CIS March 2011 Exam Diet
Examination Paper 1.3:
Derivatives Valuation Analysis
Portfolio Management
Commodity Trading and Futures
Level 1
Derivative Valuation and Analysis (1 -18)
1.
Which of the following statements is true regarding a call option writer?
A. He has the right but not an obligation to buy an underlying asset.
B. He has the right but not an obligation to sell an underlying asset.
C. He has the right but not an obligation to deliver the underlying asset if the call is
exercised.
D. He has an obligation to deliver the underlying asset if the call is exercised.
2.
Which of these derivative instruments is/are not a type of contingent claim?
I. Options.
II. Forward contract.
III. Futures.
A.
B.
C.
D.
3.
I only
I and II only
II and III only
I,II and III
Which of the following factors influence the theoretical future prices?
I.
II.
III.
IV.
Underlying spot price.
The risk free rate.
Time to expiration of the futures contract.
The strike price.
A.
B.
C.
D.
I only
I and II only
I,II and III only
II, III and IV only
4.
The price at which the buyer of a put option can sell the stock during the life of the
option is called:
A. Strike price.
B. Bid price.
C. Call price.
D. All of the above.
5.
What is the price the buyer pays the writer (seller) for an option contract?
A. Premium.
B. Spot price.
C. Cash.
D. Difference between the spot price and strike price.
6.
When the strike price is the same as the price of the underlying instrument, the
option is said to be:
A. Parity value.
B. Intrinsic value.
C. At the money.
D. Out of the money.
7.
The amount an option would command if it were to be exercised immediately is
called:
A. Intrinsic value.
B. Option value.
C. Time value.
D. Option premium.
8.
Which of the following is a benefit provided by the futures market?
A. It encourages speculation and profitable enterprise.
B. It allows for a more efficient distribution of commodities.
C. It increases the liquidity of futures contracts.
D. Both B and C.
9.
Which of these measures the sensitivity of option price to changes in interest rates?
A. Rho.
B. Vega.
C. Delta.
D. Theta.
10.
The designation for all the puts and calls options on the same stock is called:
A. Option series.
B. Option class.
C. Combinations.
D. Spreads.
11.
An
A.
B.
C.
D.
12.
Which of these is not a feature of derivative instruments?
A. They are highly leveraged.
B. They could be very complex.
C. They could be risky for small investors.
D. None of the above.
13.
Prior to expiration, an American put option on a stock:
A. Would sell for less than its intrinsic value.
B. Would never sell for less than its intrinsic value.
C. Would sell for its intrinsic value.
D. None of the above.
14.
Which of the following variables is not required to value options using the Black and
Scholes option pricing model?
A. Volatility of the stock price.
B. Risk-free rate of interest.
C. The expected return on the underlying stock.
D. Time to maturity.
15.
Which of the following strategies would you advise against the most if you were
expecting stock prices to appreciate significantly?
A. Writing calls without actually owning the underlying asset.
B. Writing a put while owning the underlying asset.
C. Longing a futures contract.
D. Writing a put without actually owning the underlying asset.
16.
Consider a non-dividend paying stock with a spot price of N50. A 6-month European
call with a strike price of N50 costs N4. A European put with the same expiration
date and strike price costs N3.50. The continuously compounded risk-free rate is 4%
per annum. The volatility of the stock is 25% per year. What can you conclude?
A. Nothing can be determined from this information.
B. There is an arbitrage opportunity because the put is overpriced.
C. There is an arbitrage opportunity because the put is underpriced.
D. There is no arbitrage opportunity.
option that can be exercised only at the end of its life is referred to as:
American option.
Asian option.
Bermudan option.
European option.
17.
If the expected dividend rate on a stock market index increases while the index level
remains the same, the price of a futures contract should:
A. Decline.
B. Remain unchanged.
C. Increase.
D. Temporarily increase and then drift back to equilibrium.
18.
Which of the following option trades, when combined with owning the underlying
asset, would constitute a portfolio "insurance" strategy?
A. Selling a put on the underlying asset.
B. Buying a put on the underlying asset.
C. Selling a call on the underlying asset.
D. Buying a call on the underlying asset.
Portfolio Management (19 - 42)
19.
The return of a portfolio consisting of n assets depends on which of the following?
