AAFM Financial Derivatives and Alternative Investments 2 — Questions and Answers
Question 1: Which options strategy combines a long call and a short call at a higher strike to limit both potential gain and cost?
- Protective put
- Bull call spread (Correct answer)
- Collar
- Straddle
Correct answer: Bull call spread
A bull call spread buys a call at a lower strike and sells a call at a higher strike with the same expiration, limiting the maximum gain to the spread width while reducing the net premium cost.
Question 2: Implied volatility derived from market option prices reflects which market sentiment measure?
- Historical volatility of returns
- The market's consensus forecast of future price variability (Correct answer)
- The risk-free rate trajectory
- Current dividend yield
Correct answer: The market's consensus forecast of future price variability
Implied volatility is backed out from observed option prices using a pricing model; it reflects the market's collective expectation of how volatile the underlying asset will be over the option's remaining life.
Question 3: A commodity futures contract traded on an exchange differs from an over-the-counter forward in that it is which of the following?
- Customizable and private
- Standardized and centrally cleared (Correct answer)
- Unregulated
- Only cash-settled
Correct answer: Standardized and centrally cleared
Exchange-traded futures are standardized contracts with fixed contract sizes, expiration dates, and delivery specifications, cleared through a central counterparty to eliminate default risk.
Question 4: Which alternative investment category includes timberland, farmland, infrastructure, and real assets that provide inflation-linked returns?
- Hedge funds
- Private debt
- Real assets (Correct answer)
- Venture capital
Correct answer: Real assets
Real assets—including infrastructure, farmland, timberland, and natural resources—provide physical, tangible value and tend to have returns correlated with inflation, offering diversification benefits.
Question 5: The J-curve in private equity describes which pattern of fund cash flows during the early years of a fund's life?
- Early positive returns followed by losses
- Negative returns early (fees and investments) followed by positive returns as exits materialize (Correct answer)
- Flat returns throughout the fund's life
- Immediate positive cash flows from portfolio companies
Correct answer: Negative returns early (fees and investments) followed by positive returns as exits materialize
Private equity funds typically show negative net returns in early years due to management fees, unrealized investments, and capital drawdowns, then generate positive returns as portfolio companies are sold—forming a J-shaped curve.
Question 6: An interest rate swap involves two parties exchanging which types of interest payments on a notional principal?
- Fixed for fixed payments in different currencies
- Fixed rate payments for floating rate payments (Correct answer)
- Dividend payments for interest payments
- Principal for interest payments
Correct answer: Fixed rate payments for floating rate payments
In a plain vanilla interest rate swap, one party pays a fixed rate and receives a floating rate (typically SOFR-based) from the counterparty on the same notional principal, without exchanging the principal itself.
AAFM Financial Derivatives and Alternative Investments 2
Which options strategy combines a long call and a short call at a higher strike to limit both potential gain and cost?