Unit 3 - Extra Flashcards
1
Q
What position will the writer of a call on a future be in if the option is exercised?
A Delivery of the underlying asset B Long-future C Short-future D Short-put
A
Short-future
Explanation
Selling the right to buy a future will leave the writer of the option delivering the futures contract if the option is exercised against them.
2
Q
Which of the following best describes how easy it is for a trader to open or close a position without incurring excessive trading costs?
A Liquidity B Basis C Trade/Cost profile D Gearing
A
Liquidity
Explanation
Liquidity is a term used to describe how easy it is to trade without incurring excessive trading costs
3
Q
Which of the following best describes hedging?
A
Taking an opposite position in futures to your position in the underlying asset
B
Buying and selling futures or options
C
Taking a matching position in futures to your position in the underlying asset
D
Buying futures in anticipation of a rise in the value of the underlying asset
A
Taking an opposite position in futures to your position in the underlying asset
Explanation
Hedging requires adopting a position in the derivatives market that will generate a profit if the underlying position makes a loss. If you own wheat (long underlying) and are worried about the price falling, a short-futures position would profit from a fall in the underlying price to compensate for your losses.
4
Q
How would you describe the risk associated with buying a futures contract?
A Unlimited B Limited to initial margin C Limited to the value of the underlying D Limited to the futures price
A
Limited to the futures price
Explanation
When entering into a futures contract, the potential downside, although large, is limited to the futures price. You could take delivery of an underlying asset worth nothing, and still be contractually bound to pay the futures price.
5
Q
Which of the following is NOT true of a put contract?
A
The holder has the right to sell a specified quantity of a specified asset at a given price
B
If the option is exercised, the writer will buy a specified quantity of a specified asset at a given price
C
The writer can choose not to buy the specified asset
D
A put with a strike price below the price of the underlying has no intrinsic value
A
The writer can choose not to buy the specified asset
Explanation
The holder of a put contract (long-put) has the right, but not the obligation, to sell the asset at the strike price. The writer must buy the asset if the contract is exercised - therefore ‘the writer can choose not to buy the specified asset’ is the correct answer.
6
Q
Which organisation has been given the responsibility for the administration of LIBOR?
A British Banking Association B ICE Benchmark Administration C Thomson-Reuters D FCA
A
ICE Benchmark Administration
Explanation
BBA used to be involved in the administration but since 31st January 2014, this has been passed onto ICE benchmark administration. Thomson-Reuters are still involved but they simply collect the submissions, calculate and then publish LIBOR. Setting LIBOR is now a regulated activity and so FCA are involved from a regulatory aspect.
7
Q
Banks accepting deposits in the inter bank market use which of the following as the average rate quote?
A LISTIR B LIBOR C LIBID D LIMEAN
A
LIBID
Explanation
London inter-bank bid (LIBID) is the rate that banks uses to accept deposits. LIBOR is what banks use to lend funds.
8
Q
In relation to warrants, which of the following is FALSE?
A They can exercise on a daily basis B They must be exercised on expiry C They are convertible into ordinary shares D They do not carry the right to vote at an AGM
A
They must be exercised on expiry
Explanation
The exercise dates are stated upfront, and may have the capability of exercising daily. Warrants never carry the right to vote in meetings. A warrant is similar to a call option, where there is a right, but not an obligation to buy new shares, and therefore does not have to be exercised at expiry.
9
Q
An investor will receive a semi-annual interest payment of how much in the following situation?
The investor purchases five 6% $1,000 par value bonds. They are selling at a discount and have a yield to maturity of 8%.
A $150 B $225 C $300 D $60
A
$150
Explanation
The investor will receive semi-annual payments of $150. The bond pays 6% interest based on $1,000 par value. There are five bonds = $5,000 par value. 6% of $5,000 = $300 / year in interest. Since the interest is paid semi-annually, the payment would = $150.
10
Q
Which of the below is the best description of a Hybrid derivative?
A
Combining a call option together with a put option
B
Combining a security and a derivative packaged together to create an investment product
C
Combining two different derivatives in creating a synthetic trade
D
Combining two different types of derivatives in one contract
A
Combining two different types of derivatives in one contract
Explanation
A Hybrid derivative incorporates two different types of risk into a single derivative contract. It allows investors to take a view on a combination of asset classes in a single contract.
A describes a combination trade, B describes a structured product and C is a synthetic trade.
11
Q
A floor broker working on an open outcry exchange carries out trades on behalf of another brokerage house. Once the trade is done, the floor broker passes the trade back to the originating firm. This is called:
A Assignment B Give-up C Dual brokerage D Cross trading
A
Give-up
Explanation
Note: ‘giving-up’ trades is also called ‘allocating’. Small brokerage houses that do not have floor brokers themselves often employ floor brokers to execute their business. Once the trade is completed, the floor broker gives up the trade to the originating firm.
12
Q
In a trade registration system, when is a trade considered to be registered?
A When the trade has been allocated B When the trade has been removed from the default account C When it is ready for clearing D When the trade has been matched
A
When it is ready for clearing
Explanation
This is a difficult question; the best answer is C, as a trade will be considered registered when it is ready to be passed into the clearing system.
13
Q
On which of the following US exchanges would you find oil derivatives?
A COMEX B CBOT C PHLX D NYMEX
A
NYMEX
Explanation
Both crude and heating oil futures (no options) are available on the New York Mercantile Exchange (NYMEX).
CBOT trades agriculturals and financial contracts.
COMEX trades metals.
PHLX trades financial contracts.
14
Q
EFP arrangements occur:
A Ex pit B Ante pit C In pit D Under pit
A
Ex pit
Explanation
EFP arrangements take place outside the trading pit (or the normal trading mechanism). This could also be called ‘Ex pit’.
15
Q
Which of the following systems allows a firm to allocate trades to the correct account?
A UCP B CPS C EDSP D PPS
A
UCP
Explanation
The Universal Clearing Platform (UCP) is used by ICE Futures Europe and Euronext Derivatives for firms to allocate trades to the correct account. The LME uses the LME matching and clearing system.
