AIM 2: Describe four primary considerations when evaluating potential positions, including hedging, in exotic derivatives.

1、Which of the following statements concerning exchange-traded options versus over-the-counter (OTC) options is FALSE?

A) OTC options are less liquid than exchange-traded options.
 
B) Exchange-traded options are less flexible than OTC options.
 
C) The OTC options market is not very large.
 
D) Exchange-traded options are guaranteed by the Options Clearing Corporation (OCC) whereas OTC options are not guaranteed by the OCC. 

The correct answer is C

The OTC options market is very large and active.

2、When choosing a hedging approach, you expect operational risks to be higher for:

A) a product traded on an organized exchange.
 
B) an OTC product.
 
C) static replication using an exchange-traded product.
 
D) dynamic replication using an exchange-traded product.

The correct answer is D

Operational risks tend to be higher for dynamic replication using an exchange-traded product, because the need for rebalancing increases the chance of mishaps in implementing the strategy.

3、When choosing a hedging approach, you expect pricing risks to be highest for:

A) a product traded on an organized exchange.
 
B) dynamic replication using an exchange-traded product.
 
C) an OTC product. 
 
D) static replication using an exchange-traded product.

The correct answer is C

Exchange traded products have minimal pricing risks. Pricing risks are highest for an OTC product. Dealers in OTC products are more likely to have superior pricing models than users.