NISM Series VIII: Equity Derivatives Mock Test (Set 5) /50 NISM Series VIII – Equity Derivatives Mock Test (Set 5) 1 / 50 1. In the case of futures contract, the profits or losses are received / paid only on maturity – State whether True or False? a) True b) False Explanation:In futures contract, the profits / losses are received / paid as and when the contract is closed (squared up) by the trader or on maturity, which ever is earlier. 2 / 50 2. If there are three series of one, two and three months futures open at a given point of time, how many calendar spread possibilities arise? a) 4 b) 2 c) 3 d) 1 Explanation:The three calendar spreads can be between months 1 and 2, 2 and 3 and 1 and 3. 3 / 50 3. ______ is not a type of financial product traded in the derivatives market. a) Options b) Futures c) Preference Share d) Swaps Explanation:Futures, Forwards, Options, Swaps etc. are all products in the derivative market.Preference share is not a derivative product. 4 / 50 4. True or False: You can sell a stock option for a specific stock even if you don’t own the underlying stock. a) True b) False Explanation:Although Futures and Options were introduced as hedgeing tools but there is no pre-condition that one has to own the stock to trade in futures and options.One can easily buy and sell options without owning the underlying stock. 5 / 50 5. True or False: Over-the-counter options are always standardized. a) False b) True Explanation:Over the Counter options are made as per the needs of the trading parties – so they are customised.Future options are standardised as per the rules of stock exchange. 6 / 50 6. Calendar spreads carry basis risk and no market risk; therefore, reduced margins are charged. a) Higher b) Very high c) Lower d) NIL Explanation:Calendar spreads carry only basis risk and no market risk – hence lower margins are adequate.That is why margin on calendar spread transaction in index futures is lower than the sum of regular margin on two independent legs of spread transaction.(Basis risk arises when the price of a futures contract does not have a predictable relationship with the spot price, which is very rare.Market risk is the risk that the price of a stock etc. will increase or decrease due to changes in market factors) 7 / 50 7. True or False: A long or short position in a futures contract can be closed by initiating a reverse trade. a) False b) True Explanation:A closing transaction is one that reduces or eliminates an existing position by an appropriate offsetting purchase or sale. This is also known as “squaring off” your position.A client is said to be closed a position if he sells a contract which he had bought before or he buys a contract which he had sold earlier. 8 / 50 8. True or False: When it is stated that there is cash settlement of an index futures contract, it means that the contract is settled in cash with no delivery of the underlying. a) True b) False Explanation:Index futures are always cash settled.Individual securities can be cash settled or by delivery. 9 / 50 9. Which of these grievances against a trading member can an exchange address for resolution? a) Claims for expenses incurred for taking up the matter with the ISC b) Claims for opportunity loss for the particular disputed trade c) Losses for transaction which are not within the framework of exchange d) Excess brokerage charged by a broker Explanation:Complaints against trading members on account of the following can be taken by an Exchange for redressal :– Non-receipt of funds / securities– Non- receipt of documents such as member client agreement, contract notes, settlement of accounts, order trade log etc.– Non-Receipt of Funds / Securities kept as margin– Trades executed without adequate margins– Delay /non – receipt of funds– Squaring up of positions without consent– Unauthorized transaction in the account– Excess Brokerage charged by Trading Member– Unauthorized transfer of funds from commodities account to other accounts etc. 10 / 50 10. In exercising a Put option on a stock, the option holder acquires from the option writer the right to sell the stock. a) a strangle position in the underlying stock b) a short position in the underlying stock c) a long position in the underlying stock d) a butterfly position in the underlying stock Explanation:The buyer / holder of a Put option is of the view that price of the underlying will fall.He thus acquires a short position on exercise. 11 / 50 11. When a person enters into a forward contract, the potential loss on the position is unlimited. a) unknown b) known Explanation:When a person enters into a forward or a futures contract, his profits or losses are uncertain as it depends on the movement of prices.(Only in the case of buying an option, the losses are fixed ie. premium paid) 12 / 50 12. If you sold a call option on a share with a strike price of Rs 250 and received a premium of Rs 16 from the option buyer, the maximum potential loss on this position is unlimited. a) Zero b) Rs. 234 c) Unlimited d) Rs. 250 Explanation:When you sell a Call Option, you believe that the price will fall.If the price rises, you start making losses. Prices can rise theoretically to unlimited levels, so the losses can be unlimited. 13 / 50 13. Clearing Member Mr. Prabhu focuses mainly on proprietary trading, while Clearing Member Mr. Mehta does not do any proprietary trades and does trades only for clients. If both have deposited the same amount of assets with Clearing Corporation, which of the foll statement is true? a) Mr. Prabhu enjoys a lower exposure limit than Mr. Mehta b) Both of them enjoy the same exposure limits c) Mr. Prabhu enjoys a higher exposure limit than Mr. Mehta Explanation:Proprietary positions are calculated on net basis (buy less sell) for each contract and that of clients are arrived at by summing together net positions of each individual client.Margins are required to be paid up-front on gross basis at individual client level for client positions and on net basis for proprietary positions.Therefore, Mr. Prabhu who does only proprietary trades will get higher exposure as his positions are calculated on net basis. 14 / 50 14. A tick is __________ . a) Minimum price difference between two buy quotes b) Both 1 and 2 c) Minimum price difference between two sell quotes d) None of the above Explanation:Tick Size is the minimum move allowed in the price quotations.(Eg – Suppose the tick size 5 paise. A buyer has entered an order to buy at Rs 100. If some other buyer wants to enter a buying quote at a higher price, he can quote the price as Rs 100.05 and not 100.01) 15 / 50 15. A stock index like Nifty ______ . a) is a basket of stocks b) Both 1 and 2 c) can be easily manipulated d) None of the above Explanation:Stock Index like Nifty and Sensex consists of a basket of stocks and so its very difficult / almost impossible to manipulate the index. 16 / 50 16. Usually, if everything else stays the same, American options are worth less than European options. Is this statement true or false? a) False b) True c) The information given is inadequate d) The information given is inadequate Explanation:American options are generally valued higher than European options.American options allow option holders to exercise the option at any time prior its maturity date, thus increasing the value of the option to the holder relative to European options, which can only be exercised at maturity. 17 / 50 17. If a Trading Member on a derivatives exchange doesn’t have Clearing rights, is this statement true or false? a) True b) False Explanation:Trading Member: They are members of Stock Exchanges. They can trade either on behalf of their clients oron their own account.Trading cum Clearing Member: A Clearing Member (CM) who is also a Trading Member (TM) of the exchange. Such CMs may clear and settle their own proprietary trades, their clients’ trades as well as trades of other TM’s & Custodial Participants 18 / 50 18. The exercise date and expiration date of a European option are __________. a) May be same b) Always the same c) Always on the 28th of the expiry month d) always different Explanation:An European option can only be exercised on the expiry date/day of the contract. So in an European option the exercise date and expiration date is always the same.An American option can be exercised on any day. 19 / 50 19. Mr. A sold a put option with a strike price of Rs. 300 on ABC stock, receiving a premium of Rs. 20. The lot size is 1000. On the expiration day, ABC stock closed at Rs. 250. What is the net profit (+) or loss (-)? a) +30000 b) -70000 c) +70000 d) -30000 Explanation:Mr. A sold a PUT option, that means he has a bullish or neutral view on PQR stock.However, ABC stock has fallen by Rs 50 ( 300 – 250 ).Which means he has lost Rs 50.Since he has sold a PUT, he will receive the premium which is Rs 20.So his net loss will be Rs 50 (Loss) – Rs 20 (Premium Recd) = Rs 30Total Loss = Rs 30 x 1000 (lot size) = Rs. 30000 20 / 50 20. When a PUT option on an index is exercised, the option holder receives _______ from the option writer. a) A cash amount that is equal to spot price b) A cash amount that is equal to the excess of spot price over exercise price c) A cash amount that is equal to the excess of exercise price over spot price d) No amount Explanation:An option will only be exercised when its In the Money (Profitable)A put option is In the Money when the Exercise price is higher than the spot price. So the excess of exercise price over the spot price will be receivable by the option holder.(IN THE MONEY – A call option with a strike (exercise) price that is lower than the market (spot) price of the underlying asset, or a put option with a strike price that is higher than the market price of the underlying asset. In the money means that your stock option is worth money and you can turn around and sell or exercise it.) 21 / 50 21. Intrinsic value is always positive for in-the-money options and zero for out-of-the-money options. Is this statement true or false? a) False b) True Explanation:In-the-money options have positive intrinsic value whereas at-the-money and out-of-the-money options have zero intrinsic value. The intrinsic value of an option can never be negative. 22 / 50 22. If the futures price is higher than the spot price of an underlying asset, this is known as _______. a) Contango b) Maximization c) Normalization d) Backwardation Explanation:If futures price is higher than spot price of an underlying asset, market participants may expect the spot price to go up in near future. This expectedly rising market is called “Contango market”. Similarly, if futures price are lower than spot price of an asset, market participants may expect the spot price to come down in future. This expectedly falling market is called “Backwardation market”. 23 / 50 23. Mr. Ashish is a portfolio manager and holds a positive view on the market. What actions should he take? a) He should sell his complete portfolio b) He should sell index futures c) He should buy index futures d) He should sell index call option Explanation:Buying index futures such as Nifty futures will help him reap good profits if his view of bullish markets prove correct. 24 / 50 24. The primary evidence of whether a futures transaction is for speculation or hedging relies on whether there already exists a related commercial position exposed to the risk of loss due to price movement. Is this statement true or false? a) False b) True Explanation:Hedgeing basically means making a trade to reduce the risk of adverse price movements in an asset which you already hold. Normally, a hedge consists of taking an offsetting position in a related security, such as a futures contractFor eg. – A company will be receiving dollars after three months. So to safe guard against any fluctuations, it sells dollars in the futures market (3 month futures) and locks in the price. 25 / 50 25. What purpose do speculators serve in the market? a) They add to the liquidity in the futures market b) They stabilise the markets c) They maintain the Dollar-Rupee price parity d) They reduce their risks by speculating Explanation:Speculators constantly buy and sell creating good liquidity. 26 / 50 26. What does the term “Index Future” mean? a) Its a synthetic option b) Its a derivative product c) Its an option d) Its a cash market product Explanation:The future price of an index is derived from the spot / cash price.So Index Future is a derivative product. 27 / 50 27. Point out the statement that is NOT correct concerning the tracking error of index funds. a) Tracking error can also arise due to mutual fund expenses b) Cash balances which are maintained by the fund manager can cause tracking error c) From the point of view of the investors a low tracking error is desirable d) Tracking error is same for all index funds as it is fixed by the regulator Explanation:Tracking error is the annualized difference between standard deviation of the fund and its benchmark. Lower the tracking difference, better the fund.“Tracking error” occurs due to fund management related expenses and cash holdings maintained to take care of redemptions. Its not fixed by the regulator. 28 / 50 28. What category of index does NSE NIFTY belong to? a) Its a market capitalisation – weighted index b) Its an equally-weighted index c) Its a free-float market capitalisation index d) Its a price-weighted index Explanation:The free-float methodology is a method of calculating the market capitalization of a stock market index’s underlying companies. With the free-float methodology, market capitalization is calculated by taking the equity’s price and multiplying it by the number of shares readily available in the market.A majority of the stock indices globally, over a period of time, have moved to free float basis, including the Indian equity indices – Sensex, Nifty and SX40. 29 / 50 29. What is the strategy where an investor takes a short position in a call option and a long position in the underlying stock? a) Protective call strategy b) Butterfly strategy c) Writing a naked call d) Writing a covered call Explanation:A Covered Call is a basic option trading strategy frequently used by traders to protect their share holdings. It is a strategy in which you own shares of a company and Sell OTM Call Option of the company in similar proportion.The Call Option would not get exercised unless the stock price increases. Till then you will earn the Premium. This a unlimited risk and limited reward strategy. 