FRM PART I

MOCK TEST PAPER

Time:- 180 Mins. Marks:-118

1. Hillary Jackson, an equity trader at Belgian Securities Company, was instructed by her
supervisor to use derivatives to hedge her equity and forex exposures. Since she had never
traded derivatives before and possess limited knowledge of derivatives, she decided to read
over the weekend a large number of articles available online on the subject of derivatives. From
what she learned from articles, she made following three conclusions:
I. You can purchase futures and swaps that actively trade on exchanges around the globe
II. Forward contracts and options can only be purchased from over-the-counter markets
III. Apart from hedging, derivatives are also used in executive compensation plans and bond
issues
Which of Hillary Jackson’s conclusions about derivatives is inaccurate?
A. Conclusions I and II only
B. Conclusions II and III only
C. Conclusions I and III only
D. All the conclusions are inaccurate

2. James Fernandez, a former derivative trader, is currently authoring/writing an introductory

book on derivatives strategies. His book aims to cater the market of beginning derivatives
traders. Following is the excerpt from the first chapter of his book:
“Derivatives are financial instruments that trade on regulated and unregulated markets and
whose value is derived from the value of underlying financial assets and commodities. These
underlying assets can be commodities such as oil, copper (physical assets) or financial assets like
bonds, stocks, etc. These derivatives are used for the purpose of hedging, speculation, and
arbitrage. ”
Why is James’ definition of derivatives incorrect?
A. James definition is incorrect because derivatives do not trade on unregulated markets
B. James definition is incorrect because the value of a specific derivative is equal to the value of
its underlying asset
C. James definition is incorrect because the underlying variables of derivatives does not only
include financial assets and commodities, but it also include any variables ranging from
interest rates to the amount of rainfall in a specific area
D. James definition is incorrect because derivatives are only used for hedging and speculation

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 1

3. Mehmet Emre, an FRM part 1 candidate, is preparing for his upcoming exam. From his
understanding of futures exchanges, he has concluded the following:
I. In futures exchanges, traders do not have to worry about the creditworthiness of
counterparty
II. In futures exchanges,the trades are more standardized
III. In futures exchanges, participants have to deposit an initial margin with the clearing house
of the exchange
Which of these features of futures exchanges are accurate?
A. Feature II only
B. Feature III only
C. Features I and II
D. Features I, II, and III

4. Before the credit crisis of 2007, over-the-counter (OTC) markets were not as regulated as
exchanges. However, after the credit crisis, many new important changes were brought into the
US as well as around the world, to align the operations of OTC markets with exchange-traded
markets. Which of the following is not a change/regulation introduced after the 2007 credit
crisis?
A. Standardized OTC derivatives must be traded on swap execution faculties (SEFs) introduced
in the US
B. Central counterparty (CCP) is required in standardized derivatives transactions
C. All the OTC trades must be reported to a central registry
D. Participants of OTC derivatives trades must deposit the initial margin requirement

5. David Dillion, head of the treasury department of Dutch Monks Corp., entered into a derivative
contract to purchase ₺350 million (Turkish lira) 3-month forwards from a Lirika Bank at the 3-
month forward exchange rate of ₺3.9 per euro. Which of the following correctly describes Lirika
Bank’s position on the Euro?
A. Short forward contract
B. Long forward contract
C. Short future contract
D. Long future contract

6. A trader at Prime Investments entered into a derivative contract to purchase 0.1 lot (or 10
ounces) of gold at the price of $1,200/ounce and take delivery in 3 months from now. Determine
the appropriate position of the trader in the derivative?
A. Long gold future contract
B. Long dollar future contract
C. Long gold forward contract
D. Short dollar forward contract

7. Which of the following equations accurately demonstrates the payoff of the short position
holder in a forwards contract?
A. K - ST
B. ST - K

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 2

 C. (0, X – ST)
D. (0, ST - X)

8. There are a number of derivatives that are used to hedge the risk or earn a profit with
speculation and arbitrage strategies. Forwards, futures and options are different from each other
in terms of their properties. Which of the following statement correctly differentiates forward,
futures, and options?
A. Forward contracts and options are different from futures, as it takes a certain cost to enter
into a futures contract.
B. Options and futures are different from forwards contracts as they give an option or future
contract holder the right, but not the obligation, to exercise the contract
C. Forwards and futures are different from options because the holder of the forwards and
futures are obligated to buy or sell the underlying
D. Forward contracts and options are different from futures because forwards and options
trade on OTC markets

9. Kapil Kumar is an individual investor who invests a portion of his salary in stocks and
derivatives at the beginning of every month. Kumar is interested in the stocks of Geneva
Computers Inc., which are currently trading at the price of $14. However, he believes the stock
will trade above $17 at the beginning of next month. If Kapil is interested in entering into an
options contract that gives him the right to take exposure in the stock at $17, then suggest the
most appropriate option position for Kapil.
A. Long call option with the strike price of $17
B. Short call option with the strike price of $17
C. Long put option with the strike price of $17
D. Short put option with the strike price of $14

10. Three months ago, the price of the stocks of Universal Builders was $48 per share. Three months
later (today) the price of the stock is $32 per share. Which of the following position holders
earned a profit if they entered into a contract three months ago?
A. Long position in a call option
B. Short position in a put option
C. Long position in a put option
D. None of above

11. Which of the following options requires the holder of the option to purchase the underlying
asset at specific date only?
A. European long call option
B. American short call option
C. American short put option
D. European short put option

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 3

12. Nisha Jatoi, a lecturer at the Karachi School of Business, is delivering a lecture on the subject of
Introduction to Derivatives. While discussing the details of derivatives, specifically options
contracts, she presented the following properties of options in her slideshow:
I. The price of a call option increases as the exercise price decreases
II. The price of a put option increases as the exercise price increases
III. The value of American call and put options increase as the time to maturity increases
Which of these properties are correct?
A. Properties I and II
B. Properties II and III
C. Properties I and III
D. Properties I, II, and III

13. The writer of a put option sold five July put options at the bid price of $7.60 to purchase 500
stock of Galaxy Carpets Co. at the strike price of $13.5 per share. If the price of Galaxy Carpet’s
stock is $9.3 per share, then which of the following options accurately describes the cash flow of
the transaction?
A. The writer of the put option made a profit of $3,800
B. The writer of the put option made a loss of $2,100
C. The buyer of the put option made a profit of $2,100
D. The writer of the put option made a profit of $1,700

