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Questions 4

Which of the following reflects the pricing convention for currency forwards, where one of the currencies is USD?

Questions 5

If a firm is financed equally by debt and equity, and the cost of debt is 10% per annum and the cost of equity is 14%, what is the weighted average cost of capital for the firm if taxes are 25%?

Questions 6

A bond with a 5% coupon trades at 95. An increase in interest rates by 10 bps causes its price to decline to $94.50. A decrease in interest rates by 10 bps causes its price to increase to $95.60. Estimate the modified duration of the bond.

Questions 7

Which of the following relationships are true:

I. Delta of Put = Delta of Call - 1

II. Vega of Call = Vega of Put

III. Gamma of Call = Gamma of Put

IV. Theta of Put > Theta of Call

Assume dividends are zero.

Questions 8

The rate of dividend on a stock goes up. What is the effect on the price of a call option on this stock?

Questions 9

Which of the following statements are true?

I. The square-root-of-time rule for scaling volatility over time assumes returns on different days are independent

II. If daily returns are positively correlated, realized volatility will be less than that calculated using the square-root-of time rule

III. If daily returns are negatively correlated, realized volatility will be less than that calculated using the square-root-of-time rule

IV. If stock prices are said to follow a random walk, it means daily returns are independent of each other and have an expected value of zero

Questions 10

[According to the PRMIA study guide for Exam 1, Simple Exotics and Convertible Bonds have been excluded from the syllabus. You may choose to ignore this question. It appears here solely because the Handbook continues to have these chapters.]

A long call position in an asset-or-nothing option has the same payoff as:

Questions 11

Repos are used for:

I. Short term borrowings

II. Managing credit risk exposures

III. Money market operations by central banks

IV. Facilitating short positions

Questions 12

What is the notional value of one equity index futures contract where the value of the index is 1500 and the contract multiplier is $50:

Questions 13

Which of the following statements are true in respect of a fixed income portfolio:

I. A hedge based on portfolio duration is valid only for small changes in interest rates and needs periodic readjusting

II. A duration based portfolio hedge can be improved by making a convexity adjustment

III. A long position in bonds benefits from the resulting negative convexity

IV. A duration based hedge makes the implicit assumption that only parallel shifts in the yield curve are possible

Questions 14

A futures contract is quoted at 105. Which is the cheapest-to-deliver bond for this contract if there are three available bonds, quoted at 97, 101 and 106 with conversion factors respectively of 0.9, 1 and 1.1 respectively?

Questions 15

A stock that pays no dividends is trading at $100 spot or $104 as a three month forward. The interest rate you can borrow at is 6% per annum. US treasury yields are 4% per annum. What should you do to profit in the situation?

Questions 17

A portfolio manager desires a position of $10m in physical gold, but chooses to get the exposure using gold futures to conserve cash. The volatility of gold is 6% a month, while that of gold futures is 7% a month. The covariance of gold and gold futures is 0.00378 a month. How many gold contracts should he hold if each contract is worth $100k in gold?

Questions 18

The securities market line (SML) based upon the CAPM expresses the relationship between

Questions 19

If the zero coupon spot rate for 3 years is 5% and the same rate for 2 years is 4%, what is the forward rate from year 2 to year 3?

Questions 20

Which of the following statements are true:

I. All investors regardless of their expectations face the same efficient frontier which is always the market portfolio

II. Investors will have different efficient frontiers based upon their views of expected risks, returns and correlations

III. Investors risk appetite will determine their choice of the combination of risk-free and risky assets to hold

IV. If all investors have identical views on expected returns, standard deviation and correlations, they will hold risky assets in identical proportions

Questions 21

Continuously compounded returns for an asset that increases in price from S1 to S2 over time period t (assuming no dividends or other distributions) are given by:

Questions 22

A bond with a 5% coupon trades at 95. An increase in interest rates by 10 bps causes its price to decline to $94.50. A decrease in interest rates by 10 bps causes its price to increase to $95.60. Estimate the convexity of the bond.

Questions 23

Credit derivatives can be used for:

I. Reducing credit exposures

II. Reducing interest rate risks

III. Earn credit risk premiums

IV. Get market exposure without taking cash market positions

Questions 24

If x represents wealth, and u(x) its utility, then a logarithmic utility function can be represented by:

Questions 25

An investor in mortgage backed securities can hedge his/her prepayment risk using which of the following?

