CIS September 2012 Diet
Examination Paper 2.3:
Derivatives Valuation Analysis
Portfolio Management
Commodity Trading and Futures
Derivative Valuation and Analysis (1 – 12)
1.
The domestic one year risk free interest rate is 10%, the current spot exchange rate
with a particular foreign currency is 1.00, and a one year futures contract on the
foreign currency has a price of 1.05 domestic units per unit of foreign currency.
Assuming continuous compounding, which of the following rates is closest to the oneyear risk free interest rate in the foreign currency?
A. 5.12%
B. 10.24%
C. 15.36%
D. 20.48%
2.
Which of the following is true with respect to credit-linked notes?
A. They are issued as zero coupon bonds.
B. They are bonds that return the par value to the investor in the event of default
or downgrade.
C. They are bonds that pay a higher coupon rate to the investor compared with
similar bonds with no credit linkage.
D. They are bonds that can be put back to the issuing firm in the event of a default
or downgrade.
3.
Which of the following comes closest to the fair price on a 6-month futures contract
on the NSE All Share Index, given the following information?
o An index at 1,500
o The risk free rate at 5%
o Dividend yield at 1%
A.
B.
C.
D.
4.
N1,530
N1,545
N1,560
N1,590
You are given the following information:
The current price to buy one share of XYZ stock is 500.
The stock does not pay dividends.
The risk-free interest rate, compounded continuously, is 6%.
A European call option on one share of XYZ stock with a strike price of K that
expires in one year costs 66.59.
o A European put option on one share of XYZ stock with a strike price of K that
expires in one year costs 18.64.
o
o
o
o
Using put-call parity, what is the strike price, K?
A. 449
B. 480
C. 559
D. 582
5.
Which of the following statements least accurately describes the characteristics of an
interest rate swap?
A. To convert a floating-rate loan into a fixed-rate loan, a company should enter
into an interest rate swap in which it would receive a floating rate and pay a
fixed rate.
B. The fixed rate in an interest rate swap is usually quoted as a spread above a
similar maturity Treasury security.
C. Netting is almost always used when computing the payment made on settlement
dates.
D. A plain vanilla refers to the swap in which both parties' commitments are
determined by separate floating rates.
6.
Which of the following statements is false with respect to the term margin and how
it's used in the securities market and the futures market?
A. In both the securities and the futures market, the margin implies that the return
to the investor will be higher than the return generated by the underlying asset.
B. In the futures market, margin is expressed as a percentage of the cost of the
underlying asset.
C. In the securities market, margin implies that the investor has financed a part of
the cost of acquiring an asset by borrowing.
D. In the futures market, margins are posted to avoid contract defaults.
7.
Currently, there is a put option available for trade. Its exercise price is N50 and its
time to maturity is three months. Which of the following statements is most
accurate?
A. If the price of the underlying asset rises to N58.00, the short put option will
have an intrinsic value that's worth N8.00
B. If the price of the underlying asset rises to N58.00, the long put option will have
an intrinsic value that's worth N8.00
C. If the price of the underlying asset drops below N50.00, the short put position
will expire unexercised.
D. If the price of the underlying asset drops to N42.00, the long put option will
have an intrinsic value that's worth N8.00
8.
Which of the following statements least accurately describes interest rate caps and
floors?
A. For either a cap or a floor, its price is simply equal to the sum of its component
parts.
B. For either a cap or a floor, an exercise implies that all its components are
exercised.
C. Interest rate caps are a series of interest rate calls.
D. In general, the exercise rates of each of the components of a cap or a floor are
the same.
9.
Consider an asset that has a spot price of N650. The asset has a monthly dividend
yield of 0.15%. Storage and insurance cost are 0.3% per month and the monthly Tbill rate is 0.67%. What is the futures price for a 9-month contract?
A. N705.63
B. N715.13
C. N699.57
D. N680.58
10. 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.
11. 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
B. N0.28
C. N0.78
D. N0.82
12. The diagram below illustrates the payoff of which of the following strategies?
Payoff
ST
K
A.
B.
C.
D.
Short call.
Short put.
Straddle.
Long put.