14. Steve Hellmuth, a former derivatives trader, runs an online derivatives investment and trading
tutorial portal. Every weekend he educates hundreds of subscribers through weekly webinars.
In his last webinar, he presented following properties of each trader type:
I. Hedgers use derivatives to guard against the risks related to future movements in market
prices of underlying variables.
II. Arbitrageurs use derivatives to bet on the direction of the market of underlying variables.
III. Speculators use derivatives to take offsetting positions in two or more instruments and
markets to earn a profit.
Which type of derivatives trader did Hellmuth define inappropriately?
A. Speculators only
B. Hedgers and speculators
C. Arbitrageurs and speculator
D. Hedgers and arbitrageurs

15. Donald Brown, an investment manager at a pension fund, manages a portfolio of twenty stocks.
Brown believes that the value of the stock of Blue Motors Inc., which forms part of the portfolio,
can decrease due to an increase in oil prices. After analyzing the fundamentals of the stock,
Brown decides to take a long position in put options on Blue Motors Inc. stocks. The given
transaction appropriately categorizes Donald Brown as a:
A. Speculator
B. Hedger
C. Market maker
D. Arbitrageur

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 4

16. Hedgers use a number of derivatives to neutralize their risk by taking long or short positions in
derivatives. These derivatives differ in costs and features. Which of the following type of
derivative provides a type of insurance to the hedger to protect against unfavorable movement
and benefit from favorable movement in the underlying variable?
A. Forward contracts
B. Future contracts
C. Options
D. None of above

17. Samuel Simpson is a commodities trader at one of the largest asset management firm in Abu
Dhabi. He believes that due to a resolution passed by all members of the OPEC committee to cut
the supply of oil, the prices of oil are expected to increase. In order to capitalize from his vision,
Simpson purchased 2,000 lots of crude oil futures for the price of $45.6 per barrel. Which type of
derivatives trader is Samuel Simpson?
A. Speculator
B. Hedger
C. Option trader
D. Arbitrageur

18. In which of the following is the holder of the derivative instrument exposed to limited
downside risk or limited losses?
A. Long future contract
B. Short forward contract
C. Long put option
D. Short call option

19. Hailey France, an equity trader based in Toronto, trades in global equities and derivatives.
Hailey is interested in a particular stock of Regal Motors Inc. that trades in both the Toronto
Stock Exchange (TMX) and the Deutsche Exchange (DAX). The price of the derivative on the
stock in TMX is CAD 13, and the price of stock in DAX is €10 while the exchange rate is CAD
1.44 per euro. In order to earn profit due to the difference in prices in both the exchanges, Hailey
purchased derivative on 1000 stocks of Regal in the TMX and sold the derivative on 1000 stocks
in the DAX. Which of the following statements regarding the transaction is accurate?
A. France is an arbitrageur that earned the risk-free profit of euro 1,400
B. France is a speculator that earned the risk-free profit of euro 1,400
C. France is an arbitrageur that earned the risk-free profit of CAD 1,400
D. France is an arbitrageur that earned the risk-free profit of CAD 972

20. Jerome Kerviel, a junior trader in Societe Generale’s Delta One unit, was responsible for one of
the biggest losses in the history of banking due to fraudulent activity. He traded equities and
futures contracts in the German, French and other European markets. Jerome’s fraudulent
activities and unauthorized positions were discovered in 2008, which led to the losses of 4.9
billion euros. Which of the following statements is appropriate regarding Jerome Kerviel?

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 5

 A. He was an arbitrageur, but he traded like a speculator
B. He was a hedger, but he traded like an arbitrageur
C. He was a speculator, but he traded like an arbitrageur
D. He was an arbitrageur, but he traded like a hedger

21. An arbitrage opportunity is least likely to be exploited when:

A. one position is illiquid.
B. the price differential between assets is large.
C. the investor can execute a transaction in large volumes.

22. An arbitrageur will most likely execute a trade when:

A. transaction costs are low.
B. costs of short-selling are high.
C. prices are consistent with the law of one price.

23. An arbitrage transaction generates a net inflow of funds:

A. throughout the holding period.
B. at the end of the holding period.
C. at the start of the holding period.

24. The price of a forward contract:

A. is the amount paid at initiation.
B. is the amount paid at expiration.
C. fluctuates over the term of the contract.

25. Assume an asset pays no dividends or interest, and also assume that the asset does not
yield any non- financial benefits or incur any carrying cost. At initiation, the price of a forward
contract on that asset is:
A. lower than the value of the contract.
B. equal to the value of the contract.
C. greater than the value of the contract.

26. With respect to a forward contract, as market conditions change:

A. only the price fluctuates.
B. only the value fluctuates.
C. both the price and the value fluctuate.

27. The value of a forward contract at expiration is:

A. positive to the long party if the spot price is higher than the forward price.
B. negative to the short party if the forward price is higher than the spot price.
C. positive to the short party if the spot price is higher than the forward price.

28. At the initiation of a forward contract on an asset that neither receives benefits nor incurs
carrying costs during the term of the contract, the forward price is equal to the:

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 6

 A. spot price.
B. future value of the spot price.
C. present value of the spot price.

29. Stocks BWQ and ZER are each currently priced at $100 per share. Over the next year,
stock BWQ is expected to generate significant benefits whereas stock ZER is not expected
to generate any benefits. There are no carrying costs associated with holding either stock over
the next year. Compared with ZER, the one-year forward price of BWQ is most likely:
A. lower.
B. the same.
C. higher.

30. If the net cost of carry of an asset is positive, then the price of a forward contract on
that asset is most likely:
A. lower than if the net cost of carry was zero.
B. the same as if the net cost of carry was zero.
C. higher than if the net cost of carry was zero.

31. Jack Lee, a commodities investor at Singapore Investment Bank, instructs his team of traders to
sell a September copper futures contract of 25,000 pounds in the COMEX (Commodities
exchange, a sub-division of the NYMEX). Given these instructions, a bank’s team of floor traders
at the COMEX physically met the seller of the September Copper futures contract and
determined the price of $0.05 (5 cents) per pound. Looking at the nature of the transaction, one
can say that the contract is being traded on:
A. An over-the-counter market
B. An open outcry exchange
C. An electronic exchange
D. None of above

32. Matias, FRM, has recently joined the London office of Venture Financials as a junior derivatives
trader. Currently, Matias has an open position of gold futures contracts on the London
Exchange. According to the contract, Matias is obligated to sell 5000 ounces of gold with
delivery in April. Determine the appropriate position of Matias’s trade.
A. Hedged futures position
B. Short put option position
C. Short futures position
D. Short forwards position

33. Matias, FRM, has recently joined the London office of Venture Financials as a junior derivatives
trader. Currently, Matias has an open position of gold futures contracts on the London
Exchange. According to the contract, Matias is obligated to sell 5000 ounces of gold with
delivery in April. Determine the appropriate position of Matias’s trade.
A. Hedged futures position
B. Short put option position

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 7

 C. Short futures position
D. Short forwards position

34. Nora Schneider is an experienced derivative trader at a German commodities investing firm.
Recently, she was given the additional responsibilities to look after the traders training
department. While training the newly employed derivatives traders, she instructed the trader to
clearly read the terms and specifications of a futures contract as it contains information related
to position limits, price limits, delivery place, delivery month, and counterparty to the futures
contract. Which of the following feature is least likely specified in the contract specification
details of a futures contract?
A. Position limit
B. Delivery month
C. Price limits
D. Price limits

35. The Karachi Mercantile Exchange (KME) has set the daily price limit of rice futures contracts to
Rs.4. The closing price of the rice future contract on Monday was Rs.140 per 100 KG. If the
evening newspaper on Wednesday reads the headline “Rice futures contracts closed limit down
at Rs.138 per 100 KG” then which of the following is the most likely closing price of the rice
future contract on the preceding day?
A. Rs. 136 per 100/KG
B. Rs. 140 per 100/KG
C. Rs. 142 per 100/KG
D. None of above

36. Elif Makarov, a derivatives trader at one the largest commodities trading firms in Moscow, is
looking at a possible arbitrage trade in the Copper futures contract. If the Copper futures
contract price is $47.6 and the spot price of the copper is $48.9, then determine the appropriate
strategy Makarov may take to earn arbitrage profit.
A. Take a short position in copper futures contract and buy copper at the spot price
B. Take a long position in copper futures contract and sell copper at the spot price
C. Wait for copper futures contracts to converge to the spot price and then take a short position
in futures contracts
D. Wait for copper futures contracts to converge to the spot price and then take a long position
in futures contracts

37. Adam Anderson is a junior officer in the settlement department of a derivatives investment
firm. He also takes a keen interest in tweeting and blogging about the derivatives education and
strategies. In one of his latest blog article, he made following comments regarding operations on
a margin account:
I. The initial margin refers to the amount that must be deposited to take a position in futures
contracts
II. The variation margin refers to the minimum margin balance required to retain a position in
the futures contract

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 8

 III. Marking to market is the process of purchasing a particular asset or commodity and selling
the futures contracts on that asset or commodity
Which of the comment is/are incorrect?
A. Comment 1 only
B. Comment 3 only
C. Comments 1 & 2
D. Comments 2 & 3

38. Jacqueline Jolie, a derivatives trader at one of the largest hedge funds on Wall Street, entered in
a March silver futures contract on the New York Mercantile Exchange (NYMEX) to purchase
5000 troy ounces of silver at the futures price of $17.5 per ounce. According to NYMEX rules, the
initial margin of $6,400 and maintenance margin of $3,000 is required to enter and retain the
futures position. The price of silver futures contracts dropped to $17, $16.9 and $16.7, at the end
of the first, second and third day, respectively. What is the margin account balance at the end of
the second day?
A. The margin account balance at the end of the second day is $2,500
B. The margin account balance at the end of the second day is $3,900
C. The margin account balance at the end of the second day is $3,400
D. The margin account balance at the end of the second day is $0

39. Jacqueline Jolie, a derivatives trader at one of the largest hedge funds on Wall Street, entered in
a March silver futures contract on the New York Mercantile Exchange (NYMEX) to purchase
5000 troy ounces of silver at the futures price of $17.5 per ounce. According to NYMEX rules, the
initial margin of $6,400 and maintenance margin of $3,000 is required to enter and retain the
futures position. The price of silver futures contracts dropped to $17, $16.9 and $16.7, at the end
of the first, second and third day, respectively. On which of the following days is Jacqueline
most likely to receive a margin call?
A. At the end of the first day
B. At the end of the second day
C. At the end of the third day
D. She will not receive a margin call

40. Jacqueline Jolie, a derivatives trader at one of the largest hedge funds on Wall Street, entered in
a March silver futures contract on the New York Mercantile Exchange (NYMEX) to purchase
5000 troy ounces of silver at the futures price of $17.5 per ounce. According to NYMEX rules, the
initial margin of $6,400 and maintenance margin of $3,000 is required to enter and retain the
futures position. The price of silver futures contracts dropped to $17, $16.9 and $16.7, at the end
of the first, second and third day, respectively. What is the amount of variation margin that the
investor will be required to deposit?
A. 600
B. 3000
C. 4000
D. No variation margin is required

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 9

41. Which of the following statements regarding futures transactions is/are incorrect?
I. Speculators are subject to lower margin requirements in futures contracts trades as
compared to hedgers.
II. In a spread transaction, the trader simultaneously takes a long position in futures on a
specific asset for a specific delivery time and takes a short position in futures on the same
asset for a different maturity or delivery time.
III. Futures contracted are settled on a daily basis, whereas forward contracts are settled at the
maturity date.
A. Statement I only
B. Statement II only
C. Statements I & II
D. Statements II & III

42. If the present value of storage costs exceeds the present value of its convenience yield,
then the commodity’s forward price is most likely:
A. less than the spot price compounded at the risk-free rate.
B. the same as the spot price compounded at the risk-free rate.
C. higher than the spot price compounded at the risk-free rate.

43. Which of the following factors most likely explains why the spot price of a commodity in short
supply can be greater than its forward price?
A. Opportunity cost
B. Lack of dividends
C. Convenience yield

44. When interest rates are constant, futures prices are most likely:
A. less than forward prices.
B. equal to forward prices.
C. greater than forward prices.

45. In contrast to a forward contract, a futures contract:

A. trades over-the-counter.
B. is initiated at a zero value.
C. is marked-to-market daily.

46. To the holder of a long position, it is more desirable to own a forward contract than a
futures contract when interest rates and futures prices are:
A. negatively correlated.
B. uncorrelated.
C. positively correlated.

47. The value of a swap typically:

A. is non-zero at initiation.
B. is obtained through replication.
C. does not fluctuate over the life of the contract.

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 10

48. The price of a swap typically:
A. is zero at initiation.
B. fluctuates over the life of the contract.
C. is obtained through a process of replication.

49. The value of a swap is equal to the present value of the:

A. fixed payments from the swap.
B. net cash flow payments from the swap.
C. underlying at the end of the contract.

50. A European call option and a European put option are written on the same underlying, and
both options have the same expiration date and exercise price. At expiration, it is possible that
both options will have:
A. negative values.
B. the same value.
C. positive values.

51. At expiration, a European put option will be valuable if the exercise price is:
A. less than the underlying price.
B. equal to the underlying price.
C. greater than the underlying price.

52. The value of a European call option at expiration is the greater of zero or the:
A. value of the underlying.
B. value of the underlying minus the exercise price.
C. exercise price minus the value of the underlying.

53. For a European call option with two months until expiration, if the spot price is below the
exercise price, the call option will most likely have:
A. zero time value.
B. positive time value.
C. positive exercise value.

