:DerivativesReading60Sample[]

:clearlycanadian:201233116:16:[2012L1]DerivativesSession17Reading60Sample
WhichofthefollowingstatementsregardingexchangetradedderivativesisNOTcorrect?Exchangetradedderivatives:
A) oftentradeinaphysicallocation.
B) areilliquid.
C) arestandardizedcontracts.

Derivativesthattradeonexchangeshavegoodliquidityinmostcases.Theyhavetheothercharacteristicslisted.
:clearlycanadian:201233116:17
Aderivativesecurity:
A) islikeacallablebond.
B) hasavaluedependentontheshapeoftheyieldcurve.
C) isonethatisbasedonthevalueofanothersecurity.

Aderivativesecurityisonethatderivesitsvaluefromthatofanothersecurity.
:clearlycanadian:201233116:17
Afinancialinstrumentthathaspayoffsbasedonthepriceofanunderlyingphysicalorfinancialassetisa(n):
A) option.
B) derivativesecurity.
C) future.

Optionsandfuturesareexamplesoftypesofderivativesecurities.
:clearlycanadian:201233116:18
Aderivativesecurity:

A) hasnodefaultrisk.
B) hasavaluebasedonstockprices.
C) hasavaluebasedonanothersecurityorindex.

Thisisthedefinitionofaderivativesecurity.Thosebasedonstockpricesareequityderivatives.
:clearlycanadian:201233116:19
Whichofthefollowingismostlikelyanexchangetradedderivative?
A) Equityindexfuturescontract.
B) Bondoption.
C) Currencyforwardcontract.

Futuresareexchangetradedderivatives.Forwardcontractsandswapsareoverthecounterderivatives.Bondoptionsare
tradedalmostentirelyintheoverthecountermarket.
:clearlycanadian:201233116:19
Whichofthefollowingdefinitionsinvolvingderivativesisleastaccurate?
A) Acalloptiongivestheownertherighttoselltheunderlyinggoodataspecificpriceforaspecifiedtimeperiod.
B) Anoptionwriteristhesellerofanoption.
C) Anarbitrageopportunityisthechancetomakearisklessprofitwithnoinvestment.

Acalloptiongivestheownertherighttobuytheunderlyinggoodataspecificpriceforaspecifiedtimeperiod.
:clearlycanadian:201233116:20
WhichofthefollowingisNOTanoverthecounter(OTC)derivative?
A) Afuturescontract.
B) Aforwardcontract.
C) Abondoption.

FuturescontractsareexchangetradedforwardsandmostbondoptionsareOTCderivatives.
:clearlycanadian:201233116:20

Overthecounterderivatives:
A) havegoodliquidityintheoverthecounter(OTC)market.
B) arebackedbytheOTCClearinghouse.
C) arecustomizedcontracts.

OTCderivativecontracts(securities)arecustomizedandhavepoorliquidity.Thecontractiswithaspecificcounterpartyand
thereisdefaultrisksincethereisnoclearinghousetoguaranteeperformance.
:clearlycanadian:201233116:20
Whichofthefollowingismostaccurateregardingderivatives?
A) Exchangetradedderivativesarecreatedandtradedbydealersinamarketwithnocentrallocation.
B) Derivativevaluesarebasedonthevalueofanothersecurity,index,orrate.
C) Derivativeshavenodefaultrisk.

Derivativesderivetheirvaluefromthevalueorreturnofanotherassetorsecurity.Exchangetradedderivativesare
standardizedandbackedbyaclearinghouse.Anoverthecounterderivative,suchasaforwardcontractoraswap,exposes
thederivativeholdertotheriskthatthecounterpartymaydefault.
:clearlycanadian:201233116:21
Derivativesareoftencriticizedbyinvestorswithlimitedknowledgeofcomplexfinancialsecurities.Acommoncriticismof
derivativesisthatthey:
A) increaseinvestortransactionscosts.
B) canbelikenedtogambling.
C) shiftriskamongmarketparticipants.

