Unit 3 - Exams

Question 1

Where a broker is extending a credit line, after how many days must the broker have a formal written agreement in place to be able to continue to offer it?

A
10
B
5
C
2
D
1

Answer 1

5

Explanation
A broker must have a formal written agreement in place to offer a credit line beyond 5 business days.

Question 2

Which of the following is true of aternative delivery procedures (ADP) offered on some physically delivered contracts?

A
The clearing house will have no obligations to guarantee the performance of the contract under ADP
B
The asset is delivered away from the clearing house procedures; the buyer pays through the clearing house account
C
Delivery will still be bound by the exchange’s rules and regulations under ADP
D
It allows an over-the-counter position for forward delivery to be exchanged for a exchange-traded position

Answer 2

The clearing house will have no obligations to guarantee the performance of the contract under ADP

Explanation

In the event that the seller and buyer (once the two have been allocated by the clearing house) agree to make delivery other than as specified in the exchange’s rules and regulations for that contract, both parties must advise the clearing house of their agreement. The clearing house will then liquidate the contracts at the agreed settlement price, in fulfilment of all its obligations under the delivery contract.

This agreement is known as an alternative delivery procedure (ADP).

An ADP may take place at any time during the delivery period, once the long and short futures positions have been matched for the purpose of delivery. ADPs are almost exclusive to commodity contracts, and are accepted by a wide range of major exchanges, such as ICE, CME and Euronext.

Question 3

A fund manager wants to hedge a £10m holding of equities using FTSE 100 option contracts with a strike of 5,450. If spot is currently 5,400, how many contracts would be required?

A
183
B
185
C
1,834
D
1,852

Answer 3

183

Explanation
Value of portfolio / (strike x £10 / point)
£10m / (5450 x £10) = 183

Question 4

Which of the following is TRUE of gamma?

A
Gamma decreases for at the money options as the option approaches expiry
B
Gamma dictates the change in the value of an option premium
C
Gamma moves in the same direction as delta
D
A decrease in gamma would reflect more stability in option

Answer 4

A decrease in gamma would reflect more stability in option deltas.

Explanation
Gamma is the sensitivity of delta, i.e. it measures how quickly delta is changing. A decrease in gamma would mean that changes in delta were smaller.

Question 5

Which of the following best represents the benefits of a covered short put position?

A
Extra return in a stable market and some protection from a rising market
B
Extra return in a stable market and some protection from a falling market
C
Protection from a falling market at the expense of limited profits in a rising market
D
Protection from a rising market at the expense of limited profits in a falling market

Answer 5

Extra return in a stable market and some protection from a rising market

Explanation
A covered short put is a trade performed by an investor that requires an asset. They wish to buy the asset, but believe the return will be low, due to a static market. If the investor sells an OTM put on this, they generate extra income and defer the purchase of the asset. If the market remains static, this creates an extra income (premium on the option plus interest on what the investor would have spent on the asset). If the market rises a little, this strategy gives a little upside protection.

Question 6

On which of the following exchanges are energy derivatives traded?

I
NYMEX
II
COMEX
III
MEFF
IV
ICE

Answer 6

I and IV

Explanation
Metals are traded on COMEX. Financial derivatives are traded on MEFF.

Question 7

On which exchange are traded average price options (TAPOs) available?

A
COMEX
B
ICE
C
LME
D
CSCE

Answer 7

LME

Explanation
Note: TAPOs are options where the price is calculated using the average price for the underlying over a period of time.

Question 8

If a member does not want the automatic exercise of in-the-money options on expiry, who needs to be notified?

A
Any NCM
B
The exchange
C
The clearing house
D
No one. Automatic exercise is an 'opt-in' facility

Answer 8

No one. Automatic exercise is an ‘opt-in’ facility

Explanation
Automatic exercise of ITM options is ‘opt-in’. If the broker does not want automatic exercise afterwards, a ‘suppression notice’ has to be filed.

Question 9

What is the motivation for conducting a horizontal spread with call options?

A
To profit from time decay
B
Expect an increase in volatility
C
Believe the market will rise
D
To hedge against an existing position

Answer 9

To profit from time decay

Explanation
Selling a near dated option and buying a far dated option and then subsequently reversing these trades should result in profit.

