Interview questions on derivatives.

Question: 1.

All else being equal, which would be more valuable: a December call option for eBay or a January call option for eBay?

Answer: The January option: The later an option’s expiration date, the more valuable the option.

Question: 2.

Why do interest rates matter when figuring the price of options?

Answer: Because of the ever-important concept of net present value, all else being equal, higher interest rates lower the value of call options.

Question: 3.

If the strike price on a put option is below the current price, is the option holder at the money, in the money or out of the money?

Answer: Because a put option gives the holder the right to sell a security at a certain price, the fact that the strike (or exercise) price is below the current price would mean that the option holder would lose money. Translate that knowledge into option lingo, and you know that the option holder is out of the money.

Question: 4.

If the current price of a stock is above the strike price of a call option, is the option holder at the money, in the money, or out of the money?

Answer: Because a call option gives the holder the right to buy a security, the holder in this scenario is in the money (making money).

Question: 5.

When would you buy a put option on General Mills stock?

Answer: Because buying a put option gives you the option to sell the stock at a certain price, you would do this if you expect the price of General Mills stock to fall.

Question: 6.

What is the main difference between futures contracts and forward contracts?

Answer: The main difference between forward and futures contracts is that futures contracts are traded on exchanges and forwards are traded over-the-counter. Because of this distinction, you can only trade specific futures contracts that are traded on the exchange. Forward contracts are more flexible because they are privately negotiated, and can represent any assets and can change settlement dates should both parties agree.

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