 # PRMIA 8006 Dumps - Exam I: Finance Theory Financial Instruments Financial Markets - 2015 Edition PDF Sample Questions Exam Code:
8006
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Exam I: Finance Theory Financial Instruments Financial Markets - 2015 Edition
287 Questions
Last Update Date : 05 December, 2023
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## Sample Questions

Realexamdumps Providing most updated PRM Certification Question Answers. Here are a few sample questions:

## PRMIA 8006 Sample Question 1

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)

#### Options:

A. \$1,007.50
B. \$1,000.00
C. \$1,007.53
D. \$1,012.58

Answer: C Explanation: Explanation: The futures price of the contract will be the future value of the spot price, calculated at a net rate equal to the cost of funding the futures position, less any dividends or other distributions. Also note that when rates are continuously compounded, Future Value = Present Value x (exp(rate x time)).Therefore in this case the futures price for the S&P = 1000 * exp((5%-2%)*3/12) = 1007.54

## PRMIA 8006 Sample Question 2

Assuming zero taxes, the effect of increasing leverage in the capital structure of a firm is to:

#### Options:

A. Decrease the value of the business as debt is riskier than equity
B. Maintain the value of the business unaltered
C. Increase the value of the business as debt is cheaper than equity
D. either increase, decrease or leave constant the value of the business depending upon other factors

Answer: B Explanation: Explanation: The value of a business derives itself from the value of its cash flows, and not its capital structure. However, the availability of tax deductions on debt allow increasing the value of the business to equity holders by using the tax shield.In the absence of taxes, there is no such advantage. Even if debt is nominally priced lower than the cost of equity, substituting debt for equity makes the remaining equity more risky and increasing the cost of equity to offset any advantage gained from the lower cost of debt. Changing the capital structure does not change the value of the firm, and this in essence is the conclusion of the Modigliani-Miller theorem.

## PRMIA 8006 Sample Question 3

A fund manager buys a gold futures contract at \$1000 per troy ounce, each contract being worth 100 ounces of gold. Initial margin is \$5,000 per contract, and the exchange requires a maintenance margin to be maintained at \$4,000 per contract. What is the most prices can fall before the fund manager faces a margin call?

#### Options:

A. \$20 per ounce
B. \$1,000 per ounce
C. \$10 per ounce
D. \$0 per ounce

Answer: C Explanation: Explanation: The most loss the fund manager can bear without facing a margin call is the loss that will make his margin balance account no lower than \$4,000. This means he can have a loss of upto \$1,000 before a margin call is triggered, implying that prices can fall by \$10 per ounce (=\$1,000/100 ounces per contract) without triggering a margin call. The margin call will be to top the margin up to the \$5,000 initial margin.

## PRMIA 8006 Sample Question 4

What would be the expected return on a stock with a beta of 1.2, when the risk free rate is 3% and the broad market index is expected to earn 8%?

#### Options:

A. 7%
B. 7.4%
C. 9%
D. 9.6%

Answer: C Explanation: Explanation: The stock has a beta of 1.2, therefore intuitively it can be expected to earn more than the broad market index. It will earn the risk free rate, ie 3%, and 1.2 times the equity risk premium of 5% (8% - 3%). The expected returns from the stock therefore are 3% + (8% - 3%)*1.2 = 9%

## PRMIA 8006 Sample Question 5

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.