16
Q
What needs to be reported on an execution of a block trade?
I Time II Price III Volume IV Client details
A
I, II and III
Explanation
Client details are not required in a trade report for a block trade.
17
Q
Which of the following contracts is physically delivered?
A Euro future B STIR future C FTSE 100 index future D FTSE 100 index option
A
Euro future
Explanation
A euro future to buy 125,000 euros at a fixed price on a fixed date will result in 125,000 euros actually being delivered. This is a physically delivered future. The others are all settled by paying or receiving the difference between the price at which the position was opened and the price that it was closed at, i.e. a contract for difference.
18
Q
Which of the following is the best definition of exchange traded?
A
On an Recognised Investment Exchange (RIE)
B
On a Designated Investment Exchange (DIE)
C
On an Recognised Investment Exchange or Designated Investment Exchange
D
On any exchange
A
On any exchange
Explanation
A deal on any exchange would be exchange traded (as opposed to ‘over the counter’).
19
Q
Which of the following is a benefit of a block trade?
A
They can be executed for any size
B
Prices can be agreed away from the order book
C
There is no need for trades to be reported
D
There is never any publication of block trades
A
Prices can be agreed away from the order book
Explanation
The exchange sets the size requirements; they must be reported and publication may be delayed. The block trade facility allows members of ICE Futures and their wholesale clients to transact business of significant size as bilaterally agreed transactions on-exchange, without delay and with certainty of price and execution.
20
Q
What is shown in the touch strip on electronic/screen-based trading systems?
A Current bid/offer prices B Best bid/offer price C Details of the day's trades D Best three bid/offer prices
A
Best bid/offer price
Explanation
The touch strip shows the best bid and offer currently available. The touch strip is sometimes referred to as Level 1.
Level 2 shows all the available buy and sell orders currently available - sometimes referred to as the market in depth.
21
Q
Universal Trading Platform is used on which of the following exchanges?
A CME B EUREX C Euronext Derivatives D LSE Derivatives
A
Euronext Derivatives
Explanation
Universal Trading Platform is the electronic order-driven trading platform used by Euronext Derivatives.
22
Q
Which of the following matches and carries registered trades between UK exchanges and UK Clearing houses?
A CPS B SPAN C UCP D UTP
A
UCP
Explanation
The details of the trade will be reported into the administration system that is used by the exchange, such as the Universal Clearing Platform (UCP) for ICE Futures Europe. These systems will ensure that the trade inputs are matched - in other words, that both a purchase and a sale exist on the same terms. This process is particularly important when the exchange uses open outcry, where there is more scope for human error than in an electronic order-matching system.
23
Q
When acting as an agent on behalf of a principal, an agent may:
I Enter into contracts on behalf of their principal II Settle contracts using their own funds III Charge the principal commission IV Allocate a proportion of trades to their own account
A
I, II, III, IV
Explanation
An agent acting on behalf of a principal is, for example, where a broker acts for a client.
All are permitted, provided any related FCA rules are adhered to: e.g. settle contracts, using own funds, would require prior written consent from a retail client.
24
Q
The price at which an exchange of futures for physical (EFP) is agreed is:
A The currently traded futures price B The price determined by the exchange C The price agreed by the counterparties D The settlement price at the end of the day
A
The price agreed by the counterparties
Explanation An EFP (exchange future for physical) is between two members, but ex-pit (off exchange). Members agree between themselves what price the EFP is to be done at.
25
If the fair value of a future is at a discount to the future's price, which of the following would generate profit?
```
A
Long future
B
Short future
C
Cash and carry
D
Reverse cash and carry
```
Cash and carry
```
Explanation
Buy cheap (the underlying) and sell the expensive (future).
```
26
In a screen-based market, the exchange has a responsibility to provide prices to which of the following people?
```
A
Quote vendors
B
Exchange members
C
The public
D
The clearing house
```
The public
Explanation
Exchanges must publish trading information giving everyone access to price and volume information. This publication of trade details is a requirement for all 'on exchange' transactions, whether they occur through screen trading or not.
27
Which of the following is TRUE of basis?
```
A
Basis always equals the cost of carry
B
Basis is calculated by deducting the future's price from the cash price
C
When the future's price increases relative to cash, the basis is said to strengthen
D
Basis risk can be avoided by hedging
```
Basis is calculated by deducting the future's price from the cash price
Explanation
Basis is not always the cost-of-carry, as the future may trade away from its fair value. Choice 'When the future's price increases relative to cash, the basis is said to strengthen' describes basis weakening and basis risk cannot be hedged against.
'Basis is calculated by deducting the future's price from the cash price' is the correct answer.
28
When is gearing highest for an option?
```
A
When it is at-the-money
B
When it is in-the-money
C
When it is out-of-the-money
D
When the exercise price equals the cash price
```
When it is out-of-the-money
Explanation
An option's gearing refers to its profit/loss potential compared to that of owning the underlying asset. The smaller the premium, the higher the gearing. Out-of-the-money options have the lowest premiums due to the fact that there is no intrinsic value. They are therefore the most highly geared.
29
Per put-call parity, which of the following combinations creates a synthetic short call?
```
A
Long asset and short put
B
Short asset and short put
C
Long asset and long put
D
Short asset and long put
```
Short asset and short put
Explanation
Rearrange put-call parity formula, C - P = S - K / (1 + r)^t to get C on its own using '- C' as a short call.
- P - S + K / (1 + r)t = - C . Therefore, shorting the asset and selling the put gives you a synthetic short call.
30
Which of the following options would have the greatest time value if the underlying is trading at 71?
```
A
June 90 call
B
June 70 call
C
June 110 call
D
June 50 call
```
June 70 call
Explanation
If everything else is constant the time value of an option is greatest when it is at-the-money.
31
The index is currently at 3,800 points. The dividend yield is 2% and interest rates are 5%. What is the fair value of the 29 day future?
