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## Question 01

You are being asked to consider the inherent properties of a lending portfolio. Which of the following statements, if any, would you consider to be most accurate?

In this type of portfolio, the gradient of the capital market line (CML) will be:

A) The variance of the standard deviation and the risk free rate

B) The sum of the market portfolio and the risk free rate

C) The difference in the market portfolio and the risk free rate

D) The square root of the portfolio’s market risk premium

E) More information is needed to determine the gradient

F) None of the above answers can be considered as accurate

ANSWER

Remember, you are being asked to choose the answer that is most accurate.

In a lending portfolio, we will have some portion of the invested funds exposed to the risk free asset and the gradient of the capital market line (CML) will be the difference in the market portfolio and the risk free rate.

Thus, the correct answer is C.

## Question 02

Of the following given options, select the one(s) that can be considered to be false with respect to operational risk:

i) Operational risk may be measured by properly and accurately separating the firm’s exposures

ii) Operational risk includes a firm’s major IT failures

iii) Operational risk is primarily internal issues related to the firm

iv) Operational risk includes the inability to make timely reports to regulators and investors

A) i only

B) ii only

C) iii only

D) i and iv only

E) ii and iii only

F) ii, iii and iv only

ANSWER

Remember we are seeking the incorrect statement.

From the given options the following are true:

- Operational risk includes a firm’s IT failures
- Operational risk is primarily internal issues related to the firm
- Operational risk includes the inability to make timely reports to regulators and investors

The only incorrect answer is that “Operational risk may be measured by properly and accurately separating the firm’s exposures”. This can be extremely difficult to achieve.

Thus, the correct answer is A.

## Question 03

Disadvantages of securitizations include the fact that:

i) The synchronisation of the interest generated by the pool and the interest paid to the investors is a very arduous and tedious process

ii) The transfer of mortgages may be difficult for legal, regulatory or tax reasons

iii) The complexity of the transaction requires a very highly sophisticated documentation

A) i only

B) i and ii only

C) i and iii only

D) ii and iii only

E) None of the above

F) All of the above

ANSWER

From the given options, disadvantages of securitizations include the fact that:

- The synchronisation of the interest generated by the pool and the interest paid to the investors is a very arduous and tedious process
- The transfer of mortgages may be difficult for legal, regulatory or tax reasons
- The complexity of the transaction requires a very highly sophisticated documentation

Thus, the correct answer is F.

## Question 04

Select which of the following is (are) true:

i) Beta can be considered as the measure of systematic risk

ii) Beta can be considered as the measure of unsystematic risk

iii) Beta can be considered as proportional to the covariance of the return on a security with that of the market portfolio’s return

A) i only

B) ii only

C) iii only

D) i and iii only

E) ii and iii only

F) None of the above

ANSWER

- Beta can be considered as the measure of systematic risk
- Beta can be considered as proportional to the covariance of the return on a security with that of the market portfolio’s return

Thus, the correct answer is E.

## Question 05

You are asked to consider the following statement:

A portfolio’s max diversification benefit will be realized whenever:

A) The correlation coefficient is less than +1

B) The correlation coefficient is equal to +1

C) The correlation coefficient is greater than +1

D) The correlation coefficient is equal to 0

E) None of the presented options are correct

Which of the answers above, if any, is considered to be the most accurate?

ANSWER

A portfolio’s max diversification benefit will occur whenever the correlation coefficient equals to -1.

Thus, the correct answer is E.

## Question 06

Select which of the following are true with respect to a simple linear regression:

i) The coefficient of correlation reveals if the regression line’s slope is positive

ii) The coefficient of correlation reveals if the regression line’s slope is negative

iii) The correlation coefficient-squared is the coefficient of determination

A) i only

B) ii only

C) iii only

D) i and iii only

E) i, ii and iii

F) ii and iii only

ANSWER

All of the given are true. With respect to a simple linear regression:

- The coefficient of correlation reveals if the regression line’s slope is positive
- The coefficient of correlation reveals if the regression line’s slope is negative
- The correlation coefficient-squared is the coefficient of determination

Thus, the correct answer is E.

## Question 07

Which of the following statements (if any) would you consider to be the aim of a regression analysis?