54. During the inauguration ceremony of a newly introduced electronic clearing system at the
Istanbul Commodities Exchange, the general manager of the operations department
emphasized the important of clearinghouses in the exchange. He said the following:
“It is because of clearinghouses that the traders of futures markets are required to honor their
contracts. The clearinghouses act as a counterparty to every buyer and seller, which allows
traders to decrease the default risk of the counterparty. Because of clearinghouses, traders can
reverse or close their positions without having to contact the counterparty.”
A. Incorrect because the traders of futures markets have the right, but not the obligation, to
honor the contract
B. Incorrect because the default risk pertaining to the counterparty exists in futures markets

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 11

 C. Incorrect because traders cannot reverse their positions at any given time until the maturity
of the contract
D. Appropriate

55. After the credit crisis of 2007-2008, the regulators have become vigilant and more concerned to
reduce the credit risk in futures and forwards markets. Regulators have introduced many
regulations in standards transactions of over-the-counter markets to make them more similar to
exchanges. Which of the following features was not introduced in over-the-counter markets to
diminish credit risk?
A. Central counterparty (CCP)
B. Credit support annex (CSA)
C. Clearinghouses
D. Initial margin requirements

56. Which of the following property of over-the-counter market and futures market is/are correct?
I. Regardless of how the transaction is being cleared, the initial margin when depositing cash
by members and investors earns interest income
II. The daily variation margin in futures markets earns interest if provided in the form of cash
III. The daily variation margin, as per CCP or CSA requirements in OTC markets, does not earn
interest.
A. I only
B. II only
C. I and II
D. II and III

57. Alisha Gomez, head of the trading department, is conducting an interview with one of the
potential candidates for a position as a junior trader in the derivatives units. Gomez asked the
candidate to identify which of the following prices is used for calculating daily gains, losses, and
margin requirements for the parties involved in trading of futures contracts. Which of the
following is the appropriate answer to Alisha Gomez’s question?
A. Opening price
B. High price
C. Closing price
D. Settlement price

58. Which of the following is not a likely method/process for terminating a position in a futures
contract?
A. By delivering the underlying assets/goods of a futures contract
B. By cash-settling in which futures are marked to market-based on the settlement price of the
last trading day
C. By reversing, where an investor can take an opposite position of his current outstanding
position
D. By offsetting, in which an investor can take the exact same position in the underlying asset
as in the futures contract

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 12

59. Vikram Pandit, a derivatives investor from Mumbai, instructs his broker to terminate his short
position in 10 futures contract of live cattle at the Chicago’s futures exchange. The broker
proposed him four alternatives for terminating the contract. Which of the following is the most
appropriate method?
A. Purchase cattle from Mumbai and physically deliver the cattle to the long party
B. Take a new short position of the same size in a live cattle futures contract with a different
delivery date
C. Find a trader with a long position in live cattle and settle up between yourselves, off the
floor of the exchange
D. Take a long position of the same size in live cattle futures contract with the same delivery
date

60. Darren Jackson has recently finished his MBA and began working with at a mid-sized asset
management company. Since Darren does not have past trading experience, he pays additional
attention while placing orders to buy/sell equity. Darren has noticed that the prices of stocks of
Banana Inc. are closing higher every day. Currently, the stock is trading at $71 per share, but
Darren is unsure if the rally will continue. However, he believes that if the price increases to $75,
then the rally will continue and that will be the right time to enter the market. Which of the
following types of order is suitable for Darren if he wants to start buying the stock when the
price increases to $75 or higher and keep filling as long as the stock is not above $78.
A. Limit order
B. Fill or kill order
C. Market-if-touched order

61. When the price of the underlying is below the exercise price, a put option is:
A. in-the-money.
B. at-the-money.
C. out-of-the-money.

62. If the risk-free rate increases, the value of an in-the-money European put option will most likely:
A. decrease.
B. remain the same.
C. increase.

63. The value of a European call option is inversely related to the:

A. exercise price.
B. time to expiration.
C. volatility of the underlying.

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 13

64. The table below shows three European call options on the same underlying:

The option with the highest value is most likely:

A. Option 1.
B. Option 2.
C. Option 3.

65. The value of a European put option can be either directly or inversely related to the:
A. exercise price.
B. time to expiration.
C. volatility of the underlying.

66. Prior to expiration, the lowest value of a European put option is the greater of zero or the:
A. exercise price minus the value of the underlying.
B. present value of the exercise price minus the value of the underlying.
C. value of the underlying minus the present value of the exercise price.

67. A European put option on a dividend-paying stock is most likely to increase if there is an
increase in:
A. carrying costs.
B. the risk-free rate.
C. dividend payments.

68. Based on put-call parity, a trader who combines a long asset, a long put, and a short
call will create a synthetic:
A. long bond.
B. fiduciary call.
C. protective put.

69. Which of the following regulatory bodies is responsible for communicating futures prices to the
public and licensing the future exchanges and its members who are willing to offer futures
trading services to the public?
A. National Futures Association (NFA)
B. Commodity Futures Trading Commission (CFTC)
C. Securities Exchange Commission (SEC)
D. Federal Reserve (Fed)

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 14

70. Vanesa Fredrick is a senior derivatives investments manager at Unicorn Hedge Funds. While
briefing a group of new employees in the accounting and finance unit of the fund, she made the
following two statements related to the tax treatment of different parties:
Statement I: For corporations, all capital gains from futures contract are taxed at the same rate as
their ordinary income, whereas capital losses from futures contracts are deductible only to the
extent of capital gains. A corporate entity may carry forward the capital losses indefinitely.
Statement II: For non-corporate taxpayers, short-term capital gains from futures contracts are
taxed at the ordinary income tax rate but long-term (contracts held for more than a year) capital
gains are taxed at the capital gains tax rate of 15% maximum. Capital losses for non-corporate
taxpayers are non-tax deductible.
Which of the following is correct?
A. Only statement I is correct
B. Only statement II is correct
C. Both statements are correct
D. Both statements are incorrect

71. Allen Christian is a derivatives trader at a unique brokerage firm that not only places orders in
futures exchange on behalf of its clients but also helps them come up with hedging strategies to
decrease their risk. Today, Allen Christian is given hedging objectives and profiles of four
different clients that want to hedge their positions. From the following client profiles, who
should he most appropriately recommend a long hedge to?
Client A is a cotton crop farmer whose crops are not ready yet but in 2 months he will harvest
200 tons of cotton from his agricultural land.
Client B is one of the largest German armored vehicle manufacturing firms which has sold
hundreds of armored vehicles to the Colombian government in the last month.
Client C is a Prince from Saudi Arabia whose son has placed an order for a brand new private
jet from an Italian jet manufacturer.
Client D is the treasurer of a gas company headquartered in Taxes who is also responsible for
selling 0.4 million barrels of gas to large distributors.
A. Client A
B. Client B
C. Client C
D. Client D

