Pass the PRMIA PRM Certification 8006 Questions and answers with CertsForce

Explanation:

If the spot rate is 1.1010 and the forward is 1.1040, the swap rate is 30 "points" (= 1.1040 - 1.1010). The annualized swap premium is the swap premium divided by the spot rate, and therefore =0.0030/1.1010 =0.27%, or 27 basis points.

Swaps rates are calculated such that the swap's value at inception is zero. Therefore statement I is correct and statement II is incorrect. OTC swaps are not standardized, in fact they are customized by the parties to suit their needs, which is why they are over-the-counter. Therefore statement III is incorrect. It is correct that interest rate and commodity swaps are the most traded, and statement IV is correct.

Therefore Choice 'c' is the correct answer.

Standard deviation of this portfolio can be calculated as SQRT(4000^2*20%^2 + 6000^2*25%^2 + 2*0.6*4000*6000*20%*25%), which is equal to $2,081. Choice 'a' is the correct answer. The other answers are incorrect.

A utility function provides a description of an individual or a firm's risk attitude. It expresses how risk seeking or risk averse a firm or an individual is. The utility function would explain differences between risk seeking and risk averse behavior, for example, as an individual becomes richer, he may seek (or shun) risk more than before. A utility function incorporates all of this, and therefore Choice 'd' is the correct answer.

To answer this question, we need to look at the put-call parity, which can be expressed as:

Value of call - Value of put = Spot price - Exercise price discounted to the present

or, Value of call - Value of put = Stock - Bond with a future value equal to exercise price

Therefore, a long call and a short put is equivalent to a long stock position and a short bond.

Choice 'a' is therefore the correct answer. (Alternatively, we could also have constructed a graph of the payoff profiles to arrive at the same answer).

The put-call parity makes sure that all else remaining equal, an increase in the value of a call option will be accompanies by an increase in the value of the corresponding put option.

Simply stated, the put-call parity can be expressed as:

Value of call - Value of put = Spot price - Exercise price discounted to the present

The two terms on the right hand side of this equation are fixed. Therefore, for the equality to be maintained, any increase in the value of the call option on the left hand side has to be accompanied by the value of the put.

Choice 'c' is therefore the correct answer.

In an interest rate swap, only the net payment is made. In this case,

- the customer pays the bank 4%*(3/12)*$100m

- the bank owes the customer (2% + 100bp))*(3/12)*$100m

Therefore the customer pays (4% - (2% + 100bp))*(3/12)*$100m. 3/12 represents the 3 month time interval. This is equal to a net payment of $250k from the customer to the bank. Therefore Choice 'c' is the correct answer and the rest are incorrect.

The forward rate from year 2 to year 3 in this case can be derived as =(1.05^3/1.04^2) - 1, or 7.03%. All other answers are incorrect.

The principle of maximum expected utility requires maximizing the expected utilities of the different possible outcomes of a gamble weighted according to the probabilities of their occurrence. This is very difficult to apply in practice in the financial markets where utility functions and various other inputs for maximizing expected utility are not known. Markowitz suggested the mean-variance criterion as a simplification of the principle of maximum expected utility, and it can be shown that the mean-variance gives a good approximation when the range of outcomes under consideration does not exceed plus or minus one coefficient of risk tolerance. (Recall that the coefficient of risk tolerance is the value of x where the gambler is indifferent between equal probabilities of winning x or losing x/2.)

The futures price of the contract will be the future value of the spot price, calculated at a net rate equal to the cost of funding the futures position, less any dividends or other distributions. Also note that when rates are continuously compounded, Future Value = Present Value x (exp(rate x time)).

Therefore in this case the futures price for the S&P = 1000 * exp((5%-2%)*3/12) = 1007.53