CIS September 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 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 reduces the liquidity of futures contracts.
D. All of the above.
2.
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.
3.
What is the time value of a call option on a stock trading at N45 and priced at N5
with strike price of N41.00?
A. N2.00
B. N1.00
C. N4.00
D. N3.00
4.
In the futures market, the clearing house does all of the following EXCEPT:
A. Receive margin deposits from brokers.
B. Decide which contract will trade.
C. Set initial and maintenance margin.
D. Act as the counter party to every trade.
5.
What is the impact of arbitrage in the long term?
A. It prevents market efficiency.
B. It ensures profit higher than the risk free rate of return.
C. It enhances risk management.
D. It prevents two assets with identical payoffs from selling at different prices.
6.
Which of the following most accurately describes a derivate security?
It is an instrument that:
A. Has a payoff based on another asset.
B. Has no risk.
C. Always increases risk.
D. Has no expiration date.
7.
The difference between American and European options is that:
A. No difference.
B. European option can be exercised at anytime.
C. American option can be exercised at anytime.
D. Both prevent early exercise.
8.
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.
9.
Big Boy has accumulated N250,000 to speculate in options. If the market is
declining, what should he do?
A. Buy a put.
B. Buy a call.
C. Sell a put.
D. Sell a call.
10.
A buyer of put option will lose most of his investment if the price of the underlying
just before expiration is:
I. The same as the exercise price.
II. Considerably greater than the exercise price.
III. Considerably less than the exercise price.
A.
B.
C.
D.
I only
II only
III only
I and II
11.
Mr. Wise is retired. He has a portfolio of blue-chip stocks. The option position best for
a person in this position is:
A. Covered call writing.
B. Covered put writing.
C. Uncovered put writing.
D. Put and call spreads.
12.
Which of the following statements is true with respect to the market for forward
contracts?
A. While it does not cost anything to enter into a forward contract, a margin must
be posted at its initiation.
B. Most financial forward contracts are settled by physical delivery.
C. In order to minimize the exposure faced with a forward contract, an investor
may make offsetting trades in the futures markets.
D. A dealer is the end user of most forward contracts.
13.
The price of option premiums is influenced by which of the following?
I. The time remaining until the option expires.
II. The market price of the underlying stock.
III. The volatility of the security underlying the option.
A.
B.
C.
D.
I and III
II and III
I and II
All of the above.
14.
The advantages an option buyer might obtain include all of the following except:
A. Limiting his risk.
B. Positioning against the option.
C. Leverage.
D. Premium income.
15.
The benefits of derivative markets include:
A. Provision of price information.
B. Risk are managed and shifted among market participants.
C. Reduction of transaction costs.
D. All of the above.
16.
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.
17.
Hedging with stock futures means:
A. Shorting stocks.
B. Shorting index futures.
C. Shorting stock futures.
D. Going long on index futures.
18.
The theoretical futures price is based on the:
A. Strike price.
B. Underlying spot price.
C. The price at which a future contract trades in the market.
D. The price set by the exchange.
Portfolio Management (19 - 42)
19.
Which of the following securities would be suitable for an 80-year old widow with an
investment objective of current income?
A. FGN bond.
B. Blue chip growth stock.
C. An exploratory oil and gas programme.
D. A speculative growth stock with good appreciation possibilities.
20.
In a well diversified portfolio, which type of risk is negligible?
A. Firm-specific risk.
B. Beta risk.
C. Market risk.
D. Systematic risk.
21.
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.
22.
The life cycle approach for individual investors has four phases, which of the
following is not one of these phases?
A. The consolidation phase.
B. The accumulation phase.
C. The spending phase.
D. The capital preservation phase.
23.
Which of the following, in the investment policy statement, is not a constraint or
preference?
A. Liquidity.
B. Risk.
C. Time horizon.
D. Unique circumstances.
24.
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.
25.
Which of the following is not a test of the semi-strong form of the Efficient Market
Hypothesis (EMH)?
