CPFM - Certified Professional in Financial Management Options, Futures, and Derivatives Questions and Answers

Question 1

A U.S. manufacturing company needs to purchase a large quantity of aluminum in three months. The financial manager is concerned that the price of aluminum will increase significantly before the purchase date. Which of the following derivative strategies would be most effective in hedging this price risk?

Accepted Answer

Buying aluminum call options or long futures.

Answer

To hedge against a price increase (the risk of paying more in the future), the manager needs a strategy that profits when the price of aluminum goes up. Buying a call option gives the right to buy aluminum at a predetermined price, capping the purchase cost. Going long (buying) a futures contract locks in a purchase price for a future date. Selling futures or buying puts would be used to hedge against a price decrease.

Question 2

Which of the following is a key difference between a futures contract and a forward contract?

Accepted Answer

Futures contracts are traded on an organized exchange and are marked-to-market daily.

Answer

Futures contracts are standardized and traded on exchanges, with a clearinghouse mitigating counterparty risk. A crucial feature is the daily 'marking-to-market' process, where gains and losses are settled each day. In contrast, forward contracts are customized, private (OTC) agreements with settlement typically occurring only at the end of the contract, which introduces greater counterparty risk.

Question 3

A financial manager is evaluating a call option on a stock with a strike price of $70. If the current market price of the underlying stock is $78, which of the following statements is correct?

Accepted Answer

The option has an intrinsic value of $8.

Answer

The intrinsic value of a call option is the amount by which it is 'in-the-money'. It is calculated as the current stock price minus the strike price. In this case, $78 (stock price) - $70 (strike price) = $8. The option is 'in-the-money', not 'at-the-money'. An option almost always has time value before expiration, and an option provides the right, not the obligation, to buy.

Question 4

A U.S.-based corporation has sold goods to a customer in Germany and is scheduled to receive a payment of €5 million in 90 days. The corporate treasurer is concerned about the risk of the Euro (EUR) depreciating against the U.S. Dollar (USD). Which derivative strategy would effectively hedge this risk?

Accepted Answer

Sell EUR forward or futures contracts.

Answer

The company's risk is that the €5 million will be worth fewer USD in 90 days. To hedge this, the company needs to lock in an exchange rate at which it can sell its euros for dollars in the future. Selling a EUR forward or futures contract achieves this by creating an obligation to sell euros at a predetermined price, thus neutralizing the risk of the euro's value falling.

Question 5

A corporation has a significant amount of variable-rate debt and the financial manager is concerned that rising interest rates will increase the company's borrowing costs. What is the primary purpose of using an interest rate swap in this scenario?

Accepted Answer

To exchange its floating-rate payments for fixed-rate payments.

Answer

An interest rate swap is an agreement where two parties exchange interest payment streams. For a company with floating-rate debt concerned about rising rates, the most common strategy is a 'plain vanilla' swap where it agrees to pay a fixed rate to a counterparty in exchange for receiving a floating-rate payment. This converts the variable-rate debt into a synthetic fixed-rate obligation, providing certainty over future interest costs.

CPFM Practice Test

CPFM Practice Test

CPFM - Certified Professional in Financial Management Options, Futures, and Derivatives Questions and Answers