Derivative Valuation and Analysis (1 – 12)
1.
In March, your client sells one GTB May 45 call for N5 per share and buys one GTB
August 45 call for N8. If the above client buys one May 45 call for N9 before the May option expires and sells one GTB August 45 call for N11, what is his profit or loss?
(Assume contract multiplier is 100).
A.
N100 profit
B.
N100 loss
C.
N500 profit
D.
N500 loss
2.
Consider the following statements concerning financial options:
I.
An American-style option gives the holder the right to exercise the option at any time up to and including its expiry date.
II.
An out-of-the-money call option has an intrinsic value of zero.
Which one of the following combinations (true/false) concerning the above statements is correct?
A.
Statement 1
True
B.
True
C.
False
D.
False
Statement II
True
False
True
False
3.
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 4200. 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.
4.
Which of the following statements is (are) true with respect to interest rate caps and floors?
I.
If on the settlement date, the reference rate is greater than the actual interest rates, than the holder of the cap receives nothing.
II.
Interest rate caps would be hedging instrument for a holder of a floating rate bond.
III.
If on the settlement date, actual interest rates are below some reference rate, the seller would have to make a payment to the buyer.
IV.
An interest rate cap is nothing more than a long call position on interest rates.
A.
I, III, and IV only
B.
I and III only
C.
II and IV only
D.
II and III only
5.
ABC stock is currently priced at N43 and is not expected to pay any dividends over the next year. A three-month call on ABC with a strike price of N45 is trading at
N0.68 and a put with similar conditions is trading at N4.05. If the risk-free rate is
3.8%, which of the following statements best describes the relative pricing of the stock?
A.
The stock price is overvalued by N1.34
B.
The stock price is undervalued by N1.37
C.
The stock price is overvalued by N1.37
D.
The stock price is overvalued by N1.79

6.
You expect the market to move sharply in the coming weeks, but you don’t know if it will rise or fall. Which option strategy would you adopt in order to benefit most from this scenario?
A.
Buy a 3-month out-of-the money call, while simultaneously selling a 3-month out-of-the-money put.
B.
Buy a 3-month out-of-the money call, while simultaneously buying a 3-month out-of-the-money put.
C.
Buy a 3-month out-of-the-money put, while simultaneously selling a 3-month out-of-the-money call.
D.
Sell a 3-month out-of-the-money call, while simultaneously selling a 3-month out-of-the money put.
7.
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
8.
A 3-month call option on a single stock has an exercise price of N35 and a quoted price of N2.45. Suppose that you sell this call option and buy the underlying stock at a price X. At expiration, if the price of the underlying stock is N31.10 and your loss is
N2.45, what is X? (Assume that the contract size is one and ignore the effect of interest rates in your calculation).
A.
N31.10
B.
N32.55
C.
N36.00
D.
N37.45
9.
Which of the following statements is incorrect?
A.
The maximum gain to a buyer of call option is unlimited.
B.
The maximum loss to a writer of an uncovered call option is unlimited.
C.
The maximum loss to the writer of an uncovered put option is unlimited.
D.
The maximum gain to the buyer of a put option is the exercise price minus the
Premium paid.
10.
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.
11.
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.
N8.00
B.
N8.50
C.
N10.00
D.
N11.50

