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CFA Level 1 – SS17 Derivatives

Multiple Choice Questions
Derivatives Markets and Instruments
1. For all parties involved, which of the following financial instruments is NOT an example of a
forward commitment?
A. Swap
B. Call option
C. Futures contract
2. The main risk faced by an individual who enters into a forward contract to buy the S&P 500 Index
is that
A. the market may rise.
B. the market may fall.
C. market volatility may rise.
3. Which of the following statements is most accurate?
A. Forward contracts require that both parties to the transaction have a high degree of
creditworthiness.
B. Forward contracts are marked to market daily.
C. Futures contracts have more default risk than forward contracts.
4. Which of the following statements is least accurate?
A. Futures contracts are easier to offset than forward contracts.
B. Forward contracts are generally more liquid than futures contracts.
C. Forward contracts are easier to tailor to specific needs than futures contracts.
5. A swap is best characterized as a
A. series of forward contracts.
B. derivative contract that has not gained widespread popularity.
C. single fixed payment in exchange for a single floating payment.
6. Which of the following is most representative of forward contracts and contingent claims?
Forward Contracts
Contingent Claims
A. Premium paid at inception
Premium paid at inception
B. Premium paid at inception
No premium paid at inception
C. No premium paid at inception
Premium paid at inception
7. For the long position, the most likely advantage of contingent claims over forward commitments is
that contingent claims
A. are easier to offset than forward commitments.
B. have lower default risk than forward commitments.
C. permit gains while protecting against losses.
8. For derivative contracts, the notional principal is best described as
A. the amount of the underlying asset covered by the contract.
B. a measure of the actual payments made and received in the contract.
C. tending to underestimate the actual payments made and received in the contract.

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CFA Level 1 – SS17 Derivatives
9. By volume, the most widely used group of derivatives is the one with contracts written on which of
the following types of underlying assets?
A. Financial
B. Commodities
C. Energy-related
10. Which of the following is least likely to be a purpose served by derivative markets?
A. Arbitrage
B. Price discovery
C. Risk management
11. The most likely reason derivative markets have flourished is that
A. derivatives are easy to understand and use.
B. derivatives have relatively low transaction costs.
C. the pricing of derivatives is relatively straightforward.
12. If the risk-free rate of interest is 5 percent and an investor enters into a transaction that has no
risk, the rate of return the investor should earn in the absence of arbitrage opportunities is
A. 0%.
B. between 0% and 5%.
C. 5%.
13. If the spot price of gold is $250 per ounce and the risk-free rate of interest is 10 percent per
annum, the six-month forward price per ounce of gold, in equilibrium, should be closest to
A. $250.00.
B. $256.25.
C. $262.50.
14. Concerning efficient financial (including derivative) markets, the most appropriate description is
that
A. it is often possible to earn abnormal returns.
B. the law of one price holds only in the academic literature.
C. arbitrage opportunities rarely exist and are quickly eliminated.
15. Stock A costs $10.00 today and its price will be either $7.50 or $12.50 next period. Stock B’s price
will be either $18.00 or $30.00 next period. If risk-free borrowing and lending are possible at 8
percent per period, neither stock pays dividends, and it is possible to buy and sell fractional
shares, Stock B’s equilibrium price today should be closest to
A. $19.00.
B. $21.00.
C. $24.00.

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C. Which of the following statements regarding early termination of a forward contract is most accurate? A. Which of the following statements regarding equity forward contracts is least accurate? A. There is no default risk on these forwards because T-bills are government backed. has no default risk. Equity forwards are sometimes on custom stock portfolio. Early termination on through an offsetting transaction with the original counterparty eliminates default risk. A party who terminates a forward contract early must make cash payment. CFA Level 1 2014 Page | 3 . 7. A. lf short-term yields increase unexpectedly after contract Initiation. at least one party must make a cash payment to the other. C. The long will receive a payment at settlement if the discount yield is above the forward yield. A. 3. B. LIBOR is published daily. 8. B. B. may enter into a contract with another dealer. B. the short may be required to sell the asset B. A.CFA Level 1 – SS17 Derivatives Forward Markets and Contracts 1. 6. A. may be issued by a Japanese bank. One difference between LIBOR and Euribor is that. A Eurodollar time deposit. 2. B. is only available in London. the short will profit on the contract. C. they are for different currencies. B. A party who enters into an offsetting contract to terminate has no risk. B. gets a small payment for each contract at initiation 5. LIBOR is for London deposits. Equity forwards may be settled in cash. On the settlement date of a forward contract: A. C. cannot be a bank. C. C. A dealer in the forward contract market. Dividends are never included in index forwards. 4. is priced on a discount basis. the long must sell the asset or make cash payment. C. Which of the following statements regarding forward contracts on T-bills is most accurate? A. is obligated to deliver the specified asset. C. receives a payment at contract initiation. Euribor weekly. The short in a deliverable forward contract.

