IMC Financial Analysis & Derivatives 1

Question 1

What does the Price-to-Earnings (P/E) ratio measure?

Accepted Answer

The market price of a share divided by earnings per share, indicating how much investors pay for each pound of earnings

Answer

The P/E ratio = Share Price / Earnings Per Share. It indicates how much investors are willing to pay for each pound of earnings, reflecting growth expectations and risk. A high P/E may indicate growth expectations or overvaluation; a low P/E may indicate value or low growth.

Question 2

What is 'discounted cash flow' (DCF) analysis?

Accepted Answer

A valuation method that estimates the present value of future expected cash flows using an appropriate discount rate

Answer

DCF analysis values an asset by projecting its future cash flows and discounting them back to present value using a discount rate that reflects the time value of money and risk. The intrinsic value = sum of discounted future cash flows.

Question 3

What is a 'forward contract' in derivatives?

Accepted Answer

An agreement to buy or sell an asset in the future at a price agreed today, traded over-the-counter (OTC)

Answer

A forward contract is a binding OTC agreement between two parties to buy or sell an asset at a specified price on a future date. Unlike futures, forwards are customised, not standardised, and are not exchange-traded, creating counterparty risk.

Question 4

What is the key difference between a 'futures contract' and a 'forward contract'?

Accepted Answer

Futures are standardised, exchange-traded, and cleared centrally; forwards are customised OTC contracts with counterparty risk

Answer

Futures are standardised contracts traded on exchanges with daily mark-to-market settlement and central clearing through a CCP, virtually eliminating counterparty risk. Forwards are customised, OTC bilateral agreements with counterparty risk but greater flexibility.

Question 5

What is a 'call option' and what is the maximum loss for the buyer?

Accepted Answer

The right to buy an asset at a strike price before expiry; maximum loss is the premium paid

Answer

A call option gives the holder the right (but not the obligation) to buy an underlying asset at the strike price before or at expiry. The maximum loss for a call buyer is the premium paid, while the potential profit is theoretically unlimited if the asset price rises.

IMC Practice Test

IMC Practice Test

IMC Financial Analysis & Derivatives 1