Free CISI Derivatives mock exam

Not quite. The answer is C.

A chooser option is an exotic option that allows its holder to decide, at a predetermined time during the option's life, whether it is a call or a put. An Asian option settles against the average price of the underlying over an agreed period. A Bermudan option can be exercised on a set of specified dates during its life, which puts it between the American and European styles. A lookback option lets the holder exercise at the most favourable price the underlying reached during the option's life, the lowest for a call and the highest for a put.

Not quite. The answer is B.

A holder of three existing shares at 262p takes up one new share at 178p, so four shares cost 786p plus 178p, a total of 964p. Dividing that total by the four shares now held gives a theoretical ex-rights price of 241p. The figure of 199p comes from weighting the issue price by the three existing shares and the cum price by the one new share, which reverses the two weights. The figure of 220p is the simple average of 262p and 178p, which ignores the fact that only one share in four is bought at the discounted price. The figure of 262p is the cum rights price left unadjusted, and the share cannot trade there once the value of the rights has been stripped out.

Not quite. The answer is A.

A give-up agreement is signed by the client, the broker who executes and the broker who clears, and it is the clearing broker that decides whether to take the trade into the client's account. Acceptance is not automatic: a trade that breaches the limits set for that client, or that falls outside the products covered by the agreement, can be rejected. Until it is accepted the trade sits on the executing broker's books, and the executing broker carries the position and funds the margin on it, which is the main risk in the arrangement. The executing broker cannot make the other firm take the trade, so it has no power to accept on its own behalf. The clearing house registers whatever its clearing member presents to it and takes no view on which client account a trade belongs in. Nor is the decision a joint one, as the agreement gives the clearing broker alone the right to refuse and leaves the executing broker to present the trade

Not quite. The answer is A.

A dividend paid on the underlying takes value out of the share on the ex-dividend date, and the call holder does not receive it, so a larger expected dividend lowers the forward price the call is written against and lowers the call premium. The same rise in expected dividends works the other way on a put, whose premium increases. Higher volatility widens the range of possible outcomes at expiry and raises the premium of calls and puts alike, so it cannot be the answer. Higher interest rates raise the cost of carrying the underlying and lift call premiums, again in the wrong direction. More time to expiry gives the underlying longer to move through the strike and adds time value, so it raises the call premium rather than reducing it.

Not quite. The answer is D.

The threshold is the unsecured exposure each party is willing to run before any collateral is called, so only the amount above GBP 2,000,000 is ever collateralised. Here the mark to market of GBP 2,100,000 leaves an excess of GBP 100,000. The minimum transfer amount then blocks any call smaller than GBP 250,000, which keeps small movements from generating a stream of trivial payments, so nothing is delivered on this valuation. Calling the full mark to market ignores the threshold entirely and would collateralise exposure the parties have agreed to leave unsecured. Calling the excess over the threshold gets the method right but forgets that GBP 100,000 falls under the minimum transfer amount. Calling the minimum transfer amount treats that figure as a fixed payment rather than as a floor below which no transfer is made.

Not quite. The answer is D.

A central counterparty becomes buyer to every seller and seller to every buyer, acting as principal to both sides of each contract it registers. That is why a member default does not leave the other side without a contract, since the central counterparty guarantees performance. A custodian holds assets, such as securities lodged as collateral, but does not take on either side of a trade. A prime broker provides services such as financing, securities lending and custody to clients such as hedge funds. A trade repository receives reports of derivative contracts under EMIR but is not a party to them.

Not quite. The answer is B.

The point of the front to back check is to prove that every deal the dealers believe they have done has reached the books at the same terms, and that nothing has been booked which they did not do. Breaks found this way are usually miskeyed prices, wrong sides or missing tickets, and they are corrected before positions and profit and loss are reported. Comparing clearing house margin with margin held from clients is a margin reconciliation, run by the settlements team for a different purpose. Comparing exchange positions with central depository holdings is a stock or position reconciliation and does not test what the dealers actually traded. Checking valuation prices against exchange closing prices is part of price verification, which supports the daily profit and loss rather than the trade record.

Not quite. The answer is A.

An OTC contract is priced by the counterparty and never appears on a public tape, so the user has no independent market price against which to value the position or to test whether the rate it was quoted was a fair one, and it falls back on the dealer's own marks or on a third party valuation. That loss of transparency is what a user pays for the flexibility of dealing away from an exchange. Matching the contract to the exposure is the opposite way round: an exchange contract comes in fixed lot sizes and fixed delivery months and leaves a remainder unhedged, while an OTC contract can be written for the exact amount and date. Initial margin with a clearing house is an exchange traded feature, and although the uncleared margin rules now make large users exchange initial margin bilaterally, that margin is held with a third party custodian and not by a clearing house. Reporting to the exchange is likewise an exchange feature, since an OTC trade is reported to a trade repository rather than to a market that never saw it.