CIS September 2013 Exam Diet
Examination Paper 2.3:
Derivative Valuation and Analysis
Portfolio Management
Commodity Trading and Futures
Level 2
SECTION A: MULTIPLE CHOICE QUESTIONS
Derivative Valuation and Analysis (1 – 12)
1.
Which of the following strategies will be profitable if the price of the underlying
asset is expected to decrease?
A. Buying a put.
B. Selling a call.
C. Selling a put.
D. (A) and (B) above.
2.
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 12%.
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. 3,870
B. 3,840
C. 3,696
D. None of the above.
3.
An option writer writes a 6-month naked call option on a stock at a premium of
N3 and the strike price of N150. The prevailing market price of the stock is N130.
If on the expiration day the price of the stock is N140, then the profit/loss to the
option writer will be __________
A. N10 profit.
B. N7 loss.
C. N3 profit.
D. N10 loss.
4.
With two call options available, you decide to construct a bull-call spread. The
first option has an exercise price of N30 at a premium of N2, and the second call
has an exercise price of N40 with a premium of N0.50. If at expiration, the
underlying asset price closes at N45, what is the most that you can profit from
this trade?
A. N10.00
B. N8.50
C. N11.50
D. N8.00
5.
Which of the following strategies is (are) appropriate?
I.
If a borrower has a fixed-rate debt and is expecting interest rates to rise, the
borrower should not enter into a swap.
II. If an investor has floating rate assets and is expecting interest rates to rise,
the investor should enter into a swap in order to receive fixed and pay float.
III. If a borrower has floating rate debt and is expecting interest rates to rise, the
borrower should enter into a swap in order to receive float and pay fixed.
IV. If an investor has fixed income assets and is expecting interest rates to drop,
the investor should enter into a swap in order to receive float and pay fixed.
A.
B.
C.
D.
I and III only.
I, III and IV only.
I and II only.
II and IV only.
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6.
Which of the following statements are true?
I.
II.
III.
IV.
Basis = Futures price plus current cash price.
Generally basis is low for contracts with longer maturity.
The basis for normal markets usually exhibits convergence.
Basis is also a valuable indicator for predicting future spot prices of the
commodities that underlie the futures contract.
A.
B.
C.
D.
I and II only.
I and III only.
II and IV only.
III and IV only.
7.
Currently, the NSE ASI 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
8.
Party A has entered a currency forward contract to purchase N10 million at an
exchange rate of N165.98 per dollar. At settlement, the exchange rate is N165.97
per dollar. If the contract is settled in cash, Party A will __________
A. Make a payment of N100,000
B. Receive a payment of N100,000
C. Receive a payment of N103,090
D. Make a payment of N103,090
9.
Which of the following statements is (are) true with respect to option Rhos?
I.
II.
III.
IV.
Rho increases as the level of interest rates increase.
Rho is high if a call option is deep in-the-money.
Rho is low if a put option is deep in-the-money.
One the expiry date of the option, rho will be equal to zero.
A.
B.
C.
D.
I and III only.
II, III and IV only.
I and II only.
II and IV only.
10. A type of option where the payoff depends on whether the underlying asset’s
price reaches a certain level during a certain period of time is referred to as
___________
A. Compound option.
B. Chooser option.
C. Barrier option.
D. Binary option.
11. Which of the following statements is least likely an advantage of swaps? Swaps
__________
A. Have little or no regulation.
B. Have customized contracts.
C. Minimize default risk.
D. None of the above.
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12. Which of the following investment strategies has unlimited profit potential?
A. Protective put.
B. Bull spread.
C. Writing a call.
D. Covered call.
Portfolio Management (13 – 28)
13. Assume that the per-share prices of a common stock are N40, N50 and N60 for
three days. What are the average price, the standard deviation and the coefficient
of variation for the stock?
A. N50, N10, 0.20
B. N50, N10, 0.30
C. N40, N20, 0.40
D. N60, N20, 0.50
14. Which of the following statements is true?
I. In a strong form efficient market, there are no mispriced assets.
II. In a strong form efficient market, all information is equally available to all
investors.
A.
B.
C.
D.
I only.
II only.
All of the above.
None of the above.
15. According to the Arbitrage Pricing theory, the value of the firm-specific factor is
expected to be, on average ___________
A. Greater than the value of the common factors.
B. Zero.
C. More important than the value of the common factors.
D. Negative.
16. Considering the single-index model, the alpha of a share is 0%, the return on the
market index is 16% and the risk-free rate of return is 5%. The stock earns a
return that exceeds the risk-free rate by 11% and there are no firm-specific
events affecting the share performance. The β of the share is ____________
A. 1.0
B. 0.75
C. 2.0
D. 1.50
17. The risk-free rate for the next year is 3%, and the market risk premium is
expected to be 10%. The beta of Acme’s stock is 1.5. If you believe that Acme’s
stock will actually return 18.2% over the next year, then according to the CAPM
you should ____________
A. Buy the stock because it is overpriced.
B. Buy the stock because it is under priced.
C. Sell the stock because it is under priced.
D. Be indifferent between buying and selling the stock.
18. To take advantage of an arbitrage opportunity, an investor would ___________
I.