Question 10

An investor who considers short-dated call options to be trading at excessive implied volatilities would consider a:

A
Long straddle
B
Horizontal spread
C
Vertical spread
D
Short straddle

Answer 10

Horizontal spread

Explanation
A short straddle would be suitable if both call and put volatility was expected to fall. As only call volatility is expected to fall, the horizontal spread is the most appropriate.

Question 11

Which of the following is not true of both initial and variation margin?

A
Protects the clearing house from default
B
Based on changes in value of the underlying asset
C
Can be paid as cash or collateral
D
Amount determined by the clearing house

Answer 11

Can be paid as cash or collateral

Explanation
Variation margin must be settled in cash whereas initial margin can be cash or suitable collateral.

Question 12

The June/December calendar spread on ICE’s STIR future contract is trading at +30 ticks. If an investor BUYS the spread, which of the following is/are true?

I
The investor buys the June leg and sells the December leg
II
The investor buys the December leg and sells the June leg
III
The investor expects the yield curve to flatten
IV
The investor expects the yield curve to steepen

Answer 12

I and IV

Explanation
The spread takes its name from what the investor does with the NEAR month. Buying the spread means that he/she is buying the June leg and selling the December leg - Option I is therefore correct. Because the calendar spread is positive, this means that the price of the June leg is greater than the price of the December leg, or in other words, the implied interest rate is lower for the June leg and higher for the December leg (remember, STIRs are priced 100 - implied rate). As the investor is buying the June leg, he/she must expect prices to go up (and interest rates to go down) in the near month. The investor is also selling the December leg, which means he/she must expect prices to go down (and rates to go up) in the far month. The investor therefore expects the yield curve to STEEPEN - Option IV is correct.

Question 13

Which of the following actions would a broker take if a client misses a variation margin call?

A
Close the position
B
Cover the amount using other client accounts
C
Cover the amount using the house account
D
No action required

Answer 13

Cover the amount using the house account

Explanation
A broker may cover variation margin calls using their own funds provided the client reimburses within five business days. After that the position would be closed.

Question 14

Which of the following best describes a FRA: Forward Rate Agreement?

A
An exchange-traded forward contract that determines an interest rate to be paid or received on an obligation beginning at a start date sometime in the future
B
An OTC forward contract that determines an interest rate to be paid or received on an obligation beginning at a start date sometime in the future
C
An exchange-traded forward contract that determines a currency rate to be paid or received on an obligation beginning at a start date sometime in the future
D
An OTC forward contract that determines a currency rate to be paid or received on an obligation beginning at a start date sometime in the future

Answer 14

An OTC forward contract that determines an interest rate to be paid or received on an obligation beginning at a start date sometime in the future

Explanation
FRAs permit the user to hedge or speculate on short term interest rates using an OTC product. They are similar to exchange traded short term interest rate futures.

Question 15

Which of the following situations would result in backwardation in cocoa futures?

A
A weakening of basis
B
A poor harvest reducing supply of cocoa
C
High interest rates
D
Strengthening of basis

Answer 15

A poor harvest reducing supply of cocoa

Explanation
Backwardation is when near prices are higher than future prices. A poor harvest in cocoa would result in demand today rising to such an extent that near prices may rise higher than future prices.

Question 16

What is making it increasing difficult to differentiate the over-the-counter market in derivatives from the exchange-traded market?

A
Use of technology in straight through processing of trades
B
Impact of regulation on pre-trade disclosures
C
Increase in the number of retail client participants
D
The ability to tailor your contract to meet your specific needs

Answer 16

Use of technology in straight through processing of trades

Explanation
The use of technology has had a significant impact on the OTC markets, and the use of straight through processing - end-to-end processing of trades - has brought the processing of many OTC contracts in line with those of exchange-traded.
Although regulation of OTC markets has increased, there are still no obligation for pre-tradetransparency and retial clients are not common in these markets. Tailoring contracts is one of the key features that differentiate the OTC market from the exchange traded market.

Question 17

A client receives a margin call after an adverse movement in the position of 10%. The initial margin was set at 5%. What will be the obligation of the client?

A
There is no obligation as the maintenance level has not been reached
B
To deliver excess collateral to the value of 5%
C
To deliver excess collateral to the value of 10%
D
To deliver excess collateral to the value of 15%

Answer 17

To deliver excess collateral to the value of 10%

Explanation
It is the obligation to return the margin back to the original level.

