Professional Documents
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Question#1of85 QuestionID:464024
Considera9monthforwardcontractona10year7%Treasurynotejustissuedatpar.Theeffectiveannualriskfreerateis
5%overtheneartermandthefirstcouponistobepaidin182days.Thepriceoftheforwardisclosestto:
A) 1,037.27.
B) 1,001.84.
C) 965.84.
Explanation
Theforwardpriceiscalculatedasthebondpriceminusthepresentvalueofthecoupon,timesoneplustheriskfreeratefor
thetermoftheforward.
(1,00035/1.05182/365)1.059/12=$1,001.84
Question#2of85 QuestionID:464070
Howismarketbackwardationrelatedtoanasset'sconvenienceyield?Iftheconvenienceyieldis:
A) positive,causingthefuturespricetobebelowthespotpriceandthemarketis
inbackwardation.
B) negative,causingthefuturespricetobebelowthespotpriceandthemarketisin
backwardation.
C) largerthantheborrowingrate,causingthefuturespricetobebelowthespotprice
andthemarketisinbackwardation.
Explanation
Whentheconvenienceyieldismorethantheborrowingrate,thenoarbitragecostofcarrymodelwillnotapply.Itmeansthat
thevalueoftheconvenienceofholdingtheassetitisworthmorethanthecostoffundstopurchaseit.Thisusuallyappliesto
nonfinancialfuturescontracts.
Question#3of85 QuestionID:464012
Aportfoliomanagerholds100,000sharesofIPRDCompany(whichistradingtodayfor$9pershare)foraclient.Theclient
informsthemanagerthathewouldliketoliquidatethepositiononthelastdayofthequarter,whichis2monthsfromtoday.
Tohedgeagainstapossibledeclineinpriceduringthenexttwomonths,themanagerentersintoaforwardcontracttosellthe
IPRDsharesin2months.Theriskfreerateis2.5%,andnodividendsareexpectedtobereceivedduringthistime.However,
IPRDhasahistoricaldividendyieldof3.5%.Theforwardpriceonthiscontractisclosestto:
A) $905,175.
B) $903,712.
C) $901,494.
Explanation
Thehistoricaldividendyieldisirrelevantforcalculatingthenoarbitrageforwardpricebecausenodividendsareexpectedto
bepaidduringthelifeoftheforwardcontract.Intheabsenceofanarbitrageopportunity,thevalueof should
be0.
Therefore,FP=S0(1+Rf)T
903,712=900,000(1.025)2/12
Question#4of85 QuestionID:464009
Atcontractinitiation,thevalueofaforwardcontract:
A) issetto100byconvention.
B) dependsonthemarketpriceoftheunderlyingasset.
C) istypicallyzeroregardlessofthepriceoftheunderlyingasset.
Explanation
Duetothenoarbitrageprinciple,thepriceofaforwardcontractiscalculatedtomakethevalueofthecontractzeroatcontract
initiation.Neitherthelongnortheshorttypicallymakesanypaymenttoenterintotheforwardagreement.Aspecialcaseisan
offmarketforwardwhere,forwhateverreason,thecontractpriceisnotsetequaltothenoarbitrageprice,andthelongor
shortpositionmakesapaymenttotheoppositecounterpartytooffsetthedifference.
Question#5of85 QuestionID:464056
Thevalueofafuturescontractis:
A) zerowhentheaccountismarkedtomarketforanaccountthathassufficient
margin.
B) calculatedinthesamemannerasthevalueofaforwardcontract.
C) equaltothevariationmarginpaidonanygivenday.
Explanation
Thevalueofafuturescontractiszerowhentheaccountismarkedtomarketandthereisnomargincall.Thepriceofthe
contractisadjustedtothenew'noarbitrage'value,whichistheoreticallythesameasthesettlepriceattheendoftrading,as
longaspricechangelimitshavenotbeenreached.Notethatthisisdifferentfromaforwardcontract.Withaforwardcontract,
theforwardpriceisfixedforthelifeofthecontractsothecontractmayaccumulateeitherapositiveornegativevalueasthe
forwardpricefornewcontractschangesoverthelifeofthecontract.
Question#6of85
QuestionID:464017
JimTrent,CFAhasbeenaskedtopriceathreemonthforwardcontracton10,000sharesofGlobalIndustriesstock.The
stockiscurrentlytradingat$58andwillpayadividendof$2today.Iftheeffectiveannualriskfreerateis6%,whatprice
shouldtheforwardcontracthave?Assumethestockpricewillchangevalueafterthedividendispaid.
A) $56.85.
B) $58.85.
C) $56.82.
Explanation
Onemethodistosubtractthefuturevalueofthedividendfromthefuturevalueoftheassetcalculatedattheriskfreerate(i.e.
thenoarbitrageforwardpricewithnodividend).
FP=58(1.06)1/42(1.06)1/4=$56.82
Thisisequivalenttosubtractingthepresentvalueofthedividendfromthecurrentpriceoftheassetandthencalculatingthe
noarbitrageforwardpricebasedonthatvalue.
Question#7of85 QuestionID:464047
Creditrisktothelong(position)inaforwardcontractwillincreaseoverthelifeofthecontractduetoallofthefollowing
EXCEPTthe:
A) shortpartyhasdeterioratingfinances.
B) settlementdateisgettingcloser.
C) contractvaluetotheshortisnegativeanddecreasing.
Explanation
Deterioratingfinancesofthecounterpartyincreasetheprobabilityofdefault.Theamountowedtothelongincreasesasthe
valueoftheunderlyingassetincreases,whichisthesameasanincreaseinthevalueofthecontract.Anincreaseinthe
amount'owed'andanincreaseintheprobabilityofdefaultcanbothbeviewedasincreasingcreditrisk.Byitself,thepassage
oftimedoesnotnecessarilyincreasecreditrisk.
Question#8of85 QuestionID:464029
Thepriceofa35forwardrateagreement(FRA)isthe:
A) 2monthimpliedforwardrate5monthsfromtoday.
B) 3monthimpliedforwardrate5monthsfromtoday.
C) 2monthimpliedforwardrate3monthsfromtoday.
Explanation
ThenotationforFRAsisunique.TherearetwonumbersassociatedwithanFRA:thenumberofmonthsuntilthecontract
expiresandthenumberofmonthsuntiltheunderlyingloanissettled.Thedifferencebetweenthesetwoisthematurityofthe
underlyingloan.Forexample,a35FRAisacontractthatexpiresinthreemonths(90days),andtheunderlyingloanis
settledinfivemonths(150days).Thepriceofthe35FRAiscalculatedbyannualizingtheimpliedforwardrate.Theimplied
forwardrateiscalculatedfromthe3monthrateandthe5monthrate.
Question#9of85 QuestionID:464025
TheU.S.riskfreerateis2.96%,theJapaneseyenriskfreerateis1.00%,andthespotexchangeratebetweentheUnited
StatesandJapanis$0.00757peryen.Bothratesarecontinuouslycompounded.Thepriceofa180dayforwardcontracton
theyenandthevalueoftheforwardposition90daysintothecontractwhenthespotrateis$0.00797areclosestto:
ValueAfter90
ForwardPrice
Days
A) $0.00764 $0.00212
B) $0.00764 $0.00037
C) $0.00750 $0.00212
Explanation
Thenoarbitragepriceofthe180dayforwardcontractis:
F T=$0.00757e(0.02960.0100)(180/365)=$0.00764
Thevalueofthecontractin90dayswith18090=90daysremainingis:
Question#10of85 QuestionID:464069
Asituationwherethefuturespriceisabovethespotpriceoftheunderlyingassetiscalled:
A) positivecarry.
B) contango.
C) normalbackwardation.
Explanation
Asituationwherethefuturespriceisabovethespotpriceoftheassetiscalledcontango.
Question#11of85 QuestionID:464046
Overthelifeofaforwardcontract,theamountofcreditriskisleastlikelyto:
A) changesigns.
B) increase.
C) staythesame.
Explanation
Theamountofcreditriskisleastlikelytostaythesame.Theamountofcreditriskisbasedonthecontractvalue,whichiszero
atcontractinitiation.Forthevaluetostaythesame(atzero),theexpectedfuturepriceoftheassetmustnotchangeoverthe
lifeofthecontract,anunlikelycircumstance.Asthevalueofthecontracttothelonggoesfrompositivetonegative,the
amountofcreditriskchangesinsign.
Question#12of85 QuestionID:464027
30daysago,J.Kleintookashortpositionina$10million(3X6)forwardrateagreement(FRA)basedontheLondon
InterbankOfferedRate(LIBOR)andpricedat5%.ThecurrentLIBORcurveis:
30day=4.8%
60day=5.0%
90day=5.1%
120day=5.2%
150day=5.4%
ThecurrentvalueoftheFRA,totheshort,isclosestto:
A) $15,280.
B) $15,495.
C) $15,154.