Portfolio Management (13 – 28)
13. The APT differs from the CAPM because the APT:
A. Places more emphasis on market risk.
B. Recognizes multiple systematic risk factors.
C. Recognizes multiple unsystematic risk factors.
D. Minimizes the importance of diversification.
14. If you believe in the ________ form of the EMH, you believe that stock prices reflect
all relevant information including historical stock prices and current public
information about the firm, but not information that is available only to insiders.
A. Semi strong.
B. Strong.
C. Weak.
D. All of the above.
15. __________ focus more on past price movements of a firm's stock than on the
underlying determinants of future profitability.
A. Credit analysts.
B. Fundamental analysts.
C. Systems analysts.
D. Technical analysts.
16. Studies of positive earnings surprises have shown that there is ___________
A. A positive abnormal return on the day a positive earnings surprise is announced.
B. A positive drift in the stock price on the days following the earnings surprise
announcement.
C. A negative drift in the stock price on the days following the earnings surprise
announcement.
D. (A) and (B) above.
17. The Sharpe, Treynor, and Jensen portfolio performance measures are derived from
the CAPM:
A. Therefore, it does not matter which measure is used to evaluate a portfolio
manager.
B. However, the Sharpe and Treynor measures use different risk measures;
therefore the measures vary as to whether or not they are appropriate,
depending on the investment scenario.
C. Therefore, all measure the same attributes.
D. (A) and (B) above.
Use the following information to answer questions 18 and 19.
You have the following information about the assets and liabilities of a pension fund:
Variable
Equities
Bonds
Liabilities
Initial value N million
60
60
100
Expected return
10.0%
5.0%
5.0%
18. What is the pension fund’s surplus return?
A. 0%
B. 4%
C. 5%
D. 10%
19. What is the fund’s funding ratio?
A. 50%
B. 60%
C. 83.33%
D. 120%
20. Exchange rate risk__________
A. Results from changes in the exchange rates in the currencies of the investor and
the country in which the investment is made.
B. Can be hedged by using a forward or futures contract in foreign exchange.
C. Cannot be eliminated.
D. (A) and (B) above.
21. Assume that you manage a N1.3 million portfolio that pays no dividends, has a beta
of 1.45 and an alpha of 1.5% per month. Also, assume that the risk-free rate is
0.025% (per month) and the NSE All Share Index is at 1220. If you expect the
market to fall within the next 30 days you can hedge your portfolio by ______ NSE
All Share Index futures contracts (the futures contract has a multiplier of N250).
A. Selling 1
B. Selling 6
C. Buying 1
D. Buying 6
22. Deferral of capital gains tax:
I.
II.
III.
IV.
Means that the investor doesn't need to pay taxes until the investment is sold.
Allows the investment to grow at a faster rate.
Means that you might escape the capital gains tax if you live long enough.
Provides a tax shelter for investors.
A.
B.
C.
D.
II and III only.
I, II, IV only.
I, III and V only.
II, III and IV only.
23. A portfolio consisting of 150 highly uncorrelated securities most likely:
A. Has a high beta.
B. Can have a large portion of its movement explained by movements in the
market index.
C. Has a low degree of systematic risk.
D. Has a low degree of unsystematic risk.
24. How is the information ratio defined? It is ___________
A. The ratio of the standard deviation of the portfolio divided by the standard
deviation of the benchmark.
B. The ratio of the average return on the portfolio less the risk free rate all divided
by the standard deviation of returns on the portfolio.
C. The ratio of the average return on long positions divided by the average return
on short positions.
D. The ratio of the average return on the portfolio less the average return on the
benchmark divided by the standard deviation of the returns difference between
the fund and the benchmark (i.e. the standard deviation of tracking error).
25. Ms. Samuel estimates the covariance between Stock A and Stock B to be 0.471. The
variance of Stock A is estimated at 0.516, and the variance of Stock B is estimated
at 0.609. Which of the following comes closest to the correlation coefficient between
the stocks?
A. 0.94
B. 0.89
C. 0.84
D. 0.79
26. 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.
27. The performance of an internationally diversified portfolio may be affected by:
A. Currency selection.
B. Country selection.
C. Stock selection.
D. All of the above.
28. You are given the following information about Portfolio A:
Average return
Standard deviation
Portfolio beta
Risk-free rate of return
10%
2%
0.5
5%
What are the Treynor Index and Sharpe Index of Portfolio A respectively?