receive $3.333. $1 million T-bill decreases from 3. how much has the holder of the T-bill gained or lost? A. 14. FRAs can be based on interest rates for 30-. pay $3.000.300. 90-day LIBOR is quoted as 3. The contract rate will change with LIBOR over the term of the agreement. $32. If 60-day LIBOR is 6% at settlement. 10. If the contract is settled in cash. 11. the long will.300. How much interest would be owed at maturity for a 90-day loan of $1. B.612. 60 days from now. Lost $800.07%. B. pay $3. make a payment of $103. A.98 per euro. The short will settle the contract by making a loan. $17. If the quoted discount yield on a 128-day. the exchange rate is $0.925.97 per euro. Gained $284. $18.090. FRA Position A. C. C.300. B. make a payment of $100. C. 12. C. or 90-day periods. The type of FRA and the position he should take to hedge the interest rate risk of this transaction are. receive a payment of $100.15% to 3.58%. Lost $284. 13. C. Consider a $2 million FRA with a contract rate of 5% on 60-day LIBOR. Party A has entered a currency forward contract to purchase €10 million at an exchange rate of $0.39% A. A company treasurer needs to borrow 10 million euros for 180 days. B. 60-.000. 2x6 Long B.5 million at LIBOR + 1. Which of the following statements regarding a LIBOR-based FRA is most accurate? A. 2x6 Short C. B.CFA Level 1 – SS17 Derivatives 9. At settlement. Party A will: A. 2x8 Long CFA Level 1 2014 Page | 4 .

B. 3. lost $1. The clearinghouse guarantees that traders in the futures market will honor their obligations. -$675. limit down. C. used to adjust the number of bonds to be delivered. also known as an exchange of physicals. + $675. then the trader must deposit variation margin. 5. C. C. short has the option to settle in cash or by delivery. The market for this contract is: A. locked limit. On this contract the trader has: A. Hedgers trade to reduce some pre-existing risk exposure. B. gained $325. 8. Which of the following statements about the transaction is most correct? The transaction is: A. a contract does not trade for two days because trades are not permitted at the equilibrium price.0180.025.14 and closes it out at a price of 98. 7. Three 125. The next day the price settles at $1. Which of the following statements is FALSE? A.CFA Level 1 – SS17 Derivatives Futures Markets and Contracts 1. short can choose which bond to deliver. B.300. B. B. A conversion factor in a Treasury bond contract is: A. 6. C. 4. In the futures market. B. The mark to market for this account changes the previous day’s margin by: A.000 euro futures contracts are sold at a price of $ 1. long chooses which of a number of bonds will be delivered.27. multiplied by the face value to determine the delivery price. also known as delivery. multiplied by the futures price to determine the delivery price. lost $325. Assume the holder of a long futures position negotiates privately with the holder of a short futures position to accept delivery to close out both the long and short positions. C. suspended. If an account rises to or exceeds the maintenance margin. The existence of a delivery option with respect to Treasury bond futures means that the: A. C. CFA Level 1 2014 Page | 5 . 2. variation margin. C. the most common way to close a futures position. initial margin. C. marking to market. B.0234. The daily process of adjusting the margin in a futures account is called: A. A trader buys (takes a long position in) a T-bill futures contract ($1 million face value) at 98. B. + $2.

Floor broker. I and III only. Day trader. C. B. A. 12. $2.170. The market is very liquid. more liquid. B. C. Futures contracts differ from forward contracts in the following ways: I. Most futures contracts are closed through: A. Which statement regarding financial futures is not true? A. B. $2. 17. Futures contracts are standardized. II. C. B. They must be held until the expiration date.00. variation margin. C. set initial and maintenance margins. the dollar gain would be: A. In futures trading. II. C. B. initial margin. 15. daily margin. Futures contracts require a daily settling of any gains or losses. the minimum level to which an equity position may fall before requiring additional margin is most accurately termed the: A. I.375.531.CFA Level 1 – SS17 Derivatives 9. $2. C. Scalper.25. C. reversing trade. act as the counterparty to every trade. 10. larger in size. Compared to forward contracts. delivery. and III. B. futures contracts are all of the following EXCEPT: A. C. 13. CFA Level 1 2014 Page | 6 . decide which contracts will trade. B. B.25. exchange-for-physicals. performance of each party is guaranteed by a clearinghouse. Which of the following is a futures exchange member who can execute public orders? A. In the futures market. I and II only. If a December Treasury bond future contract is purchased at a price of 70-21 and increases to a price of 73-06 the following week. 14. III. the clearinghouse does all of the following EXCEPT: A. For Futures. variation margin. B. 16. standardized. Funds deposited to meet a margin call are termed: A. They normally are highly leveraged. settlement costs. 11.

