EMT Practice Test

1. Question Content...

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Question1: Which of the following statements are true:
I. Protective puts are a form of insurance against a fall in prices
II. The maximum loss for an investor holding a protective put is equal to the decline in the value of the underlying III. The premium paid on the put options held as a protective put is a loss if the value of the underlying goes up IV. Protective puts can be a useful strategy for an investor holding a long position but with a negative short term view of the markets

Question2: If the continuously compounded risk free rate is 4% per year, and the continuous rate of dividend on a broad market index is 1% annually, what is the no-arbitrage 6-month futures price of the index if its spot value is
$1000?

Question3: For a portfolio of equally weighted uncorrelated assets, which of the following is FALSE:

Question4: A company has a long term loan from a bank at a fixed rate of interest. It expects interest rates to go down.
Which of the following instruments can the company use to convert its fixed rate liability to a floating rate liability?

Question5: A bank holding a basket of credit sensitive securities transfers these to a special purpose vehicle (SPV), which sells notes based on these securities to third party investors. Which of the following terms best describes this arrangement?

Question6: If r be the yield of a bond, which of the following relationships is true:

Question7: Theta for a call option:

Question8: Which of the following statements are true:
I. An yield curve plots zero coupon spot rates for different maturities for bonds with different credit ratings II. An yield curve represents the term structure of interest rates for similar instruments across a range of maturities III. The liquidity preference theory explains why the yield curve can be downward sloping IV. The term structure refers to the relationship between bond yields and bond maturities

Question9: Which of the following statements is INCORRECT according to CAPM:

Question10: Which of the following statements are true:
I. Cash markets tend to be more liquid than derivative markets
II. A higher credit risk is associated with lower liquidity in times of crises III. A higher bid-ask spread indicates greater liquidity when compared to a lower bid-ask spread IV. A higher normal market size indicates greater liquidity than a lower market size

Question11: Which of the following statements is true in relation to the capital markets line (CML):
I. The CML is a transformation line that is tangential to the efficient frontier II. The CML allows an investor to obtain the highest return for a given level of risk chosen according to the investor's risk attitude III. The CML is the line passing through the point on the efficient frontier with the highest Sharpe ratio, and a y-intercept equal to the risk free rate IV. The Sharpe ratio for the points on the CML increase in a linear fashion

Question12: The transformation line has a y-intercept equal to

Question13: A refiner may use which of the following instruments to simultaneously protect against a fall in the prices of its products and a rise in the prices of its inputs:

Question14: Assuming all other factors remain the same, an increase in the volatility of the returns on the assets of a firm causes which of the following outcomes?

Question15: The spot exchange rate between USD and AUD is 0.70. The risk free interest rates in the US and Australia are
2% and 3.5% respectively. What is the forward exchange rate between the two currencies one year hence?

Question16: A normal yield curve is generally:

Question17: A futures contract is quoted at 105. Which is the cheapest-to-deliver bond for this contract if there are three available bonds, quoted at 97, 101 and 106 with conversion factors respectively of 0.9, 1 and 1.1 respectively?

Question18: An investor holds $1m in a 10 year bond that has a basis point value (or PV01) of 5 cents. She seeks to hedge it using a 30 year bond that has a BPV of 8 cents. How much of the 30 year bond should she buy or sell to hedge against parallel shifts in the yield curve?

Question19: [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 statements relating to convertible debt are true:
I. A hard call protection means the bond cannot be called by the issuer till the share price reaches a threshold II. It is advantageous for the issuer to call its convertible securities when the share price exceeds the conversion price III. When the issuer's share prices is very high, the convertible bond trades at a discount to the value of the shares it is convertible into IV. Convertible bonds generally have to carry a higher coupon than on equivalent non-convertible securities to make them attractive to investors

Question20: Security A and B both have expected returns of 10%, but the standard deviation of Security A is 10% while that of security B is 20%. Borrowings are not permitted. A portfolio manager who wishes to maximize his probability of earning a 25% return during the year should invest in:

Question21: A 'short squeeze' refers to a situation where

Question22: When comparing compound interest rates to equivalent continuously compounded rates of return, the latter will always be:

Question23: Which of the following statements are true?
I. Macaulay duration of a coupon bearing bond is unaffected by changes in the curvature of the yield curve.
II. The numerical value for modified duration will be different for bonds with identical nominal coupons and maturity but different compounding frequencies.
III. When rates are expressed as continuously compounded, modified duration and Macaulay duration are the same.
IV. Convexity is higher for a bond with a lower coupon when compared to a similar bond with a higher coupon.