Explanation
FRAsareenteredintohedgeagainstinterestraterisk.ApersonwouldbuyaFRAanticipatinganincreaseininterestrates.If
interestratesincreasemorethantherateagreeduponintheFRA(5%inthiscase)thenthelongpositionisowedapayment
fromtheshortposition.
Step1:Findtheforward90dayLIBOR60daysfromnow.
[(1+0.054(150/360))/(1+0.05(60/360))1](360/90)=0.056198.SinceprojectedinterestratesattheendoftheFRA
haveincreasedtoapproximately5.6%,whichisabovethecontractedrateof5%,theshortpositioncurrentlyowesthelong
position.
Step2:Findtheinterestdifferentialbetweenaloanattheprojectedforwardrateandaloanattheforwardcontractrate.
(0.0561980.05)(90/360)=0.001549510,000,000=$15,495
Step3:Findthepresentvalueofthisamount'payable'90daysaftercontractexpiration(or60+90=150daysfromnow)and
noteonceagainthattheshort(whomust'deliver'theloanattheforwardcontractrate)losesbecausetheforward90day
LIBORof5.6198%isgreaterthanthecontractrateof5%.
[15,495/(1+0.054(150/360))]=$15,154.03
Thisisthenegativevaluetotheshort.
Question#13of85 QuestionID:464076
Whatisthesituationcalledwhenafuturespricecontinuouslyincreasesoveritslifebecausemosthedgingstrategiesareshort
hedges?
A) Contango.
B) Normalbackwardation.
C) Anormalmarket.
Explanation
Normalbackwardationmeansthatexpectedfuturesspotpricesaregreaterthanfuturesprices.Itsuggeststhatwhenhedgers
arenetshortfuturescontracts,theymustsellthematadiscounttotheexpectedfuturespotpricestogetinvestorstobuy
them.Thefuturespricerisesasthecontractmaturestoconvergewithspotprices.
Question#14of85 QuestionID:464063
AllofthefollowingareexamplesofthemonetarybenefitsorcostsofholdinganassetunderlyingafuturescontractEXCEPT:
A) havingareadysupplyoftheassetforbusinesspurposes.
B) dividendpaymentsfromaportfolioofstocks.
C) storageandinsurancecostsforstoringgold.
Explanation
Havingareadysupplyofanassetforbusinesspurposesisanonmonetarybenefitofholdingtheasset.Thisconvenience
yieldcanresultinbackwardation.
Question#15of85 QuestionID:464060
Comparedtofuturespricesonasixmonthcontract,forwardpricesonanidenticalcontractare:
A) alwayshigher.
B) equal.
C) higher,lower,orequal.
Explanation
Futurespricesmaybehigherorlowerthanforwardpricesonacontractwithidenticalterms,dependingonthecorrelation
betweeninterestratechangesandthepricechangesoftheunderlyingasset.Wheninterestratesandassetvaluesare
positivelycorrelated,thefuturespricetendstobehigher,andwheninterestratesandassetvaluesarenegativelycorrelated,
thefuturespricetendstobelower.
Question#16of85 QuestionID:464030
Consideraforwardcontracton1millionMexicanPesosat$0.08254/MXN.60dayspriortoexpirationtheU.S.riskfreerateis
5%,theMexicanriskfreerateis6%,andthespotrateis$0.08211/MXN.Thevalueofthecontracttothelongisclosestto:
A) $297.
B) $553.
C) $553.
Explanation
Theformulais:
Vt=St/(1+Rfor)(Tt)F T/(1+Rdom)(Tt) .
Thevalueis0.08211/1.0660/3650.08254/1.0560/365=0.081327630.08188065=0.00055302.
TheanswerisinUSD/Peso,becausewhenmultiplyingbyPesos,theanswerisinUSD.
0.000553021millionPesos=$553.02.
Question#17of85 QuestionID:464055
Thevalueofafuturescontractbetweenthetimeswhentheaccountismarkedtomarketis:
A) neverlessthanthevalueofaforwardcontractenteredintoonthesamedate.
B) equaltothedifferencebetweenthepriceofanewlyissuedcontractandthesettle
priceatthemostrecentmarktomarketperiod.
C) thesameasthecontractprice.
Explanation
Betweenthemarktomarketaccountadjustments,thecontractvalueiscalculatedjustlikethatofaforwardcontractitisthe
differencebetweenthepriceatthelastmarktomarketandthecurrentfuturesprice,(i.e.thefuturespriceonanewlyissued
contract).Themarktomarketofafuturescontractisthepaymentorreceiptoffundsnecessarytoadjustforthegainsor
lossesontheposition.Thisadjuststhecontractpricetothe'noarbitrage'pricecurrentlyprevailinginthemarket.
Question#18of85 QuestionID:464008
Thetheoreticalpriceofaforwardcontract:
A) isthenoarbitrageprice.
B) equalsthelong'sexpectationofthefuturepriceoftheunderlyingasset.
C) isalwaysgreaterthanthecurrentpriceoftheunderlyingasset.
Explanation
Thetheoreticalpriceofaforwardcontractisthefuturepriceoftheunderlyingassetimposedbythenoarbitrageconditions.It
canbelessthanthecurrentpriceoftheassetifthecostofcarryisnegative.Accruedinterestispaidbythelongatdelivery
underabondforward,butisnotincludedinthepricequote,whichisusuallyintermsofyieldtomaturityatthesettlement
date.
Question#19of85 QuestionID:464061
Toinitiateanarbitragetradeifthefuturescontractisunderpriced,thetradershould:
A) borrowattheriskfreerate,shorttheasset,andsellthefutures.
B) shorttheasset,investattheriskfreerate,andbuythefutures.
C) borrowattheriskfreerate,buytheasset,andsellthefutures.
Explanation
Ifthefuturespriceistoolowrelativetothenoarbitrageprice,buyfutures,shorttheasset,andinvesttheproceedsattherisk
freerateuntilcontractexpiration.Takedeliveryoftheassetatthefuturesprice,payforitwiththeloanproceedsandkeepthe
profit.ForTreasurybill(Tbills),shortingtheassetisequivalenttoborrowingattheTbillrate.
Question#20of85 QuestionID:464007
Whichofthefollowingbestdescribesthepriceofaforwardcontract?Theforwardpriceis:
A) alwaysequaltothemarketpriceatcontracttermination.
B) alwaysexpressedindollars.
C) thepricethatmakesthevaluesofthelongandshortpositionszeroatcontract
initiation.
Explanation
Theforwardpriceisthecontractpriceoftheunderlyingassetunderthetermsoftheforwardcontract,andisthepricethat
makesthevaluesofthelongandshortpositionszeroatcontractinitiation.Itisnottheamountitcoststopurchasetheforward
contract.Theforwardpriceisexpressedintermsoftheunderlyingasset,andmaybeadollarvalue,exchangerate,or
interestrate.Thevalueofaforwardcontractcomesfromthedifferencebetweentheforwardcontractpriceandthemarket
pricefortheunderlyingasset.Thesevaluesarelikelytobedifferentatcontracttermination,whichwillresultinaprofitfor
eitherthelongortheshortposition.
Question#21of85 QuestionID:464058
Thenoarbitragepriceofafuturescontractwithaspotrateof990,atimetomaturityof2years,andariskfreerateof5%is
closestto:
A) 792.
B) 1040.
C) 1091.
Explanation
Thenoarbitragepriceofafuturescontractisbasedonthespotrate,thetimetomaturity,andtheriskfreerate.
FP =S0(1+Rf)T
=990(1.05)2
=1091
Question#22of85 QuestionID:464077
Thetheoreticalquestionofwhetherfuturespricesareunbiasedpredictorsoffuturespotratesfocuseson:
A) whetherfuturesmarketsareefficient.
B) thecorrelationbetweeninterestratechangesandassetpricechanges.
C) whetherfuturesbuyersaretakingonassetowners'pricerisk.
Explanation
Thetheoreticalanalysisofwhetherfuturespricesareunbiasedpredictorsofspotratesatfuturesexpirationdatesdependson
whetherfuturesbuyersarebeingcompensatedfortakingontheassetpriceriskthatfuturessellersareavoiding.Underthe
assumptionthatfuturestransactionsaredrivenbythosewithnaturalshortpricerisktransactingwiththosewhohavenatural
longpositions,expectedfuturespotpricesareequaltofuturesprices.
Question#23of85 QuestionID:464016
Thepriceofaforwardcontract:
A) dependsonforwardinterestrates.
B) changesoverthetermofthecontract.
C) isdeterminedatcontractinitiation.
Explanation
Thepriceofaforwardcontractisestablishedattheinitiationofthecontractandisexpressedindifferentterms,dependingon
theunderlyingassets.Itisthepricethatmakesthecontractvaluezero,anddependsoncurrentinterestratesthroughthe
costofcarrycalculation.
Question#24of85 QuestionID:464051
Thedifferencebetweenthespotandthefuturespricemustconvergetozeroatfuturesexpirationbecause:
A) thefuturescontractbecomesequivalenttotheunderlyingassetatexpiration.
