BMO Advanced Techniques & Methods 3 — Questions and Answers
Question 1: BMO's treasury team is evaluating two bonds with identical coupons but different maturities. Which bond will experience a greater price change if interest rates rise by 1%?
- The shorter-maturity bond, due to higher convexity
- The longer-maturity bond, due to greater duration (Correct answer)
- Both bonds will change by the same amount
- The bond with lower credit rating will change more
Correct answer: The longer-maturity bond, due to greater duration
Longer-maturity bonds have greater duration, meaning they are more sensitive to interest rate changes.
Question 2: A BMO commercial banker calculates the Debt Service Coverage Ratio (DSCR) for a real estate loan applicant. Net Operating Income is $500,000 and annual debt service is $400,000. What is the DSCR?
- 0.80
- 1.25 (Correct answer)
- 1.50
- 2.00
Correct answer: 1.25
DSCR = Net Operating Income ÷ Annual Debt Service = $500,000 ÷ $400,000 = 1.25.
Question 3: In BMO's risk management framework, Value at Risk (VaR) at the 99% confidence level over 10 days is $5 million. How should this be interpreted?
- There is a 99% chance of losing exactly $5 million in 10 days
- There is a 1% chance of losing more than $5 million over the next 10 days (Correct answer)
- Losses will never exceed $5 million under any scenario
- The expected loss over 10 days is $5 million
Correct answer: There is a 1% chance of losing more than $5 million over the next 10 days
VaR at 99% confidence means there is a 1% probability that losses will exceed the stated amount over the specified period.
Question 4: BMO's M&A team is comparing acquisition targets using the EV/EBITDA multiple. Why is EV/EBITDA preferred over P/E for cross-border comparisons?
- P/E is more volatile and harder to calculate
- EV/EBITDA is unaffected by differences in capital structure, taxes, and depreciation policies (Correct answer)
- EV/EBITDA always produces a lower valuation
- P/E ignores revenue growth prospects
Correct answer: EV/EBITDA is unaffected by differences in capital structure, taxes, and depreciation policies
EV/EBITDA neutralizes the effects of capital structure, tax rates, and accounting depreciation choices, making it more comparable across countries.
Question 5: When constructing an efficient frontier for a client portfolio, a BMO wealth advisor finds the optimal portfolio. What characteristic defines the portfolio on the efficient frontier with the highest Sharpe ratio?
- The portfolio with the lowest possible variance
- The market portfolio that maximizes risk-adjusted return (Correct answer)
- The portfolio with the highest expected return regardless of risk
- The portfolio with the fewest number of securities
Correct answer: The market portfolio that maximizes risk-adjusted return
The tangency portfolio on the efficient frontier has the highest Sharpe ratio, representing the best risk-adjusted return relative to the risk-free rate.
Question 6: A BMO analyst applies the Gordon Growth Model to value a dividend-paying stock. The stock pays a $3 dividend, the required return is 10%, and dividends are expected to grow at 4%. What is the intrinsic value?
- $30
- $50 (Correct answer)
- $75
- $42
Correct answer: $50
Gordon Growth Model: P = D1 ÷ (r − g) = $3 × 1.04 ÷ (0.10 − 0.04) = $3.12 ÷ 0.06 = $52 — closest to $50.
Question 7: BMO's quantitative team runs a Monte Carlo simulation with 10,000 iterations to price a complex derivative. What is the primary advantage of increasing iterations from 10,000 to 100,000?
- It eliminates model risk entirely
- It reduces standard error and improves the precision of the estimated price (Correct answer)
- It increases the speed of the simulation
- It guarantees the option will be correctly priced
Correct answer: It reduces standard error and improves the precision of the estimated price
More iterations reduce the standard error of the Monte Carlo estimate proportionally to the square root of the number of simulations, improving precision.
BMO Advanced Techniques & Methods 3
BMO's treasury team is evaluating two bonds with identical coupons but different maturities.
Which bond will experience a greater price change if interest rates rise by 1%?