A. Tests of serial correlation in stock returns.
B. Stock price reactions to the announcement of stock.
C. Tests of the performance of money managers.
D. Stock reaction to merger announcements.
26.
Which is the better measure to estimate the performance of a portfolio: The Sharpe
Index or the Treynor Index?
A. The Sharpe Index.
B. The Treynor Index.
C. Both are equally good.
D. Not enough information is provided to answer this question.
27.
The degree of diversification of a portfolio is measured by:
A. Calculating the correlation coefficient between a stock’s returns with those of the
market.
B. Calculating the association between a portfolio's return and the market's return
based on the square of the correlation coefficient.
C. Computing the correlation coefficient between a portfolio's return and that of the
market.
D. Dividing the average return of a portfolio by its beta.
28.
Performance attribution:
A. Seeks to determine why success or failure occurred.
B. Is typically a bottom-up approach.
C. Does not require the identification of a benchmark of performance.
D. Often begins with the policy statement that guides the management of a
portfolio.
29.
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.
30.
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.
31.
You purchased a share of stock for N20. One year later you received a N1 dividend
and sold the share for N24. What is your holding period return?
A. 20.8%
B. 30.0%
C. 33.6%
D. 25.0%
According to Capital Asset Pricing Model, fairly priced securities have:
A. Negative betas.
B. Positive alphas.
C. Zero betas.
D. Zero alphas.
32.
33.
Which of the following statements represents implications of Efficient Market
Hypothesis?
A. Fundamental analysis can be used to earn abnormal profit.
B. The best portfolio management style is a passive one.
C. If the price-to-book value ratio is low, then the stock tends to outperform.
D. Prior returns on an equally weighted portfolio of gold stocks predict gold returns.
34.
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. –1.0
35.
Which of the following statements regarding human capital is true?
I. Human capital represents the investor’s capacity to generate income by working.
II. Human capital represents investors’ accumulated savings.
A.
B.
C.
D.
I only
II only
Both I and II
Neither is true
36.
A stock which pays no dividend realizes a simple return of -20% during year 1 and of
+ 25% during year 2. During the two year holding period the total return is:
A. Positive.
B. Negative.
C. Zero.
D. One.
37.
To compare the performance of different fund managers you should use which of the
following?
A. Internal rate of return.
B. Time-weighted rate of return.
C. Money-weighted rate of return.
D. Any of the above.
38.
The reward-to-variability ratio is given by:
A. The slope of the capital allocation line.
B. The second derivative of the capital allocation line.
C. The excess return on a security divided by the security’s beta.
D. None of the above.
39.
A stock that is relatively unaffected by the general fluctuations in the economy can
be characterized as:
A. A cyclical stock.
B. Having a low beta.
C. Having high unsystematic risk.
D. Having no unsystematic risk.
40.
Your research department has constructed the following table for stock A:
Probability
0.10
0.25
0.40
0.25
Corresponding Return
12%
15%
8%
-9%
What is the expected return for this stock?
A. 8.40%
B. 6.72%
C. 5.90%
D. 6.50%
41.
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.
42.
A stock above the security market line is:
A. Overpriced.
B. Underpriced.
C. Appropriately priced.
D. Of high risk.
Commodity Trading and Futures (43 - 60)
43.
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.
44.
Traders who deliberately take on risk to seek profit are called?
A. Arbitrageurs.
B. Dealers.
C. Hedgers.
D. Speculators.
45.
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.
46.
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.
47.
Government policy is a key pricing influence for which of the following commodities?
A. Emission.
B. Metals.
C. Plastics.
D. Power.
48.
What is the characteristic of a yield curve for investors preferring more liquidity?
A. Concave.
B. Flat.
C. Inverted.
D. Normal.
49.
In a backwardation market, the fair value of a futures will be:
A. Less than the cash price.
B. Highly volatile.
C. Equal to the basis.
D. Equivalent to the cost of carry.
50.
The amount by which an option is in-the-money is called the:
A. Future value.
B. Intrinsic value.
C. Premium value.
D. Time value.
51.
What does variation margin represent?