Question 18

Which of the following futures contracts is not physically delivered?

A
Copper
B
Brent crude
C
Cocoa
D
Wheat

Answer 18

Brent crude

Explanation
All non-financial futures are physically delivered except Brent (either cash settled or delivered through an EFP).

Question 19

Gold, silver, copper and crude oil contracts are available in the US on which of the following exchanges?

A
CBOE
B
NYMEX
C
CME
D
CBOT

Answer 19

CME

Explanation
The best answer is CME which allows trading of energy products including gas oil, crude oil and natural gas, as well as a range of precious metals, such as gold and silver along with base metal contracts for aluminium and copper, while ferrous metals including iron ore and hot-rolled steel are traded on the New York Mercantile Exchange (NYMEX). CBOT for agricultural and soft commodities, gold, metals and ethanol.

Question 20

The market suddenly becomes more volatile causing the price of futures contracts to drop sharply. Which of the following types of margin will be required from a member with a large long futures position?

A
Variation
B
Spot month
C
Intra day
D
Increased initial

Answer 20

Intra day

Explanation
Sudden increases in volatility are dealt with by the clearing house using intra day margin calls.

Question 21

Which of the following in relation to margin would not have to be disclosed to a retail client before conducting a transaction?

A
When the margin is to be paid
B
The form in which the margin may be paid
C
What the firm may do if the client defaults on their margin payment
D
The amount of margin payable by the client

Answer 21

The amount of margin payable by the client

Explanation
The firm would also need to disclose the other circumstances (apart from not paying margin) when it would close out the client’s position without prior reference to them.

Question 22

When a clearing house calculates a net margin call after marking to market, which of the following best describes the effect on the clearing members?

A
Less margin will be called from both the client and the house accounts
B
Trades from the same exchange are cancelled out
C
Less margin will be called from the house account only
D
House margin is netted off against client margin

Answer 22

Less margin will be called from the house account only

Explanation
Clearning houses offer a principal to principal guarantee. That is, they recognise the clearing member only, not the clearing member’s clients. If two clients’ margin payments net off, it is possible for the house (clearing member) to hold onto this margin and not pay it over to the clearing house.

Question 23

The invoice amount paid by the long upon delivery of a bond future would NOT be affected by which of the following?

A
The EDSP of the future on the chosen delivery date
B
The price factor of the deliverable bond
C
The size of the specific issue
D
The accrued interest

Answer 23

The size of the specific issue

Explanation
The invoice amount for a delivered bond future is calculated as:
(EDSP x Price factor x Scaling factor x No. of contracts) + Accrued interest
The size of the deliverable bonds issue will not influence the invoice amount.

Question 24

Which of the following best describes a covered warrant?

A
The right to have shares delivered by a company at the warrant strike price
B
A company holding sufficient cash to cover an obligation under a warrant contract
C
The right to buy or sell shares created by an investment bank in tradable form
D
A bank buying warrants whilst holding the underlying shares

Answer 24

The right to buy or sell shares created by an investment bank in tradable form

Explanation
Covered warrants are similar to traded options and create an obligation on a writer (typically an investment bank) to make or take delivery of shares.

Question 25

Which of the following statements regarding tick value is incorrect?

A
It may be calculated by multiplying contract size by tick size
B
The profit or loss on a single futures contract as the result of a one tick movement
C
It is a value specified by the exchange that the contract trades on
D
It is the unit used to express ICE Future Europe’s options on futures strike prices

Answer 25

It is the unit used to express ICE Future Europe’s options on futures strike prices

Explanation
ICE Future Europe’s Long Gilt Future has a contract size of £100,000 nominal and a tick size of £0.01 per £100 nominal. The tick value is therefore £10 per tick per contract. D refers to the tick size.

Question 26

A UK firm has been trading commodity derivatives with the same client for over two years, but the activities have only come within the scope of commodity regulations in the last three months. Why might this be?

A
The firm has achieved a CFTC Part 30 Exemption
B
The client has started trading for investment purposes
C
The client has been reclassified as a market professional
D
The client has started trading US based derivatives

Answer 26

The client has started trading for investment purposes

Explanation
The assumption is that if the client has started trading derivatives for investment purposes, then previously the trading activities related to hedging activities.
Derivatives used for hedging purposes are outside the scope of MiFID, whereas derivatives used for investment purposes would be covered.

