Risk Latte - Derivatives Quiz # 1

1) A fund manager is heavily invested in equities and believes that in the medium to long term such a equity-heavy asset allocation makes sense; however, he is afraid of the possibility of a market crash in the near term. As an insurance he would therefore be :

a) Buying lots of at the money puts on the index;
b) Buying lots of out of the money puts on the index;
c) Selling lots of out of the money calls on the index;
d) Selling lots of at the money calls on the index;

2) A forward start option (assuming constant vol) is difficult to hedge because:

a) The option is always at the money spot when it comes to life
b) The option is always in the money spot when it comes to life
c) The option is always out of the money spot when it comes to life
d) None of the above

3) A Ladder option with only one ladder can be decomposed into a portfolio of:

a) A knock out option and a knock in option;
b) Two knock out options and a knock in option;
c) A knock out option, a knock in option and a knock in digital option;
d) A knock out digital option and two knock in digital options;

4) A firm enters a plain vanilla currency swap, whereby it receives fixed rate Yen and pays USD LIBOR; the firm also enters a USD plain vanilla interest rate swap where it pays fixed and receives floating USD LIBOR. In this way the firm has combined the two swaps to create a:

a) A fixed for floating currency swap with a multiplier
b) A fixed for floating interest swap with a multiplier
c) A fixed for fixed currency swap
d) A floating for floating currency swap;

5) The above swap is called a:

a) Macro swap;
b) Differential swap;
c) Flavoured swap;
d) Circus swap;

6) The equity (as a function of interest rates) of a life insurance company resembles:

a) A long straddle;
b) A long butterfly;
c) A short straddle;
d) None of the above;

7) The policy holders of a life insurance company are:

a) Long a call option;
b) Short a call option;
c) Long a put option;
d) Short a put option;

8) In the above problem (problem # 7) the strike is:

a) Insurance company's final cash flow;
b) Insurance company's total assets;
c) Insurance company's long term debt;
d) Insurance company's losses (claims);

9) The credit card division of a commercial bank is trying to model the risk of fraud cases involving credit cards of its bank for a ten year period. It would most likely use:

a) Stochastic Markov chain analysis;
b) Operational Value at Risk analysis;
c) Extreme Value theory (EVT) analysis;
d) Spectral analysis with a Kalman filter;

10) A risk manager is running a Monte Carlo simulation to measure the risk arising from extreme events happening in the bank, such as catastrophe, fraud or systems failure. He would most likely use a:

a) A gamma distribution;
b) A Weibull distribution;
c) A Poisson distribution;
d) A Cauchy distribution;

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