FRM Part I · FRM Exam Part I · Exotic Options
A firm holds an option that pays the greater of zero and the difference between the performance of the S&P 500 index and a bond index over one year, with both expressed in the same currency units. What type of exotic option is this?
This is an exchange option, because its payoff is the maximum of zero and the difference between the values of two assets, equivalent to the right to swap one asset for the other at maturity.
- AAn exchange optionCorrect
- BAn average strike option
- CA barrier option
- DA lookback option
Explanation
The payoff is max(V_A - V_B, 0), which is the right to exchange one asset for another. This is an exchange option. Average strike options use an average of one asset's own price. Barrier and lookback options depend on path extremes of a single asset.
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