Short sell the asset in the low-priced market and buy it in the high-priced
market.
II. Construct a zero investment portfolio that will yield a sure profit.
III. Make simultaneous trades in two markets without any net investment.
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IV. Construct a zero beta investment portfolio that will yield a sure profit.
A.
B.
C.
D.
I and IV only.
I and III only.
II and III only.
I, III and IV only.
19. To achieve maximum diversification in a two-asset portfolio, investors should
choose stocks with correlation of _____________
A. +1.0
B. –0.5
C. +0.5
D. –1.0
20. Suppose two portfolios have the same average return, the same standard
deviation of returns, but portfolio X has a higher beta than portfolio Y. according
to the Sharpe measure, the performance of portfolio X __________
A. Is the same as the performance of portfolio Y.
B. Is better than the performance of portfolio Y.
C. Is poorer than the performance of portfolio Y.
D. Cannot be measured as there is no data on the alpha of the portfolio.
21. Which of the following is not normally included as one of the advantages of real
estate as an investment?
A. Liquidity.
B. Cash flow from operations.
C. Possible appreciation in value.
D. Diversification opportunities.
22. Which type of fund invests in debt securities with very short maturities?
A. Certified fund.
B. Money market mutual fund.
C. Bond fund.
D. Growth fund.
23. Which of the following is not an advantage of investing in bonds?
A. Bondholders receive their payments before shareholders can be
compensated.
B. Bond investments are relatively safe from large losses.
C. Bonds are good sources of current income
D. Bonds have unlimited profit potential.
24. The opportunity to defer investing to a later date may have value because
____________
A. The cost of capital may decline in the near future.
B. Uncertainty may be reduced in the future.
C. Investment costs fluctuate in time.
D. Market conditions may change and increase the NPV of the project.
25. Given the following information about portfolio “omega” below:
Average portfolio return
Portfolio standard deviation
Risk free rate of return
Portfolio beta
10%
2%
5%
0.1
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Which of the following statements is/are correct about the portfolio’s performance
measures?
A. Sharpe index is 4
B. Treynor index is 0.5
C. Jensen Alpha is 10%
D. (A) and (B) above.
26. If stock returns exhibit positive but small serial correlation, this means that
____________ returns tend to follow _____________ returns.
A. Positive; positive.
B. Large positive; small positive.
C. Small negative; large negative.
D. Negative; positive.
27. A mutual fund portfolio manager _____________
A. Has the authority to hold until a specified return is achieved.
B. Decides on the asset allocation.
C. Allocates investment portfolios to funds in asset classes.
D. Chooses stocks advantageously within the asset class.
28. Which of the following is true about mortgage-backed securities?
I. They aggregate individual home mortgages into homogeneous pools.
II. The purchaser receives monthly interest and principal payments received
from payments made on the pool.
III. The banks that originated the mortgages maintain ownership of them.
IV. The banks that originated the mortgages continue to service them.
A.
B.
C.
D.
II, III and IV only.
I, II and IV only.
II and IV only.
I, III and IV only.
Commodity Trading and Futures (29 – 40)
29. To exploit an expected increase in interest rates, an investor would most
likely ____________
A. Sell Treasury bond futures.
B. Take a long position in wheat futures.
C. Buy index futures.
D. Take a long position in Treasury bond futures.
30. Metals and energy currency futures contracts are actively traded
on ____________
A. Gold.
B. Silver.
C. Propane.
D. All of the above.
31. You sold one silver future contract at N3 per ounce. What would be your profit
(loss) at maturity if the silver spot price at that time is N4.10 per ounce? Assume
the contract size is 5,000 ounces and there are no transactions costs.
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A.
B.
C.
D.
5.50 profit.
5,500 profit.
5.50 loss.
5,500 loss.
32. Which of the following are true of European-style option?
I.
II.
III.
IV.
They
They
They
They
are
are
are
are
only traded on European exchanges.
traded on European and American exchanges.
exercisable at any time during a specified period.
exercisable only at expiry.
A.
B.
C.
D.
I and III only.
II and IV only.
III and IV only.
II and III only.
33. 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.
34. What type of derivative contract would a commodity producer use to fix a net
future price?
A. Contract for difference.
B. Forward.
C. Option.
D. Swap.
35. Which of these is a true statement in relation to exchange-traded and over-thecounter (OTC) products?
A. Both offer formal market places.
B. Each contract is individually negotiated.
C. Liquidity does not pose problem in either market.
D. A formal margining process does not exist in the OTC market in contrast to
exchange-traded products.