Derivativesareoftenlikenedtogamblingduetothehighleverageinvolvedinthepayoffs.Oneofthebenefitsofderivatives
isthattheyreducetransactionscosts.Anotherbenefitofderivativesisthattheyallowrisktobemanagedandshifted
amongmarketparticipants.
:clearlycanadian:201233116:21
MBTCorporationrecentlyannounceda15%increaseinearningspershare(EPS)overthepreviousperiod.Theconsensus
expectationoffinancialanalystshadbeenanincreaseinEPSof10%.AftertheearningsannouncementthevalueofMBT
commonstockincreasedeachdayforthenextfivetradingdays,asanalystsandinvestorsgraduallyreactedtothebetter
thanexpectednews.Thisgradualchangeinthevalueofthestockisanexampleof:

A) speculation.
B) efficientmarkets.
C) inefficientmarkets.

Acriticalelementofefficientmarketsisthatassetpricesrespondimmediatelytoanynewinformationthatwillaffecttheir
value.Largenumbersoftradersrespondinginsimilarfashiontothenewinformationwillcreateatemporaryimbalancein
supplyanddemand,andthiswilladjustassetmarketvalues.
:clearlycanadian:201233116:22
FinancialderivativescontributetomarketcompletenessbyallowingtraderstodoallofthefollowingEXCEPT:
A) engageinhighriskspeculation.
B) increasemarketefficiencythroughtheuseofarbitrage.
C) narrowtheamountoftradingopportunitiestoamoremanageablerange.

Financialderivativesincreasetheopportunitiestoeitherspeculateorhedgeonthevalueofunderlyingassets.Thisaddsto
marketcompletenessbyincreasingtherangeofidentifiablepayoffsthatcanbeusedbytraderstofulfilltheirneeds.
Financialderivativessuchasmarketindexfuturescanalsobeeasierandcheaperthantradinginadiversifiedportfolio,
therebyaddingtotheopportunitiesavailabletotraders.
:clearlycanadian:201233116:22
WhichofthefollowingstatementsaboutarbitrageisNOTcorrect
A) Arbitragecancausemarketstobelessefficient.
B) Noinvestmentisrequiredwhenengaginginarbitrage.
C) Ifanarbitrageopportunityexists,makingaprofitwithoutriskispossible.

Arbitrageisdefinedastheexistenceofrisklessprofitwithoutinvestmentandinvolvessellinganassetandsimultaneously
buyingthesameassetforalowerprice.Sincethetradescanceleachother,noinvestmentisrequired.Becauseitisdone
simultaneously,aprofitisguaranteed,makingthetransactionriskfree.Arbitrageactuallyhelpsmakemarketsmore
efficientbecausepricediscrepanciesareimmediatelyeradicatedbytheactionsofarbitrageurs.
:clearlycanadian:201233116:22
Whichofthefollowingisacommoncriticismofderivatives?
A) Derivativesarelikenedtogambling.
B) Derivativesaretooilliquid.

C) Feesforderivativestransactionsarerelativelyhigh.

Derivativesareoftenlikenedtogamblingbythoseunfamiliarwiththebenefitsofoptionsmarketsandhowderivativesare
used.
:clearlycanadian:201233116:22
AllofthefollowingarebenefitsofderivativesmarketsEXCEPT:
A) transactionscostsareusuallysmallerinderivativesmarkets,thanforsimilartradesintheunderlyingasset.
B) derivativesmarketshelpkeepinterestratesdown.
C) derivativesallowtheshiftingofrisktothosewhocanmostefficientlybearit.

Theexistenceofderivativesmarketsdoesnotaffectthelevelofinterestrates.Theotherstatementsaretrue.
:clearlycanadian:201233116:23
Onereasonthatcriticismhasbeenleveledatderivativesandderivativesmarketsisthat:
A) derivativeshavetoomuchdefaultrisk.
B) derivativesexpire.
C) theyarecomplexinstrumentsandsometimeshardtounderstand.