12.
Which of the following statements is (are) true with respect to option Rhos?
I.
Rho increases as the level of interest rates increase.
II.
Rho is high if a call option is deep in-the-money.
III.
Rho is low if a put option is deep in-the-money.
IV.
One the expiry date of the option, rho will be equal to zero.
A.
I and III only
B.
II, III, and IV only
C.
I and II only
D.
II and IV only
Portfolio Management (13 – 28)
13.
Consider the following statements:
I.
The amount of systematic risk varies between different forms of investment.
II.
Systematic risk can be diversified away by holding a suitably wide portfolio of investments.
Which one of the following combinations (true/false) relating to the above statements is correct?
Statement I Statement II
A.
True True
B.
True False
C.
False True
D.
False False
14.
You manage an equity fund with total assets of N100 million. 80% of the total fund assets are invested in equities (the beta of this equity portfolio against the equity market index: 1.1) and 20% are invested in cash. The equity index futures price
(one month maturity) currently trades at 4400 points (contract size: N10 per point).
What do you have to do in order to hedge your portfolio against market moves during the coming 30 days (Assume a simple risk free rate of 2.4% p.a.)?
A.
Sell 182 futures contracts.
B.
Buy 182 futures contracts.
C.
Sell 2000 futures contracts.
D.
Buy 2000 futures contract.
15.
If you were following the constant mix strategy, what would you do?
A.
You buy high and sell low.
B.
You buy low and sell high.
C.
You don’t enter any transactions.
D.
None of the above answers is correct.
16.
If A, B and C signify the present value of a pension funds assets (for A), respectively the benefits (for B) and contributions (for C), and S is the surplus of the pension fund, we can write:
A.
S = A + B + C
B.
S = A + B - C
C.
S = A - B + C
D.
S = A - B - C

17.
Consider the following statements concerning stock market efficiency: When a stock market displays weak-form efficiency, it is impossible to:
I.
Make regular profits from any trends or patterns detected in share prices.
II.
Make abnormal gains by identifying undervalued or over-valued shares.
Which one of the following combinations (true/false) relating to the above statements is correct?
Statement I Statement II
A.
True True
B.
True False
C.
False True
D.
False False
18.
A portfolio consisting of 120 highly correlated 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 high return expectation.
D.
Has a high degree of unsystematic risk.
19.
You wish to evaluate a particular portfolio manager. You note that she earned 11% at a time when the market yielded 10% and Treasury bills yielded 5%. If the portfolio has a standard deviation of 22% and a beta of 1.2, where would it lie in relation to the SML?
A.
Above the SML.
B.
Below the SML.
C.
Inconclusive with the data given.
D.
On the SML.
20.
Which of the following statements about Value at risk (VAR) is not true?
A.
VAR is the loss that would be exceeded with a given probability over a specific time period.
B.
Establishing a VAR involves several decisions, such as probability and the time period over which VAR will be measured and the technique to be used.
C.
VAR will be larger when it is measured at 5 percent probability than when it is measured at 1 percent probability.
D.
VAR will be larger when is measured over a month than when it is measured over a day.
21.
Which of the following statements is (are) true with respect to the factors that pension fund managers must take into account when managing the portfolios of the pension fund?
I.
If contribution rates exceed the payout rates from the plan, then the manager may emphasize more growth stocks.
II.
Emphasis must be placed on liquidity if the plan has a longer vesting period
III.
The plan manager must focus on maximizing after-tax real rates of return.
IV.
Any real returns in excess of the real growth in wages will benefit the plan sponsor in the form of lower plan contributions.
A.
III only
B.
I and IV only
C.
III and IV only
D.
I, III and IV only

Use the following statistical information to answer questions 23 to 25:
SD Beta α R 2
Fund 1
Fund 2
Fund 3
Fund 4
1.97
2.94
1.82
4.70
1.0
.8
1.2
1.1
1.3
.6
-3.5
4.2
.85
.80
.90
.65
22.
Which of these four funds’ returns are best explained by the market’s returns?
A.
Fund 1
B.
Fund 2
C.
Fund 3
D.
Fund 4
23.
Which of these four funds had the lowest market risk?
A.
Fund 1
B.
Fund 2
C.
Fund 3
D.
Fund 4
24.
Which of these four funds had the largest total risk?
A.
Fund 1
B.
Fund 2
C.
Fund 3
D.
Fund 4
25.
A regression analysis is required to calculate:
I.
Treynor’s measure
II.
Jensen’s alpha
III.
Appraisal ratio
A.
I and II only
B.
I and III only
C.
II and III only
D.
I, II and III
26.
During a domestic macroeconomic or microeconomic shock, the diversification effect of domestic securities in a portfolio tends to:
A.
Reduce.
B.
Increase.
C.
Remain unaffected.
D.
None of the above.
27.
Which of the following best describes the ‘small firm effect’?
A.
Stocks of small companies pay higher dividends than stocks of large companies.
B.
Stocks of small companies have historically outperformed stocks of large companies.
C.
Stocks of small companies have historically underperformed stocks of large companies.
D.
Stocks of small companies pay lower dividends than stocks of large companies.
28.
Which of the following statements with respect to CAPM and APT is true?
A.
The APT model can be thought of as a subset of the CAPM.
B.
The APT model has far more restrictive assumptions than CAPM.
C.
CAPM would have a greater predictive power in forecasting individual security returns than would an APT model.
D.
Both models state the market as a whole is a factor that will influence specific security returns.