Question 27

An exchange will monitor a member’s open interest:

A
Every few days
B
Daily, to ensure that they may meet their delivery obligations
C
Weekly, whenever big positions are maturing
D
At the end of each delivery or expiry month

Answer 27

Daily, to ensure that they may meet their delivery obligations

Explanation
A clearing house will check the clearer’s open positions (open interest) every day with respect to variation margin and initial margin.

Question 28

To secure exemption under CFTC Part 30, FCA members must do all of the following except:

A
Join the NFA arbitration scheme
B
Pay funds, the amount calculated in accordance with the size and business of the firm, into an escrow account at the NFA to cover any potential legal liabilities
C
Provide the CFTC via the FCA with any relevant client records
D
Send and receive back from clients the generic CFTC risk disclosures

Answer 28

Pay funds, the amount calculated in accordance with the size and business of the firm, into an escrow account at the NFA to cover any potential legal liabilities

Explanation
CFTC Part 30 is explained in full in Chapter 11: Derivative Regulation.

Question 29

Which of the following statements regarding warrants is false?

A
They are issued by a company to raise cash
B
They are a long-dated call option on the company’s shares
C
They are the right to subscribe for new shares at a fixed price on a future date
D
They are only issued to existing shareholders

Answer 29

They are only issued to existing shareholders

Explanation
Warrants are normally issued alongside a bond issue.

Question 30

The primary purpose for the issuance of UK government bonds is to finance what?

A
PSCD
B
Excess spending
C
CGO
D
DMO

Answer 30

Excess spending

Explanation
The official term for annual excess government spending is the Public Sector Net Cash Requirement (PSNCR).

Question 31

George is uncertain over the direction of interest rates but wants to hedge against an increase in the borrowing rate on a loan he took out three months ago. Which of the following is the most suitable position to adopt (using options on interest rate futures)?

A
Buy futures
B
Buy calls
C
Buying puts
D
Write calls

Answer 31

Buying puts

Explanation
As interest rates increase, the price of interest rate futures goes down. In other words there is an inverse relationship between the interest rates and the price of interest rate futures. It therefore follows that the value of put options (they are priced like the futures) on interest rates would go up as interest rates increase and this would act as a hedge in this example.

Question 32

Which of the following deliverables is the cheapest-to-deliver?

8% Treasury with an implied repo rate of 6.7%.
8.5% Treasury with an implied repo rate of 6.3%.
6% Exchequer with an implied repo rate of 6.9%.
6.5% Treasury with an implied repo rate of 6.4%.

Answer 32

6% Exchequer

Explanation
The cheapest-to-deliver is the gilt with the HIGHEST implied repo rate.

Question 33

One of the main purposes of regulators is to reduce:-

A
Operational risk
B
Systemic risk
C
Currency risk
D
Capital risk

Answer 33

Systemic risk

Explanation
The main purpose and aims of regulation, in all markets globally, are:-
To maintain and promote the fairness, efficiency, competitiveness, transparency and orderliness of the securities and futures industry.
To promote understanding by the public of the operation and functioning of the securities and futures industry.
To provide protection for members of the public investing in or holding financial products.
To minimise crime and misconduct in the securities and futures industry.
To reduce systemic risks in the securities and futures industry.
To assist in maintaining the market’s financial stability by taking appropriate steps in relation to the securities and futures industry.

Question 34

Euronext’s UCP is used for all of the following functions EXCEPT:

A
Account reconciliation
B
Trade allocation
C
Account assignment
D
Trade matching

Answer 34

Account reconciliation

Explanation
The Universal Clearing Platform operates behind Euronext’s Universal Trading Platform. Its primary facilities are trade allocation of trades to the appropriate clearing member, matching the detail of the trades and allocating it to a recognised account type.

Question 35

Paul buys a bond for £100 which subsequently rises to £105. He then sells a call option for a premium of £1 and a strike price of £105 as he does not think the price will rise any further. If the bond’s price actually rises to £107 what percentage return does Paul make?

A
4%
B
5%
C
6%
D
7%

Answer 35

6%

Explanation
If the bond trades at £107 the call option will be exercised against the writer (Paul).
Profit on bond delivered through option = £105 - £100 = £5
Premium received = £1
Return = £6 / £99 = 0.0606 or 6.06%
Note: the £99 is the net investment: the price of the bond minus the premium received.