B) thefuturescontracthastobeworththesameasallotherdeliverymonths.
C) anarbitragetradecanbeimplementedusingonlyotherfuturescontracts.
Explanation
Ifthefuturesandspotpricesarenotequal,arbitrageactivitywilloccur.
Question#25of85 QuestionID:464018
Anindexiscurrently965andthecontinuouslycompoundeddividendyieldontheindexis2.3%.Whatisthenoarbitrageprice
onaoneyearindexforwardcontractifthecontinuouslycompoundedriskfreerateis5%.
A) 991.1.
B) 991.4.
C) 987.2.
Explanation
ThefuturespriceFP=S0eT(eRT)
=S0e(R)T
=965e(.05.023)
=991.4
Question#26of85 QuestionID:464049
Attheexpirationofafuturescontract,thedifferencebetweenthespotandthefuturespriceis:
A) atitspointofhighestvolatility.
B) equaltozero.
C) alwayspositive.
Explanation
Thedifferencemustbezeroatexpirationbecauseboththespotpriceandthefuturespriceare,atthatpointintime,theprice
oftheunderlyingassetforimmediatedelivery.
Question#27of85 QuestionID:464079
WhichofthefollowingstatementsregardingEurodollarfuturesismostaccurate?
A) Eurodollarsfuturesarebasedon60dayLIBOR,whichisanaddonyield.
B) Everybasispoint(0.01%)moveinannualized60dayLIBORrepresentsa$25gainor
lossonthecontract.
C) EurodollarfuturesarepricedasadiscountyieldandLIBORissubtractedfrom100to
getthequote.
Explanation
Eurodollarfuturesarepricedasadiscountyieldandarequotedas100minus90dayLIBOR.
Question#28of85 QuestionID:464048
Thecreditriskinaforwardcontractis:
A) onlyanissueforthelong.
B) directlyrelatedtothecontractvalue.
C) positivelyrelatedtothetermofthecontract.
Explanation
Thecreditrisktothepartywiththepositionwiththepositivevalue(longorshort)isgreater,thegreaterthevalueofthe
forwardcontractatapointintime.Acontractwithalongertermmayhavealowercontractvalue.
Question#29of85 QuestionID:464062
Comparedtothepriceonanotherwiseidenticalforwardcontract,thepriceofafuturescontractis:
A) alwaysthesameatcontractinitiation.
B) higherwhenassetpricechangesarepositivelycorrelatedwithinterestratechanges.
C) lowerwhenassetpricechangesarepositivelycorrelatedwithinterestratechanges.
Explanation
Apositivecorrelationbetweenassetpricechangesandinterestratechangesmakesthemarktomarketfeatureattractivetoa
futuresbuyer.Thisleadstoahigherfuturespricecomparedtotheforwardpriceonanotherwiseidenticalcontract.
Question#30of85 QuestionID:464065
Thereturnfromthenonmonetarybenefitsofholdingtheassetunderlyingafuturescontractis(are)called:
A) thenonmonetaryreturn.
B) negativestoragecosts.
C) theconvenienceyield.
Explanation
Thereturnfromthenonmonetarybenefitsofholdingtheassetunderlyingafuturescontractiscalledtheconvenienceyield.
Question#31of85 QuestionID:464052
Regardingfuturescontracts,thespotpricereferstothe:
A) priceoftheunderlyingassetinaparticularlocation,or'spot',inthefuture.
B) presentvalueoftheexpectedfutureprice.
C) currentmarketpriceoftheassetunderlyingthefuturescontract.
Explanation
Thespotpricereferstothecurrentmarketpriceoftheassetunderlyingthecontract.Itisthepriceforimmediatedeliveryof
theasset.
Question#32of85 QuestionID:464066
Backwardationreferstoasituationwhere:
A) thefuturespriceisabovethespotprice.
B) thefuturespriceisbelowthespotprice.
C) longhedgersoutnumbershorthedgers.
Explanation
Backwardationreferstoasituationwherethefuturespriceisbelowthespotprice.Forbackwardationtooccur,theremustbe
asignificantbenefittoholdingtheasset,eithermonetaryornonmonetary.
Questions#3336of85
CraigChampion,CFA,managesportfoliosofU.S.securitiesforEuropeaninvestors.Hisclientshaveeachholddifferentkinds
ofsecurities,andeachhasdifferingviewswithrespecttohedgingexchangeraterisk.FrancoisLevisqueisaBelgianinvestor
whoholdsalargediversifiedportfolioofU.S.equities.LevisquehasareputationforsomesuccessintimingtheU.S.equity
market.Forexample,hehasoftenlockedingainsonhisportfoliowithderivativesshortlybeforeamarketcorrection.
Sometimeshealsohedgeshisportfolio'scurrencyrisk.LevisquehasjustinstructedChampiontotakealargeshortpositionin
S&P500index,eitherwithfuturesorwithaforwardcontract.Championnoticesthatthefuturespriceislessthanthecurrent
spotpriceandconsultswithhiscolleagueDanielleSilvers,CFA.Championsayshethinksthatthefuturespriceislessthanthe
spotpricebecausethedividendyieldoftheS&P500isgreaterthantheTreasuryBillrate.Silverssaysthatitcouldjustbe
backwardation.Silversalsonotesthattheuseofaforwardcontractmightbeagoodideabecausethecontractwillnotattract
theattentionofothermarketparticipantswhomightreacttoLevisque'smove.ChampiontellsSilversthatthereasonLevisque
wantstohedgehisequitypositionisthathethinksallU.S.interestrateswillincreasesoon.This,hebelieves,isbearishfor
equities,andhealsothinksthenegativerelationshipbetweenequitypricesandinterestratesmakesashortforwardcontract
moreattractivethanashortfuturescontract.
RagnarHvammenisaNorwegianinvestorwithalargeinvestmentinoilrelatedassetsthatheoftenhedgeswithfutures
contracts.Championnoticesthatthepriceofanoilfuturescontractisusuallyhigherthanthespotprice.Hvammenusesshort
termborrowingsindollars,frombothEuropeanandU.S.banks,tomeettheliquidityneedsofhisoilinvestments,andhehas
ChampionhedgetheseloanpositionswithEurodollarfutures.SilverssuggeststhatChampionshouldconsiderusingTbill
futurestohedgetheloansfromU.S.banks,anduseEurodollarfuturesonlyfortheEurodollarloans.Championsayshewill
lookintothat,aswellasforwardrateagreements,asalternativehedgingtoolsforHvammen.
ChampionisalsoevaluatingpricingofTbondfutures.Specifically,heislookingforpricingona1.2yearcontract.TheCTDis
a6.5%30yearbondissued10yearsagocurrentlyyielding5%.Theconversionfactorforthebondis1.08.Assumethatthe
riskfreerateoverthecontractperiodis3%.
Question#33of85 QuestionID:464092
ChampionandSilverseachgaveareasonforwhythefuturespriceoftheS&P500indexmightbelessthanthespotprice.
Withrespecttotheirstatements,itismostaccuratetoconcludethat:
A) Champion'sstatementisinvalidwhileSilver'sstatmentisvalid.
B) neitherstatementisvalid.
C) bothstatementsarevalid.
Explanation
TheequationforthepriceofafuturescontractonanequityindexisFP=S0e(R)T,whereisthedividendyieldandRis
theriskfreerate.IfR<,thenFP<S0andChampioniscorrect.Silverscouldbecorrectinthatbackwardationisdefinedas
FP<S0,withtherelationshipbeingcausedbytheriskaversionofhedgersoflongassetpositions.Theirriskaversionmakes
themwillingtotakeshortcontractsatlowerpricesthanotherwisemightbethecase.
Question#34of85 QuestionID:464093
IfChampionthinksthattheS&P500indexisnegativelycorrelatedwithinterestrates,thenchoosingtheshortforwardcontract
overtheshortfuturescontractis:
A) appropriatebecausetheforwardcontractwouldbenefitmorefromahigher
reinvestmentrate.
B) counterproductivebecauseashortfuturescontractwouldbenefitmorefromahigher
reinvestmentrate.
C) counterproductivebecauseashortfuturescontractwouldbenefitmorefromahigher
borrowingrate.
Explanation
Whenhedgingaposition,futurescontractsarebetterifthehedgeproducesapositivecashflow,viamarkingtomarket,when
interestratesriseandishurtwheninterestratesfall.Inthiscase,wheninterestratesriseandcauseequityvaluestofall,a
shortfuturespositionwillreceiveapositivecashflowthatcanbereinvestedatthehigherrate.Ifinterestratesfall,andthe
shortfuturespositionmustbemarkedtomarketwithanegativecashflow,theopportunitycostofthenegativecashflowis
lower.Forwardcontractsthatdonotrequiremarkingtomarketdonot"benefit"fromchangesininterestrates.
Question#35of85 QuestionID:464094
Oilfuturespricesmightbehigherthanthespotpricebecause:
A) therearemorecoststhanbenefitstoholdingtheasset.
