CHARTERED INSTITUTE OF
STOCKBROKERS
ANSWERS
Examination Paper 2.3
Derivatives Valuation Analysis
Portfolio Management
Commodity Trading and Futures
Professional Examination
September 2011
Level 2
1
SECTION A: MULTI CHOICE QUESTIONS
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
B
A
C
A
D
B
D
C
C
A
B
D
B
C
B
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
C
B
D
D
C
B
C
B
D
D
A
B
D
A
C
31
32
33
34
35
36
37
38
39
40
D
D
C
D
B
D
D
D
A
B
(60 marks)
SECTION B: SHORT ANSWER QUESTIONS
Question 2 – Derivative Valuation and Analysis
At the initiation of the swap, both contracts have a value of zero. As time passes
however, it is likely that the swap values will change so that one of the swaps has a
positive value while the other has a negative value to the bank
If the counterparty on the other side of the positive-value swap defaults, the bank still
has to honour its obligation to the other counterparty. It is liable to lose an amount
equal to the positive value of the swap.
(3 marks)
Question 3 – Portfolio Management
Yes. If this assertion is true, it refutes the semi-strong form of efficient market
hypothesis (EMH). If the semi-strong form of EMH is true, you should not be able to use
publicly available information like the market-to-book value ratio to earn abnormal rates
of return.
(4 marks)
2
Question 4 – Commodity Trading and Futures
Speculators are important participants in the market because they add liquidity to the
market.
However futures contracts are expected to have some useful economic purpose.
Usually regulators would only approve contracts that are likely to be of interest to
hedgers as well as speculators.
(3 marks)
SECTION C: COMPLUSORY QUESTIONS
Question 5 – Derivative Valuation and Analysis
5(a)
N(dl)=0.3426;
X=50;
N(d2) = 0.31728; r = 4%;
t=0.25 [=3/12]
Co = 0.74
We therefore have this equation:
0.74 = S (0.3426) - 50· e-0.04(3/12) (0.31728)
Expressing in terms of S:
S = N48.00
(3 marks)
5(b)
Now, the time to maturity is 2 months (therefore, t =2/12)
d1 = In (43.20/50) + (0.04 + 0.402/2)(2/12)
0.40
= - 0.7727
2/12
= - 0.7727 – 0.163299316
= - 0.9360
Looking up the normal probability table:
= N (-0.7727) = 1 - N(0.7727) = 1 - 0.7802 = 0.2198
= N (-0.9360) = 1 - N(0.9360) = 1 - 0.8254 = 0.1746
3
Plugging into the option pricing formulae:
= 43.20(0.2198) – 50e - 0.04(2/12) x (0.1746)
= 9.49536 – 8.67199357
= 0.824
(3 marks)
5(c)
The 0.74 call price on July 15th was calculated with a volatility of 14% (calculation not
needed). The market was rallying, and at that time, investors did not expect any crisis.
Low uncertainty/fear means low volatility, and low option prices. This effect was so
important that it exceeded the effect of the lower stock price and the effect of the
shorter time to maturity. The vega impact was superior to the sum of delta and theta
impact.
(2 marks)
5(d)
In order to benefit from either market scenario, the most appropriate strategy would
probably be to buy a straddle. It consists of the purchase of an "at the money" call, and
an "at the money" put. Hence, you will benefit of a downfall with the put, and of a
bounce with the call.
(2 marks)
The risk is a scenario with no clear market direction, and a stagnating stock price. This
may result in the loss of both premiums. Secondly, this strategy is expensive and
requires a quick and a large move, whatever the direction, of the underlying stock price.
(1 mark)
Long straddle
(1 mark)
Alternatively, in order to lower the cost of the strategy, a strangle could be initiated:
purchase of "out the money" call and put. Lower cost, but the stock price move must be
larger to benefit from the strategy.
Long strangle
(4 marks)
4
5(e)
F0 = S0er. T
F0 = 4183. e0.04 (37/365) = 4, 200
(4 marks)
Total = 16 marks
Question 6 – Portfolio Management
6(a1)
Treynor ratio for portfolio X
=
0.095 - 0.035
1.2
= 0.05
(1 mark)
Treynor ratio for portfolio Y
=
0.099 - 0.035
1.1
= 0.058
(1 mark)
Sharpe ratio for portfolio X
=
9.5 – 3.5
15
= 0.400
(1 mark)
Sharpe ratio for portfolio Y
=
9.9 – 3.5
17
= 0.376
(1 mark)
Jense Alpha is given in the regression equation:
Portfolio X: -0.6
(½ mark)
Portfolio Y: 0.35
(½ mark)
6(a2)
SML
14
(Y)
∆
12
E(r)
10
∆
(M)
(x)
9%
8
6
4
Rf
2
1
1.1
1.2
1.3
Beta
5
(3 marks)
6(a3)
For the individual measures:
•
The Treynor ratio indicates that Portfolio Y has achieved superior performance.
•
The Sharpe Index indicates that Portfolio X has achieved superior performance.
•
Jensen's alpha indicates that portfolio Y has achieved superior performance.
•
The SML analysis indicates that Portfolio Y has achieved superior performance
because it lies above the line, whereas Portfolio X lies below the line.
(1 mark each for any three points = 3 marks)
6(b)
=
(0.9 - 1.2) X N200 million
1.5
N135 X 1,000
= - 423.28
This indicates that 423 futures contracts should be sold.
(4 marks)
6(c)
Core Satellite Approach
In the Core/Satellite approach of constructing an overall portfolio, assets can be divided
into two parts:
i)
passive core portfolio
ii)
active satellites portfolio
Typically, the core part has a large weight in the overall portfolio and is indexed to the
strategic asset allocation of the investor. The satellites part is typically constructed of a
number of very active portfolios that cover disjoint subsets of the overall benchmark of
the investor.
(2 marks)
Advantages core/satellite approach:
i)
ii)
iii)
Potential for reduction of overall management fees (as large core part pays
passive fees).
Potential for finding specialised asset managers that provide better risk return
profiles.
Suffers less from active positions that cancel each other out.
(2 marks)
Disadvantages core/satellite approach:
i)
Problem of asset allocation between sub portfolios is left with the investor,
whereas in the generalist solution the external managers provide their services in
this important field too.
(1 mark)
Total = 20 marks
6
Question 7 – Commodity Trading and Futures
7(a)
i)
ii)
iii)
iv)
v)
vi)
By purchasing commodity generating or consuming asset (e.g a power station).
Buying shares in a company whose business is commodity related (e.g mining
company).
Buying the physical commodity.
Buying futures on commodities.
Entering into total return swap.
Buying structure OTC transaction.
(2 marks each for any four well - explained points = 8 marks)
7(b1)
The strategy here is referred to as short straddle. It involves simultaneous sale of a call
and a put with the same strike price.
(1 mark)
The strategy is appropriate when an investor is unsure as to a directional movement, but
is convinced that the price will not move too far away from the current price.
(2 marks)
7(b2)
Short straddle strategy
Profit
550
0
ST
Loss
(3 marks)
Total = 14 marks
7