Pass the PRMIA PRM Certification 8006 Questions and answers with CertsForce

The price of a treasury bill can be calculated as [Future value / (1 + yield x days-to-maturity/365)] = 100/(1+5%*90/365) = $98.78.

Choice 'a' is the correct answer as the issue of the floating rate note will provide the utility with the funds it needs, and the interest rate swap would offset the floating rate payment and leave it with a net fixed payment.

Choice 'd' is incorrect as the swap is in the wrong direction.

Choice 'c' is incorrect as buying and selling a floating rate bond would mean the utility will not have any funds that it wants to issue the note for, and combining it with interest rate futures would be just absurd.

Choice 'b' is incorrect as buying a floating rate note would use funds while the utility is trying to raise funds.

A fixed for floating interest rate swap would be the most appropriate to the company's needs. It will allow it to receive a fixed rate (which will offset the fixed payment it has to make on the loan) and pay a floating rate which it expects will be lower than the fixed rates. Choice 'a' is the correct answer.

Answer:

The efficient frontier is plotted on a graph with portfolio return (mean) as the y-axis and portfolio volatility, or standard deviation, on the x-axis. For a given level of volatility, it identifies the portfolio with the maximum return. Therefore Choice 'b' is the correct answer.

If a reading is taken from the y-axis (ie returns) by dropping a perpendicular line on to the efficient frontier, we can get the minimum risk portfolio for the given level of returns. So the efficient frontier can be used to identify either the highest return per unit of volatility, or the lowest volatility given a desired level of returns. The efficient frontier does not describe the market portfolio, though the market portfolio may be one of the many points on the efficient frontier. Thus the other choices are incorrect.

The Sharpe ratio does not require investors to be risk neutral, only that for a given level of returns they prefer less risk to more risk. (Risk neutral means that investors are indifferent to the level of risk, and are only driven by a desire to maximizing expected value, regardless of risk levels.)

The ability to borrow and lend any amounts of money at the risk free rate is a fundamental assumption for the rule that optimal portfolios will maximize the Sharpe ratio.

This rule also assumes that risk preferences are completely described by return and standard deviation of returns.

Therefore Choice 'd' is the correct answer as statements I and II are correct.

Forward currency rates can be calculated as Spot rate x (1 + rate in domestic currency)/(1 + rate in foreign currency), where the spot rate is the 'direct' rate. Direct rates are rates that are expressed as the number of domestic currency units that it takes to buy 1 unit of the foreign currency. In this case, considering the US the domestic currency, then the forward rate is given by 0.7 * 1.02/1.035 = 0.6899. Therefore Choice 'b' is the correct answer.

The efficient markets hypothesis states that all known information is captured in the prices of a security. It does not explain the shape of the yield curve.

The expectations hypothesis, the LPT and the market segmentation theory are all attempts to explain the shape of the term structure of interest rates.

Therefore Choice 'c' is the correct answer as it does not explain the shape of the yield curve.

The OTC market for foreign exchange is indeed much larger than the exchange traded futures market for FX. Therefore statement I is correct.

Delivery-versus-payment (DVP) arrangements make sure that title to a security passes only when payment has been made, and these arrangements, usually implemented through national clearing agencies such as the DTC in the US, help avoid the risk of counterparty defaults.

Electronic Clearing Networks (ECNs) offer cheaper trading costs than exchanges, in fact that is their primary attraction. Exchanges offer other advantages, but lower trading costs is not one of them.

ISDA master agreements provide templates that a large number of OTC market participants use to standardize their OTC trading activities. Therefore statement IV is correct.

According to the CAPM, the expected return from a risky asset is a function of the contribution of the risky asset to the total risk of the market portfolio. Nothing else matters. All assets are priced according to the risk they bring to the market portfolio, regardless of their individual level of risk. An asset that is very volatile on its own, but has a negative correlation to the market may be priced high, ie have low expected return, because of its impact on the risk of the market portfolio. Therefore Choice 'a' is the correct answer, and the other options are incorrect.

Recall that according to the CAPM β = covariancex, y / variancex, where x is the market portfolio and y is the risky asset.

The beta itself is a function of the covariance of the asset's returns with market returns, and therefore only the driver of expected return for an asset is its beta, which is determined by the asset's contribution to portfolio risk. (β = covariance(x, y) / variance(x), where x is the market portfolio and y is the risky asset. )

Investors have differing view of the market, which means differing view of expected returns, correlations and volatilities. Not only do they have differing views, these views change frequently as new information reveals itself. Accordingly, each investor has their own version of the efficient frontier. Once investors have determined their efficient frontiers, they will determine the extent of risk they wish to hold. If they had identical views, they would have held the same portfolio. But they do not, and if they did, there would be very little trading in the markets.

All the above statements are true except statement I which is false due to differing investor expectations.

(Re statement IV: If investors have different risk appetites, their portfolio will vary in the split between the risky and the riskfree assets. But inside the 'risky' assets bundle the proportion of the assets will be identical. Ie, they would express their varying risk appetites by varying how much of the risky bundle and the riskfree asset they hold, but inside the risky bundle the proportion of the different risky assets will be the same.)