36. All of the following could be considered to be significant influences on commodity
price, except __________
A. Weather.
B. Tariffs.
C. Interest rate.
D. Substitution.
37. An investor wants to sell when the market reaches a trigger below the current
level although they are prepared to sell higher. Which is the best order to place to
reflect this view?
A. Stop order.
B. Stop limit.
C. Guaranteed stop.
D. Sell MIT.
38. If two parties to a future contract agree to transact away from the exchange to
close out future positions this may be an example of a transaction described as
______________
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A.
B.
C.
D.
Against actuals.
Against physical.
Against regulations.
OTC transactions.
39. When the futures prices trades below the exercise prices the put option is known
as being ___________
A. At the money.
B. In the money.
C. Out of the money.
D. On the money.
40. Which of the following commodities are most impacted by seasonality factors,
such as frost and drought?
A. Lumber.
B. Barley.
C. Live hogs.
D. Natural gas.
SECTION B: SHORT ANSWER QUESTIONS
Question 2 – Derivative Valuation and Analysis
Explain the relationship between a call option value and the following:
2(a) Share price.
(1 mark)
2(b) Exercise price.
(1 mark)
2(c) Interest rate.
(1 mark)
Question 3 – Portfolio Management
List four benefits of investing in a mutual funds rather than directly in the stockmarket.
Question 4 – Commodity Trading and Futures
(4mark
s)
Briefly explain the concept of “long hedge” in the commodities market with a simple
example.
(3 marks)
SECTION C: ESSAY TYPE, CALCULATION AND/OR CASE STUDY QUESTIONS
Question 5 – Derivative Valuation and Analysis
Consider that a non-dividend paying stock of a company is currently trading with a spot
price of N60. From historical data, it is concluded that the stock exhibits a standard
deviation of the returns of 20%. Assume that the simple risk free rate prevailing in the
economy is 0.5%.
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5(a)
The theoretical 3-month ‘at the money’ call option price of the stock is N2.42.
What should be the price of a put option with the same characteristics on the
same stock? Consider the options being European.
(3 marks)
5(b)
How much would you profit if you buy a 3-month call option contract as
mentioned in 5(a) above and held it till maturity if the stock price increases to
N65 on that day? Consider the contract size to be 200 [i.e. 1 contract refers to
200 shares]. (Ignore transaction costs).
(3 marks)
5(c)
What does the delta of the option refer to? Calculate the delta of the call option
and of the put option as referred in 5(a) above. Discuss the two values.
(5 marks)
5(d)
What does the rho of the option refer to? Now assuming that the risk-free
interest rate increases from 0.5% to 0.75%, explain how the call option price
would react?
(No calculations required)
(3 marks)
Question 6 – Portfolio Management
You are the chief financial officer at a chocolate producing company and have just
entered a contract to deliver a large amount of Choco (a chocolate drink) to Mr. Biggs
in six months.
You know that your firm will be purchasing 2,000 metric tons of cocoa in five months. A
five-month futures contract on cocoa is trading at N100,000 per metric ton, and each
contract is for 10 metric tons.
If the cost of cocoa is N100,000 per metric ton in five months, you anticipate a profit of
N20 million – based on a fixed revenue of N520 million, N300 million in costs
regardless of the cocoa price, and N200 million in costs to purchase the cocoa.
6(a)
Derive the profit/loss equation from this contract with Mr. Biggs with respect
to future cocoa prices, and graphically illustrate the profit and loss from
purchasing one five-month cocoa futures contract.
(6 marks)
6(b)
How could you completely hedge the cocoa price risk? Demonstrate your
results graphically.
(4 marks)
6(c)
Discuss the costs and benefits for your company of hedging with futures
contracts.
(4 marks)
6(d)
Suppose that your company was confident that cacao prices were going to be
very stable, and your assistant suggested not to hedge price movements but
to speculate on a stable cocoa price instead. Can this be done with options? If
so, describe two strategies to achieve this.
(4 marks)
6(e)
How do you view the suggestion in 6(d) above by your assistant to speculate
on cocoa price?
(2 marks)
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Question 7 – Commodity Trading and Futures
You are a Commodities Broker who has just attended a training course on Commodities
Trading and Futures organized by the Chartered Institute of Stockbrokers. Several
concepts and trading strategies extensively discussed at the training course particularly
caught your attention, and motivated you to study more on the subject.
In today’s Business Day, you read this statement in an article on option strategies in
the commodities market: “The synthetic long stock is an option strategy entered by
buying at-the-money calls and selling an equal number of at-the-money puts of the
same underlying stock and expiration date”.
7(a)
Illustrate the potential risk and return of the synthetic long stock strategy using
a pay-off diagram.
(5 marks)
7(b)
Other terms frequently used in the commodities market also featured in the
article.
Briefly explain the following underlisted terms:
7(b1)
7(b2)
7(b3)
7(b4)
Front running.
Cash and carry arbitrage.
Cash settlement.
Position limits.
(3 marks)
(3 marks)
(3 marks)
(2 marks)
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