```
A
3,791
B
3,800
C
3,914
D
3,809
```
3,809
Explanation
This is calculated as:
Index value + index value(Interest rate - dividend yield pro-rated for 29 days)
3,800 + 3,800 x ((5% - 2%) x 29 / 365) = 3,809
32
The rate of change of delta (assuming long positions) for a given change in the underlying is:
```
A
Positive for calls, negative for puts
B
Positive for calls, positive for puts
C
Negative for calls, negative for puts
D
Negative for calls, positive for puts
```
Positive for calls, positive for puts
Explanation
The rate of change of delta - gamma - is positive for both long calls and long puts.
33
In June, a farmer is concerned about falling wheat prices and takes out a hedge by selling a December wheat contract. His wheat is ready for sale in November and he lifts the hedge by selling the wheat in the cash market and closing-out his futures contract.
From which of the following is the farmer at risk?
A
A change in the future's price from June to November
B
A change in the price of wheat from June to November
C
A change in basis from June to November
D
A change in the future's price from November to December
A change in basis from June to November
Explanation
As the farmer has lifted his hedge early he is susceptible to 'basis risk'. Basis risk can arise because the relationship between the cash price and future's price is unpredictable and can change between setting-up the hedge and lifting it early. If basis has weakened, the farmer's profits in the futures market will not be sufficient to offset the loss in the cash market.
34
Gamma:
```
A
Decreases as an option approaches expiry
B
Measures the volatility in an option
C
Always moves in the same direction as Delta
D
Is negative for short options
```
Is negative for short options
Explanation
Gamma is the sensitivity of delta relative to a change in the price of the underlying asset. It increases for ATM options as time to expiry falls. It is positive for long options and negative for short options.
35
On an open outcry market, who has the responsibility of price reporting?
```
A
The exchange member
B
A clearing house official
C
An exchange official
D
The client
```
An exchange official
Explanation
The exchange official is responsible for ensuring price transparency is upheld on the open outcry markets. LME is now the only UK based exchange that still operates open outcry.
36
Which of the following options would have the highest delta?
```
A
A far-dated deeply out-of-the-money call
B
A near-dated deeply out-of-the-money put
C
A near dated at-the-money call
D
A far-dated deeply in the money put
```
A far-dated deeply in the money put
Explanation
In the money options have the highest delta.
It is the convention to ignore the sign - therefore -1 and +1 are treated in the same way.
37
Exchange price feeds provide:
```
A
Delayed prices
B
Streaming prices
C
Settlement prices
D
Closing prices
```
Streaming prices
Explanation
Exchange price feed provide streaming prices throughout the day.
38
What would be the equivalent exposure to the UK stock market if an investor bought 7 FTSE 100 futures? The contract is currently at 6,400 points and has a tick value of £5 per half point.
```
A
£32,000
B
£64,000
C
£224,000
D
£448,000
```
£448,000
Explanation
Total exposure = 6,400 points x £10 per point x 7 contracts = £448,000.
39
How would a hedger attempt to eliminate basis risk?
A
Hold the derivative investment to expiry
B
Structure the hedge using OTC derivatives
C
Structure the hedge using exchange traded derivatives
D
Create synthetic positions using futures and options
Hold the derivative investment to expiry
Explanation
The best answer here is to hold the derivative until delivery where basis will be zero.
40
When trading on an order driven sytem, MIT stands for which of the following?
```
A
Market-inside-touch
B
Market-if-touched
C
Minimum integral tranche
D
Mandatory imminent takeover
```
Market-if-touched
Explanation
A market-if-touched (MIT) order specifies that the order is executed at the best prevailing price once price hits a certain level.
41
What might you use to determine implied volatility?
```
A
Statistical analysis
B
Pricing models
C
Regression studies
D
Trading estimates
```
Pricing models
Explanation
Implied volatility refers to the volatility implied in a premium quoted by the market. In order to extract this you would need a pricing formula such as Black-Scholes.
42
If the Delta of a long-put option is -0.65, what would the Delta of the corresponding long-call position be?
```
A
-0.65
B
-0.35
C
+0.65
D
+0.35
```
+0.35
Explanation
The combined Delta of a put and a call with the same underlying, strikes and expiries equals 1 (ignoring positive or negative signs). Therefore, if the Delta of the put is 0.65, the Delta of the corresponding call must be 0.35. Because it is a LONG-call, the Delta will be +0.35.
43
As identified by the ISDA credit support documentation, what is the main difference between UK and US law?
A
UK may use cash or collateral as margin whereas the US can use cash only
B
UK may use cash only as margin whereas the US may use cash and collateral
C
Any collateral deposited in the UK remains the legal property of the depositor whereas in the US title transfers to the holder
D
Any collateral deposited in the US remains the legal property of the depositor whereas in the UK title transfers to the holder
Any collateral deposited in the US remains the legal property of the depositor whereas in the UK title transfers to the holder
Explanation
US law dictates that a security interest of any collateral deposited as margin can be created instead of legal transfer of title. In the UK title transfers immediately.
44
```
OTC products on the inter-continental exchange (ICE) can be traded:
A
Bilaterally only
B
Electronically only
C
Bilaterally or electronically
D
There is no OTC facility on ICE
```
Bilaterally or electronically
Explanation
OTC products on ICE can be traded bilaterally, directly between the two counterparties, or electronically on ICE's 'many-to-many' trading platform.
45
A bank believes that a single debtor has become too risky for them to continue to take on the risk of their debt. What could the bank do to transfer the risk of the debtor to a third party?
```
A
Enter into a vanilla swap
B
Enter into a total return swap
C
Issue a credit linked note
D
Issue a mortgaged backed security
```
Issue a credit linked note
Explanation
A credit linked note represents the amount borrowed by the debtor. The institution buying the note will benefit from any payments from the debtor, but is, however, taking on the risk of the debtor defaulting.
46
Bclear is used for?