Treynor
Index
A. 5.0
B. 2.6
C. 2.5
D. 3.6
Sharpe
Index
0.2
0.8
0.1
2.0
Commodity Trading and Futures (29 – 40)
29. On September 22, a speculator decides to go long two December Live Cattle futures
at N92.53. Three weeks later he shorts two December Live Cattle futures at
N91.20. What is his net profit or loss? (1 contract = 400 lbs).
A. N532 loss.
B. N1,064 profit.
C. N1,064 loss.
D. N532 profit.
30. In the emission market, the “grandfathering provision” means rights to emit are
allotted to companies_________
A. In proportion to their historical emissions.
B. According to the agreement reached.
C. In line with volume of their operations.
D. In proportion to the rates of pollutants emitted.
31. You are given the following information about a commodity traded in the futures
market:
N
Current cash price of underlying
1,450
Current futures price
1,497
Fair value for the futures
1,485
What kind of trade would an arbitrageur execute?
A. Box.
B. Cash and carry arbitrage.
C. Reverse cash and carry arbitrage.
D. Basis trade.
32. Which of the following statements is/are incorrect with respect to liquidity in
commodity markets?
I. In a liquid market, it is easy to trade without incurring excessive costs.
II. Liquidity represents the market’s ability to absorb sudden shifts in demand and
supply without dramatic change in price.
III. One of the features of a liquid market is the existence of a wide difference
between the bid and offer price.
IV. There is high price elasticity of demand in a liquid market.
A.
B.
C.
D.
I only III only.
II and III only.
II and IV only.
III and IV only.
33. Crude oil is defined by which of the following primary factors?
I. Field of origin.
II. Sulphur content.
III. Convertibility.
A.
B.
C.
D.
I and II only.
I and III only.
II and III only.
All of the above.
Use the following information to answer questions 34 and 35:
You were bullish on Corn in February when June Corn futures on the Abuja Commodity
Exchange were selling for N700 per bushel and so you went long on a Corn futures
contract. Contract multiplier is 10,000.
34. If the margin requirement is 12 percent, what is the initial margin money deposit?
A. 745,000
B. 840,000
C. 950,000
D. 655,000
35. If in April, the price of June Corn futures is N780 per bushel. What is the profit or
loss you will make, if the round trip commission payable per contract is N240,000 per
contract?
A. N450,000 loss.
B. N480,000 loss.
C. N560,000 profit.
D. N590,000 profit.
36. Which of the following is true about a short futures position?
I. A trader in this position commits to sell at a pre-agreed price.
II. The risk to the trader is maximized when the value of the underlying at expiry
falls to zero.
III. The reward to the trader is theoretically unlimited.
IV. The lower the price of the underlying at expiry the higher the profit made by the
trader.
A.
B.
C.
D.
I only III only.
II and III only.
I and IV only.
III and IV only.
37. One of the following is not true of freight and shipping market:
A. Most of the freight and shipping market is done on an OTC basis.
B. Freight and shipping as commodities are not storable.
C. Freight and shipping contracts can be cleared via the clearing house.
D. Prices are determined largely by factors other than supply and demand.
38. The current fair value of an asset is N31. The risk-free rate is 10%. The premium on
a 30 strike call is N3 and on a 30 strike put is N1. Both options expire in one year.
Which of the following strategies should be used?
A. Buy call and sell put.
B. Sell call and buy put.
C. Buy call and buy put.
D. Sell call and sell put.
39. If hedging were not possible, which of the following effects would be seen on the
commodities markets?
A. Increased price volatility.
B. Higher commodities prices.
C. Less efficiency by processors and manufacturers.
D. All of the above.
40. Which of the following is an example of churning?
A. A futures broker assures his customer that selling gold futures short is a sure
thing.
B. An oil company that is long crude oil repeatedly repurchases its futures
contracts.
C. An inverted market converts to a normal market and back again within six
months.
D. A registered representative (or broker) encourages a customer to make many
futures transactions in order to increase commissions.
Total = 40 marks
Question 2 – Derivative Valuation and Analysis
Differentiate between credit risk and prepayment risk in Asset Backed Securities.
(3 marks)
Question 3 – Portfolio Management
Mention and briefly explain four common features of alternative investments such as real
estate, private equities, commodities, e.t.c.
(4 marks)
Question 4 – Commodity Trading and Futures
Why is the price of electricity more volatile than other energy sources in a deregulated
market?