72. Michael McDonnell is a junior derivatives trader at a London-based investment bank. His team
is responsible for hedging all of the bank’s risk exposure after the bank’s risk department has
disseminated the list of potential risky positions that need to be hedged. After evaluating the
given risk exposures/positions, which of the following positions can be hedged with a long
hedge?
Position I: The bank’s investment in European stocks will pay a dividend of 1.5 million Euros
next month, which the bank intends to convert into British Pounds Position II: The bank has to
pay interests of $3.6 million dollars on its bonds to American investors.
A. A long hedge is suitable for the risk exposure defined in position I
B. A long hedge is suitable for the risk exposure defined in position II

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 15

 C. A long hedge is suitable for the risk exposure defined both positions
D. A long hedge is not suitable for the risk exposure defined in any of the two positions

73. Colin Thomson, the risk manager of a tire manufacturing company, suggests that the company
should focus its resources on the company’s core business activities rather than investing
resources in hedging the risks faced by the company. He further added that the shareholders
have as much information as the management of the company. Therefore, shareholders can
easily hedge the risks. Lastly, he argued that the shareholders hedge the company’s stocks in
much smaller quantities. Hence, it is cheaper for the shareholders to hedge the risk as compared
to the company. Which of the following options is correct?
A. Thomson’s argument related to the availability of the company’s information to the
shareholders is incorrect. However, the argument related to the smaller costs incurred by
shareholders for hedging risks is correct.
B. Thomson’s argument related to the availability of the company’s information to the
shareholders is correct. However, the argument related to the smaller costs incurred by
shareholders for hedging risks is incorrect.
C. Both arguments are correct.
D. None of Thomson’s arguments are correct.

74. The island of Godiva is a small hypothetical country in the Gulf of Mexico. Godiva has its own
financial system, economic system, and laws. The only agricultural product of Godiva is rice,
which is why the government sets weekly rice prices. The retailers of rice are only allowed to
keep a maximum of 10% profit margin on the sales of rice. Coral Traders and Reef Enterprises
are the two main retailers of the island. Coral does not hedge against the risk of changes in the
price of rice while Reef hedges the risk of an increase in prices by taking a long position in rice
futures in a local futures exchange. Which of the following statements is correct?
A. Coral Traders should have smoother profit margins than Reef Enterprises
B. Reef Enterprises should have smoother profit margins Coral Traders
C. Both companies will have the same profit margins
D. None of the companies have smooth profit margins

75. A risk analyst at a mid-sized alternative investment firm is responsible for hedging the
company’s multiple exposures to alternative assets. Suppose that the analyst has taken two
positions, a long and a short in oil futures to hedge the risk of fluctuation in oil prices. If the
basis of the hedge strengthens, then which of the following is true?
A. If the basis of the hedge strengthens, the short positions of the firm will improve
B. If the basis of the hedge strengthens, the long positions of the firm will improve
C. If the basis of the hedge strengthens, the short positions of the firm will worsen\
D. If the basis of the hedge strengthens, both the firm’s positions will improve

76. Melanie Angebote is an instructor at a private business school in Vienna. She has recently begun
teaching derivatives to undergraduate business management students. In one of her lectures,
she asked the students to define their understanding on the strengthening and weakening of the
basis of a hedge. Which of the following student comments is/are correct?

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 16

 I. If the spot price increases faster than the futures price over the duration of the hedging
period, the basis is said to be strengthening.
II. Basis risk is the risk that the volatility of a futures contract will not move in line with that of
the underlying exposure.
A. Only comment I is correct
B. Only comment II is correct
C. Both comments are correct
D. None of the comments are correct

77. Togo Barrio, a portfolio manager at Mexico Asset Management Inc., is interviewing Linda Farris
for the position of risk analyst in the firm’s derivative unit. To one of the Barrio’s questions
related to the basis risk involved in hedging with futures contracts, Farris replied with the
following three factors that affect the basis risk:
I. Interruption in the convergence of the futures prices and spot prices
II. Changes in the component of costs involved in hedging transactions
III. Mismatch between the maturity of the cash asset and the hedged asset
Which of the factors provided by Linda affect the basis risk?
A. Reason I only
B. Reasons II and III
C. Reasons I and III
D. Reasons I, II, and III

78. Asim Hussain has recently joined the commodities trading desk of an investment bank in
London. He is a hedger trader that takes positions in futures contracts to earn profit arising from
the difference in the spot price and futures price of a contract. He hedges the bank’s exposure
and also hedges on behalf of the bank’s clients. One of the bank’s clients has a long exposure in
oil and believes the prices of oil can fluctuate heavily until the March of next year. Therefore, he
instructs Hussain to come up with a strategy to hedge oil with an expiration in March. Hussain
knows that the delivery months of oil futures contracts are March, June, September, and
December. Which of the following contracts is most suitable for the hedge that expires in
March?
A. Oil futures contracts with the delivery month of March
B. Oil futures contracts with the delivery month of June
C. Oil futures contracts with the delivery month of September
D. Oil futures contracts with the delivery month of December

79. FINWISE is a finance and economics magazine published by the students and members of the
finance and economics society of the University of Ankara. Last month’s publication of the
magazine contained a detailed article about the hedging strategies and the risks in hedging with
futures contracts. The article summed the factors that increase the basis risk arising in hedging
with futures. Following is an excerpt taken from the article:
“As the difference between the expiration of the hedge and the delivery month of the contract
increases, the basis risk also increases. However, as the liquidity of the hedged assets and the

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 17

 assets to be hedge decreases, the basis risk increase. Hence, the liquidity of assets is inversely
proportional to the basis risk.”
Which of the analyses provided in the article is/are accurate?
A. The analysis regarding the increase in the difference between the expiration of the hedge
and the delivery month is accurate, but the analysis regarding the inverse relationship
between the liquidity of assets and the basis risk is inaccurate
B. The analysis regarding the increase in the difference between the expiration of the hedge
and the delivery month is inaccurate, but the analysis regarding the inverse relationship
between the liquidity of assets and the basis risk is accurate
C. The analysis regarding the increase in the difference between the expiration of the hedge
and the delivery month is accurate, and the analysis regarding the inverse relationship
between the liquidity of assets and the basis risk is accurate
D. None of the analyses are correct

80. A German electronic appliances manufacturer expects to receive 30 million Turkish Liras at the
end of March. The Lira futures contracts on the Eurex Exchange are available for the delivery
months of March, June, September, and December. The size of one contract is 10 million Turkish
Liras. The company shorts three June contracts on February 1 with the futures price of 0.6500
cents per Lira with the intention of closing the contract. If the futures prices and spot price on
the closing date are 0.6250 and 0.6150, respectively, then calculate the effective price received in
Euros for 30 million Liras.
A. The effective price is Euro 10,500
B. The effective price is Euro 192,000
C. The effective price is Euro 187,500
D. The effective price is Euro 184,500