Commodity Trading and Futures (29 – 40)
29.
In the crude oil market, which of the following is a characteristic of the contango market?
A.
A glut of the commodity.
B.
A scarcity of the commodity.
C.
A strongly rising price.
D.
Volatile prices as a result of low inventories.
30.
Which one of the following is used to measure how much an option’s value changes in the time to maturity?
A.
Delta.
B.
Gamma.
C.
Theta.
D.
Vega.
31.
Which of the following are primary sources of electricity generation?
I.
Water.
II.
Wind.
III.
Oil.
IV.
Coal.
A.
I, II and III
B.
I, II and IV
C.
II, III and IV
D.
I, II, III and IV
32.
Which one of the following best describes the simultaneous buying and selling of futures contracts on different underlying assets?
A.
A contango.
B.
A strangle.
C.
An inter-market spread.
D.
An intra-market spread.
33.
An investor buys a July 100 call and sells an August 100 call. What strategy is this?
A.
Complex spread.
B.
Diagonal spread.
C.
Horizontal spread.
D.
Vertical spread.
34.
What type of risk is most associated with public disputes with clients that may lead to litigation?
A.
Credit risk.
B.
Market risk.
C.
Operational risk.
D.
Reputational risk.
35.
Which of the following is not a main price driver of the plastic market?
A.
Cost of crude oil and natural gas.
B.
Government regulation.
C.
Economic cycle.
D.
Technological progress.
36.
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.

37.
Gamma can be defined as which of the following?
A.
The speed with which a delta hedged position becomes unhedged.
B.
The exposure to actual volatility in the market.
C.
The rate of change of a trader’s profit or loss.
D.
All of the above.
38.
Which of the following is a not a factor that influence the demand for gold?
A.
Industrial uses.
B.
Producer hedging activities.
C.
Official Central Bank purchases.
D.
None of the above.
39.
An increase in the forward price of a commodity would come about as a result of the following except?
A.
A decrease in NIBOR.
B.
An increase in the spot price.
C.
A decrease in the lease rate.
D.
Increasing the maturity of a forward deal.
40.
A futures contract buyer can expect a discount when:
A.
Delivery of the commodity in question is not made on time.
B.
The delivery grade of the commodity is poorer than the base grade.
C.
The futures contract does not contain a provision for delivering a lower-quality commodity.
D.
No discounts are available as commodity prices are fixed by the exchange.
Total = 40 marks