The aim of regression analysis is to:

A) Assess how variations in an independent variable affect a dependent variable

B) Assess how variations in a dependent variable affect an independent variable

C) Assess how the error term in a dependent variable affects an independent variable

D) All of the presented options can be considered part of regression analysis

E) None of the presented options can be considered part of regression analysis

ANSWER

The aim of regression analysis is to assess how variations in an independent variable affect a dependent variable

Thus, the correct answer is A.

## Question 08

Consider your knowledge of Value-at-Risk ( VaR ) and select the statements that are most likely true.

i) Value-at-Risk will increase once holdings periods become longer

ii) Value-at-Risk will decrease once probability levels become lower

iii) Value-at-Risk cannot be calculated by using the historical returns of a portfolio

A) i only

B) ii only

C) iii only

D) i and ii only

E) i and iii only

F) ii and iii only

G) i, ii and iii

H) None of the above

ANSWER

The following are considered to be correct:

- Value-at-Risk will increase once holdings periods become longer
- Value-at-Risk will increase once probability levels become lower
- Value-at-Risk can be calculated by using the historical returns of a portfolio

Thus, the correct answer is A.

## Question 09

From the following given options, determine which correct states the rationale behind calculating a ‘ Minimum Variance Hedge Ratio ‘

A) We calculate the Minimum Variance Hedge ratio in order to minimize the variance from a combined hedge

B) We calculate the Minimum Variance Hedge ratio in order to minimize the variance from a portfolio hedging instrument

C) We calculate the Minimum Variance Hedge ratio in order to maximize the covariance from a combined hedge and the portfolio hedging instrument

D) We calculate the Minimum Variance Hedge ratio in order to minimize the covariance from a combined hedge and the portfolio hedging instrument

E) We calculate the Minimum Variance Hedge ratio in order to maximize the variance from a combined hedge and the portfolio hedging instrument

F) We calculate the Minimum Variance Hedge ratio in order to minimize the variance from a combined hedge and the portfolio hedging instrument

G) None of the above

ANSWER

We calculate the Minimum Variance Hedge ratio in order to minimize the variance from a combined hedge and the portfolio hedging instrument.

Thus, the correct answer is F.

## Question 10

When testing a hypothesis, which of the following statements is *correct *when the level of significance of the test is decreased?

A) The likelihood of rejecting the null hypothesis when it is true decreases.

B) The likelihood of making a type 1 error increases

C) The null hypothesis is rejected more frequently, even when it is actually false

D) The likelihood of making a type 2 error decreases

E) None of the above

ANSWER

- The significance level is also the probability of making a Type I error, or to reject the null hypothesis when true, which decreases.
- This is the opposite of answers b. and c., which are false.
- This leads to a likelihood of making a Type 2 error, which is to accept a false hypothesis, so d. is false.

Thus, the correct answer is A.

## Question 11

Consider your knowledge of Statistical Analysis and answer the following question.

You are informed that an investment analyst is seeking to employ the ‘ paired comparison ‘ testing method in his analysis.

Knowing this, you correctly assume that:

A) The samples will have to be irregular

B) The samples will have to be varied

C) The samples will have to be less than ( n + 32 )

D) The samples will have to be dependent

E) The samples will have to be distributive

F) The samples will have to be greater than ( n + 32 )

G) Unable to determine from given information

ANSWER

If the analyst is seeking to employ the ‘ paired comparison ‘ testing method, then the samples will have to be dependent.

Thus, the correct answer is D.

## Question 12

Consider your knowledge of Statistical Analysis and answer the following question.

You are informed that a particular score for an observation is representing ‘ the number of Standard Deviations an element is away from the Mean ‘ .

From this definition, you correctly assume that this score represents the:

A) The F-score

B) The z-score

C) The T-score

D) The p-score

E) The c-score

F) The t-score

ANSWER

The z-score for an observation is representing ‘ the number of Standard Deviations an element is away from the Mean ‘ .

Thus, the correct answer is B.

## Question 13

Consider your knowledge of Correlation Coefficients and determine the most likely correct statement(s) below:

i) The Correlation Coefficient can attain negative or positive infinity

ii) The Correlation Coefficient cannot go above +1

iii) The Correlation Coefficient cannot go below -1

A) i only

B) ii only

C) iii only

D) i and ii only

E) i and iii only

F) ii and iii only

G) i, ii and iii

H) None of the above

ANSWER

The following are considered to be correct:

- The Correlation Coefficient cannot go above +1
- The Correlation Coefficient cannot go below -1

Thus, the correct answer is F.

