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

Answer : B

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

Answer : D

Equity futures are by far the most traded futures contracts in terms of value, followed by interest rate products. Choice 'd' is the correct answer.

Answer : A

In the US, the Federal Reserve sets a limit (eg, 2 x, so that only 50% of the money could be borrowed) as a multiple of capital posted to prevent excessive leverage or gearing in the system.

The other choices are incorrect.

Answer : A

Over the counter and electronic communication networks match buyers and sellers. However, there is no market making function, ie, in periods of stress liquidity may completely disappear from these markets. Exchanges normally have market makers that are required to present two way quotes on the securities they are making the market for. Therefore Choice 'a' is the correct answer.

Answer : A

According to the dividend discount model, the spot share prices represent the present value of all the future cash flows from the stock. If held till perpetuity, this becomes an annuity equal to the dividend, growing at its expected growth rate. Therefore Choice 'a' is the correct answer. Choice 'c' would represent the total market cap, and not the value per share that the question asks.

Answer : D

Forward premium or discount can be easily calculated as {(Forward rate - Spot rate) / Spot rate x 365/number of days]. In this case, it can be calculated as =((1.1652 - 1.1763) / 1.1763 ) * 365/91 = 3.785%, which is a discount as it is a negative number. It can also be interpreted as a discount as the forward price is lower than the spot price.

Answer : C

Since AUD 1 = USD 0.6831, and USD 1 = SEK 8.1329, AUD 1 = SEK 8.1329*0.6831 = 5.5556.

It is important to remember how exchange rates are generally quoted. Most exchange rates are quoted in terms of how many foreign currencies does USD 1 buy. Therefore, a rate of 99 for the JPY means that USD 1 is equal to JPY 99. However, there are four major world currencies where the rate quote convention is the other way round - these are EUR, GBP, AUD and NZD. For these currencies, the FX quote implies how many US dollars can one unit of these currencies buy. So a quote of '1.1023' for the Euro means EUR 1 is equal to USD 1.1023 and not the other way round.

When calculating cross rates, it is important to pay attention to how the rates are quoted. This particular question is quoted in a very straightforward way because it specifies exactly what the rate means, eg by saying USD/AUD it clarifies that the rate is the number of USDs per AUD. If the question is not clear, remember how exchange rates are quoted - all are against 1 USD, except for EUR, GBP, AUD and NZD where it is the other way round.