Question 1) Which of the following is true of a volatility smil

1) Which of the following is true of a volatility smile?

A) Implied volatility is on the horizontal axis and strike price is on the vertical axis

B) Historical volatility is on the horizontal axis and strike price is on the vertical axis

C) Implied volatility is on the vertical axis and strike price is on the horizontal axis

D) Historical volatility is on the vertical axis and strike price is on the horizontal axis

2) Which of the following is true?

A) Volatility smile for European puts is the same as for European calls

B) Volatility smile for European puts is the same as for American puts

C) Volatility smile for European calls is the same as for American calls

D) Volatility smile for American puts is the same as for American calls

3) Which of the following is true when the tails of a future foreign currency distribution are compared with those of a lognormal distribution with the same mean and standard deviation?

A) The left tail and right tail are thinner

B) The left tail is thinner and the right tail is fatter

C) The right tail is thinner and the left tail is fatter

D) Both tails are fatter

4) Which of the following is true when the tails of a future stock price distribution are compared with those of a lognormal distribution with the same mean and standard deviation?

A) The left tail and right tail are thinner

B) The left tail is thinner and the right tail is fatter

C) The right tail is thinner and the left tail is fatter

D) Both tails are fatter

5) Which of the following could cause the volatility smile typically seen for foreign currency options?

A) Currencies are traded in different countries at different times of the day

B) Currencies tend to have low volatilities

C) The activities of central banks causes occasional jumps in the exchange rate

D) Interest rates may be different in the two countries

6) Which of the following is true?

A) The volatility skew for equities is much more pronounced now than it was in 1985

B) The volatility skew for equities has a positive gradient

C) The volatility skew for equities is consistent with the Black-Scholes-Merton model

D) The volatility skew for equities is similar to that for foreign currencies

7) Why do traders use volatility smiles for pricing options?

A) To allow for non-lognormality of the probability distribution of future asset price

B) Because it is consistent with recent market moves

C) As a tool to reflect their views about extreme market moves

D) Because extreme market moves are always more likely than Black-Scholes-Merton assumes

8) What does the shape of the volatility smile reveal about put options on equity?

A) Options close-to-the-money have the lowest implied volatility

B) Options deep-in-the-money have a relatively high implied volatility

C) Options deep-out-of-the-money have a relatively high implied volatility

D) All of the above

9) What does the shape of the volatility smile reveal about call options on a currency?

A) Options close-to-the-money have the lowest implied volatility

B) Options deep-in-the-money have a relatively high implied volatility

C) Options deep-out-of-the-money have a relatively high implied volatility

D) All of the above

10) Which of the following is NOT true?

A) A volatility surface provides more information than a single volatility smile

B) A volatility surface is used to determine the implied volatility of an option that does not trade actively

C) A volatility surface can be determined from a single volatility smile using interpolation

D) A volatility surface incorporates information about options with different maturity dates

11) A volatility surface is a table showing the relationship between which of the following?

A) Implied volatility, time to maturity, and strike price

B) Implied volatility, historical volatility, and time to maturity

C) Historical volatility, strike price, and time to maturity

D) None of the above

12) Which of the following causes a volatility smile that is a “frown”?

A) There is a small probability of a large stock price decrease in one week

B) There is a small probability of a large stock price increase in one week

C) The outcome of a lawsuit (roughly equal chance of being favorable or unfavorable) will create a large movement up or down in one week

D) None of the above

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