Question 2 – Derivative Valuation and Analysis
Explain why a bank is subject to credit risk when it enters into two offsetting swap contracts. ( 3 marks )
Question 3 – Portfolio Management
A portfolio manager convincingly shows that whenever the market value of a stock divided by its book value is below 0.8, it is very likely that the stock price will go up. Whenever the ratio is above 1.2, the stock price tends to fall.
Does this refute the Efficient Market Hypothesis? If yes, which form of the Efficient Market
Hypothesis does it refute?
Question 4 – Commodity Trading and Futures
( 4 marks )
‘‘Speculation in futures market is pure gambling. It is not in the public interest to allow speculators to trade on a futures exchange.’’ Discuss this viewpoint. ( 3 marks )
Question 5 – Derivative Valuation and Analysis
On a derivatives market, on July 15th 2009, you buy a European call option on the stock of Universal Bank Plc, with strike N50, which is quoted at N0.74, and which matures three months from now (no dividends). Its delta is 0.3426. The risk free rate is 4% p.a.
(continuously compounded).
The probability of exercising this call at maturity is calculated by your Investments
Department at 31.728% (this probability is the N(d2) parameter in Black & Scholes formula).
5(a) Using the Black & Scholes formula, what is the price of the stock of Universal Bank
Plc on July 15th 2009? ( 3 marks )
5(b) One month later, because of the uncertainties in the banking sector, the stock of
Universal Bank Plc is quoted at N43.20. The market expects an annualized volatility of 40% on this stock for the coming weeks. Assuming the same risk-free rate, what is the price of the call you bought? ( 3 marks )
5(c) How do you explain such a surge in the call price despite the fall of the stock price?
(-10%), and the passage of time? No calculation required. ( 2 marks )
5(d) You believe either one of the following two scenarios will definitely happen: a pessimistic scenario (banking crisis, market downfall), or an optimistic one (end of crisis, market bounce) but you are not sure which one will occur. What type of options strategy would you use in such a situation? How would you construct it?
What is the risk of such a strategy? ( 4 marks )
5(e) Government intervention in the banking sector created a crisis of confidence. You now expect the market to go down. You consider hedging your fund with futures contracts on the NSE 30 index. The price of the index is 4183 points. The maturity of the September contract is on Sept 21st, 37 days from now. No dividends will be paid on the 30 stocks constituting the index during this period of time. The risk free rate is 4% p.a., continuously compounded. What is the price of the September futures contract of the NSE 30 index? Show your calculation. (4 marks )
Question 6 – Portfolio Management
6(a) You are given the following data:

Portfolio X Portfolio Y
Return
Standard Deviation σ
Return of the Market:
R
X
= 9.5% R
X
= 15% σ
Y
Y
= 9.9%
= 17%
Risk-Free Rate:
R
M
= 9%
R
F
= 3.5%
Running regressions of the excess portfolio returns against excess market returns generates the following estimated equations:
R
X
- R
F
= -0.6 + 1.2 · (R
M
– R
F
R
Y
- R
F
= 0.35 + 1.1 · (R
M
– R
F
)
)
6(a1) Compute the Treynor ratio, the Sharpe ratio and the Jensen’s measure
(alpha), using the results of the above equations. ( 5 marks )
6(a2) Plot the Security Market Line (SML). Label the axes, and locate R
F
Portfolio (M) and the two portfolios (X,Y).
, the Market
( 3 marks )
6(a3) Interpret the relative performance of the two portfolios for each of above measures individually. ( 3 marks )
6(b) The manager of a N200 million portfolio wishes to reduce the beta of the portfolio from 1.2 to 0.9 for a short period. The manager identifies a futures contract that has a beta of 1.05 and is priced at N135, with a contract size of 1'000. Indicate whether the contracts are to be bought or sold, and calculate the number of contracts to be used. ( 4 marks )
6(c) Describe the Core/Satellite approach of constructing an overall portfolio, mixing active and passive sub-mandates. Define the major advantages/disadvantages compared to an approach that mixes generalist balanced mandates. ( 5 marks )
Question 7 – Commodity Trading and Futures
7(a) Mention and discuss four types of trades an investor could engage in to participate in the commodities market. ( 8 marks )
7(b) Mr Zuma is a commodities trader. He just consummated a transaction involving the sale of both a call and a put on mercury. The call was sold for N37 and the put was sold for N35. In both cases, strike price was 550.
7(b1) What type of option strategy is this, and under what condition is it appropriate?
( 3 marks)
7(b2) Illustrate with a diagram the pay off of the strategy identified in 7(b1) above.
( 4 marks )