30 / 50 30. Spot the incorrect statement regarding trading on the OTC market. a) On the OTC markets, there are no limits on the positions that buyers and sellers can take b) OTC markets have a centralised clearing and settlement of all trades c) In the OTC markets, risk management is usually the responsibility of the parties themselves d) Buyers and sellers can trade in tailor-made contracts in the OTC markets Explanation:Forward contracts are also known as OTC contracts.It is a contractual agreement between two parties to buy/sell an underlying asset at a certain future date for a particular price that is pre-decided on the date of contract. Both the contracting parties are committed and are obliged to honour the transaction irrespective of the price of the underlying asset at the time of delivery. Since forwards are negotiated between two parties, the terms and conditions of contracts are customized/tailor made.These contracts are not regulated by an Exchange and there is no centralised clearing and settlement of trades. 31 / 50 31. The cost incurred due to the Bid-Ask spread is known as ______. a) Impact cost b) Transction cost c) Margin cost d) Spread cost Explanation:Impact cost is a measure of the cost incurred due to the bid-ask spread.Impact cost represents the cost of executing a transaction in a given stock, for a specific predefined order size, at any given point of time.Impact cost is the measure of liquidity of the security. It is the cost a buyer or seller has to incur for a particular quantity of order at a given point of time due to the existing liquidity condition of the security available in the market. 32 / 50 32. A futures contract ______. a) will never have a specified maturity b) can be squared off any time before expiry c) can be traded on a one to one basis by counterparties d) cannot be squared off before expiry Explanation:Futures contract can be squared off any time before expiry. 33 / 50 33. A Trading-cum-clearing member has a client named X. The client has bought 1000 contracts and sold 2000 contracts in the June series of ABC futures (contract multiplier 50). Additionally, the Trading-cum-clearing member has bought 1500 contracts and sold 2200 contracts on their own account in the same June series of ABC futures (contract multiplier 50). What is the remaining liability or open position of the member toward the clearing corporation in terms of the number of contracts? a) 2200 b) 300 c) 6700 d) 1700 Explanation:The open position of a client and the clearing member cannot be netted off with each other.Open position of client X is 1000 – 2000 = 1000 sale contractsOpen position of Clearing member is 2200 – 1500 = 700 purchase contractsTotal outstanding position of the clearing member towards the Clearing Corporation is 1000 + 700 = 1700 contracts 34 / 50 34. Which one of these serves as an example of a derivative contract? a) Treasury Bills of Government of India b) Certificate of Deposit c) S&P 500 futures d) Equity shares of XYZ Ltd Explanation:Index Derivatives are derivative contracts which have the index as the underlying asset.The Standard and Poor’s 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 of the largest companies listed on stock exchanges in the United States.S&P futures are a derivative contract with S&P 500 index as the underlying. 35 / 50 35. Which of these derivative contracts, once initiated, typically cannot be closed or reversed until their expiration? a) Future contracts b) Forward contracts c) Exchange traded options on futures d) Exchange traded options Explanation:Forwards are bilateral over-the-counter (OTC) transactions where the terms of the contract, such as price, quantity, quality, time and place are negotiated between two parties to the contract.The tailor made contracts and their non-availability on exchanges creates illiquidity in the contracts. Therefore, it is very difficult for parties to exit from the forward contract before the contract’s maturity. 36 / 50 36. Who becomes the counterparty to every trade in futures transactions? a) Clearing Corporation b) Custodian c) SEBI d) Depository Explanation:Clearing Corporation is responsible for clearing and settlement of all trades executed on the F&O Segment of the Exchange.It acts as a legal counterparty to all trades on this segment and also guarantees their financial settlement. 37 / 50 37. What does the option holder receive when exercising a put option on an index? a) He will receive cash amount equal to excess of spot price over exercise price b) He will receive nothing c) He will receive cash amount equal to excess of exercise price over spot price d) He will receive cash amount equal to spot price Explanation:An option will only be exercised when its In the Money (Profitable)A put option is In the Money when the Exercise price is higher than the spot price. So the excess of exercise price over the spot price will be receivable by the option holder.