I. Weight of each asset in the portfolio.
II. Return of each asset in the portfolio.
III. Correlations between the assets.
A.
B.
C.
D.
I and II only
I and III only
II and III only
I, II and III
20.
The holding period return (HPR) on a share of stock is equal to:
A. The capital gain yield minus the inflation rate over the period.
B. The capital gain yield plus the dividend yield over the period.
C. The current yield plus the dividend yield.
D. The dividend yield plus the risk premium.
21.
Which of the following best distinguishes between covariance and correlation
coefficient?
A. Covariance indicates the extent to which two assets move together or apart.
B. Correlation coefficient is the expected product of the deviations of two variables.
C. Covariance is the square root of the correlation coefficient.
D. Correlation coefficient is scaled and bounded between +1 and -1.
22.
Consider the following two investments with the given expected returns and standard
deviations:
Expected Return
Investment A
0.10
Standard
Deviation
0.07
Investment B
0.15
0.09
Which is the riskier investment based on the coefficient of variation?
A. Investment A.
B. Investment B.
C. Both are equally risky.
D. Insufficient data to conclude.
23.
Which of the following least accurately compares the Sharpe and Teynor ratios?
A. Both ratios contain excess return in the numerator.
B. Both ratios express a measure of return per unit of some measure of risk.
C. The Sharpe ratio is based on total risk while the Treynor ratio is based on
systematic risk.
D. The Sharpe ratio is the inverse of the Treynor ratio.
24.
Which of the following is NOT a typical investor constraint in the investment policy
statement?
A. Tax concerns.
B. Expected cash flow patterns.
C. Risk tolerance.
D. Liquidity needs.
25.
According to the capital asset pricing model (CAPM), what should we expect the
value of “alpha” or abnormal return to be equal to?
A. The risk free rate.
B. The risk premium.
C. Zero.
D. The “normal” return.
26.
In a well diversified portfolio, which type of risk is negligible?
A. Firm-specific risk.
B. Beta risk.
C. Market risk.
D. Systematic risk.
27.
The efficient frontier is the set of possible investment portfolios that:
A. Have the minimum variance of all possible combinations.
B. Have the maximum return of all possible combinations.
C. Have equal weights in every risky security.
D. Have the maximum return for any given level of risk.
28.
Diversification is most effective when security returns are:
A. High.
B. Negatively correlated.
C. Positively correlated.
D. Uncorrelated.
29.
Passive portfolio management techniques assume that
A. The demand and supply of shares not included in the portfolio is not in
equilibrium.
B. The capital market is not in equilibrium.
C. The capital market is in equilibrium.
D. The market portfolio beta is equal to portfolio beta.
30.
Which of the following statements is/are not true in respect of the semi-strong form
of market efficiency?
I. Company size helps in forecasting returns.
II. Excess return can be realized by technical analysis.
III. The beta of the company helps in forecasting the future returns.
A.
B.
C.
D.
I only
I and II only
II and III only
I, II and III
31.
Which statement with respect to risk aversion is misleading?
A. Sometimes the bonds issued by a company can require a rate of return that is
higher than that required from its common shares.
B. The security market line always slopes upward.
C. While the market portfolio includes all securities, it does not mean that the
required rate of return from the market portfolio sets the ceiling for all other
required rates of return.
D. For a given level of return, investors would choose the security that has the
lowest standard deviation.
32.
With regard to asset allocation, choose the incorrect statement:
A. The Asset allocation decision involves deciding the percentage of investable
funds to be placed in stocks, bonds, and cash equivalents.
B. Differences in asset allocation will be the key factor over time causing differences
in portfolio performance.
C. It is the second most important decision made by investors in the portfolio
management process, security selection being the most important.
D. How asset allocation decisions are made by investors remains a subject that is
not fully understood.
33.
Which of the following statements is (are) true with respect to the portfolio
management process?
A. Individuals generally define risk in term of standard deviation.
B. The investment horizon for investors in the accumulation phase will be the
longest relative to the other phases.
C. The level of return that the investor desires will determine how much risk that
the investment manager should take.
D. The investment horizon is deemed to end at the investor's age of death.
34.