Question 36

The holder of a preference share would not:

A
Usually receives a fixed dividend.
B
Have priority over ordinary shares in the event of liquidation
C
Have pre-emption rights
D
Have both cumulative and participating rights.

Answer 36

Have pre-emption rights

Explanation
Preference shares do not have pre-emption rights all the others are true.

Question 37

Certain exchanges allow exchange for physicals (EFP) on some of their contracts. Which of the following would NOT be a use for EFPs?

A
To swap one futures position for another
B
To swap a position in the cash for a position in the future
C
For two parties to establish opposite positions with each other in the cash and futures market
D
For two parties to avoid the requirement of having to deliver standardized grades

Answer 37

To swap one futures position for another

Explanation
In an exchange for physical transaction there must always be a physical component.

Question 38

Which of the following would cause a reduction in supply?

A
If the price of a commodity falls to below the cost of mining it
B
If the price of a commodity falls to below the marginal cost of mining it
C
If the price of a commodity rises
D
If the price of a commodity rises too high

Answer 38

If the price of a commodity falls to below the marginal cost of mining it

Explanation
If the price of a commodity falls to below the marginal cost of mining it.

Question 39

Which ONE of the following applies to a writer of an option on a future?

A
Receives a residual credit based on the net liquidation value (NLV) of the option
B
Receives the full premium less any initial margin
C
Receives premium on day of trade
D
Receives full premium on the earlier of exercise or expiry

Answer 39

Receives full premium on the earlier of exercise or expiry

Explanation
An option on a future has the premium paid on exercise or expiry, whichever is sooner.

Question 40

Which of the following exchanges are most likely to have arbitrage trades occurring between the two?

A
ICE and LME
B
ICE and LSE Derivatives
C
ICE and NYMEX
D
OneChicago and NYMEX

Answer 40

ICE and NYMEX

Explanation
Both these exchanges have Brent crude oil contracts. However, note that the contracts are slightly different from each other.

Question 41

Which of the following trades on exchange primarily as a principal?

A
Broker acting as an agent
B
Private investor
C
Broker acting for client
D
Market maker

Answer 41

Market maker

Explanation
Market makers and private investors both trade as principals, however only the market maker will be dealing directly on exchange.

Question 42

Which of the following is NOT used in calculating closing futures prices on ICE Futures?

A
The traded price during the last thirty seconds of the closing range
B
The weighted average of the prices traded during the last thirty seconds of the closing range
C
The weighted average of the prices traded during the last ten minutes of trading
D
The mid-price at the time the settlement price is calculated

Answer 42

The weighted average of the prices traded during the last ten minutes of trading

Explanation
The closing range is also referred to by the exchange as the ‘settlement range’.

Question 43

Which option pricing model uses the ‘volatility smile’ as its pricing basis?

A
Black-Scholes
B
Binomial
C
SABR
D
Bermudan

Answer 43

SABR

Explanation
Volatility smile states that the implied volatility is greater for options with strike prices that are well in the money and very much out of the money. This is the pricing basis for SABR model which in contract to Black-Scholes model that uses a fixed level of implied volatility.

Question 44

An investor has a two-month floating rate loan and wants to hedge interest rate exposure without entering into any further contractual obligations. Which of the following is the most suitable hedge?

A
Interest rate guarantee
B
Interest rate swap
C
Interest rate future
D
Interest rate option

Answer 44

Interest rate option

Explanation
The option represents a right, not an obligation.

Question 45

Which of the following best describes the purpose of the FCA’s push towards Treating Customers Fairly (TCF)?

A
An agenda that led to the creation of MiFID and has been replaced by the rules in this directive
B
An agenda that helps consumers achieve a fair deal in the retail market
C
A set of principles set down for all FCA regulated firms to follow
D
A set of principles providing guidance to firms conducting eligible counterparty business

Answer 45

An agenda that helps consumers achieve a fair deal in the retail market

Explanation
TCF does consist of principles, but the principles only apply to firms conducting retail business.
Choice ‘B’ is the best of the descriptions given.

Question 46

What are the main differences between an interest rate swap and a currency swap?

