CHARTERED INSTITUTE OF STOCKBROKERS
QUESTIONS
Examination Paper 1.3
Derivative Valuation and Analysis
Portfolio Management
Commodity Trading and Futures
Professional Examination
March 2014
Level 1
SECTION A: MULTI CHOICE QUESTIONS
Derivative Valuation and Analysis (1 -30)
1.
The value of an option does not depend on the ___________
A. Exercise price.
B. Time to expiration.
C. Standard deviation of the option.
D. Risk free rate of interest.
2.
Warrants are similar to which of these?
A. Bonds.
B. Put option.
C. Ordinary shares.
D. Call option.
3.
The price specified on an option that the holder can buy or sell the underlying
asset is called the __________
A. Premium.
B. Call.
C. Strike price.
D. Put.
4.
If the current price of a company’s ordinary shares underlying a call option is
greater than the exercise price, which of the following describes the lower floor on
the value of the call option?
A. Zero.
B. The current share price minus the present value of the exercise price.
C. The present value of the exercise price minus the current share price.
D. None of the above.
5.
What will be your profit or loss if for a N1,000 premium, you buy a N100,000 call
option on bond futures with a strike price of 114 and at the expiration date the
price is 110?
A. Profit is N4,000
B. Loss is N4,000
C. Profit is N3,000
D. Loss is N1,000
6.
An increase in the volatility of the underlying asset, all other things held constant,
will __________ the option premium.
A. Increase.
B. Decrease.
C. Increase or decrease.
D. Not enough information is given.
7.
Which of the following must an investor consider before writing a naked option?
A. The loss potential.
B. The possibility of exercise.
C. The risk/reward ratio.
D. All of the above.
8.
The short in a deliverable forward contract ____________
A. Has no default risk.
B. To receive payment at contract initiation.
C. Is obligated to deliver the specific asset.
D. Makes a cash settlement to the long at settlement.
9.
The delta of an option measures ____________
A. The change in the ending value of the underlying.
B. The change in the ending option value.
C. The swing in the price of the call relative to the swing in stock price.
D. The ratio of the change in the exercise price to the change in the stock price.
10. An interest rate floor on a floating rate note is equivalent to a series of
___________
A. Long interest rate calls.
B. Long interest rate puts.
C. Short interest rate calls.
D. Short interest rate puts.
11. A trading opportunity that offers a riskless profit is called a(n) _________
A. Put option.
B. Call option.
C. Arbitrage.
D. Cross-hedge.
12. Assuming you own a call option on S&P 500 index with an exercise price equals
955. The multiplier for the contract is 250. What would be the payoff on the
option at expiration if the index stands at 980?
A. N6,250.00
B. N6,750.00
C. N6,850.00
D. None of the above.
13. In
A.
B.
C.
D.
Black-Scholes option valuation model Ps.N(d1) - Ke-rt.N(d2) means _________
Amount invested minus return on investment.
Rate of interest minus cost of finance.
Return on investment minus cost of finance or the opportunity cost.
None of the options.
14. In the futures market, a contract does not trade for two days because trades are
not permitted at the equilibrium price; the market for this contract is
____________
A. Suspended.
B. Limit up.
C. Locked limit.
D. Limit down.
15. The existence of delivery option with respect to Treasury bond futures means that
the ___________
A. The short has the option to settle in cash or by delivery.
B. The short can choose which bond to deliver.
C. The long can choose to deliver the bond or require cash settlement.
D. The long can choose which of a number of bonds will be delivered.
16. Compared to forward contracts, futures contracts are all of the following except
___________
A. Larger in size.
B. More liquid.
C. Less subject to default risk.
D. Standardised.
17. Three 125,000 euro futures contract are sold at a price of $1.0345. The next day
the price settles at $1.0278. The mark to market for this account changes the
previous day’s margin by ___________
A. +€2,512.50
B. –€2,512.50
C. +€2,050.50
D. –€2,025.50
18. The Black-Scholes option pricing model is dependent on which five parameters?
A. Stock price, exercise price, risk free rate, probability and time to maturity.
B. Stock price, risk free rate, probability, time to maturity and variance.
C. Stock price, exercise price, risk free rate, variance and time to maturity.
D. Exercise price, probability, stock price, variance and time to maturity.
19. An investor sells 1 UACN June 50 call at 3½. What is the investor’s maximum
potential gain?
A. N350.00
B. N3,550.00
C. N3,350.00
D. None of the options.
20. Which of the following strategies would be considered most risky in a strong bull
market?