21. B.11. Jerry Harris sells one July silver futures contract at a price of $8 per ounce. B.716. $8. Futures can be used for each of the following except: A. Which one of the following statements best describes a stock-index arbitrage strategy? A. what is the first price per ounce at which Harris would receive a maintenance margin call? A. the number of contracts traded on a given day. A silver futures contract requires the seller to deliver 5. 20. B. interest rates. and spot/forward exchange rate differentials. C. interest rates and expected future interest rates. 1. An analyst gathers the following information:  One-year interest rates: Euro 4%  U. maintenance margin. 24. 18. Taking a long or short position in the cash (spot) market represented by a market basket of stocks. C. CFA Level 1 2014 Page | 7 .70 Based on the information above.785. investments. inter-country interest rate differentials and spot/forward foreign exchange rate differentials. Trading call and put stock options in each stock represented in a market index. C. unhedged positions.S. In futures markets. clearinghouse positions.92. B.768.500.000 Troy ounces of silver.025 initial margin. volume refers to: A.89. The open interest on a futures contract at any given time is the total number of outstanding: A. 22. long and short positions. 19. dollar 5%  Spot exchange rate: €/$ 1. the number of both long and short contracts traded on a given day. posting a $2. expected future interest rates. C. C. $7. C. 1. B. price discovery. If the required maintenance margin is $1. 23. Trading in stock-index futures contracts and in individual stocks when a divergence occurs between the cash (spot) price of the market and the futures price. the forward exchange rate that will satisfy the interest rate parity condition is closest to: A. $5. C. 1. B. Interest rate parity describes relationships among current: A. speculating.CFA Level 1 – SS17 Derivatives C. B. the total number of contracts obligated for delivery.

0 = $1. and 8 percent at the end of the swap. returns on two equities are swapped.0 million. the notional principal is swapped. shares are exchanged for the notional principal. only net interest payments are made. Use the following data to answer Questions 7 through 10. B. fixed rates are traded for variable rates. C. 2. which of the following statements is TRUE? A. 3. B. have little or no regulation. Only the net difference between the dollar interest and the foreign interest is exchanged in a currency swap. 7. 6 percent at the end of year 1. The variable rate is 5 percent currently. Which of the following statements is FALSE? A. In an interest rate swap. CFA Level 1 2014 Page | 8 . end-of-period payments are based on beginning-of-period interest rates.5 = $1. at each settlement date. The time frame of a swap is called its tenor.0 million is exchanged at an exchange rate of FC 2. C. FE gives US $1. 6. B. the notional principal is actually swapped twice.0. C. B. C. returns on an index can be swapped for fixed-rate payments. B. and 7 percent at the end of year 3. B. The notional principal is swapped at inception and at termination of a currency swap. At the initiation of the swap.0 million. The traders involved in a swap are called the counterparties. In a plain vanilla interest rate swap. Consider a 3-year annual currency swap that takes place between a foreign firm (FE) with FC currency units and a United States firm (US) with $ currency units. US gives FE $1. only the net notional principal is swapped. 5. Firm US is the fixed-rate payer and Firm FE is the floating-rate payer. In a currency swap. In a currency swap. C. C. give the traders privacy. Note: With this currency swap. At the beginning of the swap. minimize default risk. In a plain vanilla interest rate swap: A. Which of the following statements is FALSE? A.0. once at the beginning of the swap and again at the termination of the swap. Which of the following statements is NOT an advantage of swaps? Swaps: A. In an interest rate swap only the net interest is exchanged. the notional principal is swapped. Which of the following statements is FALSE? A. only the net interest payments are made. US gives FE FC2. 4. At the end of the swap period the exchange rate is FC 1. $1. The fixed interest rate at the initiation of the swap is 7 percent.0 million. In an equity swap: A. C. B. 8 percent at the end of year 2.CFA Level 1 – SS17 Derivatives Swap Markets and Contracts 1.

C. The counterparty will send a payment of $5.160. Lambda Corp.000. C. FC2. EC2. US pays FC140. from Gamma to Lambda. $1 million. The fixed rate is 6 percent and the floating rate is 90-day LIBOR + 1%. has a floating-rate liability and wants a fixed-rate exposure. $1. with both calculated based on a 360-day year.5% and it ends the year at 6%. 12.000. $1. FE pays $70. 9.000 from Gamma to Lambda. The counterparty to the swap agrees to pay a fixed rate of 6% for LIBOR. based on the information given. known at the initiation of the swap.000. $5. FE pays $60.080. C. not known. At the end of the year: A. At the end of year 2: A.CFA Level 1 – SS17 Derivatives 8. $10.000 units.000. Firm FE gives Firm US which of the following notional amounts? A. The counterparty is Gamma Corp. They enter into a 2year quarterly-pay $4. At the termination of the swap. C. C. $4.000.000 from Gamma to Lambda. 14. $5.000. C. B.000. 10.000. The first swap payment is: A. US pays FC70.0% 11. with LIBOR being the reference rate. $5.4% In 3 quarters 5. CFA Level 1 2014 Page | 9 . B.000.000. The swap settles on December 31st of each year and is for the notional amount of $1. Firm FE will pay which of the following total amounts? A.000. The fifth net quarterly payment on the swap is: A. LIBOR is 5. B. Realizations of LIBOR are: Annualized LIBOR Current 5.000. Use the following information to answer Questions 11 through 13.8% In 4 quarters 6. B. Neither party makes a payment because the LIBOR rate equals the fixed rate at year end.5% In 2 quarters 5. zero. US pays EC60. At the beginning of a year. At the end of year 3. B.000.000 fixed-for-floating swap as the fixed-rate payer.000. The second net swap payment is: A. Albright Financing enters into a “plain vanilla” interest rate swap as the floating-rate payer.0% In 1 quarter 5.666. FE pays $80.000.070.000 from Lambda to Gamma. B. $666.000 to Albright. 13. B.

