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Certification Provider: PRMIA

Exam Name: Exam I: Finance Theory, Financial Instruments, Financial Markets ? 2015 Edition

Number of questions in our database: 287

Exam Version: Sep. 19, 2023

Exam I: Finance Theory, Financial Instruments, Financial Markets ? 2015 Edition Exam Official Topics:

**Topic 1:**Describe how arbitrage pricing theory can be used for decision-making/ The Term Structure of Interest Rates**Topic 2:**Identify and describe risk adjusted performance measures/ Outline the components of the Capital Asset Pricing Model (CAPM)**Topic 3:**Describe the axioms and assumptions of utility theory with respect to expected return and risk/ The CAPM and Multifactor Models**Topic 4:**Describe the lifecycle of a trade and distinguish between dealing and settlement/ Mean-Variance Portfolio Theory**Topic 5:**Understand the standardized characteristics of futures contract/ Discuss significant funding rates**Topic 6:**Define and describe the various participants within financial markets/ Calculate the bond equivalent yield of money market securities**Topic 7:**Identify and understand the components of option valuation/ Relate mean-variance portfolio theory to asset allocation decisions**Topic 8:**Assess and analyze the capital structure of entities/ Define and describe money market securities**Topic 9:**Participants in and the Structure of Financial Markets/ Discuss the rationale for futures markets and describe the settlement and clearing processes**Topic 10:**Define and describe the characteristics of bond markets/ Understand probability theory including Bayesian theory

Question #1

Futures initial margin requirements are

Futures initial margins are determined by the exchange. SPAN is the name of a framework the CME uses to determine margins. Only Choice 'd' is correct.

Question #2

Which of the following markets are characterized by the presence of a market maker always making two-way prices?

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.

Question #3

Using covered interest parity, calculate the 3 month CAD/USD forward rate if the spot CAD/USD rate is 1.1239 and the three month interest rates on CAD and USD are 0.75% and 0.4% annually respectively.

Forward rates can be calculated from spot rates and interest rates using the formula Spot x (1+domestic interest rate)/(1+foreign interest rate), where the 'Spot' is expressed as a direct rate (ie as the number of domestic currency units one unit of the foreign currency can buy). In this case the forward rate will be 1.1239 * (1 + 0.75%*90/360) / (1 + 0.4%*90/360) = 1.1249.

It can be confusing to determine which interest rate should be considered 'domestic', and which 'foreign' for this formula. For that, look at the spot rate. Think of the spot rate as being x units of one currency equal to 1 unit of the other currency. In this case, think of the spot rate 1.1239 as 'CAD 1.1239 = USD 1'. The currency that has the '1' in it is the 'foreign' and the other one is 'domestic'.

It is also 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. These are called 'direct rates'. 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.

Question #4

Which of the following markets are characterized by the presence of a market maker always making two-way prices?

Question #5

Using covered interest parity, calculate the 3 month CAD/USD forward rate if the spot CAD/USD rate is 1.1239 and the three month interest rates on CAD and USD are 0.75% and 0.4% annually respectively.

Forward rates can be calculated from spot rates and interest rates using the formula Spot x (1+domestic interest rate)/(1+foreign interest rate), where the 'Spot' is expressed as a direct rate (ie as the number of domestic currency units one unit of the foreign currency can buy). In this case the forward rate will be 1.1239 * (1 + 0.75%*90/360) / (1 + 0.4%*90/360) = 1.1249.

It can be confusing to determine which interest rate should be considered 'domestic', and which 'foreign' for this formula. For that, look at the spot rate. Think of the spot rate as being x units of one currency equal to 1 unit of the other currency. In this case, think of the spot rate 1.1239 as 'CAD 1.1239 = USD 1'. The currency that has the '1' in it is the 'foreign' and the other one is 'domestic'.

It is also 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. These are called 'direct rates'. 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.

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