What financial instrument is derived from the value of an underlying asset?
Answer(s): B
A forward contract is a derivative instrument whose value is derived from the value of an underlying asset, such as commodities, currencies, or financial instruments. It is a customized agreement between two parties to buy or sell an asset at a future date at a specified price.Why Other Options are Incorrect:A . Real estate investment trust: A REIT is an equity instrument tied to real estate assets, not a derivative.C . Preferred share: A preferred share is an equity security with fixed dividends, not a derivative.D . Inflation-linked bond: These are fixed-income securities linked to inflation rates but are not considered derivatives.
CSC Volume 1, Chapter 10, "The Role of Derivatives Forward Contracts" describes forwards as derivatives dependent on underlying assets.
When a company issues a number of common shares, some of which are held by institutional investors, what are the institutional investors' shares known as?
Answer(s): D
The shares held by institutional investors, along with other shares available for trading by the public, are referred to as the public float shares. These are the issued shares of a company that are actively traded in the market, excluding restricted shares held by insiders or strategic investors.Other options:Issued shares: Includes all shares a company has issued, including restricted shares.Outstanding shares: Includes all shares held by all shareholders, including restricted shares and shares not available for trading.Market capitalization shares: Not a term used to describe shares; market capitalization is a measure of a company's total value based on its stock price and outstanding shares.
Volume 1, Chapter 8: Equity Securities, section on "Public Float and Market Capitalization" explains the concept of public float shares.
When a futures contract is entered into, who sets the minimum initial margin rate?
The exchange that lists and trades the futures contract sets the minimum initial margin rate. This margin is required as collateral to ensure performance under the contract. The exchange determines this rate based on the volatility and risk of the underlying asset, and it is subject to adjustment depending on market conditions.Other options:Investment dealer: Acts as a facilitator but does not set the margin rates.Buyer/Seller: Must meet the margin requirements but do not set them.
Volume 1, Chapter 10: Derivatives, section on "Futures Contracts" describes the role of exchanges in setting margin requirements.
What bond should an advisor recommend to someone who wants to hold bonds and maximize potential cap-tai gams when interest rates are expected to fall?
A long-term bond with a low coupon will maximize capital gains when interest rates fall. Here's why:Long-term bonds are more sensitive to interest rate changes due to their longer duration, which amplifies the price movement.Low coupon bonds are more affected by changes in interest rates compared to high coupon bonds because more of their value comes from the principal repayment rather than periodic interest payments.Other options:Short-term bonds: Have lower duration and less sensitivity to interest rate changes, so they do not maximize capital gains.High coupon bonds: Are less sensitive to interest rate changes because of their higher periodic cash flows.
Volume 1, Chapter 7: Fixed-Income Securities: Pricing and Trading, section on "Impact of Maturity and Coupon on Bond Prices" explains the relationship between interest rate changes, bond duration, and price sensitivity.
Which derivatives transaction has the greatest default risk?
An interest rate forward agreement (FRA) is an over-the-counter (OTC) derivative contract. Unlike exchange-traded derivatives, OTC contracts are not centrally cleared, meaning there is no intermediary to guarantee performance. This increases counterparty (default) risk, making FRAs inherently riskier than exchange-traded contracts.Why Other Options are Incorrect:A . Individual investor buying shares on an exchange during the ex-rights period: This is a standard transaction involving equity securities, not derivatives, and carries no default risk.C . Exchange-traded equity option contract between an individual investor and a dealer: Exchange- traded derivatives are backed by a clearinghouse, which mitigates default risk.D . Individual investor entering a futures contract with an institutional investor: Futures contracts are also exchange-traded and centrally cleared, reducing default risk.
CSC Volume 1, Chapter 10, "The Role of Derivatives Counterparty Risks in OTC Contracts" explains the higher default risk associated with OTC derivatives like FRAs.
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