P20. A currency swap. B.240. and the interest rate on the Philippines Pesos is 7%. At the time the swap settles.CFA Level 1 – SS17 Derivatives C.000 for P20. the exchange where the transaction is executed.320. B. The interest rate on U.000 $4. 10 percent in the second year.000 to the counterparty and the counterparty will pay $60. 18.000 in year 3. The swap requires ABC to swap $4. C. the clearinghouse. P23. $200. The current LIBOR is 11 percent. 19. which of the following characterizes the net cash flow to be received by the fixed-rate payer? A. $200.S. $150.000.000.000 at the end of year 2 16. An interest rate swap. C. performance on the contract is guaranteed by: A. 15. Albright will pay $55.000 at the end of year 2 B. C.000. Which of the following accurately characterizes a net cash outflow to be received by the swap seller? A. ABC enters into a fixed-fixed rate. CFA Level 1 2014 Page | 10 .000. In any kind of swap.5 percent in the first year.000 17. the market exchange rate is $1 = P5. $100. The swap settles and terminates in one year.000 $4. LIBOR is 11 percent now.000 C. $100.000 in year 1.000. and 9 percent at the end of the second year. plain-vanilla interest rate swap agreement to exchange the LIBOR rate for a 10% fixed rate on $10 million.400.000 $4.000 to Albright. LIBOR is 11.240. and 9 percent in the third year.000 B. The payments made by each party on the settlement of the swap are: ABC Pays to the Dealer The Dealer Pays to ABC A.50. If payments are in arrears. Two parties enter a three-year interest rate swap agreement to exchange the LIBOR rate for a 9 percent fixed rate on $10 million. “plain vanilla” currency swap with a dealer. P21.000 at the end of year 3 C. In which of the following transactions will there be an initial exchange of cash? A. dollars is 6%. Two parties enter a three-year. B. $100. no one. 12 percent at the end of the first year.000 in year 1. In a swap transaction.

For put options. Can exercise the option and take delivery of the oil. American options are more widely traded and are thus easier to value. B. C.X-S). B. A $40 call on a stock trading at $43 is priced at $5. Max(0. Which of the following statements about American and European options is TRUE? A. B. C. is bounded by S . B. a put option is in-the-money. 6. S . the more the put is worth. Must pay the strike price to exercise the option. $5. $2. will never sell for less than its intrinsic value. C.S-X). B. S = X. Max(0. CFA Level 1 2014 Page | 11 . decrease put prices and increase call prices. Which of the following statements about moneyness is FALSE? When: A.70: A.X = 0. C. a call option is at-the-money. 4. B. Which of the following statements about put and call options is FALSE? A. C. $3. Can exercise the option and take a long position in oil futures. C. C. 7. Prior to expiration. an American option may have a higher value than an equivalent European option. The holder of a call option has the obligation to sell to the option writer should the stock’s price rise above the strike price. The lower bound for a European put option is: A. increase put prices and decrease call prices. A decrease in the market rate of interest will: A. decrease put and call prices. The time value of the option is: A. The holder of a call option has the obligation to buy from the option writer should the stock’s price rise above the strike price. C. There will always be some price difference between American and European options because of exchange-rate risk.X /(1 + RF)T. 8. 9. Prior to expiration. The price of the option is less volatile than the price of the underlying stock. 3. Which of the following statements is TRUE? A. the higher the strike price relative to the stock’s underlying price. will sell for its intrinsic value. The holder of a put option has the right to sell to the writer of the option. a put option is at-the-money. S > X.CFA Level 1 – SS17 Derivatives Option Markets and Contracts 1. The owner of a call option on oil futures with a strike price of $28. Option prices are generally higher the longer the time till the option expires. 5. 2. B. B. an American put option on a stock: A. B.

16. Max [0. long interest rate calls.28.72. B. C=S . short a call and long a put. Which of the following will increase the value of a put option? A. An increase in Rf. C. B. C. To account for positive cash flows from the underlying asset.X . S=C . $0 (no arbitrage).S+ X /(1 + RF)T. comes some period after option expiration. C.X/(1+RF)T]. subtracting the present value of the cash flows from S. P=C . 12. The payoff on an interest rate option: A. $0. Max [0.S]. is greater the higher the “strike” rate. B. Which of the following relations is FALSE? A. short a put and a call. we need to adjust the put-call parity formula by: A. 11. C.X/(1 +RF)T . if anything. D. The exercise price is low relative to the stock price. a 3-month put at $50 is selling for $11. S . C. subtracting the future value of the cash flows from X.P+ X /(1 + RF)T. adding the future value of the cash flows to S. typically every 90 days. B. Max [0. A stock is selling at $40. long interest rate puts. 18.S). can be made on an arbitrage? A. B. and the risk free rate is 6 percent. Which one of the following would tend to result in a high value of a call option? A.CFA Level 1 – SS17 Derivatives C. A forward rate agreement is equivalent to the following interest rate options: A. An increase in volatility. CFA Level 1 2014 Page | 12 . B. 17. 13. $0. long a call and short a put. B. C. B. a 3-month call at $50 is selling for $1. adding the future value of the cash flows to X. Max(0. A decrease in the exercise price. C. 15. short interest rate puts. 14. The lower bound for an American call option is: A. X /(1 + RF)T . C.S] 10. An interest rate floor on a floating-rate note (from the issuer’s perspective) is equivalent to a series of: A.P+ X /(1 + RF)T. How much. is periodic.