Thefactthatderivativesecuritiesaresometimescomplexandoftenhardfornonfinancialcommentatorstounderstandhas
ledtocriticismofderivativesandderivativemarkets.
:clearlycanadian:201233116:23
Whichofthefollowingrelationshipsbetweenarbitrageandmarketefficiencyisleastaccurate?
Theconceptofrationallypricedfinancialinstrumentspreventingarbitrageopportunitiesisthebasisbehindtheno
A)
arbitrageprinciple.
B) Marketefficiencyreferstothelowcostoftradingderivativesbecauseofthelowerexpensetotraders.
C) Investorsactingonarbitrageopportunitieshelpkeepmarketsefficient.

Marketefficiencyisachievedwhenallrelevantinformationisreflectedinassetprices,anddoesnotrefertothecostof
trading.Onenecessarycriterionformarketefficiencyisrapidadjustmentofmarketvaluestonewinformation.Arbitrage,
tradingonapricedifferencebetweenidenticalassets,causeschangesindemandforandsupplyoftheassetsthattendsto

eliminatethepricingdifference.
:clearlycanadian:201233116:24
WhichofthefollowingstatementsaboutarbitrageopportunitiesisCORRECT?
A) Engaginginarbitragerequiresalargeamountofcapitalfortheinvestment.
B) Pricingerrorsinsecuritiesareinstantaneouslycorrectedbythefirstarbitrageurtorecognizethem.
C) Whenanopportunityexiststoprofitfromarbitrage,itusuallylastsforseveraltradingdays.

Arbitrageistheopportunitytotradeinidenticalassetsthataremomentarilysellingfordifferentprices.Arbitrageursact
quicklytomakearisklessprofit,causingthepricediscrepancytobeinstantaneouslycorrected.Nocapitalisrequired,
becauseoppositetradesaremadesimultaneously.
:clearlycanadian:201233116:24
Whichofthefollowingisleastlikelyoneoftheconditionsthatmustbemetforatradetobeconsideredanarbitrage?
A) Therearenocommissions.
B) Thereisnorisk.
C) Thereisnoinitialinvestment.

Inordertobeconsideredarbitragetheremustbenoriskinthetrade.
Itdoesntmatterifcommissionsarepaidaslongastheamountofthepricediscrepancyisenoughtooffsettheamountpaid
incommissions.
Inordertobeconsideredarbitragetheremustbenoinitialinvestmentofonesowncapital.Onemustfinanceanycash
outlaythroughborrowing.
:clearlycanadian:201233116:24

Anyrationalquotedpriceforafinancialinstrumentshould:
A) providenoopportunityforarbitrage.
B) provideanopportunityforinvestorstomakeaprofit.
C) belowenoughformostinvestorstoafford.

Sinceanyobservedpricingerrorswillbeinstantaneouslycorrectedbythefirstpersontoobservethem,anyquotedpricemust
befreeofallknownerrors.

Thisisthebasisbehindthetextsnoarbitrageprinciple,whichstatesthatanyrationalpriceforafinancialinstrumentmust
excludearbitrageopportunities.
Thenoarbitrageopportunityassumptionisthebasicrequirementforrationalpricesinthefinancialmarkets.
Thismeansthatmarketsandpricesareefficient.
Thatis,allrelevantinformationisimpoundedintheassetsprice.
Witharbitrageandefficientmarkets,youcancreatetheoptionandfuturespricingmodelspresentedinthetext.
:clearlycanadian:201233116:25

Whichofthefollowingisthebestinterpretationofthenoarbitrageprinciple?
A) Thereisnowayyoucanfindanopportunitytomakeaprofit.
B) Theinformationflowisquickinthefinancialmarket.
C) Thereisnofreemoney.