## Question 14

Consider your knowledge of the Student’s t-distribution and from the given options, select those that are considered to be appropriate properties:

i) The Student’s t-distribution is considered to be Asymmetrical

ii) The Student’s t-distribution is considered to be defined by multiple parameters

iii) The Student’s t-distribution is considered to be less-peaked compared to a Normal Distribution

A) i only

B) ii only

C) iii only

D) i and ii only

E) i and iii only

F) ii and iii only

G) i, ii and iii

H) None of the above

ANSWER

The following are considered to be correct:

- The Student’s t-distribution is considered to be Symmetrical
- The Student’s t-distribution is considered to be defined by a single parameter (i.e. its Degrees of Freedom)
- The Student’s t-distribution is considered to be less-peaked compared to a Normal Distribution

Thus, the correct answer is C.

## Question 15

Consider your knowledge of Statistical Analysis and determine which of the following is most likely correct.

A Sample Correlation’s value necessary to reject a Null will increase as:

A) n increases

B) n decreases

C) n becomes constant

D) n trends towards 0

E) n trends towards 1

F) n trends towards – 1

G) Unable to determine from given information

ANSWER

A Sample Correlation’s value necessary to reject a Null will increase as: n increases

Thus, the correct answer is A.

Also remember that ‘ n ‘ is representing our Sample size

## Question 16

A fundamental assumption of the random walk hypothesis of market returns is that returns from one time period to the next are statistically independent.

This assumption implies:

A) Returns from one time period to the next can never be equal

B) Returns from one time period to the next are uncorrelated

C) Knowledge of the returns from one time period does not help in predicting returns from the next time period

D) Returns from one time period to the next must be positive

E) Returns from one time period to the next must be greater than – 1

F) Returns from one time period to the next can never be equal and Returns from one time period to the next are uncorrelated

ANSWER

Efficient markets imply that the distribution of future returns does not depend on past returns. Hence, returns cannot be correlated. It could happen, however, that return distributions are independent, but that, just by chance, two successive returns are equal.

Thus, the correct answer is F.

## Question 17

Consider your knowledge of Distribution curves and select the one/s that will be completely described by its/their Degrees of Freedom.

i) The Normal Distribution

ii) The Log-Normal Distribution

iii) The Student’s t-Distribution

A) i only

B) ii only

C) iii only

D) i and ii only

E) i and iii only

F) ii and iii only

G) i, ii and iii

H) None of the above

ANSWER

The Student’s t-Distribution will be completely described by its Degrees of Freedom.

Thus, the correct answer is C.

## Question 18

Consider an investment banking firm that is holding a floating rate Note having a nine (9) year maturity. It is also known that the given interest rate will be floating at the prevailing four (4)-Month LIBOR rate which rests once per quarter. Assuming that the next scheduled rest is within one (1) week, determine the floating rate Note’s approximate duration.

A) 1 week

B) 4 weeks

C) 4 months

D) 1 quarter

E) 1 year

F) 9 years

ANSWER

The floating rate Note’s approximate duration is 1 week.

Thus, the correct answer is A.

Please note that duration will not be linked to the maturity whenever coupons aren’t fixed over the life of the given investment.

Here, duration will be directly connected to the next rest time, thus our 1-week answer.

## Question 19

From the given options below, select the statement that is most likely correct:

A) The lower the risk tolerance of a given investor, the greater his acceptable risk level will be and the lower his level of risk aversion

B) The greater the risk tolerance of a given investor, the greater his acceptable risk level will be and the lower his level of risk aversion

C) The greater the risk tolerance of a given investor, the lower his acceptable risk level will be and the lower his level of risk aversion

D) The greater the risk tolerance of a given investor, the greater his acceptable risk level will be and the higher his level of risk aversion

E) The lower the risk tolerance of a given investor, the lower his acceptable risk level will be and the lower his level of risk aversion

F) None of the above

ANSWER

The following is considered to be correct:

The greater the risk tolerance of a given investor, the greater his acceptable risk level will be and the lower his level of risk aversion

Thus, the correct answer is B.