```
A
Clearing Brazilian government bonds
B
Clearing Bloomberg trades
C
Clearing OTC equity derivatives
D
Clearing UK government bonds
```
Clearing OTC equity derivatives
Explanation
Bclear service combines much of the flexibility of the over-the-counter (OTC) market with many of the benefits of an exchange and clearing house environment. Launched initially for OTC equity derivatives, Bclear now also offers commodity contracts.
47
Which document sets out the relationship between two institutions when one party executes a trade but another party becomes the ultimate counterparty of the trade?
```
A
Master agreement
B
Protocols
C
Confirmations
D
Master give up agreement
```
Master give up agreement
Explanation
What is described in the question is a give up. The master give up agreement sets out the relationship between the broker performing the trade and the third party who becomes the ultimate counterparty to the trade.
48
What is the name of LCH Group's OTC clearing system?
```
A
SwapsWire
B
Options Clearing Corporation
C
SwapClear
D
SPAN
```
SwapClear
Explanation
SwapClear is offered to LCH Group members for clearing OTC contracts.
49
Which system allows the inter-bank swap market a facility to free-up credit lines, reduce risk and use capital?
```
A
Euroswap
B
Swapswire
C
SwapClear
D
EuroCCP
```
SwapClear
Explanation
This is a description of SwapClear, which can centrally clear OTC contracts, netting off transactions to free up credit lines and reduce counterparty risk.
Swapswire is a straight through processing system.
50
Who acts as central counterparty to all transactions on SwapClear?
```
A
Euroclear
B
LCH Group
C
Clearstream
D
Depository Trust and Clearing Corporation
```
LCH Group
Explanation
LCH Group is the central counterparty to all transactions registered through SwapClear.
51
What is the purpose behind a firm maintaining adequate records of collateral?
A
To enable the return of identical assets when a client fulfils their obligations
B
To enable the return of equivalent assets when a client fulfils their obligations
C
To enable the return of identical assets when a client fails to fulfil their obligations
D
To enable the return of equivalent assets when a client fails to fulfil their obligations
To enable the return of equivalent assets when a client fulfils their obligations
Explanation
A firm only has to return equivalent, not identical assets.
52
A FLEX option gives the investor all of the following benefits over a standard exchange-traded option, except:
A
An exchange-traded product with OTC features
B
Flexibility for the long as to whether the option will be exercised or not
C
Flexibility as to what the strike price will be
D
Flexibility as to when the expiry date will be
Flexibility for the long as to whether the option will be exercised or not
Explanation
FLEX options are exchange-traded options that give investors the chance to benefit from certain characteristics of the OTC market, such as negotiating the strike price and expiry date, as well as expiry style. Whether it is a FLEX option or a standard exchange-traded option, the long always has the flexibility to choose whether to exercise or not.
53
Which of the below is TRUE of forward contracts traded away from an exchange?
A
Contracts must be novated by a central counterparty
B
All components of the contracts are negotiated fully by the counterparties
C
All components of the contract are negotiated except the asset and the quantity which is set by the exchange
D
All participants are free from counterparty/credit risk
All components of the contracts are negotiated fully by the counterparties
Explanation
Forwards are OTC contracts and therefore there is no exchange involved and terms will be fully negotiated bilaterally between the parties involved. Whilst OTC contracts can be novated by a clearing house it is not a must and so there will be exposure to counterparty risk where clearing houses are not used.
54
Which of the following is false concerning Bermudan options?
```
A
They can only be exercised on specified dates
B
They can be exercised before expiry
C
They are generally over-the-counter products
D
They can be exercised more than once
```
They can be exercised more than once
Explanation
A Bermudan option can be exercised on expiry or on specified dates before expiry. However, they can only be exercised once.
55
A credit derivative contract is based on a:
```
A
Reference obligation
B
Reference asset
C
Reference entity
D
Nominated asset
```
Reference asset
Explanation
Credit default swaps offer protection for credit event involving a reference asset. Although a reference obligation (such as debt) could be a reference asset, B is the best answer here.
56
Which of the following is not a benefit of a trade capture and confirmation system, such as MarkitServ, for an OTC product?
```
A
Straight-through processing
B
Centrally located confirmations for both counterparties to check
C
Electronic production of deal tickets
D
Novation on a principal to principal basis
```
Novation on a principal to principal basis
Explanation
Trade capture and confirmation systems would not offer novation. This would be something offered by a clearing house.
57
When would the agreed amount be paid on a forward foreign exchange contract agreed over the counter?
```
A
On the date of the agreement
B
On a daily basis
C
On the fixing date
D
On the settlement date
```
On the settlement date
Explanation
The agreed amount would be paid on the agreed settlement date.
58
Company A is paying a fixed rate of interest on a loan to a bank. It wishes to hedge this position with a vanilla interest rate swap (IRS). Bank C negotiates the IRS and takes on the role of central counterparty. At the same time Bank C hedges their own position by entering into a floating for fixed IRS with Company B. What combination of events would create an unanticipated risk that Company A is exposing themselves to?
A
Company B falling into liquidation and Interest rates falling
B
Bank C falling into liquidation and Interest rates falling
C
Bank C falling into liquidation and Interest rates rising
D
Company B falling into liquidation and Interest rates rising
Bank C falling into liquidation and Interest rates falling
Explanation
Company A is paying floating and receiving fixed through the agreed swap. They want rates to fall and don't want rates to rise. Rates rising would be an anticipated risk of entering into the swap.
The question asks for an unanticipated risk. An unanticipated risk would be the interest rates falling - making money for Company A - but Bank C going into liquidation before it could hand over the money.
59
Novation moves which of the following risks?
```
A
Counterparty risk
B
Principal risk
C
Settlement risk
D
Trading risk
```
Counterparty risk
Explanation
The risk that the other side of the transaction will default is reduced
because it is replaced by one of the CCPs, both of which are well capitalised and have insurance
policies in place lessening the risk of default. This reduces the risk of systemic collapse of the
financial system.
60
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
```
Maintenance margin
Explanation
This is a description of a maintenance margin system where variation margin payments are netted-off against initial margin.
