CHARTERED INSTITUTE OF STOCKBROKERS
QUESTIONS
Examination Paper 2.3
Derivative Valuation and Analysis
Portfolio Management
Commodity Trading and Futures
Professional Examination
March 2014
Level 2
SECTION A: MULTI CHOICE QUESTIONS
Derivative Valuation and Analysis (1 – 12)
1.
A U.S. company enters into a currency swap in which it pays a fixed rate of 5.5%
in Euros and the counter party pays a fixed rate of 6.75% in dollars. The notional
principals are $100 million and £116.5 million. Payments are made semi-annually
and on the basis of 30-days per month and 360 days per year.
What are the semi-annual payments for the domestic and counter party?
A. £3,203,750; $3,375,000
B. £3,375,000; $3,375,000
C. £3,375,000; $3,450,000
D. $3,203,750; £3,375,000
2.
Which of the following combinations of options and underlying investments have
similarly shaped profit/loss diagrams?
A. Covered call and short stock/long call.
B. Covered call and protective put.
C. Long call option/short put option and long stock position.
D. Short put option/long call option and protective put.
3.
A stock is selling at N40, a 3-month put at N50 is selling for N11, a 3-month call
at N50 is selling for N1, and the risk-free rate is 6%. How much, if anything, can
be made on an arbitrage?
A. N0.28
B. N0.72
C. N2.83
D. N0 (no arbitrage opportunity).
4.
Which of the following is most representative of forward contracts and contingent
claims?
A.
B.
C.
D.
5.
Forward contract
Premium paid at inception
Premium paid at inception
No premium paid at inception
No premium paid at inception
Contingent claims
Premium paid at inception.
No premium paid at inception
Premium paid at inception.
No premium paid at inception.
By buying a put option, an investor can ___________
I.
Avoid selling a security on which she has large capital gains and yet
participate in additional gains if the security continues to increase in price
II. Avoid selling a security which she has large capital gains and be assured that
she can sell the security at its strike price during the term of the option
III. Protect a profit on her current stock position
A.
B.
C.
D.
I and II only.
I and III only.
II and III Only.
All of the above.
6.
Given the following information:
Stock price
Time to expiration
Risk-free rate
Standard deviation
d1
N42
0.25
0.055
0.50
0.375161
What is the value of d2 as it is used in the Black-Scholes Option Pricing Model?
A. 0.021608
B. 0.125161
C. 0.175608
D. 0.200161
7.
You are the owner of a N4 million portfolio with a beta of 1.0. You would like to
insure your portfolio against a fall in the index of magnitude higher than 15%.
The index currently stands at 4,200. Put options on the index are available at
three strike prices.
Which strike will give you the insurance you want?
A. 3,570
B. 3,840
C. 3,696
D. 3,400
8.
On the 1st of June 2013, Azonto bought 1,000 binary call options on the NSE ASI
Index with exercise price of 1,650. The options carry a N100 multiplier and are
due to expire on 20 July 2013.
What is the total payoff if exercise-settlement value of NSE ASI index is 1,600 at
the day before expiration date?
A. 0
B. N100,000
C. N500,000
D. N5,000,000
9.
Currently, the S&P500 Index is at 856.50 and the annualized risk free rate is
6.2%. If the annualized dividend on the index is N13.54, what should be the
futures price on the current 6-month stock index future? (Ignore the effects of
the timing of dividends).
A. 885.43
B. 859.54
C. 864.51
D. 876.28
10. A/an _____________is similar to a "pass through" security, but it assigns
different combinations of risk and return to various investor groups.
A. Bank loan sale.
B. Loan participation.
C. Collaterized mortgage obligation.
D. Securitized Loan.
11. Which of the following statements is true of the long strangle option strategy
depicted below?
Profit
or
Loss
LONG STRANGLE
$0
Stock Price at
expiration
The position has _____________
A. Unlimited risk, but limited profit potential
B. Limited risk and limited profit potential.
C. Limited risk, but unlimited profit potential.
D. Unlimited risk and unlimited profit potential.
12. Consider a $2 million FRA with a contract rate of 5% on 60 LIBOR. If 60-day
LIBOR is 6% at settlement, the long will __________
A. Pay $3,333
B. Receive $3,333
C. Receive $3,300
D. Pay $3,400
Portfolio Management (13 – 28)
13. A stock has a beta of the stock is 1.1. The risk free rate is 2.5% and the return
on the market is 12%. The estimated return for the stock is 14%. According to
the
CAPM you should _________
A. Sell because required return is 9.95%
B. Sell because required return is 16.5%
C. Buy because required return 11.5%
D. Buy because required return is 12.95%
14. Considering two perfectly negatively correlated risky securities A and B, A has an
expected rate of return of 10% and a standard deviation of 16%. B has an
expected rate of return of 8% and a standard deviation of 12%.