Question24: What is the approximate delta of an exactly at-the-money call option?

Question25: Which of the following statements are true:
(I). A deep in-the-money call option has a value very close to that of a forward contract with a forward price equal to the exercise price
(II). If the volatility of a stock goes down to zero, the value of a call option on the stock will tend to be close to that of a forward contract so long as the option is in the money.
(III). All other things remaining the same, the issue of stock warrants exercisable at a future date will cause a decline in the current stock price
(IV). Implied volatilities are calculated from market prices of options and are forward looking

Question26: Which of the following statements are true:
I. Forward prices for a stock will fall if dividend expectations increase for the period the contract is alive II. Three month forward prices will decline if the 10 year rate goes up, and short term rates stay unchanged III. Futures exchanges require buyers but not sellers to deposit initial margins IV. Variation margin is to be deposited when a futures contract is entered into
V. Futures exchanges requires hedgers and speculators to deposit identical margins VI. Interest rate futures contracts carry duration but no convexity due to the daily cash settlements

Question27: An investor in mortgage backed securities can hedge his/her prepayment risk using which of the following?
I. Long swaption
II. Short cap
III. Short callable bonds
IV. Long fixed/floating swap

Question28: The two components of risk in a commodities futures portfolio are:

Question29: Backwardation in commodity futures is explained by:

Question30: Which of the following is one of the basic axioms on which the principle of maximum expected utility is based:

Question31: Which of the following statements is not correct with respect to a European call option:

Question32: A bond has a Macaulay duration of 6 years. The yield to maturity for this bond is currently 5%. If interest rates rise across the curve by 10 basis points, what is the impact on the price of the bond?

Question33: A and B are two stocks with normally distributed returns. The returns for stock A have a mean of 5% and a standard deviation of 20%. Stock B has a mean of 3% and standard deviation of 5%. Their correlation is -0.6.
What is the mean and volatility of a portfolio which holds stocks A and B in the ratio 6:4?

Question34: Which of the following is true about the early exercise of an American call option:

Question35: If the delta of a call option is 0.3, what is the delta of the corresponding put option?

Question36: Which of the following will have a higher reinvestment risk when compared to a 6% bond issued at par?
Assume all bonds have identical yield to maturity.
I. A coupon bearing bond with a coupon rate of 2%
II. An amortizing bond
III. A coupon bearing bond with a coupon rate of 11%
IV. A zero coupon bond

Question37: Which of the following statements are true:

Question38: A stock is selling at $90. An investor writes a covered call on the stock with an exercise price of $100 in return for a premium of $3 per share. What would be the maximum gain or loss per share that the investor could make on this position?

Question39: A trader finds that a stock index is trading at 1000, and a six month futures contract on the same index is available at 1020. The risk free rate is 2% per annum, and the dividend rate is 1% per annum. What should the trader do?

Question40: If the implied volatility for a call option is 30%, the implied volatility for the corresponding put option is:

Question41: Calculate the net payment due on a fixed-for-floating interest rate swap where the fixed rate is 5% and the floating rate is LIBOR + 100 basis points. Assume reset dates are every six months, LIBOR at the beginning of the reset period is 4.5% and at the end of the period is 3.5%. Notional is $1m.

Question42: Which of the following relationships are true:
I. Delta of Put = Delta of Call - 1
II. Vega of Call = Vega of Put
III. Gamma of Call = Gamma of Put
IV. Theta of Put > Theta of Call
Assume dividends are zero.

Question43: An investor has a portfolio with a value of $1,000,000 and a beta of 2.5. He believes the portfolio carries more market risk than he desires and wishes to reduce the beta to 1. How many futures contracts should be buy or sell to reduce the beta if the futures contracts have a beta of 1.2 and the notional value of each contract is
$240,000?

Question44: The gamma in a commodity futures contract is:

Question45: Gamma risk can be hedged by:

Question46: According to the CAPM, the expected return from a risky asset is a function of:

Question47: For a deep in-the-money option:

Question48: A bank advertises its certificates of deposits as yielding a 5.2% annual effective rate. What is the equivalent continuously compounded rate of return?

Question49: A floating rate note pays daily overnight LIBOR. It matures in exactly one year. What is the duration of the note?

Question50: Buying an option on a futures contract requires:

Question51: [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.] What is the current conversion premium for a convertible bond where $100 in market value of the bond is convertible into two shares and the current share price is $50?

Question52: A bond with a 5% coupon trades at 95. An increase in interest rates by 10 bps causes its price to decline to
$94.50. A decrease in interest rates by 10 bps causes its price to increase to $95.60. Estimate the convexity of the bond.

Question53: How will the Macaulay duration of a 10 year coupon bearing bond change if 10 year zero rates stay the same but the yield curve changes from being flat to upward sloping?

Question54: Which of the following are true:
I. A interest rate cap is effectively a call option on an underlying interest rate II. The premium on a cap is determined by the volatility of the underlying rate III. A collar is more expensive than a cap or a floor IV. A floor is effectively a put option on an underlying interest rate

Question55: [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.] A company that uses physical commodities as an input into its manufacturing process wishes to use options to hedge against a rise in its raw material costs. Which of the following options would be the most cost effective to use?

Question56: The yield to maturity for a zero coupon bond is equivalent to:

Question57: Which of the following assumptions underlie the 'square root of time' rule used for computing volatility estimates over different time horizons?
I. 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

Question58: The vast majority of exchange traded futures contracts are:

Question59: Where futures are being used to hedge a commodities position, which of the following formulae should be used to determine the number of futures contracts to buy (or sell)?

Question60: The price of an interest rate cap is determined by:
I. The period to which the cap relates
II. Volatility of the underlying interest rate
III. The exercise or the strike rate
IV. The risk free rate

Question61: What is the day count convention used for US government bonds?

Question62: The volatility of commodity futures prices is affected by

Question63: Which of the following statements is INCORRECT according to CAPM:

Question64: 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.

Question65: The yield offered by a bond with 18 months remaining to maturity is 5%. The coupon is 3%, paid semi-annually, and there are two more coupon payments to go in addition to the interest payment made at maturity. The zero rate for 6 months is 2%, that for 12 months is 3%. What is the 18 month zero rate?

Question66: When considering an appropriate mix of debt and equity, Chief Financial Officers generally consider:
I. Tax advantage of debt
II. Financial distress costs
III. Agency costs of equity
IV. Retaining financial flexibility

Question67: Determine the price of a 3 year bond paying a 5% coupon. The 1,2 and 3 year spot rates are 5%, 6% and 7% respectively. Assume a face value of $100.

Question68: Which of the following describes the efficient frontier most accurately?

Question69: What would be the most profitable strategy for an investor who expects interest rates to rise:

Question70: The forward price of a physical asset is affected by:

Question71: Which of the following is NOT a historical event which serves as an example of a short squeeze that happened in the markets?

Question72: Continuously compounded returns for an asset that increases in price from S1 to S2 over time period t (assuming no dividends or other distributions) are given by:

Question73: [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 price of an 'out-of-the-money' convertible security is affected by:
I. Changes in interest rates
II. Changes in the issuer's credit risk
III. Changes in the issuer's share price
IV. Changes in the implied volatility of the issuer's share price

Question74: When hedging one fixed income security with another, the hedge ratio is determined by:

Question75: Which of the following statements are true:
I. The convexity of a zero coupon bond maturing in 10 years is more than that of a 4% coupon bond with a modified duration of 10 years II. The convexity of a bond increases in a linear fashion as its duration is increased III. Convexity is always positive for long bond positions IV. The convexity of a zero coupon bond maturing in 10 years is less than that of a 4% coupon bond maturing in 10 years

Question76: Caps, floors and collars are instruments designed to:

Question77: Which of the following statements are true:
I. Caps allow the buyer of the cap protection against rise in interest expense II. Floors offer investors protection from downward movement in interest rates III. Collars can be used as hedges IV. Both caps and collars can be used to hedge against widening credit spreads

Question78: Backwardation can be explained by:

Question79: How are foreign exchange futures quoted against the US dollar?

