QFC Quantitative Finance Risk & Derivatives 3

Question 1

What does a negative convexity in a bond's price-yield relationship typically indicate?

Accepted Answer

Price increases slow down as yields fall, as with callable bonds

Answer

Negative convexity, common in callable bonds, means price appreciation is limited as yields fall because the issuer is likely to call the bond.

Question 2

In a plain vanilla interest rate swap, the fixed-rate payer is effectively:

Accepted Answer

Short a fixed-rate bond and long a floating-rate bond

Answer

Paying fixed and receiving floating is economically equivalent to shorting a fixed-rate bond and being long a floating-rate note.

Question 3

Model risk in quantitative finance primarily refers to:

Accepted Answer

Losses due to incorrect or misapplied financial models

Answer

Model risk arises when a pricing or risk model is misspecified, incorrectly calibrated, or used outside its valid assumptions, leading to flawed valuations or hedges.

Question 4

The risk-neutral measure Q differs from the real-world measure P in that under Q:

Accepted Answer

All assets are expected to earn the risk-free rate

Answer

Under the risk-neutral (pricing) measure, discounted asset prices are martingales and assets are priced as if investors require no risk premium beyond the risk-free rate.

Question 5

A 'bull call spread' is constructed by:

Accepted Answer

Buying a lower-strike call and selling a higher-strike call with the same expiry

Answer

A bull call spread profits from a moderate rise in the underlying by buying a lower-strike call and selling a higher-strike call, capping both potential gain and net cost.

(QFC) Quantitative Finance Certification Practice Test

(QFC) Quantitative Finance Certification Practice Test

QFC Quantitative Finance Risk & Derivatives 3