CFA Derivatives & Alternative Investments 3 — Questions and Answers
Question 1: In the context of interest rate swaps, what is the 'swap spread'?
- The difference between the fixed swap rate and the yield on a comparable Treasury security (Correct answer)
- The bid-ask spread charged by the swap dealer
- The difference between the floating rate and fixed rate on the swap
- The credit risk premium built into the swap rate
Correct answer: The difference between the fixed swap rate and the yield on a comparable Treasury security
The swap spread equals the fixed swap rate minus the Treasury yield for the same maturity, reflecting credit risk and liquidity differences.
Question 2: A real estate investment with NOI of $500,000 and a cap rate of 6.25% has an estimated value of:
- $8,000,000 (Correct answer)
- $6,250,000
- $3,125,000
- $500,000
Correct answer: $8,000,000
Property value = NOI / Cap Rate = $500,000 / 0.0625 = $8,000,000.
Question 3: Which type of option strategy involves buying a call and selling a higher-strike call on the same underlying with the same expiration?
- Bull call spread (Correct answer)
- Bear put spread
- Straddle
- Collar
Correct answer: Bull call spread
A bull call spread profits from a moderate rise in the underlying by buying a lower-strike call and selling a higher-strike call.
Question 4: What is the key distinction between a futures contract and a forward contract?
- Futures are standardized and exchange-traded with daily mark-to-market, while forwards are customized OTC contracts (Correct answer)
- Futures have no counterparty risk while forwards have no basis risk
- Futures require physical delivery while forwards are always cash-settled
- Forwards are regulated by exchanges while futures are unregulated
Correct answer: Futures are standardized and exchange-traded with daily mark-to-market, while forwards are customized OTC contracts
Futures are standardized, exchange-traded, and marked to market daily, while forwards are customized OTC agreements settled at expiration.
Question 5: A venture capital fund invests in early-stage companies. Which valuation approach is most commonly used when comparable public companies exist?
- Venture capital method using exit multiples and target IRR (Correct answer)
- Discounted cash flow using projected free cash flows
- Net asset value based on book value of assets
- Dividend discount model based on expected dividends
Correct answer: Venture capital method using exit multiples and target IRR
The VC method estimates exit value using comparable company multiples and back-solves for current value based on a target IRR.
Question 6: Which of the following describes the payoff of a long position in a credit default swap (CDS)?
- Receives payment if the reference entity defaults (Correct answer)
- Pays a periodic premium and receives nothing if no default occurs
- Receives the par value of the reference bond regardless of default
- Profits from a decrease in credit spreads of the reference entity
Correct answer: Receives payment if the reference entity defaults
The CDS buyer (long protection) receives a payment upon the reference entity's default, compensating for losses on the underlying credit exposure.
Question 7: In options pricing, implied volatility differs from historical volatility in that implied volatility is:
- Forward-looking, derived from current option market prices (Correct answer)
- Calculated from past price movements of the underlying asset
- Always lower than historical volatility in efficient markets
- Fixed by the exchange at the time the option is listed
Correct answer: Forward-looking, derived from current option market prices
Implied volatility is the market's consensus forecast of future volatility, derived by solving for the volatility that makes the model price equal to the market price.
CFA Derivatives & Alternative Investments 3
In the context of interest rate swaps, what is the 'swap spread'?