[ 2009 FRM Sample Exam ] Market risk measurement and management Q3 management, suddenly, produces, meaning, option

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3. Which type of option produces discontinuous payoff profiles, meaning that the payoff can jump suddenly as the underlying asset price changes?

A. Chooser options

B. Barrier options

C. Binary options

D. Lookback options

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A is incorrect. The payoff profile of a chooser option is continuous.

B is incorrect. The payoff profile of a barrier option is continuous.

C is correct. The binary option is the only one that produces discontinuous payoff profiles because it pays one price at the expiration if the asset value is above the strike price and nothing if the asset price is below the strike price.

D is incorrect. The payoff profile of a lookback option is continuous.

Assigned readings:

John Hull, Options, Futures, and Other Derivatives, 5th ed. (ffice:smarttags" />New York: Prentice Hall, 2002), Chapter 19.

Type of Question: Market Risk