Most Recent PRMIA 8006 Exam Dumps

THIS QUESTION REQUIRES US TO USE THE CAPM.

RECALL THAT ACCORDING TO CAPM THE EXPECTED RETURN ON AN ASSET = THE RISK FREE RATE + X MARKET RISK PREMIUM.

USING THE BETA AND EXPECTED RETURN OF SECURITY A, WE CAN DETERMINE THE MARKET RISK PREMIUM TO BE (8% - 3%)/1.2 = 4.1667%. THE EXCESS RETURN IS THE RETURN OVER THE RISK FREE RATE, AND FOR SECURITY B, THIS IS NOTHING BUT THE BETA MULTIPLIED BY THE MARKET RISK PREMIUM. THEREFORE THE CORRECT ANSWER IS 4.1667% X 1.5 = 6.25%. NOTE THAT THIS IS THE 'EXCESS RETURN', AND NOT THE TOTAL RETURN. (TOTAL RETURN WILL INCLUDE THE RISK FREE RATE).

Macaulay duration is the weighted average of the present value of payments received on a bond, weighted by the year in which the payments are received. If the yield curve changes shape, it will change the present values of the coupons and therefore also the Macaulay duration. Statement I is therefore not correct. However, if the bond were to be a zero-coupon bond, changes in the curve will not affect its duration so long as the interest rate at maturity stays constant.

Modified duration = Macaulay Duration/(1 + rate/compounding frequency). Therefore modified duration will change if the compounding frequency changes, assuming the nominal rate of interest for the coupons are identical. Therefore statement II is correct. When rates are expressed as continuously compounded rates, modified duration and Macaulay duration will be identical. This intuitively follows from the formula for modified duration: Modified duration = Macaulay Duration/(1 + rate/compounding frequency). For continuously compounded rates, the compounding frequency approaches infinity, so the denominator approaches 1, leaving modified duration equal to the Macaulay duration. Therefore statement III is correct.

Convexity is higher for a bond that has its payments spread out compared to a bond that has its payments concentrated at a single point in time. For a bond with a higher coupon, the higher coupons have the effect of spreading the present value of the bond over a longer period, when compared to a bond with lower coupons where the payment is comparatively more concentrated at the maturity. Therefore Convexity is higher for a bond with a lower coupon when compared to a similar bond with a higher coupon. Statement IV is not correct.

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.

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.

The correct answer is Choice 'b', as this question is merely asking for the forward rate based on known spot rates. The forward rate applicable to the three month period commencing in 3 months time is given by [(1 + 6%*6/12)/(1 + 5%*3/12) - 1]*4 = 6.91%. Thus Choice 'b' is the correct answer.

Here is a step by step way to think about it: $1 invested now at 6% for 6 months grows to (1 + 6%*6/12)=1.03. At the same time, using the 3 month rate, $1 invested now at 5% for 3 months grows to (1 + 5%*3/12)=1.0125. Effectively, this means that the 1.0125 at the end of 3 months grow to 1.03 at the end of 6 months, implying the rate of interest during the 3 months from 3 to 6 months is (1.03/1.0125 - 1)*4 = 6.91%.