61
Which type of margin is used by an exchange when there are sudden changes in market volatility?
```
A
Initial
B
Variation
C
Spot month
D
Intra-day
```
Intra-day
Explanation
Intra day margin is used for emergency situations such as a sudden increase in volatility.
62
Collateral for initial margin payments deposited with a UK clearing house cannot be in which of the following forms?
```
A
Corporate bonds
B
Certificates of deposit
C
Bills of exchange
D
Treasury bills
```
Corporate bonds
Explanation
Only major government bonds and bills and cash based securities are permitted.
63
What adjustment is made to the calculated SPAN scanning risk to adjust for offsetting futures positions?
```
A
Spot month charges
B
Variation margin
C
Inter-commodity spread margin
D
Short option minimum charge
```
Inter-commodity spread margin
Explanation
When calculating scanning risk an adjustment is made to take account of inter-commodity spreads, e.g. long gilt future, short bund future. Because these two positions offset each others risk, at least to a certain extent, the adjustment is subtracted from scanning risk. Note that inter-commodity spread margin is also called inter-commodity credits.
64
What is the BEST definition of clearing?
A
Recording and matching trades and maintaining positions
B
Ensure legal obligations resulting from a trade are met
C
Continuous trading activity throughout the trading day
D
Using derivatives that will be physically-delivered
Recording and matching trades and maintaining positions
Explanation
This is a difficult question which is not particularly well worded. Technically speaking clearing and settlement are two separate processes. 'Ensure legal obligations resulting from a trade are met' best describes settlement and 'recording and matching trades and maintaining positions' is closer to the process of clearing, which describes what happens before settlement.
65
Which of the following best describes variation margin?
A
It is a cash deposit with a clearing house to cover adverse daily movements in futures positions beyond the previous day's closing price
B
It is cash deposited with a clearing house to cover the maximum likely daily loss arising from the futures contract
C
It is cash deposited with an exchange to cover the maximum likely daily loss arising from the futures contract
D
It is cash deposited with an exchange to cover the adverse movements in futures positions beyond a specified point
It is a cash deposit with a clearing house to cover adverse daily movements in futures positions beyond the previous day's closing price
Explanation
The BEST description of variation margin (VM) out of these choices is 'it is a cash deposit with a clearing house to cover adverse daily movements in futures positions beyond the previous day's closing price'. Variation margin would be a payment TO a clearing house if the futures position moves against its opening price. However, it would be paid FROM a clearing house if the price moved in the investor's favour. Initial margin is the margin taken by a clearing house to cover against the maximum daily adverse movement of the contract.
66
Which of the following is the best description of the principal-to-principal guarantee structure?
A
The guarantee extends from the customer to the clearing house
B
The guarantee operates between the customer and broker
C
The guarantee operates between the broker and the clearing member
D
The guarantee operates between the clearing member and the clearing house
The guarantee operates between the clearing member and the clearing house
Explanation
The clearing house guarantees trades between itself and the clearing member only.
67
If a member of a clearing house operating an independent guarantee defaults on payment of their obligations, which of the following is true?
A
The clearing house will use any funds of the other members only to pay the default
B
The clearing house will use any funds of the defaulting member to pay the default, then use other members' funds if there is any shortfall
C
The clearing house will use any funds of the defaulting member to pay the default amount, then cover the difference itself before making a claim on the member firm
D
The clearing house will use any funds of the defaulting member to pay the default amount, then cover the difference by making a claim on the member firm
The clearing house will use any funds of the defaulting member to pay the default amount, then cover the difference itself before making a claim on the member firm
Explanation
An independent guarantee is one where the clearing house will first use the funds of the clearing member and then be obliged to cover the difference themselves. Nevertheless, the clearing house will try to recover the shortfall from the defaulting member.
68
What adjustment is made to the calculated SPAN scanning risk to adjust for offsetting futures positions?
```
A
Spot month charges
B
Variation margin
C
Inter-commodity spread margin
D
Short-option minimum charge
```
Inter-commodity spread margin
Explanation
When calculating scanning risk an adjustment is made to take account of inter-commodity spreads: e.g. long-gilt future, short-bund future. Because these two positions offset each others' risk, at least to a certain extent, the adjustment is subtracted from scanning risk. Note that inter-commodity spread margin is also called inter-commodity credit.
69
The Singapore Exchange (SGX) has pioneered a mutual offset system (MOS) for Japanese Government bond (JGB) futures since 1984 with which other exchange?
```
A
Chicago Board of Trade (CBOT)
B
Chicago Board Options Exchange (CBOE)
C
ICE futures
D
Chicago Mercantile Exchange (CME)
```
Chicago Mercantile Exchange (CME)
Explanation
This system is also available for Nikkei 225, Eurodollar and Euroyen futures.
70
In SPAN, which of the following option positions can require variation margin payments?
```
A
Option buyers only
B
Option sellers only
C
Both option buyers and sellers
D
Neither the option seller nor buyer
```
Both option buyers and sellers
Explanation
It is possible for both buyers and seller of options to be charged variation margin. Buyers and sellers of options on futures pay variation margin.
71
Which of the following best describes the main role of TIMs?
```
A
Credit and counterparty risk management
B
Calculating option portfolio margins
C
Providing guaranteed settlement for derivatives positions
D
Facilitating hedging positions for fund managers
```
Calculating option portfolio margins
Explanation
TIMS is best used for calculating margin for option portfolios.
72
What is the name of the system that calculates margin payments of options and futures portfolios?
```
A
Universal Clearing Platform
B
Clearing processing system
C
Theoretical inter-market clearing system
D
Standard portfolio analysis of risk
```
Standard portfolio analysis of risk
Explanation
SPAN is the only system given that calculates margin payments. Other systems include TIMS (Theoretical inter-market margining system) and STANS.
73
Which of the following is a major role provided by ICE Clear Europe?
A
They guarantee the performance of contracts
B
They are responsible for an orderly market
C
They guarantee the availability of the underlying asset
D
They guarantee that no member will default
They guarantee the performance of contracts
Explanation
This is the major role of ICE Clear Europe.
