CFA Derivatives & Alternative Investments 2 — Questions and Answers
Question 1: A trader sells a put option on a stock with a strike price of $50 and receives a premium of $3. What is the maximum profit for this short put position?
- $3 (Correct answer)
- $47
- $50
- Unlimited
Correct answer: $3
The maximum profit for a short put is limited to the premium received ($3), achieved when the option expires worthless.
Question 2: Which of the following best describes a total return swap?
- An agreement where one party receives the total return of an asset and pays a floating rate (Correct answer)
- An exchange of fixed for floating interest rate payments only
- A contract granting the right to buy an asset at a predetermined price
- An agreement to exchange principal amounts in different currencies
Correct answer: An agreement where one party receives the total return of an asset and pays a floating rate
A total return swap transfers both income and capital gains/losses of a reference asset in exchange for a floating rate payment.
Question 3: In private equity, what does the term 'J-curve' refer to?
- The initial negative returns followed by positive returns as investments mature (Correct answer)
- A graphical representation of leverage ratios over time
- The pattern of capital calls accelerating in the early years
- The upward slope of IRR as the fund approaches its end
Correct answer: The initial negative returns followed by positive returns as investments mature
The J-curve describes early negative returns in PE funds due to fees and slow value creation, followed by positive returns as investments mature and are exited.
Question 4: What is the primary purpose of using a currency forward contract for a US company with euro receivables?
- To lock in the exchange rate at which euros will be converted to dollars (Correct answer)
- To speculate on euro appreciation against the dollar
- To eliminate credit risk on the receivable
- To reduce the euro amount owed by the foreign buyer
Correct answer: To lock in the exchange rate at which euros will be converted to dollars
A currency forward locks in a specific exchange rate for a future date, eliminating uncertainty from exchange rate fluctuations.
Question 5: Which Greek measures the rate of change of an option's delta with respect to the underlying asset price?
- Gamma (Correct answer)
- Vega
- Theta
- Rho
Correct answer: Gamma
Gamma measures how much delta changes for a $1 move in the underlying, indicating the curvature of the option's price relative to the asset.
Question 6: A hedge fund employs a long/short equity strategy. If a manager is net long 60% and gross exposure is 200%, what is the short exposure?
- 70% (Correct answer)
- 140%
- 60%
- 130%
Correct answer: 70%
If net long = long - short = 60% and gross = long + short = 200%, then long = 130% and short = 70%.
Question 7: Which of the following is a characteristic of commodity futures markets that distinguishes them from equity futures markets?
- Convenience yield plays a significant role in commodity futures pricing (Correct answer)
- Commodity futures have no daily settlement
- Commodity futures cannot be used for hedging
- Commodity futures are always cash-settled
Correct answer: Convenience yield plays a significant role in commodity futures pricing
Convenience yield reflects the non-monetary benefit of holding the physical commodity and is a key factor in commodity futures pricing not present in equity futures.
CFA Derivatives & Alternative Investments 2
A trader sells a put option on a stock with a strike price of $50 and receives a premium of $3.
What is the maximum profit for this short put position?