(3 marks)
Question 5 – Derivative Valuation and Analysis
You have just been employed by one of the top International banks and you have
responsibility to manage the portfolios of the following clients:
Client P
She requires a call option on 8,000 ordinary shares in Guinness Plc. The option is a
European option and will be exercisable in 3 months time. An exercise price of N150 has
been requested.
The following data is available:
Current share price of Guinness
Risk free interest rate
Standard deviation (volatility) of Guinness shares
N180
10% pa
50% pa
Client Q
He owns 20,000 shares in Guinness Plc and, because of the current market uncertainty,
wishes to construct a risk less hedge for these shares.
Client R
He wishes to purchase a European put option on 4,000 Guinness shares, exercise price
N150 for 3 month exercise.
5(a)
Calculate the value/premium of the call option on 8,000 shares in Guinness for
client P, using the Black-Scholes valuation model.
(8 marks)
5(b)
Demonstrate for client Q how a delta hedge could be constructed to protect his
position using call options.
(3 marks)
5(c)
Calculate the premium you would quote to client R for a put option on 4,000 shares
in Guinness.
(4 marks)
Question 6 – Portfolio Management
6(a) You have divided the market in 4 portfolios following 2 dimensions: Value/Growth
and Small/Large. The weight of each portfolio in the index is given. The risk free rate
is 2%. Furthermore, you have designed the following model:
Portfolios
Small value
Weight Sensitivity to Sensitivity to Sensitivity to
Factor I
Factor II
Factor III
(Market beta) (Price/Book) (Average
capitalization)
5%
0.85
0.8
1
Small growth
5%
0.95
1.3
1
Large value
40%
0.9
2
8
Large growth
Risk premium
50%
1.1
8%
3
-2%
10
0.10%
Note: Multifactor Model of Arbitrage Pricing Theory:
E(Ri) RFR [bi1F1t bi2 F2t . . . biK FKt]
6a1) When using the Arbitrage Pricing Theory (APT), which portfolio has the highest
expected return? Show your calculations.
(5 marks)
6a3) One of your competitors uses the CAPM. Based on the betas above, which
portfolio will he choose to maximize his expected return?
(3 marks)
6a4) In order to diversify his perceived risk, another competitor wants to combine
the Small Value and the Large Growth Portfolios. The new portfolio should have
an overall sensitivity to Factor I (market beta) of 1. Show how much the
competitor must invest in Small Value and how much in Large Growth. The
portfolio must be fully invested and without any short sale.
(3 marks)
6(b) Your client is a wealthy individual who has a N7 million well-diversified portfolio of
stocks tracking closely the NSE 30 index. To profit from the recent increase in
volatility, your client sells 20 at-the-money index call options with a maturity of 3
months. The NSE 30 index currently stands at 3,500 and has an implied volatility of
30% per annum. The risk-free interest rate is 4% (with continuous compounding)
and no dividend will be paid during the next 3 months. Each call option is N100 times
the value of the Index. For this sale of option your client receives a total premium of
N452, 154.
Required:
What will be the return of your client’s portfolio if the index falls to 3,000 or goes to
4,000 at the maturity date of the options? Assume that the premiums initially
received are not invested. Comment upon your results.
(6 marks)
Question 7 – Commodity Trading and Futures
7(a) You have been invited as a speaker to the ‘Finance Week’ organized by the
undergraduate students of one of the Nigerian Universities to deliver a paper on
‘Futures Markets and Trading’.
In introducing your paper you are expected to briefly explain the following concepts
in the commodities market for the students to understand.
7a1) Contract for Differences.
(2 marks)
7a2) Fill or Kill Order.
(2 marks)
7a3) Open Interest.
(2 marks)
7a4) Time value of commodity option.
(2 marks)
7(b) A trader is bullish on coffee. He buys the 550 call and pays a premium of 37. At the
same time he sells the 600 call, and receives a premium of 19.
7b1) What type of option strategy is this, and what is the motivation for using it?
(2 marks)
7b2) Assume that at expiry, the price of coffee rises to 605, what is the pay-off of
this strategy? Calculate and also illustrate with a payoff diagram.
(5 marks)
END OF PAPER
FORMULAE
1)
Black and Scholes Options pricing model:
;
2)
General cost of carry relationship:
2)
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:
9) Binomial Option Valuation Model:
10)
;