CFM Derivatives & Hedging Strategies 5 — Questions and Answers
Question 1: An equity fund manager sells index futures equal to the portfolio's beta-adjusted value to temporarily reduce market exposure. This technique is called:
- Portfolio immunization
- Beta overlay
- Tactical asset allocation using derivatives (Correct answer)
- Delta hedging
Correct answer: Tactical asset allocation using derivatives
Using index futures to adjust a portfolio's market exposure without trading the underlying securities is a common tactical asset allocation technique.
Question 2: Put-call parity for European options states that:
- C - P = S - PV(K) (Correct answer)
- C + P = S + PV(K)
- C - P = PV(K) - S
- C + S = P + PV(K)
Correct answer: C - P = S - PV(K)
Put-call parity: C - P = S - PV(K), meaning a long call minus a long put equals the current stock price minus the present value of the strike.
Question 3: When hedging a foreign currency receivable due in 90 days using forward contracts, the fund manager should:
- Buy the foreign currency forward
- Sell the foreign currency forward (Correct answer)
- Buy domestic currency forward
- Enter a currency swap paying domestic fixed rate
Correct answer: Sell the foreign currency forward
Selling the foreign currency forward locks in the exchange rate for converting the future receivable back to domestic currency.
Question 4: Which of the following best describes theta in options pricing?
- The sensitivity of option price to changes in the underlying's volatility
- The rate at which an option loses value due to the passage of time (Correct answer)
- The change in option delta per unit change in the underlying price
- The sensitivity of option price to interest rate changes
Correct answer: The rate at which an option loses value due to the passage of time
Theta measures time decay — the amount by which an option's value decreases as each day passes, all else equal.
Question 5: A fund manager enters a commodity swap paying fixed and receiving floating oil prices to hedge fuel costs. If oil prices rise significantly, the fund manager's swap position will:
- Generate a loss as floating payments exceed fixed payments
- Generate a gain as floating receipts exceed fixed payments (Correct answer)
- Remain unchanged because commodity swaps are marked to par
- Require margin posting equivalent to the price increase
Correct answer: Generate a gain as floating receipts exceed fixed payments
When oil prices rise, the floating receipts increase above the fixed payments, generating a gain on the swap that offsets higher fuel costs.
Question 6: The 'Greeks' of a short straddle position (short call + short put at same strike) include:
- Positive delta, positive gamma, positive vega
- Near-zero delta, negative gamma, negative vega (Correct answer)
- Positive delta, negative gamma, positive theta
- Negative delta, positive vega, negative theta
Correct answer: Near-zero delta, negative gamma, negative vega
A short straddle has near-zero net delta (calls offset puts), negative gamma (loses from large moves), negative vega (loses from rising vol), and positive theta (gains from time decay).
Question 7: A fund manager uses a futures overlay to increase a bond portfolio's duration from 4 years to 7 years. If the portfolio is $100 million and the futures DV01 is $1,200, approximately how many contracts must be bought?
- 125 contracts
- 208 contracts
- 250 contracts (Correct answer)
- 300 contracts
Correct answer: 250 contracts
Duration increase = 3 years on $100M = $300,000 DV01 target change; $300,000 / $1,200 per contract ≈ 250 contracts.
CFM Derivatives & Hedging Strategies 5
An equity fund manager sells index futures equal to the portfolio's beta-adjusted value to temporarily reduce market exposure.
This technique is called: