2016-FRR Questions Bank

Market timing trading involves making buy or sell decisions of financial assets by attempting to predict future market price movements. This strategy:

Long positions when markets are rising: The trader buys securities expecting their prices to increase.

Short positions when markets are falling: The trader sells securities expecting their prices to decrease.

This behavior aligns with market timing, which is an active trading strategy based on the anticipated direction of market prices.

ReferencesSource: How Finance Works​

Gamma is an important measure in options trading, representing the sensitivity of the delta of the option to changes in the price of the underlying asset. The correct statements about gamma are:

III. Gamma is the second derivative of the value function with respect to the price of the underlying instrument. This means that gamma measures the rate of change of delta (the first derivative) as the price of the underlying asset changes. IV. Gamma is the rate of change of the option delta with respect to changes in the underlying price. This highlights that gamma captures the curvature in the relationship between the option price and the underlying asset price, making it crucial for understanding how the delta will change as the underlying asset price changes.

When a bank hedges with futures contracts, it needs to maintain margin accounts which are settled daily to reflect market changes:

Margin Calls: If the market moves against the position of the futures, the bank must add funds to the margin account to cover potential losses. This can create significant liquidity risk if large sums are needed quickly.

Daily Settlements: Futures markets require daily mark-to-market settlements which means that any adverse movement in prices necessitates immediate liquidity to meet the margin requirements.

Market Volatility: In times of high volatility, the daily margin requirements can be substantial, potentially causing a scramble for liquidity if the bank has not pre-arranged sufficient liquidity buffers.

Thus, the need for daily margin settlements exposes the bank to liquidity risk as it must be able to provide cash on short notice.References: How Finance Works, relevant sections on liquidity risks in derivative markets​​.

For American options, exercising an in-the-money call option before the ex-dividend date can be beneficial if the option is deep in the money and the dividend is significant. This is because the holder would receive the dividend payment, which can make early exercise profitable.