III. match up the option buyer who exercises with the original option writer. Buy a put on a stock you own. B. 23. C. B. 21. B. the purpose of the clearinghouse is to: I. European option contract is not adjusted for stock splits and stock dividends. European option is not commonly used and is often mispriced. ensure contract performance. A. purchase out-of-the-money call options/purchase in-the-money put options. If a stock is selling for $25. buying out-of-the-money calls/buying puts on stock owned. An American option is more valuable than a European option on the same dividend paying stock with the same terms because the: A. There is little time remaining until the option expires. 24. Investor B uses options as an aggressive investment strategy. C. C. I and II only. An investor who owns 100 shares of a common stock and writes a call option on that stock has: A. purchase at-the-money bull spreads/purchase at-the-money call options. 22. Buy a call on a stock you own. In the options markets. issue certificates of ownership. C. Appropriate courses of action for Investors A and B respectively are: A. and the time to expiration of the option is 90 days. diversified his position. Investor A uses options for defensive and income reasons. B. writing naked calls/buying in-the-money calls. the minimum and maximum prices for the put today are: A. C. reduced the effect of a price decline. the exercise price of a put option on that stock is $20. B. B. 25. C. II only. 19. Investor A is extremely bullish and Investor B is extremely bearish. An appropriate use of options for Investors A and B respectively would be: A. 26. writing covered calls/buying puts on stock not owned. Which one of the following transactions would be considered a protective strategy? A. Sell a call against a stock you sold short. B. protects against loss at any stock price below the strike price of the put. American option can be exercised from date of purchase until expiration. An at-the-money protective put position (comprised of owning the stock and the put): A. but the European option can be exercised only at expiration. II. purchase convertible preferred/purchase convertible bonds. $5 and $20. $0 and $5. B. written a naked call option. $0 and $20. 20. C. II and III only.CFA Level 1 – SS17 Derivatives B. has limited profit potential when the stock price rises. The variability of the underlying stock is low. C. CFA Level 1 2014 Page | 13 .

Ignoring dividends and transactions costs. Write an uncovered call option. C. I only. If an investor owns a stock and owns a put on the same stock. 30. The best action for a portfolio manager to take to preserve capital in a declining stock market is to: A.00 $3. B.50 28. the stock price and the exercise price are equal. 31. Buy a call option. this is the same thing as: CFA Level 1 2014 Page | 14 . the stock price is below the exercise price. the stock price is above the exercise price. Which of the following statements about European and American options is/are true? I. B. III. B. sell stock index futures.50 C. A call is “in-the-money” when: A.50. C. what maximum profit can the investor earn if the position is held to expiration? A. A call option will be exercised only if the market value of the underlying asset is more than the exercise price. B. buy call options. $5. 32. A European option permits the owner to exercise only at expiration. What is the maximum per share loss to the writer of the uncovered put and the maximum per share gain to the writer of the uncovered call? Maximum Loss to Put Writer Maximum Gain to Call Writer A.00 per share. 33. 27. Which is the most risky transaction to undertake in the stock index option markets if the stock market is expected to increase substantially after the transaction is completed? A. Which of the following statements describing options is false? A. Write an uncovered put option. $3.50 B.00 $36. $38. B. A. $40. An American option permits the owner to exercise at any time before or at expiration. I and III only. A put option’s profit increases when the value of the underlying asset increases.00 $3. most options are European options. C. II. while a call with a strike price of $40 is priced at $3.CFA Level 1 – SS17 Derivatives C. A put on XYZ stock with a strike price of $40 is priced at $2. less the cost of the put. buy stock index futures. dollar for dollar. A put option gives its holder the right to sell an asset for a specified price on or before the option’s expiration date. I and II only. American options are easier to analyze. In actual markets. C. 29. B. 34. $38. C. returns any increase in the stock’s value. $2. C. An investor purchases stock for $38/share and sells call options on that stock with an exercise price of $40 for a premium of $3/share.

” A. C. If the breakeven point for this hedge is at an asset price 104 at expiration. I and II only. An out-of-the-money American put option with an exercise price of 90 is purchased along with the asset. value of the long position equals zero or the exercise price minus the stock price. II. I only. All of the following statements about the value of a call option at expiration are true EXCEPT the: A. short position in the same call option can result in a loss if the stock price exceeds the exercise price. $7. 80. Employing a “protective put” strategy. 0. C. Buying a call. 4. At what value of the asset will a covered call writer break even at expiration? A. B. The following price quotations are for exchange-listed options on Primo Corporation common stock. Writing a put.50. Ignoring transaction costs. 36. C. C. then the value of the American put at the time of purchase must have been: A. 39. B.25 0. B. at-the-money American call option on this asset has a current value of 5. $725. C. A three-month. whichever is higher. 75. Employing a highly risky strategy. B. 35. A put option has an exercise price of $80. B. Which one of the following option transactions is most similar to selling a stock short? A. The value of the long position in the put is -$4 if the stock price is $76. which of the following statements about the value of the put option at expiration is true? A. 38.00. 40. The current price of an asset is 75. B. III. CFA Level 1 2014 Page | 15 .25 B. how much would a buyer have to pay for one call option contract? A. C. C. I and III only. Buying a put. 10. 70. The value of the short position in the put is $4 if the stock price is $76.CFA Level 1 – SS17 Derivatives I. $72. 37. whichever is higher. Employing a strategy known as “portfolio insurance. value of the long position equals zero or the stock price minus the exercise price.5 Ignoring transaction costs. The long put has value when the stock price is below the $80 exercise price. Company Primo Strike Expiration Call Put 63 58 Feb 7. The current price of an asset is 100.