74
Between the clearing house and a general clearing member, which of the following are true regarding exchange options on futures?
```
I
Premiums are paid upfront
II
Long-option positions are margined daily
III
Option positions are margined any time up to expiry
IV
Only short-option positions are margined
```
II and III
Explanation
Options on futures (buy or sell) are margined in the same way as futures contracts. Premiums are paid at exercise or expiry, whichever occurs earlier.
75
Spot month margin is best described as?
```
A
Additional variation margin in the delivery month
B
An intra-day margin call
C
Additional initial margin in the delivery month
D
Buffer margin
```
Additional initial margin in the delivery month
Explanation
Spot month margins occur in the delivery month and are charged in addition to initial margin. Therefore C is the best answer.
76
In the case of a member defaulting on the delivery or payment of a contract, which of the following would the UK clearing house access after the defaulting member's margin and the member’s contribution to the default fund?
```
A
The clearing house's insurance
B
The clearing house's own funds
C
Short-term loans from a BCD approved bank
D
Other member’s contributions to the default fund
```
Other member’s contributions to the default fund
Explanation
After the defaulting member's resources have been exhausted, other member's contributions to the default fund are used. If the default fund is used-up, the clearing house needs to cover any remaining losses, but this time the liability is unlimited.
77
Once a clearing house has performed novation, which of the following best describes the relationship between the parties involved?
A
The buyer remains contractually bound to the seller
B
The buyer remains contractually bound to the seller, but the clearing house guarantees that each will meet their obligations
C
The contracts of the buyer and seller are closed out, crystallising any profit or loss
D
The buyer and the seller each become contractually bound to the clearing house
The buyer and the seller each become contractually bound to the clearing house
Explanation
Novation is where the clearing house acts as central counterparty to the trade, dealing as principal to both sides.
78
Client A buys a future through Broker A. Client B sells the future through Broker B. Which of the following best describes the flow of variation margin?
```
A
Client A - broker A - client B - broker B
B
Client A - broker A - broker B - client B
C
Client A - broker A - client B
D
Client A - clearing house - client B
```
Client A - broker A - broker B - client B
Explanation
We are assuming here that the clients are not clearing members of the clearing house but the brokers are clearing members.
79
Which of the following is operated by a clearing house using a default fund?
```
A
Initial guarantee
B
Mutual guarantee
C
Independent guarantee
D
No guarantee
```
Mutual guarantee
Explanation
A clearing house provides mutual guarantees to its clearing members. This involves guarantees not only from the clearing house but also from its members. An independent guarantee, as operated by other clearing houses, is one which is backed by the clearing house alone.
80
What is the difference between the margin called by the clearing house and the margin arrangements between a private customer and their broker?
A
Variation margin is calculated on a daily basis
B
Single currency margining is used by the clearing house
C
The clearing house only uses a single system for payments and margin
D
The clearing house only uses a risk based approach
The clearing house only uses a single system for payments and margin
Explanation
Answer C is the best answer. To facilitate variation margin credits/debits all clearing members will be linked by a single payment system with the clearing house whereas brokers will use different systems with their clients.
81
Which statement best describes SPAN margin?
A
Maximum close-out cost of a defaulting member's positions
B
Maximum close-out cost of any individual position of a defaulting member
C
Minimum close-out cost of a defaulting member's position
D
Minimum close-out cost of any individual position of a defaulting member
Maximum close-out cost of a defaulting member's positions
Explanation
The margin requirements relate to the overall risk of a member defaulting, and may be reduced if the member has offsetting positions.
82
In relation to the order process, which is the correct order?
A
Trade verification, settlement and reconciliation
B
Reconciliation, trade verification and settlement
C
Settlement, trade verification and reconciliation
D
Trade verification, reconciliation and settlement
Trade verification, settlement and reconciliation
Explanation
This is an obscure question and the answer reflects the sequence in the CISI manual.
Correct order is: Trade verification Settlement Reconciliation
83
What is the main reason for an exchange declaring in the contract specifications the mechanism through which it will calculate EDSP?
A
To allow the investor to know the EDSP before opening a position
B
To ensure that the future's closing price is not affected by the cash price
C
To allow the investors to hedge against default
D
To ensure that price manipulation is avoided
To ensure that price manipulation is avoided
Explanation
The EDSP must be a fair representation of the underlying asset price on expiry, and to do this EDSP is disclosed to all in the contract specifications. This transparency is the best way to avoid any price manipulation of the contract up to expiry.
84
Which of the following is the best description of the difference between the last notice day and other days in the delivery month for the long gilt future?
A
The last notice day is the last day the contract can be traded
B
The seller cannot specify the delivery day
C
The exchange will specify the grade of asset to be delivered
D
There are no differences
The seller cannot specify the delivery day
Explanation
On any other delivery day a short can specify the delivery day. On the last notice day the delivery day is specified (T +1).
85
A broker-dealer has been assigned an exercise notice by the OCC; the firm may assign the notice to a customer by any of the following methods, except:
```
A
To the customer with the largest short-position
B
On a FIFO basis
C
On a random basis
D
By any method that is fair and equitable
```
To the customer with the largest short-position
Explanation
The OCC chooses a broker-dealer at random to assign an exercise notice; the broker-dealer can choose a customer by any fair and equitable method with FIFO (first in, first out) or randomly being the most widely used methods. Choosing the customer with the largest short-position would not be fair and equitable.
86
The correct calculation of the invoice amount for the cheapest to deliver (CTD) is as follows:
A
(EDSP x scale factor x price factor) - accrued interest
B
(EDSP x scale factor x price factor) + accrued interest
C
(EDSP x scale factor / CTD price factor)
D
(Price of underlying x price factor x scale factor) + accrued interest
(EDSP x scale factor x price factor) + accrued interest
Explanation
The invoice amount is what the long futures position pays when taking delivery of the 'cheapest to deliver' gilt. Note: The CTD is the gilt with the highest implied repo rate.
