THROUGH 48 RELATE TO RISK MANAGEMENT APPLICATIONS OF DERI...

Questions 43 through 48 relate to Risk Management Applications of Derivatives. Amy Allison Case Scenario Amy Allison is a fund manager at Downing Securities. The third quarter ends today and she is preparing for her quarterly review with her five largest U.S.-based clients. To complete her analysis she has obtained the market data in Exhibit 1. Exhibit 1 Market Data As of September 30 Level of NASDAQ 100 Index 1223.14 Level of S&P 500 Index 984.03 Level of S&P/Barra Growth Index 496.24 Level of S&P/Barra Value Index 484.28 Price of December S&P 500 Index futures contract $245,750 Price of December S&P/Barra Growth futures contract $117,475 Price of December S&P/Barra Value futures contract $120,875 Beta of S&P/Barra Growth futures contract 1.15 Beta of S&P/Barra Value futures contract 1.03 Price of December U.S. Treasury-bond futures contract $106,906 Modified Duration of U.S. Treasury-bond futures contract 6.87 Macaulay Duration of U.S. Treasury-bond futures contract 7.05 Allison’s assistant has prepared the following summaries of each client’s current situation, including any recent inquiries or requests from the clients. Client A has a $20 million technology equity portfolio. At the beginning of the last quarter, Allison forecasted a weak equity market and recommended adjusting the risk of the portfolio by lowering the portfolio’s beta from 1.20 to 1.05. To lower the beta, Allison sold 25 December NASDAQ 100 futures contracts at $124,450. During the quarter, the market decreased by 3.5 percent, the value of the equity portfolio decreased by 5.1 percent, and the NASDAQ futures contract price fell from $124,450 to $119,347. Client A has questioned the effectiveness of the futures transaction used to adjust the portfolio beta. By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to currently-registered CFA candidates. Candidates may view and print the exam for personal exam preparation only. The following activities are strictly prohibited and may result in disciplinary and/or legal action: accessing or permitting access by anyone other than currently-registered CFA candidates; copying, posting to any website, emailing, distributing and/or reprinting the mock exam for any purpose. Client B’s portfolio holds $40 million of US large cap value stocks with a portfolio beta of 1.06. This client wants to shift $22 million from value to growth stocks with a target beta of 1.21. Allison will implement this shift using S&P/Barra Growth and S&P/Barra Value futures contracts. Client C anticipates receiving $75 million in December. This client is optimistic about the near-term performance of the equity and debt markets and does not want to wait until the money is received to invest it. The client wants Allison to establish a position that allocates 60 percent of the money to a well-diversified equity portfolio with a target beta of 1.00 and 40 percent of the money to a long-term debt portfolio with a target modified duration of 5.75. Allison plans to use the December U.S. Treasury-bond futures to establish the debt position. Client D’s portfolio contains $60 million in U.S. large cap growth stocks with a beta of 0.95 and $25 million in US Treasury bonds with a modified duration of 5.20. The client believes both stocks and bonds will have negative returns over the next 3-month period. Allison recommends converting the equity and bond exposures to cash by using futures contracts. Client E has $10 million in cash and is optimistic about the near-term performance of the large-cap stocks in the U.S. equity market. The client anticipates positive performance for approximately 3 months at which time inflation fears will begin to be priced into the market and the large-cap stocks will underperform cash. Client E asks Allison to implement a strategy that will create profit from this view if it proves to be correct and can be exited quickly if it proves to be incorrect. 43. With respect to Client A, Allison’s most appropriate conclusion is the futures transaction used to adjust the beta of the portfolio was: A. effective. B. ineffective because the effective beta on the portfolio was 1.27. C. ineffective because the effective beta on the portfolio was 1.64. 44. When implementing the shift from value to growth stocks for Client B, the number of S&P/Barra value future contracts Allison shorts is closest to: A. 177. B. 182. C. 187. 45. The number of December U.S. Treasury-bond futures contracts Allison buys for Client C is closest to: A. 229. B. 235. C. 335. 46. The number of S&P/Barra Growth futures contracts needed to convert Client D’s stock portfolio into cash is closest to: A. 422. B. 511. C. 618. 47. The number of U.S. Treasury futures contracts required to convert Client D’s bond exposure to cash is closest to: A. 177 B. 234 C. 309 48. To implement Client E’s request, Allison’s most appropriate course of action is to purchase: A. risk-free bonds and buy S&P 500 index futures contracts. B. the stocks in the S&P 500 index and sell S&P 500 index futures contracts. C. the stocks in the S&P 500 index and sell U.S. Treasury bond futures contracts.