You expect ABC shares to earn a return of 11% over the long term. ABC has had a
fairly consistent beta of 1.35. If Treasury bills are yielding 6.3% and the market risk
premium is 4.9%, which of the following would best describe this situation?
A. ABC shares are underpriced.
B. ABC shares are overpriced.
C. ABC shares are fairly priced.
D. Impossible to compute since the market risk premium cannot be lower than the
risk free rate of return.
35.
Which of the following statements about performance attribution is true?
A. It does not require the identification of a benchmark of performance.
B. It seeks to distinguish the factors responsible for the portfolio’s overall
performance.
C. It is typically a bottom-up approach.
D. It analyses two basic factors: allocation effect and risk management effect.
36.
The measure of risk for a security held in a diversified portfolio is;
A. Specific risk.
B. Standard deviation of returns.
C. Reinvestment risk.
D. Covariance.
37.
A random walk occurs when:
A. Stock price changes are random but predictable.
B. Stock prices respond slowly to both new and old information.
C. Future price changes are uncorrelated with past price changes.
D. Past information is useful in predicting future prices.
38.
According to the efficient market hypothesis:
A. High-beta stocks are consistently overpriced.
B. Low-beta stocks are consistently overpriced.
C. Positive alphas on stocks will quickly disappear.
D. Negative alpha stocks consistently yield low returns.
39.
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.
40.
Index futures are used for which of these purposes?
A. To hedge against rising share prices.
B. To hedge against falling prices.
C. For adjusting the beta of a stock portfolio.
D. All of the above.
41.
Which of the following statements is (are) true with respect to risk aversion and its
implications for the investment process?
A. The longer an investor's time horizon, the greater the proportion of more risky
assets will be included in the portfolio.
B. The greater the correlation among asset classes, the greater will be the variety
of assets found in an optimal portfolio.
C. Risk averse investors are not willing to take any risk.
D. The utility curve for risk neutral investors is downward sloping.
42.
A stock that is relatively unaffected by the general fluctuations in the economy can
be characterized as:
A. A cyclical stock.
B. Having high unsystematic risk.
C. Having no unsystematic risk.
D. None of the above.
Commodity Trading and Futures (43 - 60)
43.
Trading simultaneously in one asset in two different markets to profit from short time
mispriced system is called:
A. Market-to-market.
B. Arbitrage.
C. Open interest.
D. None of the above.
44.
The difference between the spot price and the nearby futures price of an asset is:
A. Contango.
B. Fair value.
C. Basis.
D. Delivery.
45.
A speculator who believes that the price of a particular investment will fall is called a:
A. Bear.
B. Bull.
C. Speculator.
D. Trader.
46.
‘Circuit breakers’ imposed by an exchange that places limit to absolute price
movements on the futures contract on any day is called:
A. Position limits.
B. Margin limits.
C. Price limits.
D. Variation limits.
47.
An option that gives the buyer the right but not the obligation to buy the underlying
asset at an agreed price within a specific time for a premium is called:
A. Put option.
B. Asian option.
C. Call option.
D. Both A and C.
48.
Method of settlement where the underlying asset is not exchanged is called _______
A. Cash settlement.
B. Spot price.
C. Delivery of underlying.
D. Both A and C.
49.
A market where futures prices are higher than the spot price because of a positive
cost of carry is called:
A. Contango.
B. Backwardation.
C. Swaption.
D. None of the above.
50.
The contract involving the exchange of difference between the agreed price and the
closing price of the underlying investment in cash settlement is called:
A. Cash settlement.
B. Contract for the difference.
C. Combination.
D. None of the above.
51.
The cost of holding an asset over time is called:
A. Cost of asset.
B. Cost of carry.
C. Intrinsic value.
D. None of the above.
52.
A May soybean contract is selling for N4.30. A May N4.10 soybean futures call option
has what intrinsic value?
A. N0.40/bu
B. N0.30/bu
C. N0.20/bu
D. N0.10/bu
53.
A customer is long one contract of feeder cattle (40,000 lbs.) at N0.74 per
pound. She initially invests N10,000. If the price change is 1.5%, the percentage of
change in her investment would be:
A. 2.7%
B. 5.9%
C. 8.3%
D. 4.4%
54.
