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

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Total 287 questions
Question 1

What is the running yield on a 6% coupon bond selling at a clean price of $96?



Answer : B

The 'running yield' refers to the coupon rate divided by the current price. In this case, it is 6/96 = 6.25%. Remember that the running yield is also called the current yield.


Question 2

[According to the PRMIA study guide for Exam 1, Simple Exotics and Convertible Bonds have been excluded from the syllabus. You may choose to ignore this question. It appears here solely because the Handbook continues to have these chapters.]

Which of the following describes a 'quanto' instrument:



Answer : D

A quanto is any instrument in which one asset is a foreign currency. Examples include any option on a foreign currency asset with the strike price in foreign currency, and an option on a foreign currency asset with the foreign currency risk hedged.

Correlation products refer to credit products on a basket of credits. Options on options represent an option to buy or sell an option in the future, and they are not 'quantos'. Similarly, not every two asset instrument is a quanto unless one of the two assets is a foreign currency.


Question 3

A fund manager buys a gold futures contract at $1000 per troy ounce, each contract being worth 100 ounces of gold. Initial margin is $5,000 per contract, and the exchange requires a maintenance margin to be maintained at $4,000 per contract. What is the most prices can fall before the fund manager faces a margin call?



Answer : C

The most loss the fund manager can bear without facing a margin call is the loss that will make his margin balance account no lower than $4,000. This means he can have a loss of upto $1,000 before a margin call is triggered, implying that prices can fall by $10 per ounce (=$1,000/100 ounces per contract) without triggering a margin call. The margin call will be to top the margin up to the $5,000 initial margin.


Question 4

The forward price of a physical asset is affected by:



Answer : B

Choice 'b' lists all the factors that affect the forward price of a physical asset and is the most complete answer. Forward prices for physical assets are not affected by volatility (only options are), nor are they arbitrarily decided by any prevailing 'views'.


Question 5

Which of the following assumptions underlie the 'square root of time' rule used for computing volatility estimates over different time horizons?

1. asset returns are independent and identically distributed (i.i.d.)

II. volatility is constant over time

III. no serial correlation in the forward projection of volatility

IV. negative serial correlations exist in the time series of returns



Answer : D

The square root of time rule can be used to convert, say a 1-day volatility to a 10-day volatility, by multiplying the known volatility number by the square root of time to get the volatility over a different time horizon. However, there are key assumptions that underlie the application of this rule, and statements I to III correctly state those assumptions. If serial correlations (whether negative or positive) exist, then asset returns are not independent as they are affected by the prior day or prior period's returns, and we cannot use the square root of time rule. Therefore Choice 'd' is the correct answer.

In order to use the 'square root of time' rule, asset returns should be iid, volatility should stay constant (ie there should be no volatility clustering), and no serial correlations (ie the returns of one day should not be affected by the returns of the prior periods). Choice 'd' is the correct answer.


Question 6

Theta for a call option:



Answer : C

Theta measures time decay, ie the change in value of the option with the passage of time. When the option is close to expiry, theta is very low as the value of the option is driven by intrinsic value rather than the time value. Therefore theta approaches zero as the option comes closer to expiry.


Question 7

Calculate the number of S&P futures contracts to sell to hedge the market exposure of an equity portfolio value at $1m and with a of 1.5. The S&P is currently at 1000 and the contract multiplier is 250.



Answer : C

Since the equity portfolio has a beta of 1.5, we need to sell short enough number of futures contracts as to have $1 x 1.5 = $1.5m short in notional. The value of one S&P futures contract is 1000 x 250 = $250,000, and therefore in order to be short $1.5m, we need to sell 6 contracts.


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