The weights of A and B in the global minimum variance portfolio are ___ and ___
respectively.
A. 0.24; 0.76
B. 0.50; 0.50
C. 0.57; 0.43
D. 0.43; 0.57
15. A market timing approach that increases the proportion of funds in stocks when
the stock market is expected to be rising, and increases cash when the stock
market is expected to be falling is a __________
A. Strategic asset allocation.
B. Tactical asset allocation.
C. Portfolio optimization.
D. Liquidity expectation timing.
16. Which of the following is not an advantage of mutual funds?
A. They offer a variety of investment styles.
B. They offer small investors the benefits of diversification.
C. They treat income as "passed through" to the investor for tax purposes.
D. None of the above.
17. Assume that you have just purchased some shares in an investment company
reporting N500 million in assets, N50 million in liabilities, and 50 million shares
outstanding. What is the Net Asset Value (NAV) of these shares?
A. N12.00
B. N9.00
C. N10.00
D. N1.00
18. An individual in the consolidation phase of the investment life cycle would most
likely____________
A. Have retired and would seek to preserve the real value of their investments.
B. Have enough income to cover expenses and excess assets would be used to
benefit charities and family.
C. Be past the midpoint of their careers and have excess earnings that can be
invested in moderately risky investments.
D. Be in the early to middle stage of their career, have a small net worth and
long investment time horizon.
19. Hedge funds are _________ transparent than mutual funds because of
_________ strict SEC regulation.
A. More; less.
B. Less; more.
C. Less; less.
D. More; more.
20. Suppose you currently manage a N50 million bond portfolio with duration of 10.
Suppose also that the T. bond futures contract has duration of 12.50 and a price
of 997/32 with face value of N1,000. What position in futures contracts that will
completely negate long-term interest risk exposed?
A. Long 411 contracts.
B. Short 40,315 contracts.
C. Long 40,315 contracts.
D. Short 411 contracts..
21. Which of the following statements is/are true?
I. Beta of the market is 1 and the beta of the risk-free security is zero.
II. The beta of a portfolio is the arithmetic sum of all individual asset betas.
III. The beta is a measure of the systematic risk.
A.
B.
C.
D.
I and III only.
I and II only.
II and III only.
All of the above.
22. Given the data below on three mutual funds and the market:
Fund
AAA
BBB
CCC
Market
Beta
0.75
1.05
0.89
1.00
Standard
Deviation (%) Return (%)
7.0
14
5.0
18
8.0
20
8.0
12
Rf (%)
3
3
3
3
What is the Sharpe Measure for the AAA fund?