I. Long swaption

II. Short cap

III. Short callable bonds

IV. Long fixed/floating swap

Questions 27

What would be the most profitable strategy for an investor who expects interest rates to rise:

Questions 28

Which of the following statements is not correct with respect to a European call option:

Questions 29

A refiner may use which of the following instruments to simultaneously protect against a fall in the prices of its products and a rise in the prices of its inputs:

Questions 31

Which of the following expressions represents Jensen's alpha, where μ is the expected return, σ is the standard deviation of returns, rm is the return of the market portfolio and rf is the risk free rate:

Questions 32

Arrange the following rates in descending order, assuming an upward sloping yield curve:

1. The 10 year zero rate

2. The forward rate from year 9 to 10

3. The yield-to-maturity on a 10 year coupon bearing bond

Questions 33

Which of the following is NOT an assumption underlying the Black Scholes Merton option valuation formula:

Questions 34

The gamma of a call option is 0.08. What is the gamma of the corresponding put option?

Questions 35

Security A and B both have expected returns of 10%, but the standard deviation of Security A is 10% while that of security B is 20%. Borrowings are not permitted. A portfolio manager who wishes to maximize his probability of earning a 25% return during the year should invest in:

Questions 36

Which of the following is NOT a historical event which serves as an example of a short squeeze that happened in the markets?

Questions 38

For a forward contract on a commodity, an increase in carrying costs (all other factors remaining constant) has the effect of:

Questions 39

The yield offered by a bond with 18 months remaining to maturity is 5%. The coupon is 3%, paid semi-annually, and there are two more coupon payments to go in addition to the interest payment made at maturity. The zero rate for 6 months is 2%, that for 12 months is 3%. What is the 18 month zero rate?

Questions 40

When hedging one fixed income security with another, the hedge ratio is determined by:

Questions 42

Which of the following statements are true:

I. Protective puts are a form of insurance against a fall in prices

II. The maximum loss for an investor holding a protective put is equal to the decline in the value of the underlying

III. The premium paid on the put options held as a protective put is a loss if the value of the underlying goes up

IV. Protective puts can be a useful strategy for an investor holding a long position but with a negative short term view of the markets

Questions 45

Which of the following statements is true in relation to the capital markets line (CML):

I. The CML is a transformation line that is tangential to the efficient frontier

II. The CML allows an investor to obtain the highest return for a given level of risk chosen according to the investor's risk attitude

III. The CML is the line passing through the point on the efficient frontier with the highest Sharpe ratio, and a y-intercept equal to the risk free rate

IV. The Sharpe ratio for the points on the CML increase in a linear fashion

Questions 47

According to the dividend discount model, if d be the dividend per share in perpetuity of a company and g its expected growth rate, what would the share price of the company be. 'r' is the discount rate.

Questions 48

[According to the PRMIA study guide for Exam 1, Simple Exotics and Convertible Bonds have been excluded from the syllabus. You may choose to ignore this question. It appears here solely because the Handbook continues to have these chapters.]

Which of the following statements are true for a contingent premium option:

I. They are also called 'pay-later' options

II. Premiums are due only if the option expires in the money

III. They are a combination of a vanilla option and an appropriate number of cash-or-nothing options

IV. They are preferred because the premiums are always less than those on equivalent vanilla options

Questions 49

If the CHF/USD spot rate is 1.1010 and the one year forward is 1.1040, what is the annualized forward premium or discount, and the one year swap rate?

Questions 50

Which of the following statements are true:

I. The swap rate, also called the swap spread, is initially calculated so that the value of the swap at inception is zero.

II. The value of a swap at initiation is different from zero and is equal to the difference between the NPV of the cash flows of the two legs of the swap

III. OTC swaps are standardized and limited to a defined set of standard contracts

IV. Interest rate and commodity swaps are the types of swaps that are most traded

Questions 51

Determine the enterprise value of a firm whose expected operating free cash flows are $100 each year and are growing with GDP at 2.5%. Assume its weighted average cost of capital is 7.5% annually.

Questions 52

Which of the following statements are true:

I. For a delta neutral portfolio, gamma and theta carry opposite signs

II. The sum of the absolute value of gamma for a call and a put for the same option is 1

III. A large positive gamma is desirable in a delta neutral portfolio

IV. A trader needs at least two separate tradeable options to simultaneously make a portfolio both gamma and vega neutral

Questions 54

For a stock that does not pay dividends, which of the following represents the delta of a futures contract?

Questions 55

[According to the PRMIA study guide for Exam 1, Simple Exotics and Convertible Bonds have been excluded from the syllabus. You may choose to ignore this question. It appears here solely because the Handbook continues to have these chapters.]

The profit potential from the conversion of convertible bonds into stock is limited by

Questions 56

If the implied volatility for a call option is 30%, the implied volatility for the corresponding put option is:

Questions 57

An investor enters into a 4 year interest rate swap with a bank, agreeing to pay a fixed rate of 4% on a notional of $100m in return for receiving LIBOR. What is the value of the swap to the investor two years hence, immediately after the net interest payments are exchanged? Assume the current zero coupon bond yields for 1, 2 and 3 years are 5%, 6% and 7% respectively. Also assume that the yield curve stays the same after two years (ie, at the end of year two, the rates for the following three years are 5%, 6%, and 7% respectively).