A. Buying calls.
B. Writing naked calls.
C. Writing naked puts.
D. Either writing naked calls or writing naked puts.
21. The payoffs for financial derivatives are linked to __________
A. Securities that will be issued in the future.
B. The volatility of interest rates.
C. Previously issued securities.
D. Government regulations specifying allowable rates of return.
22. Financial derivatives include which of the following?
A. Stocks.
B. Bonds.
C. Futures.
D. None of the above.
23. By
A.
B.
C.
D.
hedging a portfolio, a bank manager __________
Reduces interest rate risk.
Increases reinvestment risk.
Increases exchange rate risk.
Increases the probability of gains.
24. A contract that requires the investor to buy securities on a future date is called a
__________
A. Short contract.
B. Long contract.
C. Hedge.
D. Cross.
25. You own five put option contracts on XYZ stock with an exercise price of N25.
What is the total intrinsic value of these contracts if XYZ stock is currently selling
for N24.50 per share?
A. -N250
B. -N50
C. N250
D. N0
26. If a bank manager chooses to hedge his portfolio of treasury securities by selling
futures contracts, he __________
A. Gives up the opportunity for gains.
B. Removes the chance of loss.
C. Increases the probability of a gain.
D. (A) and (B) above.
27. To
A.
B.
C.
D.
say that the forward market lacks liquidity means that ___________
Forward contracts usually result in losses.
Forward contracts cannot be turned into cash.
It may be difficult to make the transaction.
Forward contracts cannot be sold for cash.
28. When interest rates fall, a bank that perfectly hedges its portfolio of Treasury
securities in the futures market ___________
A. Suffers a loss.
B. Experiences a gain.
C. Has no change in its income.
D. None of the above.
29. Futures markets have grown rapidly because futures __________
A. Are standardized.
B. Have lower default risk.
C. Are liquid.
D. All of the above.
30. GS Limited stock is selling for N28 a share. A 3-month call on GS stock with a
strike price of N30 is priced at N1.50. Risk-free assets are currently returning
0.3% per month. What is the price of a 3-month put on GS stock with a strike
price of N30?
A. N2.73
B. N3.23
C. N4.02
D. N2.02
Portfolio Management (31 - 70)
31. Which of the following is least likely a part of the execution step of the portfolio
management process?
A. Security analysis.
B. Portfolio construction.
C. Performance measurement.
D. None of the above.
32. Which of the following represents the intercept of the security market line (SML)?
A. Expected return on the market.
B. Expected return on the stock.
C. Level of systematic risk.
D. Risk-free rate.
33. The point of tangency between the capital allocation line (CAL) and the efficient
frontier of risky assets most likely identifies the ___________
A. Optimal risky portfolio.
B. Optimal investor portfolio.
C. Global minimum-variance portfolio.
D. Indifferent point.
34. An investor has ₦10 million to invest. ₦4 million is invested in risk-free asset and
₦6 million in Security K. If Security K has standard deviation of 25%, what is the
risk (standard deviation) of the investor’s portfolio?
A. 5%
B. 15%
C. 10%
D. More information needed.
35. A return-generating model that provides an estimate of the expected return of a
security based on factors such as earnings growth and cash flow generation is
best described as a __________
A. Market factor model.
B. Fundamental factor model.
C. Macroeconomic factor model.
D. Ideal model.
36. Which of the following statements concerning the graphs of the capital market
line (CML) versus the security market line (SML) is true? The __________
A. SML has unsystematic risk on the horizontal axis.
B. SML has systematic risk on the vertical axis.
C. CML has systematic risk on the horizontal axis.
D. CML has total risk on the horizontal axis.
37. If two stocks have positive covariance, which of the following statements is true?
A. The rates of return tend to move in the same direction relative to their
individual means.
B. If one stock doubles in price, the other will also double in price.
C. The two stocks must be in the same industry.
D. The two stocks will create a perfectly diversified portfolio.
38. When the market is in equilibrium __________
A. All assets plot on the CML.
B. Stock betas converge to one.
C. All assets plot on the SML.
D. Investors own 100% of the market portfolio.
39. Which one of the following invests in a portfolio that is fixed for the life of the
fund?
A. Mutual fund.
B. Money market fund.
C. Managed investment company.
D. Unit investment trust.
40. The correlation coefficient between stocks A and B is 0.75. The standard deviation
of stock A’s returns is 16% and the standard deviation of stock B’s returns is
22%.
What is the covariance between stock A and B?