A. 4.49
B. 2.74
C. 1.57
D. 1.70
23. A portfolio that incurs the smallest risk for a given level of return is called
________
A. The efficient frontier.
B. The optimal portfolio.
C. The efficient portfolio.
D. The market portfolio.
24. A manager who uses the mean-variance theory to construct an optimal portfolio
will satisfy __________
A. Investors with low risk-aversion coefficients.
B. Investors with high risk-aversion coefficients.
C. Investors with moderate risk-aversion coefficients.
D. All investors, regardless of their level of risk aversion.
25. A stock has gradually gone from being a growth stock to a value stock to a cheap
value stock. We can safely assume that in the case of this stock, ___________
A. The P/E ratio has been constant, but high.
B. The P/E ratio has been decreasing.
C. The P/E ratio has been increasing.
D. The P/E ratio has been constant, but low.
26. If you expect the price of Security X will be 5 times the current price in 5 years
and Security Y will be 10 times the current price in 10 years, then ___________
A. Security X provides a higher annual return than Security Y.
B. Security Y provides a higher annual return than Security X.
C. Security X provides the same annual return as Security Y.
D. We need more information.
27. At every time, in a Constant Proportion Portfolio Insurance (CPPI) strategy, the
cushion is __________
A. The value of the portfolio part invested in bonds.
B. The value of the portfolio part invested in stocks.
C. The portfolio insured value.
D. None of the above answers is correct.
28. An analyst gathered the following information about two common stocks:
 Variance of returns for the B Ltd = 15.5
 Variance of returns for the T Ltd = 22.3
 Covariance between returns of B Ltd and T Ltd = 8.65
The correlation coefficient between returns for the two common stocks is closest
to____________
A. 0.025
B. 0.388
C. 0.465
D. 0.645
Commodity Trading and Futures (29 – 40)
29. A futures contract for 5,000 bushels of wheat has a futures price of N0.62 per
bushel. The cost of carry is 1.5 percent. If at maturity the spot price is N0.60 per
bushel, upon maturity the holder of the ___________
A. Long position will have a positive cash flow of N53.50
B. Short position will have a positive cash flow of N153.50
C. Long position will have a positive cash flow of N100.00
D. Short position will have a positive cash flow of N100.00
30. For a given futures contracts, the futures price has been less than the expected
spot price and gradually converging to the spot price. The term for this situation
is _________
A. Contango.
B. Normal backwardation.
C. An arbitrate opportunity.
D. None of the above.
31. What is the term used when a trader sells a put option and buys a matching call
option, both with the same strike and expiry?
A. Arbitrage.
B. Bull spread.
C. Contango.
D. Synthetic long.
32. Which of the following trades would you recommend to a risk-averse investor
anticipating a rise in market volatility?
A. Long straddle.
B. Short strangle.
C. Bull spread.
D. Long call.
33. The following information reflects current market prices and rates:
Palm oil price = N5,000
Palm oil future price = N5,250
Risk-free rate = 4.5%
Storage costs = 1.0%
Days to expiry = 365
Assume simple interest.
What trade would be undertaken?
A. Buy futures and palm oil and put money on deposit.
B. Borrow money and buy palm oil and sell the future.
C. Do nothing, as professional arbitragers would remove any potential profit you
would make.
D. Sell the palm oil future as it overpriced.
34. A manufacturer is concerned about the cost of copper rising. He wants to protect
against this and is willing to give up some of the benefit of a fall in price. Which of
these trades is most appropriate?
A. A cap.
B. A swaption.
C. A floor.
D. A collar.
35. Assume the following for a particular precious metal:
*Risk free interest rate
*Spot price
*Forward price
*Expiration
5.50%
N174
N172
6 months.
What is the basis for the forward contract?
A. N2
B. N5.50
C. N1.95
D. N2.95
36. What is actually swapped in a commodity swap?
A. The physical commodity for a floating cash payment.
B. The physical commodity for a fixed cash payment.
C. The net of a floating payment linked to the commodity price and a fixed price.
D. A floating interest rate for a fixed interest rate.
37. In which commodity market is buyer power most likely to be used?
A. Livestock.
B. Gold.
C. Softs.
D. Agricultural.
38. In which one of the following ways do OTC traded products differ from exchangetraded contracts?
A. Liquidity is better.
B. Contract specifications are more flexible.
C. Counterparty risk is greater.
D. Transactions cost are higher.
39. What will be the effect on the price of gold future, if the implied volatility of gold
price increases all else being equal?
A. No effect.
B. The price will be lower.
C. The price will be higher.
D. We don’t have enough information to answer.
40. Suppose the soybean market is in backwardation with cash price of 1,040/bushel
and a futures price of N960/bushel. Also assume that a trader owns 5,000
bushels of soybeans and does not need the soybeans until after futures
expiration. Which of the following is the best strategy for the trader?
A. Do nothing sine the convenience yield is so high.
B. Sell the soybeans in the spot market, buy an appropriate futures, and profit
N400,000
C. Sell the soybeans in the spot market, buy an appropriate futures and profit
N200,000
D. None of the above.
Total = 40 marks
SECTION B: SHORT ANSWER QUESTIONS
Question 2 – Derivative Valuation and Analysis
WAZOBIA Plc has just issued N100m 18% convertible loan stock at par. They are
convertible at any time up to redemption on the basis of 50 shares for N100 debenture
stock. Calculate the conversion price and the conversion ratio.
(3 marks)
Question 3 – Portfolio Management
The CBN Governor was suspended on Monday evening. By the close of trading the next
day (Tuesday), the NSE All Share Index had nosedived significantly in response to this.
Required:
What attribute of the capital market does this depict?
Explain.
(4 marks)
Question 4 – Commodity Trading and Futures
Identify and briefly explain factors that affect the spot price of a storable asset.