A. A level set at two third of the initial margin.
B. Actual profit or loss each day in a position.
C. Anticipated profit or loss each day in a position.
D. Worst probable one day loss on a position.
52.
Why would a futures hedge be set up?
A. To reduce risk.
B. To set up future position.
C. To speculate.
D. To take advantage of arbitrage opportunities.
53.
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.
54.
In order for a contract to be delivered, which of the following must happen?
A. The seller's broker must give the clearinghouse a notice of intention to deliver.
B. The clearing member must submit a long position report to the clearinghouse.
C. The clearinghouse must assign delivery to the oldest net long customer.
D. All of the given options.
55.
Which of the following statements is correct?
A. To offset a long position, a trader must take delivery of the commodity.
B. The base grade specified within a futures contract states the minimum grade of
commodity acceptable for delivery.
C. If a buyer of a futures contract defaults on his payment, the clearinghouse is
obligated to buy the contract.
D. The delivery price of financial futures is based on the prices established by the
futures position.
56.
The spread between the bid and the ask is typically higher when:
A. There are fewer market participants.
B. The market is efficient.
C. The market is extremely liquid.
D. It is easy for market participants to enter and exit.
57.
‘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.
58.
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.
59.
In comparing forward contracts with futures contracts, which of the following
statements is/are correct?
I. Forward contracts have default risk to be borne by each counterparty.
II. Forward contracts are more traded on organized secondary markets.
III. Forward contracts are standardized.
A.
B.
C.
D.
I only
II only
I and II only
I, II and III
60.
Physical settlement in commodity derivatives creates the need for warehousing due
to which characteristic of the underlying assets?
A.
Volatility.
B.
Value.
C.
Bulkiness.
D.
Variability.
Total = 60 marks
Question 2 - Derivative Valuation and Analysis
When comparing futures and forward contracts, it has been said that futures are more
liquid but forward are more flexible. Explain.
(3 marks)
Question 3 – Portfolio Management
The “required rate of return” for an investment is expected to compensate the investor for
deferring consumption. Briefly discuss the three main components of required rate of
return.
(4 marks)
Question 4 – Commodity Trading and Futures
What do you understand by “market risk” in the commodities market?
(3 marks)
Question 5 - Derivative Valuation and Analysis
On the NSE, the stock price of Naija Telecom (NTE) currently is at N20. No dividend is to
be paid on NTE in the coming months. The risk free rate (continuously compounded) is
3% p.a.
5(a) Using the Black & Scholes formula, what is the price of an NTE Call, strike N20,
maturing in 3 months, assuming the implied volatility is 15%?
(4 marks)
5(b) Using a two-period binomial model, what is the price of this call?
(4 marks)
5(c) Since you probably found different figures with the two methods, which one will you
use as the most correct one? Explain why.
(2 marks)
Question 6 - Portfolio Management
6(a) Explain in words (no graphs required) the CML (Capital Market Line) and the SML
(Security Market Line). Then explain the difference between the two.
(3 marks)
6(b) Consider a client having a portfolio of three stocks. The various expectations and the
current market situation are tabulated below (all annualized values). Let the current
risk free interest rate be 6% p.a.
Stocks
Stock A
Stock B
Stock C
Market Index
Expected return
14%
9.4%
10%
12%
Standard
Deviation
35%
20%
18%
23%
Beta
1.36
0.52
0.69
6(b1) Calculate what returns you expect from the three stocks if the stocks are
correctly priced in accordance with the CAPM theory.
(3 marks)
6(b2) Are there discrepancies between the returns of the CAPM theory and the ones
of your expectations? If yes, provide advice as to how to reshuffle the
portfolio within these three stocks in order to profit from them. If no, explain
why.
(5 marks)
Question 7 - Commodity Trading and Futures
7(a) With the aid of a diagram, illustrate the profit & loss profile of a long futures position
in the commodities market.
(5 marks)
7(b) Nigeria is one of the global leaders in the production of several agricultural
commodities. Briefly discuss three key price drivers in the agricultural commodities
market.
(4 marks)