A. 0.0264
B. 0.0352
C. 0.3750
D. 0.7272
41. The market portfolio consists of all __________
A. Stocks on the Nigerian Stock Exchange.
B. High grade stocks and bonds.
C. Stocks and bonds.
D. Risky assets.
42. Which type of investment fund is commonly known to invest in options and
futures in large scale?
A. Commingled funds.
B. Hedge funds.
C. ETFs.
D. REITS.
43. Securities X and Y are perfectly negatively correlated. X has standard deviation of
20% and Y has standard deviation of 25%. You have N500,000 to invest. If you
desire to build a risk-free portfolio, using the two securities only, how much
should you invest in X?
A. N225,000
B. N220,000
C. N275,000
D. N280,000
44. Given the following information:
State of Economy
Excellent
Wonderful
Probability
0.4
0.6
What is the expected return?
A. 20%
B.
5%
C. 10%
D.
8%
Rate of Return
20%
0%
45. When identifying undervalued and overvalued assets, which of the following
statements is false?
A. An asset is properly valued if its estimated rate of return is equal to its
required rate of return.
B. An asset is considered overvalued if its estimated rate of return is below its
required rate of return.
C. An asset is considered undervalued if its estimated rate of return is above its
required rate of return.
D. An asset is considered overvalued if its required rate of return is below its
estimated rate of return.
46. Stock A has standard deviation of 5% and Stock B has a standard deviation of
7.5%. If the stocks are perfectly positively correlated, which portfolio weights
minimize the portfolio’s standard deviation?
Stock A
A. 100%
B.
0%
C. 63%
D. 37%
Stock B
0%
100%
37%
63%.
47. Secondary markets are important because __________
A. The prevailing market price of securities is determined in the secondary
market.
B. It has an impact on price stability.
C. It has an impact on price continuity.
D. New securities are being issued.
48. Which of the following is not considered to be an investment constraint?
A. Liquidity needs.
B. Risk tolerance.
C. Time horizon.
D. Tax concerns.
49. Assume that a stock market index has standard deviation of 0.18. A particular
stock in the market has standard deviation of 0.27. What can be the highest
possible beta for the stock?
A. 0.67
B. 1.00
C. 1.50
D. 0.90
50. A stock has a quarterly simple return of 8%, what is the annual return?
A. 32%
B. 2%
C. 36.05%
D. 54.60%
51. In a price weighted average stock market indicator series, which of the following
types of stock has the greatest influence?
A. The stock with the highest price.
B. The stock with the lowest price.
C. The stock with the highest market capitalization.
D. The stock with the lowest market capitalization.
52. All else equal, as the correlations of returns among a set of securities increase,
will a portfolio composed of those securities most likely experience an increase in
expected ___________
A.
B.
C.
D.
Return?
No
No
Yes
Yes
Risk?
No
Yes
No
Yes
53. The ability to sell an asset quickly at a fair price is associated with ___________
A. Business risk.
B. Liquidity risk.
C. Exchange rate risk.
D. Financial risk.
54. In a two stock portfolio, if the correlation coefficient between two stocks were to
decrease over time everything else remaining constant the portfolio's risk would
____________
A. Decrease.
B. Remain constant.
C. Increase.
D. Fluctuate positively and negatively.
55. When using a regression model to evaluate the return on an individual asset, the
asset’s systematic risk is estimated using the ____________
A. Efficient frontier.
B. Characteristic line.
C. Capital market line.
D. Security market line.
56. An investor has an equal amount invested in each of the following four securities:
Security Expected Annual rate of Return
W
0.10
X
0.12
Y
0.16
Z
0.22
The investor plans to sell Security Y and use the proceeds to purchase a new
security that has the same expected return as the current portfolio.
What will be the expected return for the investor’s new portfolio, compared to the
current portfolio?
A. Lower regardless of changes in the correlation of returns among securities.
B. The same regardless of changes in the correlation of returns among
securities.
C. Lower only if the correlation of the new security with Securities W, X and Z is
lower than the correlation of Security Y.
D. The same only if the correlation of the new security with Securities W, X and
Z is lower than the correlation of Security Y.
57. Which of the following would be inconsistent with an efficient market?
A. Information arrives randomly and independently.
B. Stock prices adjust rapidly to new information.
C. Price changes are independent.
D. Price adjustments are biased.
58. An analyst has gathered the following data about a stock:
A Beta of 1.25
An actual return of 10.5%
The market rate of return is 6%
The stock’s risk-adjusted abnormal return is ___________
A. 2%
B. 3%
C. 4%
D. 5%
59. The basic trade-off in the investment process is ___________
A. Between the anticipated rate of return for a given investment instrument and
its degree of risk.
