Master 2021 Latest The Questions PRM and Pass 8006 Real Exam!
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NEW QUESTION 164
For a forward contract on a commodity, an increase in carrying costs (all other factors remaining constant) has the effect of:
- A. increasing the spot price
- B. increasing the forward price
- C. decreasing the spot price
- D. decreasing the forward price
Answer: B
Explanation:
Explanation
The forward price for a commodity is nothing but the spot price plus carrying costs till the maturity date of the forward contract. Any increase in carrying costs therefore has the effect of increasing the forward price. Note that carrying costs include interest cost in respect of funding the position, costs of storage, less any convenience yield.
Increase in the carrying costs will not affect the spot prices.
NEW QUESTION 165
Identify the underlying asset in a treasury bond futures contract?
- A. Any long term US Treasury note with a maturity between 6.5 years and 10 years from the date of delivery
- B. Any long term US Treasury bond with a maturity of more than 10 years and not callable within 10 years
- C. Any of the above, with the price adjusted with the coupon and maturity date of the bond delivered
- D. Any long term US Treasury bond with a maturity of more than 15 years and not callable within 15 years
Answer: D
Explanation:
Explanation
The underlying asset in a treasury bond futures contract is any long term US Treasury bond with a maturity of more than 15 years and not callable within 15 years. The underlying asset in a Treasury note futures contract is any long term Treasury note with a maturity of no less than 6.5 years and no more than 10 years.
Note the difference between what the underlying asset is for treasury bond futures and treasury note futures. In either case, adjustments will be made for the coupon and maturity of the actual bond delivered (the concept of the adjustment of 'cheapest-to-deliver').
NEW QUESTION 166
A normal yield curve is generally:
- A. Flat
- B. Humped
- C. Upward sloping
- D. Downward sloping
Answer: C
Explanation:
Explanation
A normal yield curve is generally upward sloping. Downward sloping, humped or flat yield curves are less common and indicate exceptional market conditions.
NEW QUESTION 167
According to the dividend discount model, if d be the dividend per share in perpetuity of a company and g its expected growth rate, what would the share price of the company be. 'r' is the discount rate.
- A. https://riskprep.com/images/stories/questions/123.01.c.png
- B. https://riskprep.com/images/stories/questions/123.01.d.png
- C. Option
- D. Option
- E. Option
- F. https://riskprep.com/images/stories/questions/123.01.a.png
- G. Option
- H. https://riskprep.com/images/stories/questions/123.01.b.png
Answer: F
Explanation:
Explanation
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.
NEW QUESTION 168
An investor believes that the market is likely to stay where it is. Which of the following option strategies will help him profit should his view be proven correct (assume all strategies described below are long only)?
- A. Collar
- B. Butterfly spread
- C. Straddle
- D. Strangle
Answer: B
Explanation:
Explanation
Only the butterfly spread has a payoff profile that benefits when prices do not move much. The collar benefits during declining markets, the straddle and the strangle benefit from sharp movements in the markets.
Therefore Choice 'c' is the correct answer.
NEW QUESTION 169
Which of the following is an example of a multifactor model explaining expected asset returns:
I. Arbitrage pricing theory
II. Single index model
III. Capital asset pricing model
- A. III
- B. II and III
- C. II
- D. I
Answer: D
Explanation:
Explanation
The arbitrage pricing theory is a multifactor model for explaining asset returns as it can be used to incorporate multiple factors, for example inflation, GDP growth rate, employment, interest rates etc to explain asset returns. Choice 'a' is the correct answer.
The single index model, as the name implies, uses only a single factor, and so does the CAPM which uses excess returns to explain an individual security's returns. Neither of these are multi-factor models.
NEW QUESTION 170
[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.] The profit potential from the conversion of convertible bonds into stock is limited by
- A. conversion premium charged by the issuer
- B. a rise in interest rates
- C. the issuer's option to call the security at short notice
- D. volatility of the stock
Answer: C
Explanation:
Explanation
The profit potential from the conversion of convertible bonds into stock is limited by the issuer's option to call the security at short notice. Generally, the convertible debt security is convertible into a certain number of shares, and the debt holder will generally not convert the security to shares unless there is a profit to be made.
The 'premium' is irrelevant, because as long as the premium exists, the debt holder has no incentive to convert, as he would be better off buying the shares in the market. It is only when share prices go beyond a level that it becomes advantageous convert the security into shares. However, the prospect of granting cheap shares to the debt holders is not too appealing to the issuer, and as soon as the share price goes beyond a point where the value of the shares exceeds the face value of the debt the issuer has an incentive to exercise its option to call the security.
Therefore the profit potential from the conversion of convertible bonds into shares is limited by the issuer's option to call the security, and Choice 'a' is the correct answer. The 'premium', or interest rates, or volatility are irrelevant.