(3 marks)
SECTION C: ESSAY TYPE, CALCULATION AND/OR CASE STUDY QUESTIONS
Question 5 – Derivative Valuation and Analysis
5(a) A portfolio manager outperformed the market in the recent quarters of the bull
market on the floor of the Nigerian Stock Exchange. His portfolio has a beta ()
of 1.8. He expects some volatility in the market in the next quarter or two and
therefore wishes to lower his portfolio beta () to 0.85.
How many NSE ASI Index contracts are needed if the value of his portfolio is
N200m and the NSE ASI futures sells for N6,500.00 (Note: contract multiplier =
500)
(4 marks)
5(b) Assume that the following 6-month European options on the NSE 30 Index are
available for both purchase and sale, as shown in the table below:
Strike price
Call premium (in N)
Put premium (in N)
400
115
6
500
48
36
600
15
100
Mr. Rochas, a wealthy investor, thinks that the index volatility will decrease and
therefore decides to sell 1 put with an exercise price of N400 and to sell 1 call
with an exercise price of N600
5(b1) Calculate the initial investment of this strategy [named short strangle].
(2 marks)
5(b2) Write down the payoff of this strategy at maturity under two scenarios: (i)
if the Index value at maturity happens to be N700 and (ii) if the index
value at maturity is N450.
(4 marks)
5(b3) Draw a graph that shows the profit/loss of the strategy at expiration (per
index unit). Label the axes and mark the relevant levels. Do not consider
interest on option premium.
Comment on the potential risk and return of this strategy.
(4 marks)
0
Question 6 – Portfolio Management
6(a) Ema K is a portfolio manager at Abaco & Associates, which specializes in
providing advice to clients about their overall asset allocation strategy. For all of
his clients, Ema manages portfolios that lie on the Markowitz efficient frontier.
Ema asks Amaka J, a senior analyst at Abaco, to review the portfolio of two of his
clients, Quality Flooring Ltd (QFL) and Rainbow Life Insurance Co (RLI). The
expected returns of the two portfolios are substantially different. Using the
assumptions of capital market theory, Amaka determines that the RLI portfolio is
the market portfolio and concludes that the RLI portfolio is superior to the QFL
portfolio.
6(a1) State whether you agree or disagree with Amaka’s conclusion that the RLI
portfolio is superior to the QFL portfolio. Justify your response with one reference
to the Capital Market Line.
(3 marks)
6(a2) Ema remarks that the RLI portfolio has a higher expected return because it
has greater unsystematic risk than QFL’s portfolio.
Explain your understanding of unsystematic risk. State whether you agree
or disagree with Ema’s remark and justify your response with one reason.
(4 marks)
6(b)
The research unit of Abaco & Associates has developed the information in the
following table:
Forecast Returns, Standard Deviations, and Betas
Forecast
Standard
Betas
Return
Deviation
Stock X
14%
36%
0.8
Stock Y
17%
25%
1.5
Market index
14%
15%
1.0
Risk-free rate
5%
6(b1)
Calculate expected return and alpha for each stock.
(4 marks)
6(b2)
Identify and justify Which stock would be more appropriate for an
investor who wants to:
6(b2) (i) Add this stock to a well-diversified equity portfolio.
(3 marks)
6(b2) (ii)
Hold this stock as a single-stock portfolio.
(2 marks)
6(c) Finally, Ema is reviewing the performance of two stocks K and P, in his portfolio.
You have the following details concerning the two stocks
Stock
Expected
Current
Market Price
Return
K
12.20%
N22.50
P
17.20%
N15.00
If both stocks are expected to pay a dividend of N0.75 during the coming year,
what is the expected price of each stock one year from now?
(4 marks)
Question 7 – Commodity Trading and Futures
7(a) At the end of March 2013, the following data on spot and futures prices was
observed on Raw cocoa and Raw Coffee:
Commodity
Spot (March 2013)
July 2013
October 2013
Cocoa (N/kg)
90,000
89,500
87,900
Coffee(N/kg)
25,000
26,200
26,800
7(a1) As can be seen, the trend in futures is decreasing for Raw Cocoa and
increasing for Raw coffee with respect to the month left to delivery. How
do you describe these situations in the commodities market? Explain the
difference in the trends using the hedging pressure theory.
(5 marks)
7(a2) Which of the two commodity futures provides a positive roll yield? How can
an investor benefit from a positive roll yield?
(3 marks)
7(b) Explain the following in relation to the practice of commodities trading and
futures:
7(b1) Cost of carry.
(2 marks)
7(b2) Riskless arbitrage.
(3 marks)
7(b3) Maintenance margin.
(3 marks)