same)

time value is the value of option because of time to maturity.In simpler terms, the higher the time to maturity the higher are the chances of an option to moving into in-the-money or to be profitable.

Here since intrinsic value is same and the time to maturity is more for option maturing in June its price should be higher than call option expiring in april.

4)TRUE

call options price determined by two factors on is intrinsic value and the other is time value.

intrinsic value=Spot Price-Strike Price

time value is the value of option because of time to maturity.In simpler terms, the higher the time to maturity the higher are the chances of an option to moving into in-the-money or to be profitable.

since here maturities are same time value wiil be similar.

looking at the formulae for intrinsic value, call option with lower strike price will have higher call price which in this case is call option with 170 exercise price.

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