## Question 20

Determine which of the following options below may be considered as reasons for causing a yield curve to slope upwards.

i) Expectations of higher inflation rates

ii) Expectations of higher interest rates

iii) Expectations of improving outlook for credit risk

iv) Investors favoring maturities with short terms

A) i and ii only

B) i and iii only

C) i, ii and iii only

D) i, ii and iv only

E) i, iii and iv only

F) ii, iii and iv only

G) i, ii, iii and iv

ANSWER

The following may be considered as reasons for causing a yield curve to slope upwards:

- Expectations of higher inflation rates
- Expectations of higher interest rates
- Expectations of improving outlook for credit risk
- Investors favouring maturities with short terms

Thus, the correct answer is G.

## Question 21

Of the given options below, select the measure most frequently used in gauging interest rate risk:

A) The Duration

B) The Yield

C) The Maturity

D) The Price

E) The Coupon

F) All of the above

ANSWER

The measure most frequently used in gauging interest rate risk is the Duration

Thus, the correct answer is A.

## Question 22

Select which of the following options is (are) correct with regards to reinvestment risk:

i) Reinvestment will be greater for bonds with high coupons

ii) Reinvestment will be greater for bonds with longer maturities

iii) Reinvestment will be greater for bonds without call features

A) i only

B) ii only

C) iii only

D) i and ii only

E) i and iii only

F) i, ii and iii

ANSWER

It is true that:

- Reinvestment will be greater for bonds with high coupons
- Reinvestment will be greater for bonds with longer maturities
- Reinvestment will be greater for bonds having call features

Thus, the correct answer is D.

## Question 23

You are asked to consider a typical bond instrument.

A bond’s convexity may be considered as the:

A) Rate of change in its duration

B) Rate of change in its interest rate

C) Rate of change in its systematic risk

D) Rate of change in its unsystematic risk

E) Rate of change in its total risk

F) Rate of change in its beta

ANSWER

A bond’s convexity may be considered as the rate of change in its duration.

Thus, the correct answer is A.

A bond’s convexity is the rate of change of its duration. Callable bonds usually exhibit negative convexity at lower yields. Most mortgage bonds are negatively convex.

## Question 24

Assuming all-else-equal, determine which of the following given statements will be most likely true:

i) Having a short position in a bond that is callable is equivalent to having a short position in a ‘straight’ bond + having a long callable option on the price of the bond

ii) As interest rates go higher, an inverse-floater’s price will go higher

iii) When compared to the equivalent straight bond, the put option feature for a puttable bond causes a lowering of the yield

A) i only

B) ii only

C) iii only

D) i and ii only

E) i and iii only

F) ii and iii only

G) i, ii and iii

ANSWER

The following are considered to be correct:

- Having a short position in a bond that is callable is equivalent to having a short position in a ‘straight’ bond + having a long callable option on the price of the bond
- As interest rates go higher, an inverse-floater’s price will go lower
- When compared to the equivalent straight bond, the put option feature for a puttable bond causes a lowering of the yield

Thus, the correct answer is E.

## Question 25

Consider an investment manager who is in charge of a large fixed income portfolio. The manager wants to ensure that her portfolio will not face any reinvestment risk over the next three (3) years.

You advice the manager that in order to eliminate reinvestment risk, she will have to:

i) Acquire callable securities

ii) Acquire callable securities with a tenor of less than three (3) years

iii) Acquire zero coupon bonds having a three (3) year maturity

iv) Ensure interest rates stay the same over the period

A) i and ii only

B) i and iii only

C) i and iv only

D) ii and iii only

E) ii and iv only

F) iii and iv only

G) ii, iii and iv only

ANSWER

In order to eliminate reinvestment risk:

- Acquire zero coupon bonds having a three (3) year maturity
- Ensure interest rates stay the same over the period

Thus, the correct answer is F.

Purchasing callable securities will make the problem of reinvestment risk even worse since such securities can be called early.