81. Emanuel is a junior trader working in the derivatives and hedging unit of a brokerage firm.
Emanuel’s superior instructed him to take a hedged position for one of its clients who wants to
hedge its exposure in 10 million tons of plastic. Since the underlying asset is plastic and it is
difficult to find futures contracts with the underlying asset of plastic, the trader is advised to
take a position in rubber futures contracts. The contract size of rubber is 45 tons. If the standard
deviation of the spot prices of plastic is 0.019, the standard deviation of the futures prices of
rubber is 0.032, and the correlation coefficient between the two is 0.87, then determine what
should be the optimal hedge ratio.
A. 0.52
B. 0.59
C. 1.46
D. 1.68

82. Emanuel is a junior trader working in the derivatives and hedging unit of a brokerage firm.
Emanuel’s superior instructed him to take a hedged position for one of its clients who wants to
hedge its exposure in 10 million tons of plastic. Since the underlying asset is plastic and it is
difficult to find futures contracts with the underlying asset of plastic, the trader is advised to
take a position in rubber futures contracts. The contract size of rubber is 45 tons. If the standard

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 18

 deviation of the spot prices of plastic is 0.019, the standard deviation of the futures prices of
rubber is 0.032, and the correlation coefficient between the two is 0.87, then determine the
optimal number of rubber futures contracts required to hedge the exposure in plastic.
A. The optimal number of 5,200,000 rubber contracts are required.
B. The optimal number of 325,615 rubber contracts are required.
C. The optimal number of 114,791 rubber contracts are required.
D. The optimal number of 96,568 rubber contracts are required.

83. Melanie Gomez is a former trader and the anchor of a local business TV channel. She is famous
for her analysis and forecasts of commodities prices. She also presents a weekly education
program where she educates beginners traders on complex derivatives instruments and
hedging strategies. In her TV program, she made the following definitions of some jargons used
for hedging:
I. Cross hedging occurs when two offsetting positions are opened in futures contracts with
identical underlying assets.
II. Tailing the hedge is a process of calculating the correlation between percentage one-day
changes in the futures and spot prices in order to estimate the number of contracts needed to
hedge over the next day.
Which of the following is correct?
A. Statement I is correct while statement II is incorrect
B. Statement I is incorrect while statement II is correct
C. Statement I is correct and statement II is also correct
D. Statement I is incorrect and statement II is also incorrect

84. A portfolio manager has constructed a portfolio that perfectly mirrors the NASDAQ-100 index.
The portfolio manager is worried about the changes in the value of portfolio, so he decides to
hedge the portfolio using futures contracts on the mini NASDAQ-100 index. If the value of the
portfolio is $16,165,000, the index futures price is 5,056 with each contract on $20 times the
index, then estimate the number of contracts required to hedge the portfolio.
A. 138
B. 142
C. 160
D. 101120

85. Julia Lange, an investment manager, has constructed a portfolio that somewhat mirrors the S&P
500 index. The investment manager intends to hedge the portfolio by taking a short position in
S&P 500 futures. The current worth of the portfolio is $672,000,000, and the S&P 500 index
futures price is 2,906 with each contract on $250 times the index. If the beta of the portfolio is
0.78, then estimate the number of contracts Lange should short to hedge her portfolio.
A. 1,455 S&P 500 futures contracts
B. 925 S&P 500 futures contracts
C. 876 S&P 500 futures contracts
D. 722 S&P 500 futures contracts

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 19

86. Julia Lange, an investment manager has constructed a portfolio with a beta of 0.78 that
somewhat mirrors the S&P 500 index. The investment manager hedged the portfolio 1 month
ago by taking a short position in the S&P 500 futures. The current worth of the portfolio is
$672,000,000, and the S&P 500 index futures price at the time of the purchase was 2,906 with
each contract on $250 times the index. If the S&P 500 futures contracts price fell to 2,715 this
month, then estimate the number of additional contracts Lange should short to hedge her
portfolio.
A. The manager must short an additional 50 S&P 500 futures contract tos hedge the portfolio
B. The manager must buy 50 S&P 500 futures contracts to hedge the portfolio
C. The manager must short an additional 2,715 S&P 500 futures contracts to hedge the portfolio
D. The manager must short an additional 772 S&P 500 futures contracts to hedge the portfolio

87. The index futures contracts are not only used to hedge the risk of the portfolio, but sometimes
the futures contracts are also used to change the current systematic risk or the beta of the
portfolio to a desirable level. Here are two potential strategies to reduce and increase the beta of
a portfolio:
I. If the beta of the portfolio is to increase from its current beta, a short position in a specific
number of additional futures contracts must be taken
II. If the beta of the portfolio is to reduce from its current beta, a long position in a specific
number of additional futures contracts must be taken
Which of the potential strategies is/are accurate?
A. The strategy to increase the beta is accurate, but the strategy to reduce the beta is inaccurate
B. The strategy to reduce the beta is accurate, but the strategy to increase the beta is inaccurate
C. Both strategies to increase and reduce the beta of the portfolio are accurate
D. Neither strategies are accurate

88. An investor owns a portfolio of some of the S&P 500 stocks that worth $50 million. The
systematic risk of the portfolio to the S&P 500 index is 0.96. The investor wants to remove the
systematic risk from his portfolio completely, so he decides to reduce the beta of the portfolio to
zero. If the value of the S&P 500 index futures contracts is 1,111 and each index point costs $250,
how many contracts should he use to reduce the systematic risk?
A. The investor must buy 173 index futures contracts
B. The investor must short 173 index futures contracts
C. The investor must buy 180 index futures contracts
D. The investor must short 180 index futures contracts

89. Adam Ryman was taking an aptitude test to join the graduate trainee program of a German
investment bank. One of the questions in the exam asked to identify in which of the following
processes an investor closes out the existing position as the maturity of the futures contract
approaches and replaces it with another futures contract with a later delivery date or maturity.
Which of the following is the correct answer to the question?
A. Cross over hedging
B. Rolling a hedge forward
C. Basis risk of hedging
D. Reducing the beta of the portfolio

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 20

90. A French carmaker expects to purchase 50,000 tons of copper at the end of April. The copper
futures contracts on the Eurex Exchange are available for the delivery months of March, June,
September, and December. The size of one contract is 25 tons of copper. The company took a
long position in 200 June contracts on March 1st with the futures price of 2.450 euros per ton
with the intention of closing the contract. If the futures price and spot price on the closing date is
2.30 and 2.42, respectively, then calculate the effective price paid in Euros and the gain or loss on
the futures contract.
A. The effective price is Euro 128,500 and the loss on the contract is Euro 6,000
B. The effective price is Euro 121,000 and the loss on the contract is Euro 6,000
C. The effective price is Euro 128,500 and the loss on the contract is Euro 7,500
D. The effective price is Euro 121,000 and the loss on the contract is Euro 7,500