87
A trader enters into a contract to buy 25 tonnes of lead at $890 per tonne in three months' time on the London Metals Exchange (LME). If on the delivery the settlement price is calculated at $860 per tonne, how much will the trader pay for delivery of the contract?
```
A
$22,250
B
$21,875
C
$21,500
D
$750
```
$21,500
Explanation
The trader will pay $21,500 for delivery of the contract ($860 x 25 tonnes). The $860 will be used rather than the $890 as variation margin will have covered the difference.
The $860 will be referred to as EDSP (exchange delivery settlement price).
88
Once a notice of intention to deliver has been filed with the clearing house in respect of the long gilt future, which of the following occurs?
A
The long decides which bond should be delivered
B
The short decides which bond to deliver during the delivery month
C
The clearing house decides which bond should be delivered
D
The long decides which bond to deliver on the delivery date
The short decides which bond to deliver during the delivery month
Explanation
The short will decide which bond, from a list of deliverable bonds, to deliver. This can be delivered on any day during the delivery month.
89
A warrant on LME:
A
Gives right of possession to a specific lot of deliverable metal
B
Is the name given to a long-hedge
C
Is the final settlement for cash-cleared LME contracts through SWORD
D
Is the electronic transfer of cash within SWORD for physically-delivered contracts
Gives right of possession to a specific lot of deliverable metal
Explanation
Ownership of warrants is used to prove ownership of deliverable metal.
90
Which of the following spreads would be best used in anticipation of a major announcement by a commodity producer?
```
A
Diagonal spread
B
Horizontal spread
C
Bull call spread
D
Bear put spread
```
Horizontal spread
Explanation
There are two basic types of horizontal spreads. The first is based on the view that volatility will fall. The spread takes advantage of the fact that short-dated options will lose their time value faster, and therefore react quicker to a fall in volatility.
The second type of horizontal or calendar spread is based on the view that volatility, particularly short-term volatility, will rise. This strategy is used most often ahead of key announcements, such as companies' earnings reports or central bank meetings, to take advantage of any dramatic short-term moves that may occur from the news.
91
An investor believes that the price of a share will stay at 240 between now and the expiry date. What strategy should he adopt to get the most profit available?
```
A
Long-put
B
Short-call
C
Short-straddle
D
Long-straddle
```
Short-straddle
Explanation
The short-straddle can be used to profit from low volatility (compared to that implied by the option premiums). This is the best answer as the questions suggest that volatility will be low.
92
How many bond futures would be traded to hedge an anticipated holding of £50m nominal of the cheapest to deliver bond? The contract size is £250,000 and the price factor of the CTD is 1.112233, the notional coupon is 6%.
```
A
180
B
200
C
222
D
247
```
222
Explanation
(50m / 0.25m) x 1.112233 = 222
93
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
```
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.
94
Erica writes a 90 strike put and a 90 strike call. This strategy is known as a:
```
A
Long-strangle
B
Short-strangle
C
Short-straddle
D
Long-straddle
```
Short-straddle
Explanation
Long-strangle - buy call and put - different strikes.
Short-strangle - sell call and put - different strikes.
Short-straddle - sell call and put - same strike.
Long-straddle - buy call and put - same strike.
95
Which of the following best describes the formula for hedging a holding of the cheapest-to-deliver (CTD) bond using gilt futures?
A
(nominal value of CTD/face value of future) x pricing factor
B
(nominal value of CTD/face value of future) x 1/pricing factor
C
(face value of future/nominal value of CTD) x pricing factor
D
(face value of future/nominal value of CTD) x 1/pricing factor
(nominal value of CTD/face value of future) x pricing factor
Explanation
This is a common question.
96
An investor writes 10 puts on a long gilt future with a strike price of 105.00 at a premium of 10p per contract. At the same time the investor also sells 10 long gilt futures at 105.25. On expiry of the options, the future is trading at 104.25. Assuming all options are exercised and all positions closed out, what profit or loss is made?
```
A
15p loss per contract
B
25p loss per contract
C
35p profit per contract
D
90p profit per contract
```
35p profit per contract
Explanation
The investor has two positions: short puts on a long gilt future and short positions in the long gilt future.
As the writer of the put, the investor receives the premium of 10p per option. If the option is exercised, the investor will receive a long position in the long gilt future at 105.00. When this occurs it will close out the short positions originally opened at 105.25,
Long at 105.00 and short at 105.25 gives a 25p profit. Remember, the investor also gained 10p premium on the options, taking his profit to 35p.
NOTE: the contract is somewhat confusingly called the 'long gilt future' and you can be long the 'long gilt future' or short the 'long gilt future'.
97
A fund manager is long a portfolio of the cheapest to deliver bond (CTD) worth £20m. The contract size is £100,000 and the price factor 1.043375. How does he hedge his position?
```
A
Buy 209 futures
B
Sell 209 futures
C
Buy 192 futures
D
Sell 192 futures
```
Sell 209 futures
Explanation
As he is long the bond, we need to do a short hedge and sell the contract.
To calculate how many to sell we:
Portfolio value / contract size x price factor
£20,000,000 / £100,000 x 1.043375 = sell 209 futures
98
A UK investor is long 8 greasy wool contracts quoted on ASX at a price of 1,000 cents per kilogramme. The contract currency is AUD. The contract size is 2500kg; the tick size is 1 cent for a 1 kg movement. The GBP/AUD exchange rate is 1 GBP = 1.5206 AUD. The full contracted amount would be:
```
A
200,000 AUD
B
25,000 AUD
C
16,441 GBP
D
131,527 GBP
```
200,000 AUD
Explanation
As this question asks for the contract amount, the exchange will calculate in the currency of the contract using the EDSP of 1,000 cents or AUD10.00 as follows: AUD 10.00 x 2500 kg x 8 contracts = AUD 200,000
99
Where would a unit trust manager set out the objectives and strategies in relation to derivatives?