B) ofreversecontango.
C) therearemorebenefitsthancoststoholdingtheasset.
Explanation
Incalculatingthefuturesprice,wewouldsubtractthebenefitsofholdingtheasset,e.g.,thepresentvalueofdividendsand
coupons,andaddthecostsofholdingtheasset.Oildoesnotpayadividend,andtherewouldbecostsforholdingoil.
Contangodescribesthesituationwherethefuturespriceexceedsthespotprice,andthereisnotsuchthingasreverse
contango.
Question#36of85 QuestionID:464095
WithrespecttousingEurodollarfutures,insteadofTbillfutures,tohedgeshorttermloansfromU.S.banks,Championis:
A) justifiedbecausetheEurodollarfuturesmarketisveryliquid,andLIBORisless
correlatedwithshorttermloanratesthanistheTbillrate.
B) justifiedbecausetheEurodollarfuturesmarketisveryliquid,andLIBORismore
correlatedwithshorttermloanratesthanistheTbillrate.
C) notjustifiedbecausetheEurodollarfuturesmarketisnotveryliquid,andLIBORis
morecorrelatedwithshorttermloanratesthatTbills.
Explanation
EurodollarfuturesarefuturesondollarLIBOR,andLIBORistheprevailingrateonverylargebankloanscalledEurocurrency
loans.TheratesonTbillscanbedrivenbyinfluences(e.g.,aflighttoquality)thataredifferentthanthosethatdrivedollar
LIBORrates.Asaresult,Eurodollarfuturesaremorehighlycorrelatedwith(dollar)bankloanratesshouldprovideabetter
hedgefortheclient'sbankloanexposure.Moreover,theEurodollarfuturesmarketislargeandveryliquid.
Question#37of85 QuestionID:464081
UnlikeU.S.Tbillsandtheirfuturescontracts,norisklessarbitragerelationexistsbetweenLIBORandtheEurodollarfutures
contract:
A) butEurodollarfuturescontractsarestillauseful,widelyusedhedgingvehicle
forexposuretoLIBOR.
B) thereforeinvestorsmustutilizesyntheticinstrumentstohedgetheirexposureto
LIBOR.
C) resultinginmostinvestorshedgingtheirLIBORexposurewith90dayTbillcontracts.
Explanation
Althoughanimperfecthedge,EurodollarfuturesarestillwidelyusedtohedgeexposuretoLIBOR.
Question#38of85 QuestionID:464045
Thebestmeasureoftheamountofcreditriskexposureforaforwardcontract,atapointintime,isthe:
A) notionalamountofthecontract.
B) liabilitiesofthecounterparty.
C) valueofthecontract.
Explanation
Theamountofcreditriskisbestmeasuredbythecontractvalueatapointintime.Thisisthepresentvalueofthesettlement
payment,basedoncurrentmarketprices,interestrates,orexchangerates.Thepartytowhomthepaymentwouldbemade
hasthecreditrisk,theriskthatthepaymentwillnotbemadeorthattheassetwillnotbedelivered/purchasedatcontract
expiration.
Question#39of85 QuestionID:464015
Atexpiration,thevalueofaforwardcontractis:
A) equaltothemarketpriceoftheunderlyingasset.
B) thedifferencebetweenthecontractpriceandthemarketvalueoftheunderlying
asset.
C) alwaysgreaterthanorequaltozero.
Explanation
Inaforwardcontract,thelongisobligatedtobuy,andtheshortisobligatedtosell,theunderlyingassetatthecontractprice.
Thedifferencebetweenthecontractpriceandthemarketpriceoftheassetiswhatgivesthecontractvalue.Thecontracthas
apositivevalueatexpirationtothelong/shortonlyifthecontractpriceisbelow/abovethemarketprice.
Question#40of85 QuestionID:464011
Theforwardpriceina90dayforwardcontractonanondividendpayingstockcurrently(atcontractinitiation)sellingfor$55
whenthe90dayriskfreerateis5%isclosestto:
A) $54.32.
B) $52.38.
C) $55.67.
Explanation
Question#41of85 QuestionID:464028
Whatisthevalueofa6.00%1x4(30daysx120days)forwardrateagreement(FRA)withaprincipalamountof$2,000,000,
10daysafterinitiationifL10(110)is6.15%andL10(20)is6.05%?
A) $700.00.
B) $767.40.
C) $745.76.
Explanation
Thecurrent90dayforwardrateatthesettlementdate,20daysfromnowis:
([1+(0.0615x110/360)]/[1+(0.0605x20/360)]1)x360/90=0.061517
Theinterestdifferenceona$2million,90dayloanmade20daysfromnowattheaboveratecomparedtotheFRArateof
6.0%is:
[(0.061517x90/360)(0.060x90/360)]x2,000,000=$758.50
Discountthisamountatthecurrent110dayrate:
758.50/[1+(0.0615x110/360)]=$745.76
Question#42of85 QuestionID:464022
Acompanyhaschosentousea6x9FRAexpiringin6monthstomitigatetheriskofpayingafloatingcoupononthebond
issue.ThecurrenttermstructureforLIBORisasfollows:
Term InterestRate
180days 5.65%
270days 5.95%
Whatisthepriceofthisforwardrateagreement(FRA)?
A) 3.19%
B) 6.37%
C) $6.37
Explanation
ThepriceofanFRAisthefixedrate.TodeterminetheFRA'sfixedrate,thefollowingformulashouldbeused:
TheFRA"sfixedratewouldbequotedas6.37%.
ThepriceofanFRAisgivenasaratepercentage,neverasadollaramount.
Question#43of85 QuestionID:464053
Attheexpirationofafuturescontract,thefuturespriceis:
A) thesameasthepriceattheinitiationofthecontract.
B) equaltothemarketpriceforimmediatedeliveryoftheasset.
C) aboveorbelowthemarketprice,dependingonsupplyanddemand.
Explanation
Atexpiration,thefuturespriceisequaltothepriceoftheassetforimmediatedeliverybecausethecontractcallsfordeliveryof
theassetonthatdate.Notethatatexpiration,thespotpriceandthefuturespriceareequal.
Question#44of85 QuestionID:464073
Supposethesoybeanmarketisinbackwardationwithacashpriceof$6.50/bushelandafuturespriceof$6.00/bushel.Also
assumethatatraderowns5,000bushelsofsoybeansanddoesnotneedthesoybeansuntilafterfuturesexpiration.Whichof
thefollowingisthebeststrategyforthetrader?
A) Sellthesoybeansinthespotmarket,buyanappropriatefutures,andprofit
$1,250.
B) Sellthesoybeansinthespotmarket,buyanappropriatefutures,andprofit$2,500.
C) Donothingsincetheconvenienceyieldissohigh.
Explanation
Sincethetraderdoesnotneedthesoybeansnowheshouldmonetizetheconvenienceyieldbysellinginthespotmarketand
simultaneouslybuysoybeanfuturesforhislaterneeds.Thetotalprofitiscomputedasfollows:
Totalprofit=(CashPriceFuturesPrice)Amount=($6.50$6.00)5,000=$2,500.
Questions#4550of85
ChantalDuPontistheCFOofVetementsVerdun,amanufacturerofspecialtyclothinganduniforms,locatedinnorthern
France.ThefirmiscurrentlyundergoinganexpansionwhichwillrequireDuPonttodrawdown25milliononVetements
Verdun'screditlineasa90daybridgeloanbeforethemortgagecloses.Themoneywillnotbeneededfor60days,atwhich
pointtheinterestratewillbedetermined.Theinterestrateontheloanwillbebasedoff90dayLIBOR.
DuPontisbecomingconcernedbecauseofsignsthatinterestratesmaybegintorise.Thefirmcannotaffordtohaveits
borrowingcostsincreasesignificantlyovercurrentrates.InresponsetoDuPont'sconcerns,thecompany'sCEO,Viviane
Lamarre,hasaskedDuPonttohedgethefirm'sborrowingcosts,evenifthatentailssomeneartermoutlays.
DuPontandLamarrediscussenteringintoaforwardrateagreement(FRA)tohedgeVetementsVerdun'sinterestrate
exposureonthecreditline.CurrentLIBORratesare:
Liborrate
30day 2.6%
60day 2.8%
90day 3.0%
120day 3.2%
150day 3.3%
180day 3.4%
TheydecidetogoforwardwiththehedgeandDuPontentersintotheappropriateFRAforthefullamountof25million.
Inthefirst30daysoftheFRA,thefixedincomemarketsrallysharply.ThenewsetofLIBORrates,onthethirtiethdayofthe
FRA,is:
Liborrate
30day 2.2%
60day 2.4%
90day 3.6%
120day 3.8%
150day 3.8%
180day 3.8%
Atthesettlementdate,theinterestsavingsontheloantermis23,750.DuPonttellsLamarre,"Iamlookingforwardtocashing
oursettlementcheckfor23,750."Lamarreadds,"Yes,andontopofthatwegettoborrowfor90daysatabelowmarket
rate."BothDuPontandLamarrearepleasedwiththeirdecisiontohedge.
