FIA Derivatives & Risk Products 3

Question 1

What is the primary purpose of a total return swap (TRS)?

Accepted Answer

To transfer the total economic exposure of an asset without transferring ownership

Answer

A TRS transfers both the income and capital gains/losses of a reference asset to the receiver, without the asset changing hands.

Question 2

In an interest rate cap agreement, the cap seller must pay when:

Accepted Answer

The reference rate exceeds the cap rate

Answer

The cap seller pays the difference when the floating reference rate rises above the agreed cap rate on each reset date.

Question 3

Which risk arises when the maturity of a futures hedge does not perfectly match the maturity of the exposure being hedged?

Accepted Answer

Basis risk

Answer

Basis risk occurs because the futures price and spot price may not move in perfect lockstep, especially when maturities differ.

Question 4

A protective put strategy is best described as:

Accepted Answer

Buying a put to limit downside on an existing long stock position

Answer

A protective put combines long stock with a long put, effectively creating a floor below which losses are capped.

Question 5

What is 'contango' in futures markets?

Accepted Answer

When futures prices are higher than spot prices

Answer

Contango describes when futures prices exceed current spot prices, typically due to storage costs and carrying charges.

(FIA) Financial Information Associate Certification Practice Test