NEW QUESTION 171
The relationship between covariance and correlation for two assets x and y is expressed by which of the following equations (where covarx,y is the covariance between x and y, x and y are the respective standard deviations and x,y is the correlation between x and y):
A)
B)
C)
D)
None of the above
- A. Option D
- B. Option B
- C. Option A
- D. Option C
Answer: B
Explanation:
Explanation
Choice 'b' is the correct answer. The other relationships are not correct.
NEW QUESTION 172
Which of the following is one of the basic axioms on which the principle of maximum expected utility is based:
- A. Transportation of choice
- B. Cognitive bias
- C. Stochastic dominance
- D. Utility maximization
Answer: C
Explanation:
Explanation
Given a choice, decision makers will maximize expected utility. The four basic axioms on which the principle of maximizing expected utility is based are:
- Transitivity of choice,
- Continuity of choice,
- Independence of choice, and
- Stochastic dominance.
NEW QUESTION 173
Of the following, which measures can debt holders adopt to protect against a transfer of wealth to their detriment to the shareholders:
I. Restrictive covenants limiting dividends
II. Insisting on professional management separate from owners
III. Higher interest rates
IV. Periodic audits
- A. I, II and III
- B. I and III
- C. I, II, III and IV
- D. I, III and IV
Answer: D
Explanation:
Explanation
Professional management that acts as the agent of the shareholders is not likely to protect debt holders from a transfer of wealth to the shareholders. All other mechanisms listed are intended to offset the agency cost for debt holders, ie the expected cost that shareholders and management will transfer wealth away to the detriment of the debt holders.
NEW QUESTION 174
Which of the following statements is false:
- A. Forward and futures prices differ due to differences in the timing of cash flows
- B. Forward contracts are settled at the end of the contract while futures gains and losses are settled daily
- C. Forward contracts, unless collateralized, carry credit risks while the exchange practically eliminates the credit risk on a futures contract.
- D. Futures are OTC instruments with transparent pricing while forward contracts are not
Answer: D
Explanation:
Explanation
This question addresses the key differences between futures and forward contracts. Forward contracts are over the counter (OTC) instruments, while futures are exchange traded. Therefore Choice 'b' is not a true statement.
Futures contracts require an initial margin to be paid to the exchange, and gains and losses to be settled daily, while forward contracts generally settle only at the maturity of the contract. Therefore Choice 'a' is a true statement.
The exchange is the counterparty in a futures contract, and through its system of initial and variation margins guarantees the performance of the contract. Futures therefore have very little credit risk when compared to forwards. Therefore Choice 'c' is a true statement.
Because futures gains and losses give rise to daily cash flows, while the P&L on forward contracts is settled only at the end of the contract, the timing differences create small pricing differences between the two.
Therefore Choice 'd' is a true statement.
NEW QUESTION 175
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. Prices fall the next day to $980. What is the margin call the fund manager faces in respect of daily variation margin ?
- A. $2000
- B. $7000
- C. $0
- D. $1000
Answer: A
Explanation:
Explanation
The loss to the fund manager is $20*100 = $2,000. The initial margin placed was $5,000. After the loss is charged to his account, the margin balance is only $3,000 ($5,000 - $2,000). The margin to be maintained is
$5,000. Therefore the margin call is $2,000.
Note that there would have been no margin call till the balance in the margin account had reduced to the
'maintenance' level of $4,000. So if the price had fallen by $5, and the loss had been $500, there would have been no margin call. But when the margin call would be made, it would require the balance to be brought up to the initial margin of $5,000 (and not the maintenance margin of $4,000).
NEW QUESTION 176
Theta for a call option:
- A. approaches 1 as the expiration date draws closer
- B. approaches 0 as the expiration date draws closer
- C. approaches -1 as the expiration date draws closer
- D. approaches as the expiration date draws closer
Answer: B
Explanation:
Explanation
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.
NEW QUESTION 177
Which of the following is NOT an assumption underlying the Black Scholes Merton option valuation formula:
- A. There are no transaction costs
- B. There is no credit risk
- C. The option can be exercised at any time up to expiry
- D. Volatility of the underlying and the risk free interest rate is constant
Answer: C
Explanation:
Explanation
All the choices listed are valid assumptions underlying the BSM option valuation formula except that the BSM formula is based upon the option being exercisable only at expiry. The assumption is that early exercise is not permitted. In other words, BSM applies to European options and not American options. Therefore Choice 'd' represents the correct answer as it is not an assumption underlying Black Scholes.
NEW QUESTION 178
The risk of a portfolio that cannot be diversified away is called
- A. Portfolio risk
- B. Diversifiable risk
- C. Systematic risk
- D. Specific risk
Answer: C
Explanation:
Explanation
Systematic risk refers to market risk that cannot be diversified away. Specific risk relates to the unique risk from the securities selected in the portfolio, and these can be diversified away by adding other securities to the portfolio. Diversifiable risk is risk that can be diversified away, ie the same as specific risk. Portfolio risk is the total risk of the portfolio that includes both specific and systematic risk.
NEW QUESTION 179
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