Question#45of85 QuestionID:464039
Whichstatementmostaccuratelydescribesa2x3forwardrateagreement?
A) Contractexpiresintwomonthsonanunderlyingloansettledinthreemonths.
B) Underlyingloanoftwomonthmaturityunderacontractthatexpiresinthreemonths.
C) Twomonthunderlyinginterestrateonacontractsettledinthreemonths.
Explanation
A2x3forwardrateagreementisacontractthatexpiresintwomonthsandtheunderlyingloanissettledinthreemonths.The
underlyingrateisa30day(1month)rateona30day(1month)loanin60days(2months).(StudySession16,LOS48.a)
Question#46of85 QuestionID:464040
WhichforwardrateagreementwouldmosteffectivelyhedgeVetementsVerdun'sexposuretoLIBOR?
A) 2x3.
B) 2x5.
C) 3x2.
Explanation
VetementsVerdunneedstobehedgedagainst90dayLIBORratesthatwillprevail60daysfromnow.Suchahedgewould
requireatwomonthcontractonthreemonthrates,tobesettledinfivemonths:a2x5.(StudySession16,LOS48.c)
Question#47of85 QuestionID:464041
WhichvalueisclosesttothepriceofthemosteffectivehedgeforVetementsVerdun?
A) 3.3%.
B) 3.6%.
C) 3.0%.
Explanation
Theactual,unannualizedrateonthe60dayloanis:
R60=0.02860/360=0.00467
Theactual,unannualizedrateonthe150dayloanis:
R150=0.033150/360=0.01375
Sotherateona90dayloantobemade60daysfromnowis:
FR(60,90)=((1+R150)/(1+R60))1
FR(60,90)=(1.01375/1.00467)1
FR(60,90)=1.009041
FR(60,90)=0.904%
Weannualizethisrateusingtheformula:
0.904%(360/90)=3.62%
(StudySession16,LOS48.c)
Question#48of85 QuestionID:464042
Whatmustthe90dayLIBORratehavebeenattheexpirationofthecontract?
A) 4.0%.
B) 3.6%.
C) 3.4%.
Explanation
SinceVetementsVerdunislongtheFRA,themarketrateofinterestatsettlementmustbehigherthanthepriceofthe
contractandthe23,750hasapositivevalue.Theinterestsavingsattheendoftheloantermwillbe:
Interestsavings=((marketrate(90/360))(0.0362(90/360)))25,000,000
23,750=((marketrate90/360)0.00905)25,000,000
0.000950=marketrate90/3600.00905
0.0100=marketrate0.25
0.0400=marketrate
Themarketratemusthavebeen4.0%.
(StudySession16,LOS48.c)
Question#49of85 QuestionID:464043
RegardingthestatementsmadebyLamarreandDuPontabouttheultimatevalueoftheirhedge:
A) Lamarre'sstatementiscorrectDuPont'sstatementisincorrect.
B) Lamarre'sstatementisincorrectDuPont'sstatementisincorrect.
C) Lamarre'sstatementisincorrectDuPont'sstatementiscorrect.
Explanation
TheinterestsavingsattheendoftheloantermmustbediscountedbacktothepresentvalueontheFRAsettlementdate:
Settlementpayment=Presentvalueofinterestsavings
Settlementpayment=23,750/(1+(0.04090/360))
Settlementpayment=23,750/(1+0.010)
Settlementpayment=23,750/1.010
Settlementpayment=23,515
Thesettlementcheckwouldbefor23,515.DuPont'sstatementisincorrect.Lamarre'sstatementisalsoincorrectbecausethe
settlementcheckrepresentsthevalueofthebelowmarketloan.Theactualloanwillbeattheprevailingrate,andthe
settlementontheFRAwilloffsettheinterestcostontheloan.
(StudySession16,LOS48.c)
Question#50of85 QuestionID:464044
ThirtydaysintotheFRA,whatisthevalueofthecontractfromVetementsVerdun'sperspective?
A) Due43,943.
B) Due45,000.
C) Owes43,943.
Explanation
Sincewehavemoved30daysintotheFRA,thenewratefortheendofthecontractisthe30dayrate(60daysoriginally
minus30dayspassed)andthenewrateforthesettlementoftheloanisthe120dayrate(150daysoriginallyminus30days
passed).
Withthatinformation,thepricingisstraightforward:
Theactual,unannualizedrateonthe30dayloanis:
R30=0.02230/360=0.00183
Theactual,unannualizedrateonthe120dayloanis:
R120=0.038120/360=0.01267
Therateona90dayloantobemade30daysfromnowis:
FR(30,90)=((1+R120)/(1+R30))1
FR(30,90)=((1+0.01267)/(1+0.00183))1
FR(30,90)=(1.01267/1.00183)1
FR(30,90)=1.0108201
FR(30,90)=1.0820%
Weannualizethisrateusingtheformula:
1.082%(360/90)=4.33%
Theinterestsavingis:
Interestsaving=((0.043390/360)(0.036290/360))25,000,000
Interestsaving=(0.010830.00905)25,000,000
Interestsaving=0.0017825,000,000
Interestsaving=44,500
Theinterest"saving"isapositive44,500.Discountingthatbackatthecurrent120dayratewehave:
FRAvalue=44,500/(1+(0.038120/360))
FRAvalue=44,500/(1+(0.012667))
FRAvalue=44,500/1.012667
FRAvalue=43,943
ThevalueoftheFRAtoVetementsVerdun30daysintothecontractis43,943.Inotherwords,theyaredue43,943.
(StudySession16,LOS48.c)
Question#51of85 QuestionID:464054
Theprimarydifferenceincreditriskbetweenforwardsandfuturescontractsismostlikelybecause:
A) futuresaremarkedtomarketdaily.
B) futuresmarketshavehigherqualityparticipants.
C) forwardsmarketshavehigherqualityparticipants.
Explanation
Futuresaremarkedtomarketdailythisreducescreditrisktoasingleday'slosses.
Question#52of85 QuestionID:464020
Calculatethenoarbitrageforwardpricefora90dayforwardonastockthatiscurrentlypricedat$50.00andisexpectedtopayadividend
of$0.50in30daysanda$0.60in75days.Theannualriskfreerateis5%andtheyieldcurveisflat.
A) $48.51.
B) $50.31.
C) $49.49.
Explanation
Thepresentvalueofexpecteddividendsis:$0.50/(1.0530/365)+$0.60/(1.0575/365)=$1.092
Futureprice=($50.001.092)1.0590/365=$49.49
Question#53of85 QuestionID:464071
Whichofthefollowingstatementsisleastaccurate?
A) Backwardationmeansthefuturespriceisbelowtheasset'spriceandoccursif
rfisgreaterthanthedividendyield.
B) Normalbackwardationmeansthatthefuturespriceislessthantheexpectedasset
priceatcontractexpiration.Itcouldoccurbecausethefuturespriceonlyreflectsthe
riskfreerateinanarbitragetransaction.
C) Normalcontangomeansthefuturespriceisgreaterthantheexpectedassetpriceis
atcontractexpiration.Thismightoccurifthereishighdemandtobuycontracts.
Explanation
Recognizethatthequestionislookingforafalsestatement.Backwardationmeansthatf0<S0.However,rfincreasesthe
valueoff0anddividendyielddecreasesthevalueoff0.Backwardationwouldoccurifrfislessthanthedividendyield.
Normalbackwardationoccurswhenthefuturespriceislessthantheexpectedassetpriceatcontractexpirationandcorrectly
explainswhyf0isgenerallylessthantheexpectedfuturespotprice.Notethecontrastwithbackwardationwhichmeansf0<
S0.
Normalcontangooccurswhenthefuturespriceisgreaterthantheexpectedassetpriceatcontractexpiration.Thestatement
thathighdemandtobuythecontractcouldincreasethecontractpriceisalsocorrect.Notethecontrastwithcontango,which
meansthefuturespriceisabovetheasset'sspotprice.(LOS49.f)
Question#54of85 QuestionID:464014
Duringthelifeofaforwardcontract,thevalueofthecontractisbestdescribedas:
A) thedifferencebetweenthefuturevalueofthespotpriceandtheexpected
futurepriceoftheunderlyingasset.
B) thedifferencebetweenthespotpriceandthepresentvalueoftheforwardpriceofthe
underlyingasset.
C) thepresentvalueoftheexpectedfuturepriceoftheunderlyingasset.
Explanation
Thevalueofaforwardcontractonanassetwithnocashflowsduringitstermisequaltospot(forwardprice)/(1+Rf)t ),the
differencebetweenthespotpriceandthepresentvalueoftheforwardpriceoftheunderlyingasset.