I
The principal amounts of an interest rate swap are transferred between the counterparties but not transferred between counterparties of a currency swap
II
The principal amounts of a currency swap are transferred between the counterparties but not transferred between counterparties of an interest rate swap
III
The periodic payments of an interest rate swap are made gross but in a currency swap are paid net
IV
The periodic payments of a currency swap are made gross but in an interest rate swap are paid net

Answer 46

II and IV

Explanation
The principal amount of an IRS is notional and not actually transferred between the counterparties to the swap. IRSs also make payments net, i.e. payments between the counterparties are netted out.

Question 47

Which of the following is the SEC not responsible for?

A
Stock options
B
Stock index options
C
Currency transactions on exchange
D
NYMEX

Answer 47

NYMEX

Explanation
NYMEX and CME are the responsibility of the CFTC.

Question 48

Interbank deposit rates are used to determine which of the following?

A
Repo rate
B
Interbank borrowing rates
C
Fed funds rate
D
Forward rates

Answer 48

Interbank borrowing rates

Explanation
Deposit rates (e.g. LIBID) and lending rates (e.g. LIBOR) are always closely linked. The interest rate paid in repo agreements is an important benchmark in the money markets, and so is influential on interbank rates (NOT the reverse as suggested by A).

Question 49

Which of the following factors leads to the spread on forward foreign exchange quotes being wider than on spot quotes?

A
Larger exchanges
B
Volatility
C
Time
D
Liquidity

Answer 49

Time

Explanation
Forward bid-ask spreads are wider than spot bid-ask spreads because of the time factor.

Question 50

Which of the following exchanges operates a period of trading known as a kerb?

A
NYSE
B
LME
C
NYMEX
D
ICE

Answer 50

LME

Explanation
The LME has two types of open outcry trading sessions. In ‘ring’ trading, each metal is traded in turn for five minutes. There are four of these per day. In the ‘kerb’ sessions trading can be in any metal at any time. There are two kerb sessions per day - one at the end of the morning and one at the end of the afternoon.
Note: In general, the term ‘kerb’ is also used but there it is an additional ‘after hours’ session.

Question 51

In an open outcry market what is the market price?

A
Last trade
B
Current bid/offer quotes
C
Average of the last ten minutes of trading
D
No market price is reported

Answer 51

Current bid/offer quotes

Explanation
Current bid/offer quotes represent prices at which trading is possible and are therefore the market price.

Question 52

Which of the following types of margin would allow future margin payments to be deducted from initial margin?

A
Intra-day margin
B
Maintenance margin
C
Variation margin
D
Net margin

Answer 52

Maintenance margin

Explanation
This is a description of a maintenance margin system where variation margin payments are netted-off against initial margin.

Question 53

Which is the best definition of wide basis?

A
A market in contango
B
Unusually high demand on the cash/underlying asset
C
When cost of carry is negative
D
When there is poor liquidity in the futures contract

Answer 53

Unusually high demand on the cash/underlying asset

Explanation
If there is an unusually high demand on the cash asset then the price will rise. If the price of the underlying rises the spread will widen and therefore give a wider basis assuming a constant cost of carry as a percentage.

Question 54

Why do exchanges require member firms to fulfil their obligations regarding transaction reports, for instance, the requirement of the members of ICE Futures Europe to report trades into the UCP?

A
To ensure price transparency in the market place
B
To ensure counterparties know who to pay for settlement purposes
C
To ensure a fair and orderly market
D
To ensure market abuse does not occur between member firms

Answer 54

To ensure counterparties know who to pay for settlement purposes

Explanation
Transaction reporting systems compare details of the buy and sell sides of a trade and allow settlement staff to direct the trade to the appropriate counterparty.

Question 55

Which of the below options is not an influencing factor on supply of Metals?

A
Availability
B
Cost of extraction
C
Government subsidies and tariffs
D
Suitable Land

Answer 55

Suitable Land

Explanation
All play a part in supply of metals except suitable land. Land is a factor for agriculturals where we require suitability for growth.

Question 56

An investor is long an 97 BTP call at a 30 tick premium and short a put at the same exercise price at a 20 tick premium. What is the overall position?

A
A synthetic long future at 97.10
B
A synthetic long call at 97.10
C
A synthetic short future at 97.10
D
A synthetic long future at 96.90

Answer 56

The correct answer is: A - A synthetic long future at 97.10

Explanation
Long call + short put = synthetic long. The breakeven price will be equal to the strike price plus the difference between the two premiums, i.e. 97 + (0.3 - 0.2) = 97.10. Note that the premiums are expressed as ticks. One tick is 0.01.

Question 57

If a client defaults on a clearing broker before a trade has been novated, what is the risk to the broker?

A
As a clearing broker the clearing house will take-on the risk
B
The risk is transferred to the party the broker traded with
C
The clearing broker assumes the risk less any client margin held
D
As the default is pre-novated, there is no risk and the trade is declared null and void

Answer 57

The clearing broker assumes the risk less any client margin held

Explanation
The risk is with the broker, the fact that the trade hasn’t novated doesn’t have an impact.
A clearing house sees’ only its members and not its members’ clients.
The clearing broker would be holding margin/collateral which it could use to off-set the risks caused by the default.

Question 58

Which of the following is true in relation to segregation of assets?

A
US and UK rules require segregation of all client assets from those of the firm
B
US and UK rules require segregation of all retail client assets from those of the firm
C
UK rules require segregation of retail client assets from those of the firm and US rules require segregation of all client assets
D
UK rules require segregation of all client assets from those of the firm and US rules require segregation of retail client assets

Answer 58

UK rules require segregation of retail client assets from those of the firm and US rules require segregation of all client assets

Explanation
A UK firm dealing with a US client must treat all US money as client money and give it adequate protection.
It is possible, however, for some UK clients to opt out of this protection. A retail client may never opt out.

Question 59

Which of the following actions would a clearing house be unable to take if a counterparty to a trade defaulted on their obligations?

A
Close out and settle open contracts belonging to the defaulting member and their original counterparty
B
Transfer open positions to another member
C
Hedge the risk of the defaulting member’s open position by entering into new contracts on the exchange
D
Hedge the risk of the defaulting member’s open position by entering into other off-exchange transactions

Answer 59

Close out and settle open contracts belonging to the defaulting member and their original counterparty

Explanation
The clearing house would close out the positions of the defaulting member but not their counterparty. Remember, the clearing house is the counterparty to every cleared trade, so would close out the trades of the defaulting member and look to transfer or hedge their exposure.

Question 60

Which of the following statements regarding basis and basis risk is false?

A
Basis risk is the uncertainty of basis values affecting the user of the future
B
Basis is said to weaken when it becomes more positive or less negative
C
Basis is calculated by deducting the futures price from the cash price
D
If a future is trading at its fair value basis equals the cost of carry

Answer 60

Basis is said to weaken when it becomes more positive or less negative

Explanation
Basis weakens when the cash prices weaken relative to futures. Because basis is calculated at Cash - Futures, the lower relative cash price results in basis becoming either less positive or more negative.

Question 61

Which of the following would not be disclosed to a retail client in relation to potential margin payments?

A
When margin will be required and when it is due
B
The form of investments the clearing house accepts as margin
C
The steps the firm will take if the client fails to pay the required margin
D
Any other circumstances in which the firm may close out the client’s position

Answer 61

The form of investments the clearing house accepts as margin

Explanation
A retail client must be notified BEFORE conducting a contingent liability transaction. They will be notified of what the broker accepts as margin, but not what the clearing house accepts.

Question 62

Where a client gets a brokerage to manage their derivative positions specifically to their needs, but retains liability for all losses, this would be called:

A
A retail scheme
B
A pooled fund
C
An investment
D
An account

Answer 62

An account

Explanation
An account is where, usually, a wealthy investor holds a private account with a brokerage.

Question 63

In a back market, if a trader expects the spread to widen he should:

A
Buy the nearby contract and sell the deferred contract
B
Sell the nearby contract and buy the deferred contract
C
Buy the nearby dated contract and buy the deferred contract
D
Sell the nearby contract and sell the deferred contract

Answer 63

Buy the nearby contract and sell the deferred contract

Explanation
In a back market, with widening spreads, the investor should buy the spread, i.e. buy the near dated contract and sell the far dated contract.

Question 64

Who issue an assignment notice before expiry?

A
The holder of an option
B
ICE Clear Europe - at its discretion
C
The exchange - at its discretion
D
The writer of an option

Answer 64

ICE Clear Europe - at its discretion

Explanation
The clearing house will send out the assignment notice to a short position of its choice.

Question 65

Which of the following is a difference between FLEX options and OTC options?