(IN THE MONEY – A call option with a strike (exercise) price that is lower than the market (spot) price of the underlying asset, or a put option with a strike price that is higher than the market price of the underlying asset. In the money means that your stock option is worth money and you can turn around and sell or exercise it.) 38 / 50 38. When does the Clearing Corporation adjust the initial margin requirements? a) Clearing Corporation changes the initial margin requirements periodically, based on specific instructions received from SEBI b) Clearing Corporation changes the initial margin requirements periodically, after each expiry date c) Clearing Corporation can continuously change the initial margin requirements whenever their is an increase in trading volumes d) Clearing Corporation can continuously change the initial margin requirements according to changes in market volatility Explanation:The initial margin is dependent on price movement of the underlying asset. As high volatility assets carry more risk, the Exchange / Clearing Corporation would charge higher initial margin on them. 39 / 50 39. Mark-to-market margins are collected ______. a) Every 3 days b) On a daily basis c) On a weekly basis d) Every 2 days Explanation:In the futures market, profits and losses are settled on day-to-day basis – called mark to market (MTM) settlement.The exchange collects these margins (MTM margins) from the loss making participants and pays to the gainers on day-to-day basis. 40 / 50 40. The ability to lend and borrow securities is typically essential for the smooth execution of ________. a) Reverse cash-and-carry arbitrage b) Cross-hedge using futures c) Cash and carry arbitrage d) Calendar spread using futures Explanation:Usually the futures prices are higher than cash market prices. The reverse cash-and-carry arbitrage is done when the futures contract are lower than the cash market price. For eg. Reliance Industries Ltd. is trading at Rs 2050 in the cash market and Rs. 2000 in futures market. The arbitrageur will sell in the cash market at Rs 2050 and buy in the future market at Rs 2000, thus making a profit of Rs 50 (less expenses).The arbitrageur should have the stock to deliver in the cash market, which will be bought back at the time of reversing the position. If stock is not available, arbitrageur needs to borrow the stock to implement the arbitrage. Therefore, existence of a facility for lending and borrowing securities is required for smooth execution Reverse cash-and-carry arbitrage. 41 / 50 41. Identify the strategy that is most suitable when anticipating very low volatility. a) Long Straddle b) Short Butterfly c) Short Straddle d) Long Straddle Explanation:Short Straddle Strategy – Here, the trader’s view is that the price of underlying would not move much or remain stable (Low volatility). So, he sells a call and a put so that he can profit from the premiums received. 42 / 50 42. Spot the statement that is TRUE regarding Option Spreads. a) A bearish call spread will result in an initial cash inflow for the trader b) A bullish put spread will result in an initial cash outflow for the trader c) A bullish call spread will result in an initial cash inflow for the trader d) A bearish put spread will result in an initial cash inflow for the trader Explanation:In a bearish call spread, there is a net in-flow of premium when the spread is initiated. A bear call spread is achieved by simultaneously selling a call option and buying a call option at a higher strike price but with the same expiration date. The maximum profit to be gained using this strategy is equal to the credit received when initiating the trade.(In a bearish put spread and bullish call spread there is a net out-flow of premium when the spread is initiated. In a bullish put spread, there is a net in-flow of premium when the spread is initiated.) 43 / 50 43. In India, when the option holder exercises a call option on an equity stock, _________. a) The option holder receives cash amount equal to excess of strike price of the call option over the spot price (at the time of exercise) b) The option holder buys the underlying stock from the option writer at a pre-specified price c) The option holder will receives cash amount equal to excess of spot price (at the time of exercise) over the strike price of the option d) The option holder sells the underlying stock to the option writer at a pre-specified price Explanation:Unlike index options, stock options are settled by physical delivery. All long ITM options are automatically assigned by the exchange on the expiry day to short positions in option contracts with the same series on a random basis. The final settlement takes place by physical delivery in accordance with the settlement schedule of the clearing corporation. 