Questions#5560of85
MonicaLewis,CFA,hasbeenhiredtoreviewdataonaseriesofforwardcontractsforamajorclient.Theclienthasaskedfor
ananalysisofacontractwitheachofthefollowingcharacteristics:
1. AforwardcontractonaU.S.Treasurybond
2. Aforwardrateagreement(FRA)
3. Aforwardcontractonacurrency
InformationrelatedtoaforwardcontractonaU.S.Treasurybond:TheTreasurybondcarriesa6%couponandhasa
currentspotpriceof$1,071.77(includingaccruedinterest).Acouponhasjustbeenpaidandthenextcouponisexpectedin
183days.Theannualriskfreerateis5%.Theforwardcontractwillmaturein195days.
Informationrelatedtoaforwardrateagreement:Therelevantcontractisa39FRA.Thecurrentannualized90day
moneymarketrateis3.5%andthe270dayrateis4.5%.Basedonthebestavailableforecast,the180dayrateatthe
expirationofthecontractisexpectedtobe4.2%.
Informationrelatedtoaforwardcontractonacurrency:TheriskfreerateintheU.S.is5%and4%inSwitzerland.The
currentspotexchangerateis$0.8611perSwissFrance(SFr).Theforwardcontractwillmaturein200days.
Question#55of85 QuestionID:464032
Basedontheinformationgiven,whatinitialpriceshouldLewisrecommendforaforwardcontractontheTreasurybond?
A) $1,073.54.
B) $1,035.12.
C) $1,070.02.
Explanation
Theforwardprice(FP)ofafixedincomesecurityisthefuturevalueofthespotpricenetofthepresentvalueofexpected
couponpaymentsduringthelifeofthecontract.Inaformula:
FP=(S0PVC)(1+Rf)T
A6%coupontranslatesintosemiannualpaymentsof$30.Withariskfreerateof5%and183daysuntilthenextcouponwe
canfindthepresentvalueofthecouponpaymentsfrom:
PVC=$30/(1.05)183/365=$29.28.
With195daystomaturitytheforwardpriceis:
FP=($1,071.77$29.28)(1.05)195/365=$1,070.02.
(StudySession16,LOS51.c)
Question#56of85 QuestionID:464033
SupposethatthepriceoftheforwardcontractfortheTreasurybondwasnegotiatedoffmarketandtheinitialvalueofthe
contractwaspositiveasaresult.Whichpartymakesapaymentandwhenisthepaymentmade?
A) Theshortpaysthelongatthematurityofthecontract.
B) Thelongpaystheshortattheinitiationofthecontract.
C) Thelongpaystheshortatthematurityofthecontract.
Explanation
Ifthevalueofaforwardcontractispositiveatinitiationthenthelongpaystheshortthevalueofthecontractatthetimeitis
enteredinto.Ifthevalueofthecontractisnegativeinitiallythentheshortpaysthelongtheabsolutevalueofthecontractat
thetimethecontractisenteredinto.(StudySession16,LOS51.a)
Question#57of85 QuestionID:464034
SupposethatinsteadofaforwardcontractontheTreasurybond,asimilarfuturescontractwasbeingconsidered.Whichone
ofthefollowingalternativescorrectlygivesthepreferencethataninvestorwouldhavebetweenaforwardandafutures
contractontheTreasurybond?
A) Itisimpossibletosayforcertainbecauseitdependsonthecorrelation
betweentheunderlyingassetandinterestrates.
B) Theforwardcontractwillbepreferredtothefuturescontract.
C) Thefuturescontractwillbepreferredtotheforwardcontract.
Explanation
Theforwardcontractwillbepreferredtoasimilarfuturescontractpreciselybecausethereisanegativecorrelationbetween
bondpricesandinterestrates.Fixedincomevaluesfallwheninterestratesrise.Borrowingcostsarehigherwhenfundsare
neededtomeetmarginrequirements.Similarlyreinvestmentratesarelowerwhenfundsaregeneratedbythemarktomarket
ofthefuturescontract.Consequentlythemarktomarketfeatureofthefuturescontractwillnotbepreferredbyatypical
investor.(StudySession16,LOS51.a)
Question#58of85 QuestionID:464035
Basedontheinformationgiven,whatinitialpriceshouldLewisrecommendforthe39FRA?
A) 4.96%.
B) 4.66%.
C) 5.66%.
Explanation
ThepriceofanFRAisexpressedasaforwardinterestrate.A39FRAisa180dayloan,90daysfromnow.Thecurrent
annualized90daymoneymarketrateis3.5%andthe270dayrateis4.5%.Theactual(unannualized)ratesonthe90day
loan(R90)andthe270dayloan(R270)are:
R90=0.035(90/360)=0.00875
R270=0.045(270/360)=0.03375
Theactualforwardrateonaloanwithatermof180daystobemade90daysfromnow(writtenasFR(90,180))is:
Annualized=0.02478(360/180)=0.04957or4.96%.
(StudySession16,LOS51.c)
Question#59of85 QuestionID:464036
Basedontheinformationgivenandassuminganotionalprincipalof$10million,whatvalueshouldLewisplaceonthe39
FRAattimeofsettlement?
A) $38,000paidfromshorttolong.
B) $37,218paidfromlongtoshort.
C) $19,000paidfromlongtoshort.
Explanation
ThevalueoftheFRAatmaturityispaidincash.Ifinterestratesincreasethenthepartywiththelongpositionwillreceivea
paymentfromthepartywithashortposition.Ifinterestratesdeclinethereversewillbetrue.Theannualized180dayloanrate
is4.96%.Giventhatannualizedinterestratesfora180dayloan90dayslaterareexpectedtodropto4.2%,acashpayment
willbemadefromthepartywiththelongpositiontothepartywiththeshortposition.Thepaymentisgivenby:
ThepresentvalueoftheFRAatsettlementis:
38,000/{1+[0.042(180/360)]}=38,000/1.021=$37,218
(StudySession16,LOS51.c)
Question#60of85 QuestionID:464037
Basedontheinformationgiven,whatinitialpriceshouldLewisrecommendforaforwardcontractonSwissFrancsbasedona
discretetimecalculation?
A) $1.1552.
B) $0.8656.
C) $1.0053.
Explanation
Thevalueofaforwardcurrencycontractisgivenby:
WhereFandSarequotedindomesticcurrencyperunitofforeigncurrency.Substituting:
(StudySession16,LOS51.c)
Questions#6166of85
WandaBrockworksasaninvestmentstrategistforGlobos,aninternationalinvestmentbank.Brockhasbeentaskedwith
designingastrategyforinvestinginderivativesinMazakhastan,anEasternEuropeancountrywithimpressiveeconomic
growth.
OneofthefirsttasksBrocktacklesinvolveshedging.GloboswantstohedgesomeofitsinvestmentsinMazakhastanagainst
interestrateandcurrencyvolatility.Afterabitofresearch,Brockhasgatheredthefollowingdata:
TheU.S.riskfreerateis5.5%,andmostinvestorscanborrowat2%abovethatrate.
TheFederalReserveBoardisexpectedtoraisethefedfundsrateby0.25%inoneweek.
ThecurrentspotratefortheMazakhastaniancurrency,thegluck,is9.4073G/$.
Annualized90dayLIBORis7.6%.
Globos'economistsexpectannualized90dayLIBORtoriseto7.9%overthenext60days.
TheMazakhastanriskfreerateis3.75%,andmostinvestorscanborrowat1.5%abovethatrate.
Usingtheabovedata,Brockdevelopssomehedgingstrategies,andthendeliversthemtoGlobos'futuresdesk.
BrockthenturnsherattentiontoMazakhastaniancommodities.Globoshasacquiredtherightstolargedepositsofcopper,
silver,andmolybdenuminMazakhastanandsuspectsthefuturesmarketsmaybemispriced.Brockhasassembledthe
followingdatatoaidherinmakingrecommendationstoGlobos'futuresdesk:
Copper
Spotprice:G3.15/pound.
1yearfuturesprice:G3.54/pound.
Silver
Spotprice:G12.75/pound.
1yearfuturesprice:G12.82/pound.
Molybdenum
Spotprice:G34.45/pound.
1yearfuturesprice:G35.23/pound.
Aftermakingsomecalculations,BrockassessesthearbitrageopportunitiesinMazakhastanandpassestheinformationonto
thefuturesdesk.Shortlyafterward,sheisinformedthatGlobos'Mazakhastansubsidiaryusesitssilverholdingsascollateral
forbusinessloans,whichallowstheunittoobtainafavorableinterestrate.
JonahMason,oneofGlobos'traders,asksBrockforafewdetailsabouttheMazakhastanfinancialmarkets.Brocksends
Masonashortemailcontainingthefollowingobservations:
Mazakhastan'sinvestorsdon'tlikerelyingonoldvaluationdatabecauseassetvalueshavechangedrapidlyinthepast,so
theygenerallyuseamarktomarketvaluationsystem.
Standard&Poor'sjustraisedMazakhastan'ssovereigndebttoinvestmentgrade.
Interestratestendtomoveinthesamedirectionasassetvalues.