A
All terms are standardised for FLEX contracts
B
OTC are centrally cleared
C
FLEX contracts have lower credit risk
D
The market maker dictates the contract specifications for a FLEX option

Answer 65

FLEX contracts have lower credit

Explanation
FLEX options are hybrid exchange-traded products which introduce some over-the-counter (OTC) features. Some of the terms such as maturity or strike price are agreed between the two counterparties (hence ‘the market maker dictates the contract specifications for a FLEX option’ is not correct). FLEX options have the added benefit of reducing credit risk normally associated with OTC contracts. The credit risk is substantially reduced due to the exchange’s use of a central clearing house.

Question 66

Which of the following may a firm call as collateral from a client with their permission?

I
Equity
II
Warrants
III
Debentures
IV
Cash

Answer 66

I, II, III, IV

Explanation
With the permission of the client a firm could call any of these. UK Clearing houses, however, would only accept debentures and cash.

Question 67

Which of the following is the most frequent use of synthetics?

A
Speculation
B
Arbitrage
C
Hedging
D
Regulatory purposes

Answer 67

Arbitrage

Explanation
The reason for using synthetics might be to create positions that may not be available on the underlying asset. However, the main reason for the use of synthetics is arbitrage.

Question 68

Which of the following is true in relation to client margin requirements?

A
A firm may net client and firm margin requirements at all times
B
A firm may never net client and firm margin requirements
C
Margin requirements from clients may sometimes be netted-off against offsetting positions with the firm’s own margin requirements
D
Margin requirements from clients are always netted-off against offsetting positions with the firm’s own margin requirements

Answer 68

Margin requirements from clients may sometimes be netted-off against offsetting positions with the firm’s own margin requirements

Explanation
If client accounts are held within a NON-SEGREGATED account, then netting off is permitted. Netting-off is not permitted is the firm operates a segregated account for the client.

Question 69

Which of the following statements best describes open interest?

A
It is the volume of lots on the bid and offer at the opening for a particular delivery month
B
The sum of all long positions less all short positions currently open for delivery for a particular delivery month
C
The sum of all segregated and in-house positions open for delivery for a particular delivery month
D
The total of short positions open for delivery for a particular delivery month

Answer 69

The total of short positions open for delivery for a particular delivery month

Explanation
The open interest for a given delivery month is the total of all long OR short positions open for delivery in that contract.

Question 70

A trader has a view in the market that the basis will be strengthening in a contango market. Which of the below best describes the basis movement and the action the trader should perform?

A
Basis will narrow, sell the basis
B
Basis will narrow, buy the basis
C
Basis will widen, sell the basis
D
Basis will widen, buy the basis

Answer 70

Basis will narrow, buy the basis

Explanation
In a contango market, if the basis is strengthening then it will narrow as the price in the cash market will be getting stronger relative to the futures market. If the basis strengthens, the trader should buy the basis which means buy the cash asset and sell the future.

Question 71

Which of the following best describes an accreting swap?

A
A swap based on a notional principal which will increase over the life of the contract
B
A swap based on a notional principal which is linked to a withholding tax liability and the purchase of a cash bond
C
A swap based on a notional principal which will increase or decrease in line with seasonal borrowing requirements
D
A swap based on a notional principal which will decrease over the life of the contract

Answer 71

A swap based on a notional principal which will increase over the life of the contract

Explanation
Answer A is the best description of an accreting swap. Answer C is a rollercoaster swap and Answer D an amortising swap.

Question 72

A broker enters an order to sell three futures at a price of 18.50 MIT GTC on Euronext’s Universal Trading Platform before the market opens. Which of the following would not happen to that order?

A
Would be filled if the market opened at 18.61
B
Would be filled if the market opened at 18.50
C
Could possibly be filled at 18.40
D
If, by the close that day the range had been 18.36 to 18.49 the order would be cancelled automatically

Answer 72

If, by the close that day the range had been 18.36 to 18.49 the order would be cancelled automatically

Explanation
The order is Market if Touched, Good Till Cancelled. Selling MIT orders are placed above the market and are executed at the next price after the trigger price (in this case 18.50) has been traded. The market opening at 18.61 would mean that 18.50 had assumed to be traded and would be filled. Likewise, if the market opens at 18.50 the order would become live. It is possible for the order to be filled at 18.40 if, after having traded 18.50 the next available price is at 18.40. Good till cancelled orders are cancelled on the clients say so, not automatically at the end of that day.