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

Exam Code:
Exam I: Finance Theory, Financial Instruments, Financial Markets – 2015 Edition

Related Certification(s): PRMIA Professional Risk Managers PRM Certification

Certification Provider: PRMIA

Number of Exam I: Finance Theory, Financial Instruments, Financial Markets – 2015 Edition practice questions in our database:
287 (updated: Oct. 27, 2024)

Expected Exam I: Finance Theory, Financial Instruments, Financial Markets – 2015 Edition Exam Topics, as suggested by PRMIA :

**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

Calculate the settlement amount for a buyer of a 3 x 6 FRA with a notional of $1m and contract rate of 5%. Assume settlement rate is 6%.

An m x n FRA is an agreement to borrow money for a period starting at time m and ending at time n at the contracted rate. Therefore, the buyer of the 3 x 6 FRA has committed to borrow $1m at the beginning of 3 months and return it at the end of 6 months, ie a total borrowing period of 3 months at a rate of 5%. Of course, the $1m is never actually exchanged, and at the beginning of the 3 month period when the next three months' interest rate is known (6%), the parties merely exchange the difference in the interest. SInce this interest was only due at the end of the 6 months and is being exchanged at the 3 month time point, it will have to be discounted to its present value.

The correct answer to this question is =(1,000,000 * (6% - 5%) * 3/12)/(1 + (6%*3/12))=$2463.05. Since interest rates rose, the borrower gained as he has the right to borrow at a lower rate, and therefore the seller will pay the borrower.

(Here:

- $1m is the notional

- 6% - 5% represents the difference between the contracted and the realized interest rates

- 3/12 is the 3 month period from month 3 to 6

- Finally, we divide by the current interest rate for 3 months to present value the payment from month 6 to month 3)

Question #2

A currency with a lower interest rate will trade:

Given covered interest parity, the currency with a lower interest rate will trade at a forward premium. Choice 'b' is the correct answer.

For an intuitive reasoning, consider a currency forward contract that matures in 3 months. The seller has agreed to sell, say JPY 1,000,000 in exchange for USD 10,000 in the future. In order to cover himself, he borrows the USD right now and converts it to JPY at spot which he puts in a JPY deposit. Assuming JPY interest rates are less than USD interest rates, he pays more on his USD borrowing than he receives on his JPY deposit. Therefore he has to price the forward contract at a premium to spot to cover the interest rate differential.

Question #3

What is the notional value of one equity index futures contract where the value of the index is 1500 and the contract multiplier is $50:

The correct answer is the index value times the contract size, in this case 1500 x 50.

One way to think about index futures is this: Consider equity index trading as trading in the shares of a company whose share price is equal to a number of dollars which is the same as the index. If the 'contract multiplier' for a index futures contract is 50, that means the futures contract is for 50 shares of such a fictitious company. Therefore the notional value of the contract will be 15000 x 50, and Choice 'a' is the correct answer.

Question #4

The gamma in a commodity futures contract is:

Futures contracts carry no gamma. Only options have gamma. Choice 'a' is the correct answer. Any instrument whose price varies in a linear fashion with respect to the underlying will have gamma equal to zero.

Question #5

Which of the following indicate a long position on the TED (treasury-Eurodollar) spread?

The TED spread is a bet on the spread between treasury bill futures and Eurodollar futures. T-bill rates are lower than Eurodollar rates, as the former carries no risk. Eurodollars deposits, which are interbank deposits between the highest rated banks, carry very little risk as well. Therefore both these instruments generally trade at very narrow spreads. The spread widens, ie the Eurodollar rates rise in comparison to treasury bill rates when the market has credit risk fears.

A trader is said to be 'long' the spread when he benefits from the spread increasing, and 'short' the TED spread when he gains from the spread decreasing. A trader can buy the spread by being long t-bill futures and short Eurodollar futures. Similarly he can be short the spread by being short t-bill futures and long Eurodollar futures.

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