CIS SEPTEMBER 2010 Exam Diet
Examination Paper 1.3:
Derivatives Valuation Analysis
Portfolio Management
Commodity Trading and Futures
Level 1
SECTION A
Derivatives Valuation and Analysis
1.
Which of the following is a criticism of the derivatives markets?
A.
B.
C.
D.
2.
Cash
Difference in cash
Payment of margin
Delivery of the asset
On expiration, the settlement price of a stock option contract is the:
A.
B.
C.
D.
7.
Floating; fixed
Interest; interest
Fixed; floating
Option; future
Forward contracts on expiration have to be settled by ______________
A.
B.
C.
D.
6.
N3
N2
N1
N1.50
A payer swaption is an option to pay________ rate and receive __________ rate.
A.
B.
C.
D.
5.
Options
Forward contract
Futures
None of the above
A stock is currently selling at N165. The put option at N163 strike price, costs N3.
What is the time value of the option?
A.
B.
C.
D.
4.
They allow arbitrageurs to exploit price differences to make profits
They introduce risk into the underlying spot market due to the profit-seeking
action of hedging
They create complex products that end users may not adequately understand
They exclude small investors from active participation
Which of the following is a type of contingent claim?
A.
B.
C.
D.
3.
(Questions 1 to 18)
Closing futures price
Closing stock price
Closing options price
None of the above
An index put option at a strike price on N4,200 is selling at a premium of N30.
At what index level will it break even for the buyer of the option?
A.
B.
C.
D.
N4,175
N4,176
N4,170
N4,162
8.
The only way an investor can manage risks in the underlying cash market is by:
A.
B.
C.
D.
9.
You have bought a stock on the exchange. To eliminate the risk arising out of the
stock price, you should:
A.
B.
C.
D.
10.
3
0.25
9
90
The spot price of ABC Limited is N2,000, and the cost of financing is 10%
(with continuous compounding). What is the fair price of a one-month futures
contract on ABC Ltd?
A.
B.
C.
D.
12.
Buy index futures
Buy stock futures
Sell the stock futures
None of the above
On 1st January, a three month call option with a strike of 4,280 is available
for trading. The ‘T’ that is used in the Black Scholes formula should be:
A.
B.
C.
D.
11.
Hedging in the futures market
Speculating in the futures market
Speculating in the option market
All of the above
N2,015.00
N2,016.75
N2,018.75
N2,019.00
Hedging with stock futures means:
A. Shorting stocks
B.
Shorting index futures
C.
Shorting stock futures
D.
Going long on index futures
13.
14.
A stock is currently selling at N50. The call option to buy the stock at N45 costs N9.
What is the time value of the option?
A.
N9
B.
N7
C.
N4
D.
N2
An option contract which will not be exercised on the expiry date is:
A.
B.
C.
D.
An in-the-money option
A deep in-the–money
An out-of-the-money option
None of the above
15.
The theoretical future price is based on the:
A.
B.
C.
D.
16.
Which of the following is most appropriate for stock call options?
A.
B.
C.
D.
17.
An American option is always worth more than an European option
A European option is always worth more than an American option
An American option may be worth more than an European option
A European option always has the same worth as an American option
Which of the following statements least accurately describes the characteristics of
option contracts?
A.
B.
C.
D.
18.
Strike price
Underlying spot price
The price at which a future contract trades in the market
The price set by the exchange
Only the long side to an over-the-counter option is exposed to counterparty risk
A short put is a right to deliver the underlying asset and receive a
predetermined price for it
A long put position implies a bearish outlook for the price of the underlying
asset
A long call is a right to but the underlying asset at a predetermined price
Which of the following statements is (are) true with respect to the mechanics
involved in options trading?
I.
II.
III.
IV.
A.
B.
C.
D.
The existence of a clearing house ensures that options sellers do not face any
credit risk
To close out an existing long position in a particular put, an investor must buy
that exact same put
Options buyers will never have to post any margins
Upon the exercise of a call option on a futures contract, the buyer will receive
the underlying futures contract plus a cash amount equal to the difference
between the higher current settlement price of the futures and the lower
exercise price of the call
I, III and IV only
I only
III and IV only
I and II only
Portfolio Management (Questions 19 to 42)
19.
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.
B.
C.
D.
20.8%
30.0%
33.6%
25.0%
20.
The efficient frontier is the set of possible investment portfolios that:
A.
B.
C.
D.
21.
24.
Beta
Beta
Beta
Beta
both
measures both systematic and unsystematic risks
measures systematic risk while standard deviation measures total risk
measures total risk while standard deviation measures systematic risk
measures only unsystematic risk while standard deviation measures
systematic risk and unsystematic risk
Which of the following represents the correct ordering of steps in the portfolio
management process?
I.
II.
III.
IV.
Forecast market conditions
Construct portfolio
Create investment policy statement
Measure performance
A.
B.
C.
D.
I, III, II, IV
I, II, III, IV
II, III, IV, I
III, I, II, IV
Stock A has a beta of 2.0 and expected return of 2.1%, while Stock B has beta of
0.5 and an expected return of 13%. If the risk-free rate were 5%, which statement
would best describe the given situation?
A.
B.
C.
D.
25.
Negative betas
Positive alphas
Zero betas
Zero alphas
Standard deviation and beta both measure risk, but they are different in that:
A.
B.
C.
D.
23.
the minimum variance of all possible combinations
the maximum return of all possible combinations
equal weights in every risky security
the maximum return for any given level of risk
According to Capital Asset Pricing Model, fairly priced securities have:
A.
B.
C.
D.
22.
Have
Have
Have
Have
An investor may profit by selling Stock A and using the proceeds to invest
in Stock B
An investor may profit by selling Stock B and using the proceeds to invest
in Stock A
There are no profit opportunities since both stocks are fairly priced
The principles of diversification dictates that both securities be held in a
portfolio
Which statement best captures the relationship between risk and its corresponding
required rate of return?
A.
B.
C.
D.
The amount of risk for a given unit of return determines the slope of the SML
The slope of the SML is really flat for a risk-adverse investor
Stocks that are more risky than the market can cause the SML slope to
become steeper
As security risk changes, there will be a corresponding movement along the
SML
26.
To achieve maximum diversification, what should the correlation coefficient be
between two stocks that are being considered for inclusion in a portfolio?
A.
B.
C.
D.
27.
Which of the following statements is (are) true with respect to diversification?
I.
II.
III.
IV.
28.
C.
D.
The SML plots all securities efficiently priced
Due to its efficiency, all investors will ultimately end up investing in the
market portfolio situated on the SML
The SML can serve as a benchmark for all stock portfolios, regardless of their
risk
The SML is a straight line that captures the relationship between risk and return
Which of the following features is not characteristic of an individual in the
consolidation phase?
A.
B.
C.
D.
30.
Diversification is only possible if the correlation coefficient between
the securities is negative
To reduce the systematic risk of a portfolio, more securities should be added
to a portfolio
In a very well-deserved portfolio, beta will be very low
The elimination of unsystematic risk should have no impact on portfolio return
A.
II, III and IV only
B.
I and III only
C.
II and III only
D.
IV only
Which of these statements is misleading with respect to the security market line?
A.
B.
29.
+1.0
- 0.5
0
-1.0
Asset management becomes a high priority
Debt management becomes a low priority
Fixed-income investments would be the best choice at this phase
Income levels are the highest, relative to the other phases
Your research department has constructed the following table for stock A:
Probability
.10
.25
.40
.25
Corresponding Return
12%
15%
8%
-9%
What is the expected return for this stock?
A.
B.
C.
D.
31.
8.40%
6.72%
5.90%
6.50%
Which of the following items would not generally be addressed when constructing an
investment policy?
A.
B.
C.
D.
Eligible asset categories that may be included in the portfolio
The required rate of return expected for the risk that is being taken
Credit rating above which securities may be considered
Allowable margins within which the manager may deviate away from the
original asset mix
32.
Which of the following statements is least accurate with respect to the factors that
contribute to portfolio risk?
A.
B.
C.
D.
33.
In a “fully” diversified portfolio, all of the following would be true except:
A.
B.
C.
D.
34.
Liquidity risk
Trade failure risk
Exchange rate risk
Financial risk
The reward-to-variability ratio is given by:
A.
B.
C.
D.
38.
Firm-specific risk
Beta risk
Market risk
Systematic risk
The inability to sell an asset quickly at a fair price is associated with:
A.
B.
C.
D.
37.
A cyclical stock
Having a low beta
Having high unsystematic risk
Having no unsystematic risk
In a well-diversified portfolio, what type of risk is negligible?
A.
B.
C.
D.
36.
Portfolio standard deviation would be lower than the weighted average of the
standard deviations of the individual securities
Expected portfolio return would simply be the weighted average of the expected
returns of all individual securities
The expected return of the portfolio will equate that of the expected market
return
There would be no unsystematic risk
A stock that is relatively unaffected by the general fluctuations in the economy can
be characterized as:
A.
B.
C.
D.
35.
The weights of each of the securities in the portfolio must be computed
The expected return of all securities in the portfolio must be examined
The correlation among all pair-wise combinations of securities must be
examined
The standard deviation of all individual securities must be examined
The slope of the capital allocation line
The second derivative of the capital allocation line
The excess return on a security divided by the security’s beta
None of the above
Which of the following actions is MOST accurately associated with tactical asset
allocation?
A.
B.
C.
D.
Investment
Investment
Investment
Investment
decisions
decisions
decisions
decisions
with a long term perspective
that do not emphasize current market conditions
with a primary goal of maximizing return
that do not depend on ability to diversity
39.
The Sharpe ratio for Company A is 0.34, while the Sharpe ratio for Company B is
0.39. What can be said about Company B?
A.
B.
C.
D.
40.
by the Sharpe ratio, Company B’s excess return is higher
Tax concerns
Expected cash flow patterns
Risk tolerance
Liquidity needs
If you were confident that the price of stock X would drop dramatically within two
months, which of the following investment transactions would yield the highest
return on your investment?
A.
B.
C.
D.
42.
by the Sharpe ratio, Company B’s risk adjusted return is superior
by the Sharpe ratio, Company B’s mean return is higher
by the Sharpe ratio, Company B’s standard deviation of returns is
Which of the following is NOT a typical investor constraint in the investment policy
statement?
A.
B.
C.
D.
41.
As measured
As measured
As measured
higher
As measured
Purchase stock X
Sell stock X short
Purchase a call on stock X
Purchase a put on stock X
A liquid asset may
A.
B.
C.
D.
be converted into cash
be converted into cash with little chance of loss
not be converted into cash
not be converted without loss
Commodity Trading and Futures (Questions 19 to 36)
43.
Traditionally __________ has been the largest producers of gold in the world.
A.
B.
C.
D.
44.
By using the currency forward market to sell dollars forward, a(n) ________ can
lock on to a rate to hedge and reduce his uncertainty.
A.
B.
C.
D.
45.
Arbitrageur
Speculator
Importer
Exporter
OTC derivatives are considered risky because:
A.
B.
C.
D.
46.
Europe
South America
South Asia
South Africa
They are not settled on a clearing house
They do not follow any formal rules or mechanisms
There is no formal margining system
All of the above
The option to give delivery is given during a period identified as:
A.
B.
C.
D.
Delivery notice period
Settlement period
Delivery period
Option notice period
47.
The first use of derivatives contract was:
A.
B.
C.
D.
48.
To manage price uncertainty
For speculation
For arbitrage
None of the above
The margin is charged so as to cover _________ that can be encountered on the
position of the days.
A.
B.
C.
D.
49.
One
One
One
One
day loss
week loss
month loss
trading period loss
_________ give the buyer the right but not the obligation to buy a given quantity of
the underlying asset, at a given price on or before a given future date.
A.
B.
C.
D.
50.
Futures
Forwards
Call options
Put options
Due to the _________ nature of the underlying assets, physical settlement in
commodity derivatives creates the need for warehousing.
A.
B.
C.
D.
51.
Who identifies the buyer to whom the delivery notice is assigned?
A.
B.
C.
D.
52.
The
The
The
The
clearing corporation
buyer
exchange
warehouse
Members can opt to meet the security deposit requirement by way of:
A.