44 / 50 44. Trader A wants to sell 20 contracts of the August series at Rs 4500, and Trader B wants to sell 17 contracts of the September series at Rs 4550. The lot size is 50 for both these contracts, and the Initial Margin is fixed at 6%. How much Initial Margin is required to be collected from both these investors (the sum of the initial margins of A and B) by the broker? a) 4,10,000 b) 2,70,000 c) 2,32,050 d) 5,02,050 Explanation:Payment of Initial Margin by a broker cannot be netted against two or more clients. So he will have to pay the margin for the open position of each of his clients.So margin payable for Trader A is : 20 x 4500 x 50 (Lot size) at 6% = Rs 2,70,000Margin payable for Trader B is : 17 x 4550 x 50 (Lot size) at 6% = Rs 2,32,050Total = Rs 5,02,050. 45 / 50 45. State whether the following statement is true or false: A trading member of a derivatives exchange can clear his trades through a Clearing member, who may or may not be a Professional clearing member. a) False b) True Explanation:There are Trading cum Clearing Members on an Exchange. They are Clearing Members who are also Trading Members of the exchange. Such Clearing Members may clear and settle their own proprietary trades, their clients’ trades as well as trades of other Trading Members and Custodial Participants. 46 / 50 46. A trader holds a short position in a futures contract. If the prices of this futures contract increase, then the mark-to-market margin account of the trader will be _____________. a) Debited for the loss b) Credited for the loss c) Debited for the gain d) Credited for the gain Explanation:In a short position, if the price increases, there is a loss. So, the mark to market margin will be debited. 47 / 50 47. A Mutual Fund manager has gathered Rs. 300 crores from a New Fund Offer. He intends to invest this amount over the next month in purchasing 20 selected stocks. How can he hedge the risk for this planned stock purchase? a) He can execute a short hedge using index futures contracts on each of the 20 stocks b) He can execute a long hedge using index futures c) He can execute a long hedge using put options on each of the 20 stocks d) He can execute a short hedge using index futures Explanation:A long hedge can be created for all the 20 stocks using put options as follows :The fund manager sells the put options of the 20 stocks as per required quantity. He has now locked his prices. If the price falls, he can buy them in the spot market (at lower prices) and square up his put options at a loss.If the prices rise, he squares up is options at a profit and buys in the spot market at a higher price.Therefore, in both the situations, his purchase price is not affected. 48 / 50 48. Default risk is also known as _________. a) Counterparty Risk b) Credit Risk c) Both of the above d) None of the above Explanation:Counterparty risk is the risk arising out of the default of a counterparty to the transaction. It is the risk of an economic loss from the failure of the counterparty to fulfil its contractual obligation. This risk is also called default risk or credit risk.It is generally not applicable to clients trading in exchange-traded equity derivatives because the settlement of such transactions is guaranteed by the exchange / clearing corporation. 49 / 50 49. What does the term ‘Stock Option’ mean? a) Its a foreign exchange instrument b) Its a derivative instrument c) Its a debt instrument d) Its a money market instrument Explanation:Stock option: These options have individual stocks as the underlying asset. For example, option on ONGC, NTPC, etc. These options are derivative instruments. 50 / 50 50. On the announcement of the record date for merger/demerger, the unexpired futures and options contracts on the underlying securities that are outstanding on the last cum date ____________. a) Will compulsorily be settled at the settlement price on the last cum date b) Will be squared up by the broker at the day’s opening price c) Will be closed-off by the merged /demerged company at a predetermined price d) Will continue to be traded till their expiry date Explanation:On announcement of the record date for merger/demerger, the last cum-date for merger/demerger would be determined by the Exchange/ Clearing Corporation.Un-expired contracts in the underlying, which shall cease to exist subsequent to the merger/demerger, outstanding as on last cum-date shall be compulsorily settled at the settlement price. The settlement price shall be the last available closing price of such underlying in the Capital Market segment of the Exchanges, on the last cum-date. 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