B. Between understanding the nature of a particular investment and having the
opportunity to purchase it.
C. Between high returns available on single instruments and the diversification
of instruments into a portfolio.
D. Between the desired level of investment and possessing the resources
necessary to carry it out.
60. Risk that cannot be diversified away is called ___________
A. Company specific risk.
B. Unsystematic risk.
C. Systematic risk.
D. Total risk.
61. The net asset value of a mutual fund investing in stock rises with ___________
A. Higher stock prices.
B. Lower equity values.
C. An increased number of shares.
D. Increased liabilities.
62. Investing in foreign securities has which of the following significant risk(s)?
A. Foreign exchange risk.
B. Diversification risk.
C. Accounting risk.
D. (A) and (B) above.
63. An investor is trying to discover whether a stock is over-or undervalued in the
market using the capital asset pricing model (CAPM). The beta on the stock is
0.8, the risk-free rate is 5 percent and the market risk premium is 6 percent. She
expects the holding period return on the stock to be 11 percent.
Which of the following statements is true?
A. The stock is overvalued based on the CAPM.
B. The stock is undervalued based on the CAPM.
C. The stock is properly valued based on the CAPM.
D. The CAPM cannot tell us whether a stock is over or under valued.
64. An investor has a portfolio with 10 percent cash, 30 percent bonds and 60
percent stock. If last year’s return on cash was 2.0 percent, the return on bonds
was 9.5 percent, and the return on stock was –32.5 percent, what was the return
on the investor’s portfolio?
A. 33.33%
B. -7.00%
C. -16.45%
D. -33.33%
65. The risk/return performance measure that shows a portfolio’s average excess
return (compared to the riskless asset) divided by the standard deviation of its
returns is known as (the) __________
A. Sharpe ratio.
B. Mean absolute deviation.
C. Information ratio.
D. Coefficient of variation.
66. An analysis has gathered the following information:
JACKSON PLC ANNUAL STOCK PRICES
2010
2011
2012
2013
15%
22%
-6%
10%
What is the geometric mean return over the 4-year period?
A. 9.75%
B. 10.25%
C. 14.21%
D. It cannot be determined because of the negative return in 2012.
67. A risk-neutral investor ___________
A. Is more concerned about the expected return on his investment, not the risk
involved.
B. Is not concerned about the risk-return profile of an investment at all.
C. Is more concerned about the level of risk of his investment, not the expected
return.
D. Has a preference for risk.
68. If abnormal returns are consistently available only to those with private
information, then the market is ____________
A. Inefficient.
B. Weak form efficient.
C. Semi-strong form efficient.
D. Strong form efficient.
69. To achieve maximum diversification in a two-asset portfolio, investors should
choose stocks with correlation of __________
A. +1.0
B. 0
C. +0.5
D. None of the above.
70. Which of the following statements best describes an investment not on the
efficient frontier?
A. There is a portfolio that has a lower risk for the same return.
B. There is a portfolio that has a lower return for the same risk.
C. The portfolio has very high risk.
D. The portfolio has a very high return.
Commodity Trading and Futures (71 - 100)
71. Which of the following statements is true?
A. A futures contract does not incur obligations to buy or sell an asset.
B. A future is standardized.
C. A future always requires delivery of an asset.
D. A long future is the equivalent of a long put and short call at the same
exercise price.
72. What should be included in the calculation of a soy bean future’s fair value?
I.
II.
III.
IV.
Storage costs.
Margin payment.
Market sentiment.
Brokers fees.
A.
B.
C.
D.
I only.
I and II only.
I and III only.
All of the above.
73. Which of the following factors affects the price of coffee the most?
A. Subsidies.
B. Weather.
C. Taxes.
D. Import duties.
74. In terms of risk and reward what is the position of the holder of an option?
A. Upside known, downside unknown.
B. Upside unknown, downside unknown.
C. Upside known, downside known.
D. Upside unknown, downside known.
75. Sugar is less affected by the weather than other agricultural commodities because
__________
A. Supply is controlled by the Sugar Co-operation Agreement.
B. It is produced from more than one crop.
C. Developed countries set high tariffs.
D. Substitution is possible.
76. If Nigeria was to
impact on prices
A. Prices would
B. Prices would
C. Prices would
D. Prices would
introduce a tariff on all exports of cocoa, what would be the
on the international markets?
fall.
rise.
become more volatile.
stay the same.
77. A farmer wishing to lock into a fixed sales price for his future wheat harvest
would __________
A. Buy a future.
B. Buy a call.
C. Sell a future.
D. Buy a put.
78. An investor has bought a commodity which she now believes is going to fall in
price. Which two of the following would be appropriate trades?