B.
C.
D.
53.
Volatility
Valuable
Bulky
Varying
Bank guarantee
Cash
Fixed deposit receipts
All of the above
An option gives the __________ the right to do something.
A.
B.
C.
D.
Seller
Exchange
Clearing house
Buyer
54.
__________ is the closing price of the underlying commodity on
the last trading day of the futures contract.
A.
B.
C.
D.
55.
The seller intending to make delivery takes the commodities to:
A.
B.
C.
D.
56.
The
The
The
The
clearing house
buyer
exchange
seller
Clearing house
Exchange
Approved banks
Depository clearing system
Which of the following features differentiates a commodity futures contract from a
financial futures contract?
A.
B.
C.
D.
60.
Sunflower seeds
Soybean
CPO
Soy
Delivery in respect of all deals for the clearing in commodities happens through the:
A.
B.
C.
D.
59.
designated warehouse
clearing house
buyer
exchange
Whenever delivery notices are given by the seller, the __________ identifies the
buyer to whom the notice may be assigned.
A.
B.
C.
D.
58.
The
The
The
The
Soy oil is the derivative of:
A.
B.
C.
D.
57.
Market price
Final settlement price
Auction price
Daily settlement price
Standardised contract size
Margin requirements
Varying quality of underlying asset
Exchange traded product
A trader has purchased crude oil futures at N750 per barrel. He wishes to limit his
loss to 20%. He did so by placing a stop order to sell an offsetting contract if the
price falls to or below:
A.
B.
C.
D.
N600
N650
N800
N825
SECTION B
Question 2 - Derivatives Valuation and Analysis
2(a) Derivatives are a ‘zero-sum game’. Explain, using a simple example.
2(b) State the put-call parity relationship for a non-dividend paying stock.
(2 marks)
(1 mark)
Question 3 - Portfolio Management
3(a) List four active equity portfolio management strategies.
3(b)
What is the difference between a load fund and a no-load fund?
(2 marks)
(2 marks)
Question 4 - Commodity Trading and Futures
4(a) List four key differences between forward and futures contracts.
(2 marks)
4(b) Distinguish between Contango and Backwardation in the commodity market.
(1 mark)
SECTION C
Question 5 - Derivatives Valuation and Analysis
5(a) A stock price is currently N40. It is known that at the end of one month it will be
either N42 or N38. The risk-free interest rate is 8% per annum with continuous
compounding. What is the value of a 1 month European call option with a strike price
of N39?
(4 marks)
5(b) List the factors that affect call option premium, and give a brief summary of the
impact of a change in those factors on call option premium.
(5 marks)
Question 6 - Portfolio Management
A financial analyst is analysing investments in the stocks of two companies, Apple Limited
and Grape Limited, to guide his investment decision.
The estimated rates of return and their chances of occurrence for the next year are given
in the table below:
Probability of occurrence
Rate of return
Apple limited
Rate of return
Grape limited
0.20
0.60
0.20
22%
14%
- 4%
5%
15%
25%
Required
6(a) Determine for each stock the expected rate of return, variance and standard
deviation.
(4 marks)
6(b) Which of the two investment alternatives is comparatively less risky and why?
(2 marks)
6(c) The financial analyst wishes to invest half of the available funds in Apple Limited and
the other half in Grape Limited. Would you advise him to go ahead taking cognisance
of the implication for risk? Justify your position.
(5 marks)
Question 7 - Commodity Trading and Futures
Consider a hypothetical futures contract in which the current price is N212. The initial
margin requirement is N10, and the maintenance margin requirement is N8. You go long
20 contracts and meet all margin calls but do not withdraw any excess margin.
7(a) When could there be a margin call?
(2 marks)
7(b) Complete the table below and explain any funds deposited. Assume that the contract
is purchased at the settlement price of that day so there is no mark-to-market profit
or loss on the day of purchase.
Day
Beginning
Balance
Funds
Deposited
0
Futures
Price
212
1
211
2
214
3
209
4
210
5
204
6
202
Price
Change
Gain/
Loss
Ending
Balance
(5 marks)
7(c) How much are your total gains or losses by the end of day 6?
(2 marks)