## Question 26

Determine which of the following is most likely true:

i) The ‘regular redemption price’ is the term used for the call price whenever we have a bond that is redeemed based on sinking fund provisions

ii) The ‘special redemption price’ is the term used for the call price whenever we have a bond that is redeemed based on call provisions outlined in the indenture

iii) Bonds that are non-callable in nature typically will be retired before maturity

A) i and ii only

B) ii and iii only

C) i and iii only

D) i, ii and iii

E) iii only

F) None of the above

ANSWER

The ‘special redemption price’ is the term used for the call price whenever we have a bond that is redeemed based on sinking fund provisions

The ‘regular redemption price’ is the term used for the call price whenever we have a bond that is redeemed based on call provisions outlined in the indenture

Bonds that are non-callable in nature typically will not be retired before maturity

Thus, the correct answer is F.

## Question 27

Determine which of the following is (are) true:

i) A bond’s call feature will specify the conditions under which the issuer may redeem the bond before the originally appointed maturity date

ii) A bond’s call feature will specify the conditions under which the holders may request bond payment before the originally appointed payment date

iii) Having a call option attached will grant an issuer the ability to rid themselves of bonds that are considered to be expensive (i.e. bonds with high coupons)

iv) Bonds are most likely to be called whenever interest rates are high

A) i only

B) i and iii only

C) i and iv only

D) ii and iii only

E) i, iii and iv only

F) ii, iii and iv only

ANSWER

The following are true:

- A bond’s call feature will specify the conditions under which the issuer may redeem the bond before the originally appointed maturity date
- Having a call option attached will grant an issuer the ability to rid themselves of bonds that are considered to be expensive (i.e. bonds with high coupons)
- Bonds are most likely to be called whenever interest rates are low

Thus, the correct answer is B.

## Question 28

Of the following given statements, select the one that is most likely correct:

A) A convenience yield is an explicit return on holding options. It is an adjustment to the cost of carry in the non-arbitrage pricing formula for forward prices in markets without trading constraints.

B) A convenience yield is an explicit return on holding inventories. It is an adjustment to the cost of carry in the non-arbitrage pricing formula for futures prices in markets with trading constraints.

C) A convenience yield is an implied return on holding options. It is an adjustment to the cost of carry in the arbitrage pricing formula for futures prices in markets with trading constraints.

D) A convenience yield is an implied return on holding futures. It is an adjustment to the cost of carry in the non-arbitrage pricing formula for forward prices in markets without trading constraints.

E) A convenience yield is an explicit return on holding inventories. It is an adjustment to the cost of carry in the arbitrage pricing formula for futures prices in markets without trading constraints.

F) A convenience yield is an implied return on holding inventories. It is an adjustment to the cost of carry in the non-arbitrage pricing formula for forward prices in markets with trading constraints.

ANSWER

A convenience yield is an implied return on holding inventories. It is an adjustment to the cost of carry in the non-arbitrage pricing formula for forward prices in markets with trading constraints.

Thus, the correct answer is F.

## Question 29

A put option will increase in value due to an increase in:

i) The price of the underlying stock

ii) The associated volatility

iii) The time-to-expiration

iv) The dividends issued

A) i and ii only

B) i and iii only

C) ii and iv only

D) i, ii and iii only

E) ii, iii and iv only

F) i, ii and iv only

ANSWER

A put option will increase in value due to an increase in:

- The associated volatility
- The time-to-expiration
- The dividends issued

Thus, the correct answer is E.

## Question 30

Of the following given options, select the most likely correct one(s):

i) Typically, a company will experience a decrease in share price following a bond downgrade and will typically see no (or very little) change following a bond upgrade

ii) If an underlying asset’s price is correlated negatively with market interest rates, then, we would likely see traders preferring to have forwards over having futures

iii) “Backwardation” is a term used to describe the situation of having futures price below the spot price.

A) i only

B) ii only

C) i and ii only

D) ii and iii only

E) i and iii only

F) i, ii and iii

ANSWER

The following are true:

- Typically, a company will experience a decrease in share price following a bond downgrade and will typically see no (or very little) change following a bond upgrade
- If an underlying asset’s price is correlated negatively with market interest rates, then, we would likely see traders preferring to have forwards over having futures
- “Backwardation” is a term used to describe the situation of having futures price below the spot price.

Thus, the correct answer is F.

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## Question 31

As a result of British interest rates being above US rates and are expected to remain this way for the foreseeable future, you are informed that local banking institutions are currently focused on taking hedged position in English loans and they are acquiring more pounds.