91. Donald Gregg is a senior professor of economics at the University of Vikings. He has authored
various books on the subject of macroeconomics, financial instruments, and derivatives. He is
famous for conducting a bi-yearly informative seminar where he delivers his analysis and
opinion about finance and economic related topics. In his last seminar, he said that the
government also borrow funds from public institutions in exchange for their guarantee to return
the funds with interest. These transactions are considered risk-free as governments are not likely
to default. Which of the following rates do governments use to borrow funds denominated in
their own currency?
A. LIBOR
B. Fed funds rate
C. Repo rate
D. Treasury rate

92. Franky Johnson is a junior trader at the Beijing office of a large German investment bank. He is
an Ivy League graduate and brings with him very little experience in derivatives trading. Today,
he is instructed by his investment team to purchase the floating vs. floating interest rate swaps
in the derivatives markets. Which of the following rates he is most likely to use to value a
floating interest rate swap?
A. LIBOR
B. Fed funds rate
C. Repo rate
D. Treasury rate

93. Since the LIBOR rate is composed of estimates, not actual rates, it has been seen in recent years
that the banks were involved and sanctioned for manipulating the LIBOR rate. An excerpt from
a newspaper reads:
“As the LIBOR rates are published on the basis of the estimates provided by banks, the traders
at some of the larger banks conspired to provide inaccurate rates in order to manipulate the
average of rates used for the LIBOR.”
One of the analysts at a local business news channel suggested the following two factors for the
manipulation of the LIBOR:

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 21

 I. One motive for banks to manipulate the LIBOR was to make exceptional profits on
instruments like interest rate swaps, whose cash flows depend on the LIBOR.
II. Another factor that motivated banks to manipulate the LIBOR downward is that if the LIBOR
is lower, then the reserve requirement for the banks is also lower and the banks have more
funds to invest.
Which of the factors for the banks to manipulate the LIBOR is/are correct?
A. Only factor I is a correct factor that motivated banks to manipulate the LIBOR
B. Only factor II is a correct factor that motivated banks to manipulate the LIBOR
C. Both factors motivated banks to manipulate the LIBOR
D. None of the factors motivated banks to manipulate the LIBOR

94. Xiaojun Lee is the treasury manager at the Atlanta Small Business Bank. She works in a team
that supervises all the branches of the banks in Atlanta. Her core responsibility is to look after
treasury transactions and to make sure the bank, at all time, meets its reserve requirements with
the Federal Reserve. Today, Lee has analyzed that the bank will fall short $200 million from its
reserve requirements. In order to avoid penalties, the bank must borrow the short for the
amount from another bank. Which of the following rate must Lee use as the reference rate for
borrowing $200 million overnight?
A. LIBOR
B. Fed funds rate
C. Repo rate
D. Treasury rate

95. Mohan Das is the treasury manager of a bank based in Frankfurt. He is responsible for looking
at the bank’s treasury operations, and the compliance unit of the bank closely supervises his
department. Today, Das is informed by the front office that the bank has to disburse a large
fund to an institutional client which they believe will affect the bank's reserves with the central
bank. The management suggested borrowing the funds from another bank to meet the central
bank’s reserve requirements, but he argues that the bank, instead, should sell its securities to
another bank with the promise to purchase the securities back at a higher price. Which of the
following interest rates is the manager most likely to use for the given transaction?
A. LIBOR
B. Fed funds rate
C. Repo rate
D. Treasury rate

96. Gamze Goc is an independent wealth advisor that focuses on providing investment and savings
advice to professionals. She advised one of her clients to invest $10,000 for 5 years into a
government’s national saving plan which pays monthly interest of 8% per year. This rate is fixed
regardless of the tenure of the investment. Since the client does not have an alternative option to
invest his savings, he asked what interest rates he would earn if the rate was compounded
continuously. Identify the most appropriate answer to the client’s inquiry.
A. The continuously compounded interest rate is 9.23%
B. The continuously compounded interest rate is 8.33%

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 22

 C. The continuously compounded interest rate is 8.05%
D. The continuously compounded interest rate is 7.97%

97. Ahmed Hatti is an undergrad business and finance student at the University of Millennials.
Along with his friend, he manages a small hypothetical fund from his dorm room. The fund
consists of the small investments from his colleagues and family. As a fund manager, he is also
responsible for generating a quarterly income newsletter, which he has to email to all of the
contributors of the fund. Recently, Hatti decided to invest a small portion of his fund into an
interest bearing account that quotes an interest rate of 16% compounded continuously. In order
to add the interest rate into the quarterly newsletter, he must convert the continuously
compounded rate into a quarterly compounded rate. Which of the following is the most
appropriate conversion of the rate?
A. The quarterly compounded rate is 15.6%
B. The quarterly compounded rate is 16%
C. The quarterly compounded rate is 16.3%
D. The quarterly compounded rate is 17.1%

98. A news anchor at a business TV channel made the following statements regarding bonds and
their rates.
Statement I: Zero rates are the appropriate discount rates that are used for discounting a single
cash flow at a particular future time or maturity. Zero rates corresponds to zero coupon bond
yields.
Statement II: A bond yield, also known as spot rate, is the unique discount rate that, if applied to
all cash flows, makes the bond price equal to its market price.
Statement III: The par yield is the coupon rate of a bond with a certain maturity that, if applied,
makes the bond price equal its par value.
Which of the statements are correct?
A. Statements I and II are correct
B. Statements II and III are correct
C. Statements I and III are correct
D. Statements I, II, and III are correct

99. An investor has invested $1000 in a 7-year zero coupon bond with continuously compounding.
If the bond is quoted as 9% per year, then estimate the value of investor’s investment at the end
of 7 years.
A. The future value of a zero coupon is $1,656.0
B. The future value of a zero coupon is $1,828.0
C. The future value of a zero coupon is $1,877.6
D. The future value of a zero coupon is $1,912.0

100. John Johnson works in the fixed income investments department of Fast Asset Management,
headquartered in London. Today, the head of the department asked Johnson to calculate the 6-
month spot rates using the quotes of zero coupon GILTs (UK treasury bonds) provided in the
table

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 23

 Bond Principal in (GBP) Time to Maturity (in yeard) Bond Price
100 0.25 99.15
100 0.5 97.80
100 1 94.25