Consider a trader who has entered into a long Copper futures contract. Now if he
wants to close his futures position, he should:
A. Purchase the underlying asset at the spot market.
B. Short a similar futures contract on the underlying asset.
C. Sell the underlying asset at the spot market.
D. Go long in another similar contract on the underlying asset.
55.
For no arbitrage profit (excluding transaction costs), at expiration the price of the
future contract should be:
A. Less than the spot price.
B. More than the spot price.
C. Equal to the spot price.
D. Insufficient data.
56.
An equity index spot price is 1000 points; the simple risk free rate is 6% p.a.; no
dividends are to be paid during the coming 30 days. Based on this index, what is the
price of the futures contract maturing in 1 month?
A. 940 points.
B. 995 points.
C. 1005 points.
D. 1060 points.
57.
In comparing forward contracts with futures contracts, which of the following
statements is/are correct?
I.
II.
III.
A.
B.
C.
D.
Forward contracts have default risk to be borne by each counterparty.
Forward contracts are more traded on organized secondary markets.
Forward contracts are more liquid.
I only
II only
I and II only
I, II and III
58.
Whenever delivery notices are given by the seller, who identifies the buyer to whom
the notice may be assigned.
A. The clearing house.
B. The buyer.
C. The exchange.
D. The seller.
59.
An investment strategy involving buying a security and at the same time selling calls
against it is called:
A. Arbitrage.
B. Covered call.
C. Buy call.
D. Buy put.
60.
The closing price of the underlying commodity on the last trading day of the futures
contract is referred to as:
A. Market price.
B. Final settlement price.
C. Auction price.
D. Daily settlement price.
Total = 60 marks
Question 2 - Derivative Valuation and Analysis
2(a) List three reasons why derivatives are considered risky instruments.
(1½ marks)
2(b) Briefly explain the concept of cheapest-to-deliver bond.
(1½ marks)
Question 3 – Portfolio Management
3(a) What is the capital market line?
(2 marks)
3(b) Briefly explain how time horizon could be an investment constraint to individual
investors
(2 marks)
Question 4 – Commodity Trading and Futures
What do you understand by hedging in the futures market? Give an example.
(3 marks)
Question 5 - Derivative Valuation and Analysis
You are given the following information about an European call option:
Underlying stock price - N68.5
Exercise price
- N65
Risk-free rate (continuously compounded) - 4%
Time to expiration
- 110 days
Volatility
- 0.38
(Note: find below the Black-Scholes formula).
5(a) Using the Black-Scholes valuation model, determine the price of the European call
option.
(4 marks)
5(b) By exploring the put-call parity relationship, determine the price of a put option on
the same stock, at N65 exercise price and expiring in 110 days.
(4 marks)
5(c) Briefly explain the meaning of option delta.
(2 marks)
Question 6 - Portfolio Management
The results of two portfolios X and Y, along with the market portfolio are given below:
Return
Volatility
Beta
Portfolio X
15%
30%
1.4
Portfolio Y
10%
22%
1.2
8%
18%
1
Market
The risk-free rate is 6%.
6(a) Between portfolio X and Y, which one dominates the other?
(2 marks)
6(b) Verify whether the return on portfolio Y is in line with the CAPM model.
(3 marks)
6(c) Using the Treynor Ratio, rank the three portfolios in order of performance.
(6 marks)
Question 7 - Commodity Trading and Futures
7(a) The current price of gold is N45,000 per ounce. Consider the net cost of carry of gold
to be zero. The risk-free interest rate is 6%. What should be the price of a gold
futures contract that expires in 90 days?
(2 marks)
7(b) Assuming the futures contract is priced at N46,500, is there an arbitrage
opportunity? Illustrate how an arbitrage trade could be executed?
(4 marks)
7(c) Briefly explain the following terms in relation to the futures market:
7(c1) Clearing house.
(1 mark)
7(c2) Variation margin.
(1 mark)
7(c3) Cash settlement.
(1 mark)
END OF PAPER
FORMULAE
1)
Black and Scholes Options pricing model:
;
2)
2)
General cost of carry relationship:
3)
Continuous time cost of carry relationship:
4)
Determinants of Options Price:
5)
Correlation/Covariance:
6)
Static portfolio insurance using put option:
7)
Hedging with Stock Index Futures:
8)
Risk adjusted performance measures:
;