As a result of this scenario, you would expect that:

i) The forward-rate spreads will go down

ii) The forward-rate spreads will go up

iii) The spot exchange rate (for purchasing pounds) will go up

iv) The spot exchange rate (for purchasing pounds) will go down

A) i only

B) iii only

C) iv only

D) i and iii only

E) ii and iv only

F) i and iv only

G) ii and iii only

ANSWER

As a result of this scenario, you would expect that:

- The forward-rate spreads will go down
- The spot exchange rate (for purchasing pounds) will go up

Thus, the correct answer is D.

We expect that the forward-rate spreads will go down to the point when market equilibrium is achieved.

## Question 32

Consider your knowledge of the Market Segmentation Theory. Determine which of the following is (are) correct:

The Market Segmentation Theory affirms that:

i) The yield for any particular maturity on the yield-curve will be independently determined

ii) There is no correlation between short and long term interest rates

iii) Yields will reflect the expected spot rates

iv) Yields will reflect the expected liquidity premiums

A) i and ii only

B) i and iii only

C) i and iv only

D) i, ii and iii only

E) ii, iii and iv only

F) i, ii, iii and iv

ANSWER

The Market Segmentation Theory affirms that:

- The yield for any particular maturity on the yield-curve will be independently determined
- There is no correlation between short and long term interest rates
- Yields will NOT reflect the expected spot rates
- Yields will NOT reflect the expected liquidity premiums

Thus, the correct answer is A.

## Question 33

You observe that once interest rates go downward, the price of a particular bond goes upward, but at an ever decreasing rate.

Such an observation best describes the concept of:

A) Convexity

B) Concavity

C) Convergence

D) Divergence

E) Negative convexity

F) Positive convexity

ANSWER

Such an observation best describes the concept of negative convexity.

Thus, the correct answer is E.

## Question 34

You are told that the indifference curve of a particular investor actually intersects his CAL (Capital Allocation Line) at two different areas.

From this revelation, you determine that:

A) This investor is maximizing his (total) utility

B) This investor is not maximizing his (total) utility

C) This investor is minimizing his (total) utility

D) This investor is not minimizing his (total) utility

E) This investor is on the efficient frontier

F) None of the above

ANSWER

Here, this investor is not maximizing his (total) utility if his indifference curve actually intersects his CAL (Capital Allocation Line) at two different areas.

Thus, the correct answer is B.

## Question 35

Consider having a Forward Rate Agreement ( FRA ) with an underlying LIBOR having:

- The same compound-frequency as a given Euro-dollar futures contract
- The same maturity as this Euro-dollar futures contract

From the given information, determine which of the following statements may be considered as true with respect to the connection between the futures rare and the forward rate.

A) There is no connection between the two

B) More information is needed

C) The futures rate is typically an inverse function of the forward rate

D) The futures rate is typically the same than the forward rate

E) The futures rate is typically higher than the forward rate

F) The futures rate is typically lower than the forward rate

ANSWER

The futures rate is typically higher than the forward rate.

Thus, the correct answer is E.

## One more for the road?

Yeah. Why not

## Question 36

Form the following given options, select the one(s) which is (are) considered most likely to be correct:

i) Barrier options will be considered as more valuable when compared to a typical regular option. This, as they may be structurally arranged such that two (2) barrier options can be summed to equal one (1) regular option.

ii) Lookback options will be considered as more valuable when compared to a typical regular European option. This, as they well use the max price of the given stock over the given period (which is going to be greater than the value at the end of the timeline)

iii) Chooser options will be considered as more valuable when compared to a typical regular option- This, as they grant an added selection over its lifetime.

A) i only

B) ii only

C) iii only

D) i and ii only

E) i and iii only

F) ii and iii only

G) i, ii and iii

ANSWER

The following are considered most likely to be true:

- Barrier options will be considered as less valuable when compared to a typical regular option. This, as they may be structurally arranged such that two (2) barrier options can be summed to equal one (1) regular option.
- Lookback options will be considered as more valuable when compared to a typical regular European option. This, as they well use the max price of the given stock over the given period (which is going to be greater than the value at the end of the timeline)
- Chooser options will be considered as more valuable when compared to a typical regular option- This, as they grant an added selection over its lifetime.

Thus, the correct answer is F.

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