```
A
Articles of association
B
Trust deed
C
Instrument of incorporation
D
The collective investment scheme sourcebook
```
Trust deed
Explanation
The objectives and strategies would be set out in the trust deed. An investment company with variable capital (ICVC) would use an instrument of incorporation. Both, if they wish to be regulated funds, would need to refer to the collective investment scheme sourcebook, set out by the FCA.
100
The price of a March gilt future is 104.10. The June future is priced at 105.35. An investor expects the spread to narrow. She should:
```
A
Buy March and buy June
B
Buy March and sell June
C
Sell March and buy June
D
Sell March and sell June
```
Buy March and sell June
Explanation
It is expected that:
1. March futures will increase in price relative to the June contract
2. June futures will decrease in price relative to the March contract
101
Selling futures against the delivery of the underlying asset such as cocoa is which type of strategy?
```
A
Arbitrage
B
Hedging
C
Speculation
D
Repo
```
Hedging
Explanation
Selling futures when you are taking delivery of the underlying is a way of hedging your exposure to fluctuating prices.
102
An option credit spread is:
A
Purchase and sale of a different strike and same expiry put options. This will cause a net initial credit.
B
Purchase and sale of different expiry options. This will cause a net initial debit.
C
Selling both a put and call for the same underlying asset
D
Purchase and sale of the same strike and expiry call options. This will cause a net initial credit.
Purchase and sale of a different strike and same expiry put options. This will cause a net initial credit.
Explanation
An initial credit is created when a (out-of-the-money) low strike put is purchased and a high strike put (in-the-money) is sold.
103
The regulator of US derivatives exchanges is:
```
A
NFA
B
SEC
C
CFTC
D
CSCE
```
CFTC
Explanation
The CFTC provides government oversight for the futures industry in the US.
104
A client moves into physically delivered OTC traded commodity derivatives. Which of the following statements is true in relation to the application of MiFID?
```
A
MiFID will always apply
B
MiFID will apply if the client is an eligible counterparty
C
MiFID will apply if the client is a professional client
D
MiFID will never apply in this situation
```
MiFID will always apply
Explanation
MiFID does not cover derivatives used for commercial (risk management) purposes, but does cover the trading of commodity derivatives for non-commercial or speculative uses. This includes physically delivered OTC derivatives.
105
Which statement about the NFA is false?
```
A
They regulate US derivative trading
B
They resolve disputes
C
They are an SRO
D
They regulate all US exchanges
```
They regulate all US exchanges
Explanation
For derivatives, the SEC regulates the CBOE.
106
Which of the below body is responsible for the conduct of a deposit taking institution?
```
A
FCA and PRA
B
FCA
C
PRA
D
BOE
```
FCA
Explanation
In relation to deposit takers, insurance companies and significant investment firm, these are considered dual regulated. This means in relation to prudential regulation, PRA ensures regulation but in relation to conduct the FCA will ensure regulation is met.
107
Which of the below is false? EMIR introduced:
A
Reporting obligation for OTC derivatives
B
Clearing obligation for eligible exchange traded derivatives
C
Common rules for central counterparties (CCPs) and for trade repositories
D
Rules on the establishment of interoperability between CCPs
Clearing obligation for eligible exchange traded derivatives
Explanation
All exchange traded derivatives have to be cleared through a CCP but this was not introduced by EMIR. The new regulations have specifically targeted the OTC markets.
108
Which of the below is not a major role or aim of regulation?
```
A
Maintain orderly markets
B
Provide protection for members of the public
C
Ensuring a financial firm is stable and does not go into liquidation
D
Reduction of crime
```
Ensuring a financial firm is stable and does not go into liquidation
Explanation
The regulation should make sure the markets are stable and perhaps firms keep adequate capital so the effect of a collapse is minimised. Regulations do not ensure that firms never fail but that if they do, the effects are minimised through imposing the right level of capital requirements.
109
What is the objective of the EU transparency directive?
A
To ensure the market is aware of the prices of all trades
B
To promote and improve the reputation of financial services firms
C
To establish minimum requirements on periodic financial reporting
D
To promote and improve the reputation of the financial services industry
To establish minimum requirements on periodic financial reporting
Explanation
This is the main objective of the transparency directive.
110
Which piece of legislation states that regulation of single stock futures should be a joint effort between the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC)?
```
A
Commodity Exchange Act
B
Commodities Futures Modernisation Act
C
Commodities Futures and Hedging Modernisation Act
D
Securities and Futures Act
```
Commodities Futures Modernisation Act
Explanation
The Commodities Futures Modernisation Act made the regulation of single stock futures a joint effort between the CFTC and SEC.
111
Which of the following is the main US regulator for the futures markets?
```
A
NFA
B
SEC
C
NASD
D
CFTC
```
CFTC
Explanation
Overall responsibility for the futures markets lies with the CFTC. Responsibility for regulating firms but not exchanges is delegated to the NFA.
112
Which of the following describes the most important benefit of using a Trade Repository?
```
A
To agree the terms of a trade
B
Speed up settlement of transaction
C
To provide a transparent record
D
Ensure central counterparties are used
```
To provide a transparent record
Explanation
This is seen as the most important as far as regulators are concerned.
113
Who is the regulator of US stock indices?
```
A
CFTC
B
NFA
C
NYSE
D
SEC
```
SEC
Explanation
The SEC is responsible for overseeing securities in America.
114
Under the Commodities Futures Modernization Act 2000, who has the responsibility to regulate single stock futures?
```
A
SEC
B
CFTC
C
SEC and CFTC
D
NASD
```
SEC and CFTC
Explanation
Under CFMA 2000 there is joint regulation of single stock futures between the Securities and Exchange Commission and the Commodity Futures Trading Commission.
115
Under CFTC Part 30, if a UK firm wishes to trade with a US client, it must:
```
A
Trade on a US exchange
B
Be accompanied by an NFA registered firm
C
Be registered with the SEC
D
Sign an exclusion of liability policy
```
Be accompanied by an NFA registered firm
Explanation
Part 30 prohibits direct contact between non-US firms and US clients.