What is the semi-annual spot rate

A. 0.0341
B. 0.0445
C. 0.0488
D. 0.0592

101. How is called the process by which traders can use the quotes of treasury bills and coupon
bearing treasury bonds to derive a zero coupon yield curve or spot curve?
A. Forward Rate agreement
B. Duration
C. Bootstrapping
D. Calibrating term structure

102. Every year, thousands of students in Turkey take the Certified Trader exam. The exam tests in
details the knowledge of students who are willing to join the banking sector. In last year’s
exam, a question asked the students to calculate a 1-year forward rate 2 years from now. The
question also provided the following table of zero spot rates:
Year Zero rates (p.a)
1 6%
2 6.5%
3 7.2%
Using the information provided in the table, which of the following is the accurate 1-year
forward rate 2 years from now?
A. 0.065
B. 0.072
C. 0.086
D. 0.093

103. Beijing Shipping Corp. enters into a forward rate agreement with Geneva Bank to receive a 7%
fixed rate on the principal of $50 million based on the quarterly rate in six months. If the
quarterly rate in six months is 6.8%, then wat is the cash inflow/outflow for the Beijing
Shipping at the end of the ninth month?
A. Cash outflow of $25,000
B. Cash inflow of $25,000
C. Cash outflow of $24,580
D. Cash inflow of $24,580

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 24

104. A German bank and a French bank entered into a forward rate agreement contract where the
German bank will pay a fixed rate of 4.2% compounded semiannually and receive the floating
rate on the principal of €700 million. The forward rate between 0.5 years and 1 year is 5.1%. If
the risk-free rate at the 1-year is 6% with continuous compounding, then which of the
following is the true value of the FRA contract between the two banks?
A. €6300000
B. €6,143,344
C. €4,005,875
D. €2,966,558

105. On a graduate level exam on to the subject of fixed income investments, students were asked to
define duration in three sentences. One of the students mentioned the following three
sentences associated with duration:
I. The duration of a bond is a measure that tells how long the holder of the bond has to wait
until the cash flow on the bond is received.
II. Since there are no coupons in a zero coupon bond, the zero coupon bond does not have
duration.
III. The duration of a coupon bond is equal to its time to maturity.
Which of the sentences are inconsistent with the definition of duration?
A. Statements I and II are inconsistent with the definition of duration
B. Statements II and III are inconsistent with the definition of duration
C. Statements I and III are inconsistent with the definition of duration
D. All of the statements are inconsistent with the definition of duration

106. Hina Bibi is a fixed income analyst at Vio Investment Company. She is responsible for
analyzing the risk and return of a company’s portfolio of fixed income investments. She is
analyzing the change in the price of a hypothetical 7-year bond with the face value of 100 and
the price of 96.86. If the duration of the bond that she analyzing is 1.962, then which of the
following options presents the accurate change in the price of the bond if the yield on the bond
increases by 50 basis points?
A. The price of bond will increase by $0.95
B. The price of bond will decrease by $0.95
C. The price of the bond will increase by $0.98
D. The price of the bond will increase by $0.98

107. Matt Christian is a former equity trader who has recently lost his job due to the rise of
algorithmic trading. Christian is aiming to change his focus from equity trading to fixed income
assets trading. He regularly educates himself by taking online seminars on fixed income assets
and using demo accounts to trade bonds. In one of the online seminar, he read following
definitions of duration:
I. The duration of a bond entails the average time it takes the holder to receive cash flows on
the bond; it is suitable to measure if the yield on a bond is continuously compounding.
II. Modified duration is a similar measure to duration but it is more suitable when the yield on
the bond is not continuously compounded.

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 25

 III. Dollar duration is defined as the duration multiplied by the price of the bond.
Which of the statements that he learned during his seminar is/are inaccurate?
A. The definition of duration is inaccurate
B. The definition of modified duration is inaccurate
C. The definition of dollar duration is inaccurate
D. More than one definition is inaccurate

108. There are different measures available that are used to measure the change in the price of the
bond given the change in the yield curve. Which of the following measures is used for the
purpose of estimating changes in bond prices if the changes in yield curve are larger?
A. Duration
B. Convexity
C. Modified duration
D. Concavity

109. Fredrick Hessen is a senior professor in the department of macroeconomics at Welth Business
School. In the current semester, his course focuses on interest rates and the term structure of
interest rates. One day, he made the following comment:
“There is no relationship between short-term, medium-term, and long-term interest rates.
These interest rates are independently determined by the supply and demand in their specific
bond market. For instance, the short-term interest rate is determined by the supply and
demand of short-term bonds”.
Which of the following theories is associated with the professor’s comment?
A. Expectation theory
B. Market segmentation theory
C. Liquidity preference theory
D. None of the above

110. Transactions worth billions of dollars depend on the shape of the zero rate curve. The shape of
the zero curve has gained the attention of economists, mathematicians, and investors. Many
theories exist that present their perspective about the shape of the zero curve. One of those
theories suggests that investors are likely to invest their funds for a shorter period while
borrowers are more willing to borrow the funds at long-term fixed rates. The theory also
concludes that the forward rates are greater than the future spot rates, which justify the
empirical result that the yield curve tends to be upward sloping. Which of the following
theories provides the above-mentioned conclusion?
A. Expectation theory
B. Market segmentation theory
C. Liquidity preference theory
D. None of the above

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 26

111. An at-the-money American call option on a stock that pays no dividends has three months
remaining until expiration. The market value of the option willmost likely be:
A. less than its exercise value.
B. equal to its exercise value.
C. greater than its exercise value.

112. At expiration, American call options are worth:

A. less than European call options.
B. the same as European call options.
C. more than European call options.

113. Derivatives pricing models use the risk-free rate to discount future cash flows because these
models:
A. are based on portfolios with certain payoffs.
B. assume that derivatives investors are risk-neutral.
C. assume that risk can be eliminated by diversification.

114. The price of a forward or futures contract:

A. is typically zero at initiation.
B. is equal to the spot price at expiration.
C. remains the same over the term of the contract.

115. For a forward contract on an asset that has no costs or benefits from holding it to have
zero value at initiation, the arbitrage-free forward price must equal:
A. the expected future spot price.
B. the future value of the current spot price.
C. the present value of the expected future spot price.

116. The underlying asset of a derivative is most likely to have a convenience yield when the asset:
A. is difficult to sell short.
B. pays interest or dividends.
C. must be stored and insured.

117. At expiration, the exercise value of a put option:

A. is positive if the underlying asset price is less than the exercise price.
B. is zero only if the underlying asset price is equal to the exercise price.
C. is negative if the underlying asset price is greater than the exercise price.

118. The price of an out-of-the-money option is:

A. less than its time value.
B. equal to its time value.
C. greater than its time value.

SANJAY SARAF EDUCATIONAL INSTITUTE PVT. LTD. Page 27