Anarbitrageopportunityisthechancetomakearisklessprofitwithnoinvestment.
Inessence,findinganarbitrageopportunityislikefindingfreemoney.
Asyourecall,inarbitrage,youobservetwoidenticalassetswithdifferentprices.
Yourimmediateresponseshouldbetobuythecheaperoneandselltheexpensiveoneshort.
Youcanthendeliverthecheaponetocoveryourshortposition.
Onceyoutaketheinitialarbitrageposition,yourarbitrageprofitislockedin.
Thenoinvestmentstatementreferencedinthetextreferstotheassumptionthatwhenyoushorttheexpensiveasset,youwillbegivenaccess
tothecashcreatedbytheshortsale.
Withthiscash,younowhavethemoneytobuythecheaperasset.
Thenoinvestmentassumptionmeansthatthefirstpersontoobserveamarketpricingerrorwillhavethefinancialresourcestocorrectthe
pricingerrorinstantaneouslyallbythemselves.
:clearlycanadian:201233116:25
Theprocessthatensuresthattwosecuritiespositionswithidenticalfuturepayoffs,regardlessoffutureevents,willhavethe
samepriceiscalled:
A) arbitrage.
B) exchangeparity.
C) thelawofoneprice.

Iftwosecuritieshaveidenticalpayoffsregardlessofevents,theprocessofarbitragewillmovepricestowardequality.
Arbitrageurswillbuythelowerpricedpositionandsellthehigherpricedposition,foranimmediateprofitwithoutanyfuture
liability.Thelawofoneprice(forsecuritieswithidenticalpayoffs)isnotaprocessitisenforcedbyarbitrage.
:clearlycanadian:201233116:25
Whichofthefollowingisanexampleofanarbitrageopportunity?
A) Aputoptiononashareofstockhasthesamepriceasacalloptiononanidenticalshare.
B) Aportfoliooftwosecuritiesthatwillproduceacertainreturnthatisgreaterthantheriskfreerateofinterest.
C) Astockwiththesamepriceasanotherhasahigherrateofreturn.

Anarbitrageopportunityexistswhenacombinationoftwosecuritieswillproduceacertainpayoffinthefuturethatproduces
areturnthatisgreaterthantheriskfreerateofinterest.Borrowingattherisklessratetopurchasethepositionwillproduce
acertainfutureamountgreaterthantheamountrequiredtorepaytheloan.
:clearlycanadian:201233116:27
TheprocessofarbitragedoesallofthefollowingEXCEPT:
A) promotepricingefficiency.
B) producerisklessprofits.
C) insurethatriskadjustedexpectedreturnsareequal.

Arbitragedoesnotinsurethattheriskadjustedexpectedreturnstotworiskyassetswillbeequal.Arbitrageisbasedon
riskfreeportfoliosandpromotesefficientpricingofassets.Whenanarbitrageopportunityispresentedbyamispricingof
assets,theincreasedsupplyoftheoverpricedassetandtheincreaseddemandfortheunderpricedassetbyarbitrageurs,
willmovethepricestowardequalityandacttocorrectthemispricing.
:clearlycanadian:201233116:27
Astandardizedandexchangetradedagreementtobuyorsellaparticularassetonaspecificdateisbestdescribedasa:
A) forwardcontract.
B) futurescontract.
C) swap.

Futurescontractsarestandardizedforwardcontractsthattradeonorganizedexchanges.Othertypesofforwardcontracts,
aswellasswaps,arecustominstrumentsthataregenerallynotexchangetraded.

:clearlycanadian:201233116:28
Anagreementthatgivestheholdertheright,butnottheobligation,tosellanassetataspecifiedpriceonaspecificfuture
dateisa:
A) calloption.
B) putoption.
C) swap.

Aputoptiongivestheholdertherighttosellanassetataspecifiedpriceonaspecificfuturedate.Acalloptiongivesthe
holdertherighttobuyanassetataspecifiedpriceonaspecificfuturedate.Aswapisanobligationtobothparties.

CFA(http://bbs.cfaspace.com/)

PoweredbyDiscuz!7.2