#### Options:

A. I and IV
B. I, II and III
C. II and III
D. All statements are correct

Answer: C Explanation: Explanation: Macaulay duration is the weighted average of the present value of payments received on a bond, weighted by the year in which the payments are received. If the yield curve changes shape, it will change the present values of the coupons and therefore also the Macaulay duration. Statement I is therefore not correct. However, if the bond were to be a zero-coupon bond, changes in the curve will not affect its duration so long as the interest rate at maturity stays constant.Modified duration = Macaulay Duration/(1 + rate/compounding frequency). Therefore modified duration will change if the compounding frequency changes, assuming the nominal rate of interest for the coupons are identical. Therefore statement II is correct.When rates are expressed as continuously compounded rates, modified duration and Macaulay duration will be identical. This intuitively follows from the formula for modified duration: Modified duration = Macaulay Duration/(1 + rate/compounding frequency). For continuously compounded rates, the compounding frequency approaches infinity, so the denominator approaches 1, leaving modified duration equal to the Macaulay duration. Therefore statement III is correct.Convexity is higher for a bond that has its payments spread out compared to a bond that has its payments concentrated at a single point in time. For a bond with a higher coupon, the higher coupons have the effect of spreading the present value of the bond over a longer period, when compared to a bond with lower coupons where the payment is comparatively more concentrated at the maturity. Therefore Convexity is higher for a bond with a lower coupon when compared to a similar bond with a higher coupon. Statement IV is not correct.

## PRMIA 8006 Sample Question 6

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

#### Options:

A. I and IV
B. I
C. II and III
D. I, II, V and VI

Answer: B Explanation: Explanation: Statement I is correct - since forward prices are determined as (Spot - PV of dividends)*e^(rt), an increase in dividends will reduce forward prices.Statement II is incorrect as forward prices will be determined by near term interest rates, specifically by the borrowing rate for the period of the contract, and will stay unchanged if near term interest rates do not change.Statement III is incorrect. Futures exchanges require both buyers and sellers to deposit initial margins as prices can move adversely for either of them.Statement IV is incorrect, as the margin deposited when a contract is entered into is called initial margin. Margin calls thereafter resulting from movements in prices are called variation margin.Statement V is incorrect. Most futures exchanges distinguish between hedgers and speculators and require different margins from each.Statement VI is incorrect. Interest rate futures behave almost identically to their bond counterparts, and carry both duration and convexity.

## PRMIA 8006 Sample Question 7

Which of the following statements are true:

#### Options:

A. The mean-variance criterion is a simplification of the principal of maximum expected utility
B. The mean-variance criterion is superior to the principal of maximum expected utility
C. The mean-variance criterion is the same thing as the principal of maximum expected utility
D. The mean-variance criterion is inferior to the principal of maximum expected utility

Answer: A Explanation: Explanation: The principle of maximum expected utility requires maximizing the expected utilities of the different possible outcomes of a gamble weighted according to the probabilities of their occurrence. This is very difficult to apply in practice in the financial markets where utility functions and various other inputs for maximizing expected utility are not known. Markowitz suggested the mean-variance criterion as a simplification of the principle of maximum expected utility, and it can be shown that the mean-variance gives a good approximation when the range of outcomes under consideration does not exceed plus or minus one coefficient of risk tolerance. (Recall that the coefficient of risk tolerance is the value of x where the gambler is indifferent between equal probabilities of winning x or losing x/2.)

## PRMIA 8006 Sample Question 8

The risk of a portfolio that cannot be diversified away is called

#### Options:

A. Specific risk
B. Portfolio risk
C. Systematic risk
D. Diversifiable risk

Answer: C Explanation: Explanation: Systematic risk refers to market risk that cannot be diversified away. Specific risk relates to the unique risk from the securities selected in the portfolio, and these can be diversified away by adding other securities to the portfolio. Diversifiable risk is risk that can be diversified away, ie the same as specific risk. Portfolio risk is the total risk of the portfolio that includes both specific and systematic risk.

## PRMIA 8006 Sample Question 9

Which of the following statements are true:

I. For a delta neutral portfolio, gamma and theta carry opposite signs

II. The sum of the absolute value of gamma for a call and a put for the same option is 1

III. A large positive gamma is desirable in a delta neutral portfolio

IV. A trader needs at least two separate tradeable options to simultaneously make a portfolio both gamma and vega neutral