B. 42. As the stock price rises above $30 per share: A. the exercise of warrants provides new equity capital to the company that issued the stock. call options trade on the various options exchanges.. call options are written by investors for existing stock of the company. $3. The major difference between a common stock warrant and a call option is that: A. and III. Investor A is short the call option. a futures contract is an obligation. and Investor B is long the put option. and Qwerty pays an annual dividend of $1. II. The premium paid on both options was $3. Unlike the exercise of options.40 44. The difference between a futures contract and an option contract is: A. C.60. Consider a call option and a put option. Investor B will gain while Investor A’s loss remains constant.00 C. both on the stock of PLK. whereas warrants trade only on the New York and American Stock Exchanges. options are more expensive. an option is a right. Unlike options. I. Warrants tend to have much longer terms to maturity than call options.CFA Level 1 – SS17 Derivatives 41. Inc. Investor A will lose while Investor B’s gain remains constant. a future is longer term. 45. with the same strike price. Which of the following statements accurately contrasts common stock warrants and common stock call options? I. II. warrants are usually issued by the company that issued the stock. whereas warrants are issued by companies. I and II only. B. If the current market price of Qwerty stock is $32 per share. $25. $32. III. the intrinsic value of a put option on Qwerty stock with a $35 strike price is: A. 43. B. Investor A will gain while Investor B’s loss remains constant. C. CFA Level 1 2014 Page | 16 . $1. call option valuation models such as Black-Scholes cannot be used to value common stock warrants. A. I and III only. C. B. C.00 B.

The call option gives the holder a right but does not impose an obligation. which are usually for standardized amounts and are exchange traded. A A swap is most like a series of forward contracts.10/2)] = 250 x (1.4 shares of A. 2. 6. B A call option is not binding on both parties in the same sense that the other financial instruments are.50) to return them. C Because the holder of a contingent claim (the party in the long position) has a right but not an obligation. 14. Stock B should be priced at $24. a forward commitment typically requires no premium to be paid up front.4 shares of A short for $24. the party in the short position demands (and receives) compensation. Arbitrage. 11. imagine selling 2.4 times the price of A. 9. 12.00 today.05) = $262. For example. is the basis for pricing most derivative contracts. 5. although certainly not impossible. Now. C Unlike a contingent claim. such as Treasury instruments and stock indices. unlike futures contracts. A The notional principal is the amount of the underlying asset covered by the derivative contract. B Forward contracts are usually less liquid than futures contracts because they are typically private transactions tailored to suit both parties. This type of transaction requires a high degree of creditworthiness for both parties. this might not always happen and thus is a secondary consideration. or the rapid elimination. C In the absence of arbitrage opportunities. buying a risk-free Treasury security and a futures contract on the S&P 500 Index to replicate payoffs to the index is cheaper than buying the 500 stocks in the index in their proper proportions to get the same payoff.4 shares of A (at $12. An example is a swap in which one party makes a set of fixed rate payments over time in exchange for a set of floating-rate payments based on some notional amount. The six-month forward price of gold should be 250 x [1 + (0. 8. CFA Level 1 2014 Page | 17 . than the index is worth when the contract matures. A The most widely used derivative contracts are written on underlying assets that are financial. of arbitrage opportunities. suppose B is worth $30. 7. it is relatively unusual. for derivative markets to be used to generate arbitrage profits.00. Then selling B permits you to buy 2. the buyer of a forward contract could pay more for the index. while a contingent claim is binding only on the party in the short position. if B is worth $18. Alternatively.4 times the price of A. C C 15. the price of B is 2. B 3.CFA Level 1 – SS17 Derivatives Proposed Solutions Derivatives Markets and Instruments 1. an investor bearing no risk should expect to earn the risk-free rate. Consequently. selling B permits you to still buy 2. For this. A Forward contracts are usually private transactions that do not have an intermediary such as a clearinghouse to guarantee performance by both parties. Although it is possible that a rise in interest rates could cause the market to fall.50. she will only exercise when it is in her best interest to do so and not otherwise. This will happen only when she stands to gain and never when she stands to lose. Efficient markets are characterized by the absence. as determined by the price that was contracted for at the inception of the contract. B One reason derivative markets have flourished is that they have relatively low transaction costs. An intuitive way to look at this is to realize that a forward commitment is binding on both parties. The same no profit situation holds if you sell one share of B and buy 2. To see this. in the next period.50 per share) to return the shares sold short. or the absence of it. A 10.4 shares of A (at $7. An alternative explanation lies in the fact that in each of the two outcomes. C 13. If the market falls. 4. and buying one share of B.00. so any up-front fees would cancel. Thus. the price of B today must be 2.00.