I.
II.
III.
IV.
Long call.
Short call.
Long put.
Short put.
A.
B.
C.
D.
I and II only.
I and III only.
II and IV only.
II and III only.
79. The process of marking-to-market ___________
A. Posts gains or losses to each account daily.
B. May result in margin calls.
C. Impacts only long positions.
D. (A) and (B) above.
80. The terms of futures contracts __________ standardized, and the terms of
forward contracts __________ standardized.
A. Are; are.
B. Are not; are.
C. Are; are not.
D. Are not; are not.
81. A hedge in which the asset underlying the futures is not the asset being hedged
is __________
A. None are correct.
B. A cross hedge.
C. A basis hedge.
D. An optimal hedge.
82. A put option has a strike price of N35. The price of the underlying stock is
currently N42. The put is _________
A. Out of the money.
B. In the money.
C. Near the money.
D. At the money.
83. For which of the following commodities would storage be considered a very minor
cost?
A. Copper.
B. Milk.
C. Lumber.
D. Crude oil.
84. Which of the following costs would you not consider when assessing the value of a
commodity and its future prices?
A. Finance costs.
B. Storage costs.
C. Insurance costs.
D. Dis-economies of scale costs.
85. A market participant who is looking to exploit risky profit making opportunities in
a market are classified as which of the following?
A.
B.
C.
D.
Commercial hedger.
Speculator.
Arbitrageur.
None of the above.
86. How are obligations under a forward contract usually closed out?
A. By agreement with the original counterparty to the trade.
B. By entering into an equal and offsetting trade with another counterparty.
C. Through the exchange.
D. By net cash settlement via the clearing house.
87. Which of the following is not a common use of futures?
A. Hedging.
B. Speculating.
C. Crushing.
D. Arbitraging.
88. The terms of futures contracts such as the quality and quantity of the commodity
and the delivery date are _________
A. Specified by the buyers and sellers.
B. Specified only by the buyers.
C. Specified by the futures exchanges.
D. Specified by brokers and dealers.
89. A futures hedge position may not give full protection against adverse price
movements because __________
A. The basis may change.
B. Cash prices and futures prices usually move in unison.
C. The various futures months do not trade at the same price.
D. Transportation costs vary from one area to another.
90. Agricultural futures contracts are actively traded on __________
A. Corn.
B. Oats.
C. Pork bellies.
D. All of the above.
91. You sold one wheat future contract at N3.04 per bushel. What would be your
profit (loss) at maturity if the wheat spot price at that time were N2.98 per
bushel? Assume the contract size is 5,000 ounces and there are no transactions
costs.
A. 30 profit.
B. 300 profit.
C. 300 loss.
D. 30 loss.
92. Open interest includes ___________
A. Only long or short positions but not both.
B. Only contracts with a specified delivery date.
C. The sum of short and long positions.
D. The sum of short, long and clearinghouse positions.
93. The current portfolio is short ten calls (call delta = 0.4). How can this portfolio be
made delta neutral?
A. Buy four futures.
B. Buy ten futures.
C. Sell ten futures.
D. Sell four futures.
94. Which of the following best describes a contango market?
A. A market where the near prices are higher than far prices.
B. A market where the far prices are higher than near prices.
C. A market where prices are constant.
D. A market where the prices increase or decrease by a constant amount.
95. An investor buys a call option with a strike of 100 for a premium of 6. He also
sells the underlying asset for 101. What is the maximum profit of this strategy?
A. 94
B. 95
C. 96
D. 97
96. A future is trading below the cash price, which of these statements is true?
A. The basis is rising.
B. The market is in contango.
C. The cost of carry is negative.
D. The basis is narrowing.
97. Margin in a futures transaction differs from margin in a stock transaction
because ____________
A. Stock transactions are much smaller.
B. Delivery occurs immediately in a stock transaction.
C. No money is borrowed in a futures transaction.
D. Futures are much more volatile.
98. Normal backwardation ____________
A. Maintains that for most commodities, there are natural hedgers who desire to
shed risk.
B. Maintains that speculators will enter the long side of the contract only if the
futures price is below the expected spot price.
C. Assumes that risk premiums in the futures markets are based on systematic
risk.
D. (A) and (B) above.
99.
Variation margin is called on all futures and certain options positions. Variation
margin represents which of the following?
A. The worst probable one-day loss on a position.
B. The actual profit or loss in a position each day.
C. The anticipated profit or loss in a position each day.
D. The level set at two-thirds of the initial margin.
Total = 100 marks