Newtechnologicalinnovationsandcommercialexpansionhassubstantiallyboostedtheincomeoftheaverage
Mazakhastanian.
BeforeMasonreceivestheemail,heturnshisattentiontoamemoaboutafuturescontractasubordinateisconsidering.
Unfortunately,thememoarriveswithoutthesummarypagetothenotes.Masonmustdeducethenatureofthehedgebased
onitscharacteristics:Theriskfreerateusedincalculatingthefuturesprice,andthatpriceadjustedtoaccountforindividual
futurecashflows.
Question#61of85 QuestionID:464085
Thepriceofa75daygluckfutureshouldbeclosestto:
A) 9.3750G/$.
B) 9.4429G/$.
C) 0.1081$/G.
Explanation
Tocalculatethepriceofacurrencyfuture,usethefollowingequation:
Spotexchangerate(1+domesticriskfreerate)t /(1+foreignriskfreerate)t .
Inthiscase,sincetheexchangerateisexpressedinglucksperdollar,theMazakhastaninterestrateisconsidereddomestic.
Sincewearepricinga75dayfuture,thetimevariable"t"is75/365.
9.4073G/$(1.0375)(75/365)/(1.055)(75/365)=9.3750G/$.
(StudySession16,LOS52.h)
Question#62of85 QuestionID:464086
BasedontheinformationhereceivedfromBrock,Masoncanbestconcludethat:
A) futurespricesarehigherthanforwardpricesinMazakhastan.
B) inflationinMazakhastanislikelytorise.
C) pricesofcorporatebondsinMazakhastanarelikelytorise.
Explanation
SinceMazakhastanianinvestorsprefermarktomarketaccountingandinterestratesarepositivelycorrelatedtoassetvalues,
Masoncanconcludethatfuturespricesarehigherthanforwardprices.Theupgradeofsovereigndebtcouldspilloverintothe
privatesector,drivingupbondprices.Andanincreaseinconsumerincomecouldsparkspendingthatdrivesupinflation.But
neitherthedebtinformationnortheincomeinformationissufficienttodrawconclusions.(StudySession14,LOS46.c)
Question#63of85 QuestionID:464087
BasedonthetwocharacteristicsofthefuturescontractinMason'smemo,whichofthefollowingdoesthecontractreferto?
Treasurybondfutures? Stockindexfutures?
A) Yes No
B) Yes Yes
C) No Yes
Explanation
BothTreasurybondfuturesandstockindexfuturesrequiretheuseoftheriskfreeratetodetermineprice.Butwhilethe
pricingofbondfuturesrequiresthediscountingofindividualcoupons,thepricingofstockindexfuturesdoesnot,insteadusing
acontinuouslycompoundeddividendyield.(StudySession14,LOS46.f)
Question#64of85 QuestionID:464088
BasedonBrock'sinformation,howshouldtradersbesttakeadvantageofarbitrageopportunitiesinMazakhastan?Forthis
questiononly,assume3%transactioncostforfuturescontracts.
A) Buyspotcopper,donottradesilver,andsellspotmolybdenum.
B) Buyspotcopper,sellspotsilver,andsellspotmolybdenum.
C) Buyspotcopper,sellspotsilver,anddonottrademolybdenum.
Explanation
Firstwemustdeterminewhetherthefuturescontractsaremispriced,bymultiplyingthecommoditypriceby(1+theriskfree
rate),or1.0375.Thebasicequationusestheriskfreerate,butwehavetheactualborrowingrate,andforrealworld
purposestheactualborrowingrateprovidesamoreaccuratepriceestimate.Forpracticalpurposes,weshouldprobablyuse
theborrowingrate,butbothratesprovidethesameanswertothequestionabove.Forillustrationpurposes,weusetherisk
freerateinthediscussionbelow.
Itturnsoutthatallthreecontractsaremispriced.Copperfuturesareoverpriced,andsilverandmolybdenumfuturesare
underpriced.However,transactioncostsmuddythewater.Assuminga3%commissiononfuturestrades,thepricedifferential
onmolybdenumisnotsufficienttojustifyanarbitragetrade.Thus,thetradersshouldbuycopper,forwhichthefutures
contractisoverpriced,andsellsilver,forwhichthefuturescontractisunderpriced,andmakenotradesinmolybdenum
despitethefactthatthefuturescontractisunderpriced.
(StudySession16,LOS52.h)
Question#65of85 QuestionID:464089
AssumethatGloboshastakenapositionintheEurodollarfuturescontract,itisnow60dayslaterandthecontractisexpiring.
Globosinterestrateforecastfor90dayLIBORwascorrect.Thevalueofthefuturescontractatexpirationisclosestto:
A) $980,250.
B) $981,000.
C) $921,000.
Explanation
TheEurodollarfuturescontractisbasedon90dayLIBOR.
Theforecastfor90dayLIBORwas7.9%.Thus,thecontractpriceatexpirationis:
$1,000,000(1(0.07990/360))=$980,250.(StudySession14,LOS46.g)
Question#66of85 QuestionID:464090
WhichofthefollowingwouldbemostlikelytocauseacontangosituationwithsilverfuturesinMazakhastan?
A) Anincreaseintheavailabilityofassetbackedloans.
B) Ahugesilverdiscovery.
C) Ashortageofwarehousespacethatdrivesuprentalrates.
Explanation
Inacontangosituation,futurespricesarehigherthanthespotprice.Thisnormallyoccurswhentherearenobenefitsto
holdinganasset,orwhenthecostsofstoringanassetarehighenoughtooffsetthebenefitsofholdingtheasset.Anincrease
intheavailabilityofassetbackedloanswouldincreasetheconvenienceyieldofsilver,whichwouldnotcauseacontango
situation.Asilverdiscoverycouldhavesomeeffectonthepriceofsilver,butshouldnotaffectacontangosituationonewayor
another.Ontheotherhand,anincreaseinstoragecostswouldoffsetsomeoftheconvenienceyield.Wedon'tknowwhether
suchanincreaseincostswouldbeenoughtomakethenetcostofholdingsilverpositive,butanyincreaseincostscould
contributetoacontangosituation.(StudySession14,LOS46.e)
Question#67of85 QuestionID:464013
Thepriceofaforwardcontract:
A) mustbeequaltothemarketpriceatcontracttermination.
B) isequaltothevalueofthecontractinequilibrium.
C) isthesettlementpricefortheunderlyingasset.
Explanation
Thepriceofaforwardcontractisthepriceoftheunderlyingassetthatthelongwillpaytotheshortatsettlement(fora
deliverablecontract).Thevalueofaforwardcontractcomesfromthedifferencebetweentheforwardcontractpriceandthe
marketpricefortheunderlyingasset.Thisdifferencebetweenpriceandvalueisakeyconcepttounderstand.Aforward
contracthasonlyoneprice,whichappliestoboththelongandtotheshort.
Question#68of85 QuestionID:464078
Undertheviewthatfuturesmarketsareprimarilyamechanismforshorthedgersandlonghedgerstooffsettheirrespective
assetpricerisks:
A) expectedfutureassetpricesarelessthanthefuturesprices.
B) futurespriceswillbeunbiasedpredictorsoffuturespotrates.
C) forwardpriceswillbegreaterthanfuturesprices.
Explanation
Undertheviewthatfuturesmarketsareprimarilyamechanismforshorthedgersandlonghedgerstooffsettheirrespective
risks,futurespriceswillbeunbiasedpredictorsoffuturespotrates.
Question#69of85 QuestionID:464074
Whichofthefollowingbestdefinesnormalcontango?Normalcontangoiswhenthefuturespricelies:
A) belowtheexpectedfuturespotpriceandthefuturespricefallsoverthelifeof
thecontract.
B) abovetheexpectedfuturespotpriceandthefuturespricerisesoverthelifeofthe
contract.
C) abovetheexpectedfuturespotpriceandthefuturespricefallsoverthelifeofthe
contract.
Explanation
Apatternoffallingfuturespricesisknownasnormalcontango.Thissituationoccursifhedgersarenetlong.
Question#70of85 QuestionID:464082
Anindexiscurrently876,theriskfreerate(Rf)is7%,andthedividendyieldontheindexportfoliois1.8%.Assumingthat
thesearecontinuouslycompoundedyields,thepriceofan18monthindexfutureisclosestto:
A) 947.1.
B) 943.0.
C) 945.2.
Explanation
FP=876e(0.070.018)1.5=947.1.
Question#71of85 QuestionID:464067
Whichofthefollowingbestdefinesbackwardation?Themarketissaidtobeinbackwardationif:
A) thefuturespriceexceedsthecashpriceorthedistantfuturespriceexceeds
thenearbyfuturesprice.
B) thecashpriceexceedsthefuturesprice.
C) thefuturespriceexceedsthecashprice.
Explanation
Backwardationoccurswhenthereisaconvenience,orsecurity,associatedwithholdingthespotasset,usuallywhenitis
uncertainwhethertheassetwillevenbeavailableinthefuture.Backwardationisrarewithfinancialfutures.
