Free Practice Questions for PRMIA 8006 Exam

From the put-call parity, we know that Call - Put = Stock - Bank deposit. Since the bank deposit has a zero Gamma, and the Gamma of the Stock itself is also 0, we get the relationship Gamma of Call - Gamma of Put = 0. Therefore, if the Gamma of a call option is 0.08, the Gamma of the corresponding put option is also 0.08.

The 'running yield' refers to the coupon rate divided by the current price. In this case, it is 6/96 = 6.25%. Remember that the running yield is also called the current yield.

The dividend payment has a present value of $2.20*e^( -6%*6/12) = $2.14. Therefore the forward price for delivery 9 months hence should be ($102 - $2.14)*e^(7%*9/12) = $105.25

Price quotes for futures where one of the currencies is the US dollar follow the convention of using the number of US dollars that one unit of the foreign currency can buy. (For JPY, 100 Yen is used.)

In the forward market, the convention used is the same as that used in the spot market.

In the spot market, prices are expressed as the number of units of the foreign currency that 1 USD can buy, except for GBP, EUR, AUD and NZD where it is the other way round (ie, number of USDs that 1 of each of these currencies can buy).

The crack spread is the difference between the price of refined products and crude oil. An option on the crack spread can protect a refiner from both a fall in the price of its output and a rise in the price of its inputs. Calendar spreads are options with different maturities. Crude oil futures and swaps only protect against an adverse change in the price of crude, and not that of refined products. Choice 'b' is the correct answer.

The dates on which the interest rates applicable to the floating rate leg of an IRS are determined are called 'reset dates'. Choice 'c' is the correct answer, the other choices are incorrect. Settlement date is the date a transaction settles, normally a few days after the trade is done depending upon the market. Trade date is the date the terms of the transaction are agreed. (Settlement normally happens on T+n, where T is the trade date, and n the number of days to settlement as decided by agreement or market convention.)

The investor would benefit from the risk reversal and the bull spread as both these strategies have a payoff profile that benefit from rising prices of the underlying. The collar is the opposite of risk reversal, and benefits during a bear market, and the butterfly spread benefits when prices remain range bound. Therefore Choice 'c' is the correct answer.

To solve this question, we need to revisit how delta is calculated in a single step binomial model:

Consider a portfolio with just two positions: 1 Long Call option, and Δ Short Stock. We do not know what Δ (Delta) is.

Now if the current price of the stock is P, which can take the value P2 (higher value) and P1 (lower value) in the future at time T, then Δ needs to be such that the value of the portfolio is equal in both the cases. If the price goes up, the value of the option will be $1 (given) and the value of the short stock will be -Δ P2. If the price goes down, the value of the option will be $0, and the value of the stock will be -Δ P1.

Therefore, $1 - Δ P2 = $0 - Δ P1.

Solving for Δ, we get Δ = $1 /(P2 - P1) = $1 / ($102-$98) = 1/4.

Implied volatilities are the same for calls and puts with similar exercise and strike prices. If not, it would offer an arbitrage opportunity. Therefore Choice 'b' is the correct answer.

The operating free cash flows can be considered a perpetual annuity with a given growth rate.

The value of a perpetuity of a periodic cash flow of 'c', with a discount rate 'r' and growth rate 'g' is given by c/(r - g). In the given case, the company can be considered as providing a perpetual annuity which provides an annual cash flow of $100 which are growing at 2.5% (equal to the GDP's growth rate, as given), and whose cost of capital, or the discount rate to use, is 7.5%

Therefore the value of the firm in this case is given by $100/(7.5% - 2.5%) = $2,000. Recall that the value of the firm is equal to the Operating Free Cash Flow/Weighted Average Cost of Capital (OFCF/WACC). Therefore Choice 'd' is the correct answer.