98 when they are only worth $0.000. Both LIBOR and any premium to LIBOR are quoted as annualized rates. A long position is used to reduce the price risk of an expected future purchase. The actual discount has decreased by: (0. ($0. 9. B A LIBOR-based contract can he based on LIBOR for various terms. Under a deliverable contract. No payment is typically sparse at contract initiation. This requires a long position in a 2 x 8 FRA. A When short-term rates increase. 11. B Index forward contracts may he written as total return contracts. 10. 4. 6. There is typically no payment made at contract initiation.05) x (60 / 360) x $2 million x 1/(1 + 0.0307) x (128/360) = 0. and either party may have default risk if there is any probability that the counterparty may not perform under the terms of the contract 2. A Terminating a forward contract early by entering into an offsetting forward contract with a different counterparty exposes a parry to default risk.300. dollar-denominated accounts while Euribor is for euro-denominated accounts.98 . or may be on custom portfolios. dollar-denominated accounts with banks outside the United States and are quoted as an add-on yield rather than on a discount basis. There is default risk on the forward. not differences in default risk. The long will receive a payment when LIBOR is higher than the contract rate at settlement. C (0.$0.000 or $284.000. C A 12. Differences in these rates are due to the different currencies involved.0.S.01 x 10 million = $100.300. Contracts may be written to settle in cash.97) x 10 million = $100. Obey are settled in cash. If the offsetting transaction is with the original counterparty. the short is required to deliver the asset at settlement. B Forward contracts dealers are commonly banks and large brokerage houses.CFA Level 1 – SS17 Derivatives Forward Markets and Contracts 1. B 13. not to make cash payment. A A forward contract may call for settlement in cash or for delivery of the asset which does not typically contain an option to do one or the other. is obligated to buy euros at $0. Both can change daily and neither is location-specific. 7. CFA Level 1 2014 Page | 18 . 5.0284% of $1.000 loss. (0. C The short in a forward contract is obligated to deliver the specified asset at the contract price on the settlement date. A decrease in the discount is an increase in value. The price of a T-bill prior to maturity is always less than its face value. C 8.S. be deliverable. The long.0358 + 0. Parts’ A. They frequently enter into forward contracts with other dealers to offset long or short exposure.013) (90/360) 1.33.0315 – 0. LIBOR is for U.5 million = $18.06 . the default risk is eliminated. T-bill prices fall and the short position will profit. and the contract rate is fixed for the life of the contract. C 14. even though the underlying asset is considered risk free. B Eurodollar time deposits are U.06 / 6) = $3. 3. No cash payment is required if an offsetting contract is used for early termination.97 and must pay $0. which include dividends.

1. A 6. 22. 7. Only if an account falls below the maintenance margin does variation margin need to be paid to bring the level of the account back up to the level of the initial margin. B This describes the situation when the equilibrium price is either above or below the prior day’s settle price by more than the permitted (limit) daily price move. whereas forwards are customized for each party. Brokers execute orders for those off the exchange. The exchange determines which contracts will trade. CFA Level 1 2014 Page | 19 . 19. (1.025. although the contract size of futures is standardized. When insufficient funds exist to satisfy margin requirements. C C 9. When the holder of a long position negotiates directly with the holder of the short position to accept delivery of the underlying commodity to close out both positions. so the adjustment is an addition to the account margin.0 180) x 125. Trading is not suspended.000 x 3 = $2. 17. a variation margin must be posted. this is called an exchange for physicals. C 13. 24. The price is up 13 ticks and 13 x $25 is a gain of $325 for a long position. trades can take place if they are within the band of the limits. B C C C C C A B B B B A It adjusts the delivery price based on the futures price at contract expiration. A 5. 11.0234 . 2. B The price is quoted as (one minus the annualized discount) in percent. 21. We do not know whether it is limit up or limit down. Variation margin is the funds that must be deposited when marking to market draws the margin balance below the maintenance margin. and also differs from delivery in which the commodity is simply delivered as a result of the futures expiration with no secondary agreement. 3. 16. The short has the option to deliver any of a number of permitted bonds. Traders trade with other exchange members on the exchange floor. 15. no payment needs to be made. C 10. and the trader has the option to remove the excess funds from the account. 18. 4. Remember that the gains and losses on T-bill and Eurodollar futures are $25 per basis point of the price quote. The delivery price is adjusted by a conversion factor that is calculated for each permitted bond. Most futures positions are settled by an offsetting trade. 14.CFA Level 1 – SS17 Derivatives Futures Markets and Contracts 1. A B 12. Size is not one of the things that distinguish forwards and futures. 20. C The process is called marking to market. The contracts were sold and the price declined.) Note that the exchange for physicals differs from an offsetting trade in which no delivery takes places. C If an account rises to or exceeds the maintenance margin. 8. 23. (This is a private transaction that occurs ex-pit and is one exception to the federal law that all trades take place on the exchange floor.