#### Options:

A. II and IV
B. I and II
C. III and IV
D. I, III and IV

Answer: D Explanation: Explanation: Statement I is true. Consider the Black Scholes PDE 202.23.e1and substitute delta = 0 (as this is a delta neutral portfolio), and we get the result 202.23.e.Since r is generally small, and Ï and S are positive, theta will be negative when gamma is positive and vice versa.Statement II is incorrect. The gamma of a call and a put are equal and do not add to 1. The relationship described applies to delta, and not gamma.Statement III is correct because positive gamma means that the portfolio gains both from an increase and a decrease in the value of the underlying, given delta neutrality. (Generally, a positive gamma is a good thing, but like everything else, it does not come free. A trader can choose to keep their portfolio gamma positive, but in doing so he or she would be giving up premiums from options they would have sold to neutralize the gamma.)Statement IV is correct because the only way to hedge gamma and vega is through other options positions as only options have gamma and vega. If only one tradeable option is available, it would be possible to hedge either the gamma or the vega, but not both, as achieving neutrality in one will upset the neutrality of the other. The only way to simultaneously hedge the two would be to use two different options on the underlying, and determine the number of options to be traded (using a system of simultaneous equations).

## PRMIA 8006 Sample Question 10

A stock has a spot price of \$102. It is expected that it will pay a dividend of \$2.20 per share in 6 months. What is the price of the stock 9 months forward? Assume zero coupon interest rates for 6 months to be 6%, for 9 months to be 7%, and 12 months to be 8% - all continuously compounded.

#### Options:

A. 104.26
B. \$94.76
C. \$105.25
D. \$100

Answer: C Explanation: Explanation: The dividend payment has a present value of \$2.20*e^( -6%*6/12) = \$2.14. Therefore the forward price for delivery 9 months hence should be (\$102 - \$2.14)*e^(7%*9/12) = \$105.26

## PRMIA 8006 Sample Question 11

The price of a bond will approach its par as it approaches maturity. This is called:

#### Options:

B. amortization effect
C. pull-to-par phenomenon
D. negative carry

Answer: C Explanation: Explanation: As a bond approaches maturity, its value will be driven less by the time value of money or its coupons, and more by its redemption value, ie the par. Therefore as maturity approaches, its value converges to its par value and this phenomenon is called pull to par.

## PRMIA 8006 Sample Question 12

The zero rates for 1, 2 and 3 years respectively are 2%, 2.5% and 3% compounded annually. What is the value of an FRA to a bank which will pay 4% on a principal of \$10m in year 3?

#### Options:

A. \$732.90
B. \$800.25
C. None of the above
D. \$670.70

Answer: D Explanation: Explanation: In this case, we need to determine the value today of an FRA where the bank has to pay 4% from year 2 to 3 in exchange for the then prevailing LIBOR. We do this by using the forward rate from year 2 to 3, and comparing it to the fixed rate. The forward rate is determined from the zero rates as =(1.03^3 / 1.025^2) - 1 = 4.0073%. The bank is committed to paying 4%, therefore the value of the FRA at the end of year 3 = (4.0073% - 4%) * \$10m = \$732.90. But this is the value at the end of year 3, and needs to be discounted to the present using the 3 year zero rate. Therefore the value of the FRA is \$732.90/(1.03^3) = \$670.70.

## PRMIA 8006 Sample Question 13

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

#### Options:

A. A increase in the risk-free rate of interest always increases the value of the option
B. An increase in the price of the underlying always increases the value of the option
C. An increase in the time to expiry always increases the value of the option
D. An increase in the volatility of the underlying always increases the value of the option

Answer: C Explanation: Explanation: An increase in volatility increases the value of the option, and so do increases in the price of the underlying and the risk free rate. However, since a European option can only be exercised at expiry, an increase in the time to expiry may not necessarily increase the value of the option as it may increase the uncertainty around a more certain payout.Consider the extreme case of a deep in the money European call option that has 1 day left to expiry, and a payout is certain. Now imagine the time to expiry is increased by say, 6 months. Now the payout is no longer certain as no one knows what the value of the underlying will end up at after 6 months. In such a case, the value of the option would decline. But this applies only to a European option. An American option, which can be exercised any time, will not be affected by this reasoning.