Question#72of85 QuestionID:464021
Astockiscurrentlypricedat$110andwillpaya$2dividendin85daysandisexpectedtopaya$2.20dividendin176days.
Thenoarbitragepriceofasixmonth(182day)forwardcontractwhentheeffectiveannualinterestrateis8%isclosestto:
A) $110.20.
B) $110.00.
C) $110.06.
Explanation
Intheformulationbelow,thepresentvalueofthedividendsissubtractedfromthespotprice,andthenthefuturevalueofthis
amountattheexpirationdateiscalculated.
(1102/1.0885/3652.20/1.08176/365)1.08182/365=$110.06
Alternatively,thefuturevalueofthedividendscouldbesubtractedfromthefuturevalueofthestockpricebasedontherisk
freerateoverthecontractterm.
Question#73of85 QuestionID:464068
Asituationwherethefuturespriceisbelowthespotpriceoftheassetiscalled:
A) contango.
B) backwardation.
C) negativecarry.
Explanation
Asituationwherethefuturespriceisbelowthespotpriceoftheunderlyingassetiscalledbackwardation.
Question#74of85 QuestionID:464050
Whatisthedifferencebetweenspotandfuturesprices?Spotpricesarealways:
A) lowerthanfuturesprices.
B) equaltothefuturespriceatfuturesexpiration.
C) deliveredtomeetthefuturesobligationatexpiration.
Explanation
Thedifferencebetweenthespotandthefuturespricemustbezeroatexpirationtoavoidarbitrage.
Question#75of85 QuestionID:464057
Thevalueofafuturescontract:
A) iszeroafterthemarktomarketperiod.
B) isequaltothemarginbalanceinthefuturesaccountafterthemarktomarketperiod.
C) isbasedonthedifferencebetweenthefuturespriceatcontractinitiationandthe
currentfuturesprice.
Explanation
Thevalueofafuturescontractmaybepositiveornegativeduringatradingday,howeverwhentheaccountismarkedto
marketthefuturespriceiseffectivelyresettothemostrecentsettlepricesothatthecontracthaszerovalueunlessthe
equilibriumpriceisoutsidedailypricechangelimits.
Question#76of85 QuestionID:464072
Undertheviewthatfuturestransferriskfromassetholderstofuturesbuyers,the:
A) convenienceyieldispositive.
B) expectedassetpriceinthefuturewillbelessthanthefuturesprice.
C) futurespricewillbelessthantheexpectedfuturespotprice.
Explanation
Undertheviewthatfuturestransferriskfromassetholderstofuturesbuyers,thefuturespricewillbelessthantheexpected
futurespotprice.Thelongs(speculators)mustbecompensatedforbearingassetpriceriskbyreceivingalowerfuture
purchasepricefortheasset.
Question#77of85 QuestionID:464064
Considertwoassetswithidenticalstoragecosts.Fortheassetwiththegreaterconvenienceyield,thepercentagedifference
betweenthenoarbitragepriceandthespotpricewillbe:
A) greateratcontractinitiationbutthesameatexpiration.
B) loweranytimepriortoexpiration.
C) greaterthroughoutthetermofthecontract.
Explanation
ThenetcostsofholdinganassetareNetCosts=StorageCostsConvenienceYield.Whentheconvenienceyieldishigher,
netcostsofcarrying(storing)theassetarelower,andthefuturespricewillbelower.Thedifferencebetweenthespotprice
andthefuturespriceiszeroatexpirationforanyasset.
Question#78of85 QuestionID:464010
Thecontractpriceofaforwardcontractis:
A) thepricethatmakesthecontractazerovalueinvestmentatinitiation.
B) alwaysthepresentvalueoftheexpectedfuturespotprice.
C) determinedatthesettlementdate.
Explanation
Thecontractpricecanbeaninterestrate,discount,yieldtomaturity,orexchangerate.Theforwardpriceisthefuturevalueof
thespotpriceadjustedforanyperiodicpaymentsexpectedfromtheasset.Anexampleofwhentheforwardpricemaybeless
thanthespotpriceisinthecaseofanequityindexcontractwherethedividendyieldisgreaterthantheriskfreerate.
Question#79of85 QuestionID:464026
Calculatethepriceofa200dayforwardcontractonan8%U.S.Treasurybondwithaspotpriceof$1,310.Thebondhasjustpaida
couponandwillmakeanothercouponpaymentin150days.Theannualriskfreerateis5%.
A) $1,305.22.
B) $1,333.50.
C) $1,270.79.
Explanation
Coupon=(1,0000.08)/2=$40.00
Presentvalueofcouponpayment=$40.00/1.05150/365=$39.21
Forwardpriceonthefixedincomesecurity=($1,310$39.21)(1.05)200/365=$1,305.22
Question#80of85 QuestionID:464080
TheprimaryreasonthatEurodollarfuturescontractsdonotallowapurearbitrageopportunityrelativetoLIBORisthat:
A) theEurodollarfutureisdenominatedinU.S.dollarsandLIBORisbasedupon
Eurodollartimedeposits.
B) Eurodollarfuturesdonothaveadeliveryoptionthatincreasespriceefficiency.
C) thevalueofthedepositdoesnotchange$25foreverybasispointchangeinexpected
90dayLIBOR.
Explanation
Eurodollarfuturesarepricedatadiscountyield.LIBORisanaddonyield,whichistheratethatisearnedonthefaceamount
ofadeposit.TheresultisthatthedepositvalueisnotperfectlyhedgedbytheEurodollarcontract.
Question#81of85 QuestionID:464059
Wheninterestratechangesarenegativelycorrelatedwiththepricechangesoftheassetunderlyingafutures/forward
contract:
A) futurespricesmaybehigherorlowerdependingontheriskfreerateandprice
volatility.
B) futurespricesarehigher.
C) forwardpricesarehigher.
Explanation
Anegativecorrelationbetweenassetpricechangesandinterestratechangesmakesthemarktomarketfeatureunattractive
toafuturesbuyer.Thisleadstoalowerfuturesprice,comparedtotheforwardpriceonanotherwiseidenticalcontract.
Question#82of85 QuestionID:464023
Calculatetheprice(expressedasanannualizedrate)ofa1x4forwardrateagreement(FRA)ifthecurrent30dayrateis5%
andthe120dayrateis7%.
A) 6.86%.
B) 7.47%.
C) 7.63%.
Explanation
A1x4FRAisa90dayloan,30daysfromtoday.
Theactualrateonthe30dayloanis:R30=0.05x30/360=0.004167
Theactualrateonthe120dayloanis:R120=0.07x120/360=0.02333
FR(30,90)=[(1+R120)/(1+R30)]1=(1.023333/1.004167)1=0.0190871
Theannualized90dayrate=0.0190871x360/90=.07634=7.63%
Question#83of85 QuestionID:464083
Thepriceofa9monthfutureonanewlyissuedTreasurybondiscalculatedasthebondprice:
A) increasedatthe9monthriskfreerate,minusonecouponpayment.
B) minusonecouponpayment,increasedatthe9monthriskfreerate.
C) increasedatthe9monthriskfreerate,minusonecouponpaymentincreasedatthe
3monthrateformoney6monthsfromnow.
Explanation
Thenoarbitrage9monthfuturespriceforanewlyissuedcouponbondiscalculatedas:
BondPrice(1+Rf)9/12Coupon(1+Rf)3/12
Analternative(equivalent)methodis:
[BondPrice(Coupon/(1+Rf)6/12)](1+Rf)9/12
Question#84of85 QuestionID:464019
ThevalueoftheS&P500Indexis1,260.Thecontinuouslycompoundedriskfreerateis5.4%andthecontinuousdividendyieldis
3.5%.Calculatethenoarbitragepriceofa160dayforwardcontractontheindex.
A) $562.91.
B) $1,310.13.
C) $1,270.54.
Explanation
FP=1,260e(0.0540.035)(160/365)=1,270.54
Question#85of85 QuestionID:464075
WhichofthefollowingstatementsregardingnormalbackwardationisCORRECT?Futurespricestendto:
A) riseoverthelifeofthecontractbecausehedgersarenetlongandhaveto
receivecompensationforbearingrisk.
B) falloverthelifeofthecontractbecausehedgersarenetshortandhavetoreceive
compensationforbearingrisk.
C) riseoverthelifeofthecontractbecausespeculatorsarenetlongandhavetoreceive
compensationforbearingrisk.
Explanation
Normalbackwardationmeansthatexpectedfuturespotpricesaregreaterthanfuturesprices.Itsuggeststhatwhenhedgers
arenetshortfuturescontracts,theymustsellthematadiscounttotheexpectedfuturespotpricestogetspeculatorsto
assumetheriskofholdinganetlongposition.Thefuturespricerisesoverthelifeofthecontract,whichcompensates
speculatorsfortheexposureoftheirlongpositions.