CFA Level 1 – SS17 Derivatives Swap Markets and Contracts 1. Firm FE pays $60.000.0 million. the U. 17. full interest payments are made. firm will be handing over dollars to the foreign firm. C 6.0million = $80. A 5.000 from Gamma to Lambda. Because this is a currency swap. Swap does not minimize default risk.000 at the end of year 2.5% + 1%) x (90/360) x 4mil = $65. 13. Because the U. and there are no guarantees that one of the parties will not default. B C B A B A Equity swap involve one party paying the return or total return on a stock or index periodically in exchange for a fixed return. 16. which is 6%. The floating rate is (5. 5. firm holds dollars. A 7. which are both 6%. Competition in the market for swaps makes pricing relatively efficient.S. 19. 18. B 8. 15. Since payments are made in arrears. the notional principal also exchanged. the floating rate is 7% compared to 6% fixed. C 3. the notional principal is only used to calculate the interest payments and does not change hands. Full interest payments are made. plus the floating rate payment (in arrears) of 8% x $1.000. In a plain vanilla interest rate swap. and the national principal is exchanged. we know that the notional principal is exchanged. A The notional principal is exchanged at termination. A Remember. being private transactions. $1. Note that notional principal is not exchanged for a fixed return.0 million.S. The total payment will be $1. The fixed rate payment is $60. Firm FE gives back what it borrowed. CFA Level 1 2014 Page | 20 . C The 5th quarterly floating-rate payment is based on the realization of LIBOR at the end of the 4th quarter.5%.000 11.000. With the 1% margin.000 14. have little to no regulation and offer the ability to customize contracts to specific needs 2. making the net payment $5. 9. C 4. and the terminal exchange rate is not used. In a currency swap. FF will pay the return of $1. In a currency swap. A 10. Note that swaps do give traders privacy and. There is not net payment made at the first quarterly payment date and this is known at the initiation of the swap. C The second quarter payment is based on the realization of LIBOR at the end of the first quarter. the currency swap is pay floating on dollars and pay fixed on foreign. so the net payment is $10. The notional principal is only exchanged in a currency swap. Swaps are agreements between two or more parties. interest payments are netted.080.000 and Firm US pays FC140. B The first payment is based on the fixed rate and current LIBOR + 1%.0million in principal at the termination of the swap. Firm FF is the floating-rate dollar payer. C In an interest rate swap. Floating at the end of year 1 is 6% of $1. 12. payments are not netted because they are made in different currencies.

where the exercise price is discounted at the risk-free rate. you can short a share of stock for $40 and buy the synthetic for an immediate arbitrage profit of $0.06) = $39. A The lower bound for an American call ranges from zero to the prevailing stock price less the present value of the exercise price discounted at the risk-free rate. 30. Options have time value which means prices are higher the longer the time until the option expires. 24.$40 = $3. 25. 4. and they will have equal value when it is not. 27. C 15. just as lower rates can require a payment from a floor. C The lower bound for a European put ranges from zero to the present value of the exercise price less the prevailing stock price.CFA Level 1 – SS17 Derivatives Option Markets and Contracts 1. but not for calls. T CFA Level 1 2014 0. T The put-call parity relationship is S + P = C + X / (1 + RF) . C The payoff to a FRA is equivalent to that of a long interest rate call option and a short interest rate put option. the assets value must be reduced by the present value of the cash flow discounted at the risk-free rate. B A B B B A C A A A A A C C Increased volatility of the underlying asset increases both put values and call values. All individual securities can be expressed as rearrangements of this basic relationship. Stating that the holder of a put option has the right to sell to the writer of the option is a true statement. 11. C A synthetic stock is: S = C . C If the underlying asset used to establish the put-call parity relationship generates a cash flow prior to expiration. 26. an American put will never sell below intrinsic value.25 Page | 21 .X = $43 . Ct ≥ ct and Pt ≥ pt. it is the price on the relevant futures contract (which may be higher). the time value is $5 . A A C 8. A 14. A The writer of the put option has the obligation to buy. 10. 16. At any time t. 12.28. Since the stock is selling for $40. C Interest rates are inversely related to put prices and directly related to call prices. 29. A A put option is out-of-the-money when S > X and in-the-money when S <X. 23. 20. a lower strike price increases the value of a call option.$11 + 50/(1. So. and a higher strike price increases the value of a put option. The intrinsic value is S . A call on futures gives the holder the right to buy a futures contract upon exercise. 5. 18. 22. A Option prices are more volatile than the price of the underlying stock. There is only one payment and it comes after option expiration by the term of the underlying rate. and the holder of the call option has the right. 28.P + X /(1 + RF) = $1 . 9. 19. It is not the current price of oil that determines whether the option is in-the-money. The other statements are true. An American option allows the holder the right of early exercise. 6. Short interest rate puts require a payment when the market rate at expiration is below the strike rate. so American options will be worth more than European options when the right to early exercise is valuable. The payment on long put increases as the strike rate increases. X – ST]. The lower bound is.72. Max[0. A 13. 7. The other statements are true. 2. but may sell for more than that.$3 = $2. 17. but not the obligation to buy. C 3. 21.

C A A C C C C A B A A C A B C CFA Level 1 2014 Page | 22 .CFA Level 1 – SS17 Derivatives 31. 36. 37. 32. 33. 43. 38. 45. 35. 34. 39. 40. 41. 42. 44.