Questions 58

What can the buyer of a 6 x 12 FRA expect to receive (or pay) if the contracted rate is 10% and the settlement rate is 12%? Assume contract notional is $100m.

Questions 59

An asset has a volatility of 10% per year. An investment manager chooses to hedge it with another asset that has a volatility of 9% per year and a correlation of 0.9. Calculate the hedge ratio.

Questions 60

The cheapest to deliver bond for a treasury bond futures contract is the one with the :

Questions 61

What is the price of a treasury bill with $100 face maturing in 90 days and yielding 5%?

Questions 62

For a pair of correlated assets, the achievable portfolio standard deviation will be the lowest when the correlation ρ is:

Questions 63

A borrower who fears a rise in interest rates and wishes to hedge against that risk should:

Questions 66

Which of the following statements are true:

I. A total return swap (TRS) helps gain an exposure without having to fund a long position

II. A short position in a corporate bond can be covered using a repo

III. A total return swap (TRS) is useful to eliminate counterparty risk

IV. A bank borrowing funds using a repo continues to hold the underlying assets on its balance sheet

Questions 68

When considering an appropriate mix of debt and equity, Chief Financial Officers generally consider:

I. Tax advantage of debt

II. Financial distress costs

III. Agency costs of equity

IV. Retaining financial flexibility

Questions 69

It is January. Which of the following is an appropriate hedging strategy for a corn farmer expecting a harvest in June?

Questions 70

A corn farmer has committed to sell 20,000 bushels of corn in November. The spot price has a standard deviation of 20 cents per bushel, and its correlation with the December futures prices is 0.9. The futures contract is for 5000 bushels and has a standard deviation of 24 cents per bushel. What should the corn producer do if he/she wishes to hedge the risk of price movements between now and November?

Questions 71

Which of the following is NOT true about a fixed rate bond:

I. The higher the coupon, the lower the duration

II. The higher the coupon, the lower the convexity

III. If the bond is callable, it has negative modified duration

IV. If the bond is callable, the bond has negative convexity

Questions 72

The price of a bond will approach its par as it approaches maturity. This is called:

Questions 73

The LIBOR square swap offers the square of the interest rate change between contract inception and settlement date. If LIBOR at inception is y, and upon settlement is x, the contract pays (x - y)2 for x > y; and -(x - y)2 for x < y.

What of the following cannot be a value of the gamma of this contract?

Questions 74

Which of the following statements are true?

I. Macaulay duration of a coupon bearing bond is unaffected by changes in the curvature of the yield curve.

II. The numerical value for modified duration will be different for bonds with identical nominal coupons and maturity but different compounding frequencies.

III. When rates are expressed as continuously compounded, modified duration and Macaulay duration are the same.

IV. Convexity is higher for a bond with a lower coupon when compared to a similar bond with a higher coupon.

Questions 75

A bond manager holding $1m long in a bond portfolio is concerned that interest rates might rise over the next three months. Which of the following represents the best hedging strategy for the manager?

Questions 76

An investor holds a portfolio of mortage backed securities valued at $100m. Using a Monte Carlo based pricing model, he determines that the value of the portfolio would rise to $102m if interest rates were to fall by 45 basis points, and fall to $97m if interest rates were to rise by 45 basis points. What is the estimated modified duration of the investor's portfolio?

Questions 77

Given identical prices, a bond trader prefers dealing with Bank A over Bank B. Given a choice between Bank B and Bank C, he prefers Bank B. Yet, when given a choice between Bank A and Bank C, he prefers dealing with Bank C. What axiom underlying the utility theory is he violating?

Questions 78

The annual borrowing rate for investors is 10% per annum. What is the par no-arbitrage futures price for delivery one year hence for a stock currently selling in the spot market at $100 ? Assume the stock pays no dividends.

Questions 79

Security A has a beta of 1.2 while security B has a beta of 1.5. If the risk free rate is 3%, and the expected total return from security A is 8%, what is the excess return expected from security B?

Questions 80

Where futures are being used to hedge a commodities position, which of the following formulae should be used to determine the number of futures contracts to buy (or sell)?

Questions 81

Of the following, which measures can debt holders adopt to protect against a transfer of wealth to their detriment to the shareholders:

I. Restrictive covenants limiting dividends

II. Insisting on professional management separate from owners

III. Higher interest rates

IV. Periodic audits

Questions 84

Which of the following cause convexity to increase:

I. Increase in yields

II. Increase in maturity

III. Increase in coupon rate

IV. Increase in duration

Questions 85

What kind of a risk attitude does a utility function with downward sloping curvature indicate?