8006 Exam Dumps : Exam I: Finance Theory Financial Instruments Financial Markets - 2015 Edition

The crack spread is the difference between the price of refined products and crude oil. An option on the crack spread can protect a refiner from both a fall in the price of its output and a rise in the price of its inputs. Calendar spreads are options with different maturities. Crude oil futures and swaps only protect against an adverse change in the price of crude, and not that of refined products. Choice 'b' is the correct answer.

A portfolio loses its delta neutrality if the delta of the portfolio changes but the underlying hedge is unchanged. The portfolio that will require the most rebalancing will be one whose delta changes by larger amounts in response to a given change in the price of the underlying. The sensitivity of the changes in delta in response to changes in the price of the underlying is measured by gamma. The higher the gamma, the more the portfolio will go out of delta neutrality given a change in the price of the underlying. Therefore Choice 'b' is the correct answer.

A portfolio with a low gamma will maintain its delta over a larger price range for the underlying, and is therefore likely to require less frequent rebalancing. The absolute level of the delta itself does not matter, what matters is the gamma. Vega is irrelevant to the delta hedging decision. Therefore the other choices are incorrect.

The put-call parity can be expressed as:

Call – Put = Spot – PV of exercise price

Note that a negative sign above means a short position. The 'term PV of exercise price' is the same as a bank deposit placed today equivalent to the PV of the exercise price so that we will have the cash flow on the exercise date to exercise the option.

Therefore only Choice 'd' is the correct answer as rearranging the above gives us Buying a call + Bank Deposit = Buying the stock + Buying a put.

Choice 'd' is therefore the correct answer.