Question80: Which of the following statements are true:
I. A credit default swap provides exposure to credit risk alone and none to credit spreads II. A CDS contract provides exposure to default risk and credit spreads III. A TRS can be used as a funding source by the party paying LIBOR or other floating rate IV. A CLN is an unfunded security for getting exposure to credit risk

Question81: Which of the following statements are true in respect of a fixed income portfolio:
I. A hedge based on portfolio duration is valid only for small changes in interest rates and needs periodic readjusting II. A duration based portfolio hedge can be improved by making a convexity adjustment III. A long position in bonds benefits from the resulting negative convexity IV. A duration based hedge makes the implicit assumption that only parallel shifts in the yield curve are possible

Question82: The LIBOR square swap offers the square of the interest rate change between contract inception and settlement date. If LIBOR at inception is y, and upon settlement is x, the contract pays (x - y)2 for x > y; and
-(x - y)2 for x < y.
What of the following cannot be a value of the gamma of this contract?

Question83: Imagine two perpetual bonds, ie bonds that pay a coupon till perpetuity and the issuer does not have an obligation to redeem. If the coupon on Bond A is 5%, and on Bond B is 15%, which of the following statements will be true:
I. The Macaulay duration of Bond A will be 3 times the Macaulay duration of Bond B.
II. Bond A and Bond B will have the same modified duration
III. Bond A will be priced at less than 1/3rd the price of Bond B
IV. Both Bond A and Bond B will have a duration of infinity as they never mature

Question84: [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 is not an approach to attempt to value to a convertible security:

Question85: Which of the following cause convexity to increase:
I. Increase in yields
II. Increase in maturity
III. Increase in coupon rate
IV. Increase in duration

Question86: A)

B)

C)

D)

Question87: For a pair of correlated assets, the achievable portfolio standard deviation will be the lowest when the correlation is:

Question88: It is January and an Australian importer needs to pay USD 1,120,000 at the end of August to a US creditor. If a AUD/USD futures contract is trading on the exchange at a futures price of 0.6750 (ie, 1 AUD = 0.6750 USD), and the contract size is USD 100,000, what would represent an appropriate hedge?

Question89: Callable corporate bonds:

Question90: Which of the following statements is a correct description of the phrase present value of a basis point?

Question91: Which of the following best describes a 'when-issued' market?

Question92: According to the mean-variance criterion, which of the following statements are true in relation to an investor who does not borrow or lend?
I. The investor would select a portfolio of assets to minimize drawdowns II. The investor would prefer a portfolio on the efficient frontier III. The investor would prefer a portfolio with a higher return given the same level of risk IV. The investor would maximize portfolio return alone as the mean-variance criterion assumes risk neutrality

Question93: Suppose the S&P is trading at a level of 1000. Using continuously compounded rates, calculate the futures price for a contract expiring in three months, assuming expected dividends to be 2% and the interest rate for futures funding to be 5% (both rates expressed as continuously compounded rates)

Question94: What kind of a risk attitude does a utility function with an upward sloping curvature indicate?

Question95: What is the delta of a forward contract on a non-dividend paying stock?

Question96: Which of the following statements are true:
I. The swap rate, also called the swap spread, is initially calculated so that the value of the swap at inception is zero.
II. The value of a swap at initiation is different from zero and is equal to the difference between the NPV of the cash flows of the two legs of the swap III. OTC swaps are standardized and limited to a defined set of standard contracts IV. Interest rate and commodity swaps are the types of swaps that are most traded

Question97: A borrower who fears a rise in interest rates and wishes to hedge against that risk should:

Question98: If interest rates and spot prices stay the same, an increase in the value of a call option will be accompanied by:

Question99: Arrange the following rates in descending order, assuming an upward sloping yield curve:
1. The 10 year zero rate
2. The forward rate from year 9 to 10
3. The yield-to-maturity on a 10 year coupon bearing bond

Question100: Backwardation can happen in markets where

Question101: [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.] A long call position in an asset-or-nothing option has the same payoff as: