PRMIA 8006 Exam Practice Test Instant Access

Question 1

The two components of risk in a commodities futures portfolio are:

AChanges in the convenience yield and storage costs

BChanges in spot prices and carrying costs, also called commodity lease rates

CChanges in interest rates and spot prices

DThe risk from change in basis and interest rates

Answer : B

Commodity futures prices can be expressed as the summation of their spot prices and the carrying costs. Therefore any changes in either of these two would be a risk to the futures prices, and Choice 'b' is the correct answer. It is common to decompose complex commodity portfolios into underlying equivalent spot positions and the carrying costs, which includes interest, convenience yield and storage costs. For liquid commodities such as gold where changes of a short squeeze are low, interest costs dominate the carryings costs. Choice 'b' is the correct answer as it is most complete and covers the elements in the other choices. The 'lease rate' for a commodity is equivalent to (Fwd Price - Spot Price)/Spot Price, and comprises the interest and storage costs and the convenience yield. The other choices do not represent complete answers.

Question 2

Profits and losses on futures contracts are:

Asettled upfront

Bsettled upon the expiry of the contract

Csettled by moving collateral

Dsettled daily

Answer : D

Profits and losses on futures contracts are settled daily. (P&L on forward contracts is often settled upon the expiry of the contract, and may even be collateralized.) Therefore Choice 'd' is the correct answer.

Question 3

The gamma in a commodity futures contract is:

Azero

Balways negative

Cparabolic

Ddependent upon the convexity

Answer : A

Futures contracts carry no gamma. Only options have gamma. Choice 'a' is the correct answer. Any instrument whose price varies in a linear fashion with respect to the underlying will have gamma equal to zero.

Question 4

What is the notional value of one equity index futures contract where the value of the index is 1500 and the contract multiplier is $50:

A75000

B200

C50

D1500

Answer : A

The correct answer is the index value times the contract size, in this case 1500 x 50.

One way to think about index futures is this: Consider equity index trading as trading in the shares of a company whose share price is equal to a number of dollars which is the same as the index. If the 'contract multiplier' for a index futures contract is 50, that means the futures contract is for 50 shares of such a fictitious company. Therefore the notional value of the contract will be 15000 x 50, and Choice 'a' is the correct answer.

Question 5

A currency with a lower interest rate will trade:

Aat a forward discount

Bat a forward premium

Cat the same prices for forwards as for the spots

Dcannot be determined solely on the basis of interest rates

Answer : B

Given covered interest parity, the currency with a lower interest rate will trade at a forward premium. Choice 'b' is the correct answer.

For an intuitive reasoning, consider a currency forward contract that matures in 3 months. The seller has agreed to sell, say JPY 1,000,000 in exchange for USD 10,000 in the future. In order to cover himself, he borrows the USD right now and converts it to JPY at spot which he puts in a JPY deposit. Assuming JPY interest rates are less than USD interest rates, he pays more on his USD borrowing than he receives on his JPY deposit. Therefore he has to price the forward contract at a premium to spot to cover the interest rate differential.

Question 6

Which of the following best describes a 'when-issued' market?

Awhere members of the syndicate bringing a bond issue to the market are obliged to not undercut the issue price till the first settlement date

BThe when-issued market is one where dealers trade in a security after its price has been set but before the bonds are available for delivery

CThe when-issued market is one where securities are traded on the OTC forward markets prior to their issue

DThe when-issues market is one where the lead manager agreed to buy an entire bond issue at an agreed price, and having done so may sell them onwards to institutional or other investors

Answer : C

Each of the choices describes various scenarios related to the issue of bonds. A when-issued market is a market in government securities where securities are traded as forward contracts prior to their issue. Choice 'c' is the correct answer.

Choice 'd' refers to a 'bought deal'. Choice 'b' refers to the 'grey market', usually in corporate bonds. Choice 'a' refers to a fixed price re-offer mechanism.

Question 7

What is the day count convention used for US government bonds?

AActual/360

BActual/Actual

CActual/365

D30/360

Answer : B

The day count convention used for US treasury bonds is Act/Act. The other choices are incorrect.

PRMIA 8006 Exam I: Finance Theory, Financial Instruments, Financial Markets – 2015 Edition Exam Practice Test