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

Questions 43 through 48 relate to Risk Management Applications of Derivatives.

Rose Michael Case Scenario

Rose Michael, CFA, is a senior portfolio manager at Platinum Investments, Inc. Selected

data for the funds she manages is shown below in Exhibit 1:

Exhibit 1

Summary of Fund Characteristics

Fund A Fund B Fund C Fund D

60% mid-cap

100% mid-cap

U.S. equities

100% U.S.

100% large-cap

Asset

Treasury bonds

Allocation

40% U.S.

Stock Beta 0.95 1.20 N/A 1.12

Duration n.a. n.a. 5.9 5.9

Michael is training Joseph Owen, a newly hired research assistant, in the strategies used

to adjust clients’ exposures to various markets. She asks Owen to collect current market

data on the futures contracts she uses to employ the asset allocation strategies. Owen

presents Michael with the data in Exhibit 2 and notes that the U.S. risk-free rate is 4

percent while the European risk-free rate is 2 percent.

Exhibit 2

Summary of Futures Contracts Data

U.S.

European

U.S. Treasury

U.S.

U.S

Bill

Large-cap

Broad-based

Treasury

Mid-cap

Equity

Equity

Bond

(Cash Equivalent)

Contract

Contract

Beta 1.10 1.29 0.80 1.0 0

Contract Price 2,875 2,350 3,000 $110,000* $100,000*

Multiplier 100 100 10 N/A N/A

Duration N/A N/A N/A 6.5 0.25

Expiration 0.25 years 0.25 years 0.25 years 0.25 years 0.25 years

*includes the effect of any multiplier

Michael presents a summary of client portfolios in Exhibit 3:

Exhibit 3

Summary of Current Client Holdings

Client Name Market Value of Holdings

Andrew Bolton $50 million invested in Fund A

Carly Dungan €100 million in Eurodollar deposits

Georgia Harrison $400 million invested in Fund D

Kathryn Lewis $100 million invested in Fund A

$50 million invested in Fund B

Isaac Jeffries $75 million invested in Fund B

Industrie des Eaux $350 million invested in Fund C

Andrew Bolton wants to reduce the level of portfolio equity risk and Michael

recommends reducing Bolton’s portfolio beta to 0.8 using futures contracts.

Carly Dungan requests that her portfolio be reallocated to a synthetic index fund of

European equities for the next three months.

Owen informs Michael that Georgia Harrison wants to change her portfolio mix to 80

percent bonds and 20 percent equity for the next three months, but retain the other

characteristics of Fund D. Michael decides this temporary reallocation will be

accomplished using futures contracts.

Owen reports that Kathryn Lewis wants to adjust her portfolio allocation so that she has

50 percent invested in Fund A and 50 percent in Fund B. Michael responds, “We can

restructure her portfolio by first buying U.S. Treasury bill futures to raise cash, then

selling U.S. large-cap equity futures and buying U.S. mid-cap equity futures.”

Isaac Jeffries is concerned that U.S equities are about to suffer a sharp downturn and

wants to convert his current holdings to cash for a period of 3 months.

Industrie des Eaux is a French company. Michael explains to Owen the currency risk that

this client faces from its investments with Platinum Investments.

43. In order to implement Michael’s recommendation for Bolton’s portfolio, the

number of U.S. large-cap equity future contracts that must be sold is closest to:

A. 24.

B. 26.

C. 33.

By accessing this mock exam, you agree to the following terms of use: This mock exam is provided to

44. In order to reallocate Dungan’s portfolio, the number of European futures

contracts that should initially be purchased is closest to:

A. 3,333.

B. 3,350.

C. 3,400.

45. In order to reallocate Harrison’s portfolio as requested, the number of bond

futures contracts that Michael should purchase is closest to:

A. 1264.

B. 1320.

C. 1454.

46. Michael’s plan for reallocating Lewis’ portfolio is most likely incorrect with

respect to:

A. buying U.S. Treasury bill futures.

B. buying U.S. mid cap equity futures.

C. selling U.S. large cap equity futures.

47. To achieve Jeffries’ objective, the number of U.S mid-cap equity futures contracts

that Michael will sell is closest to:

A. 319.

B. 322.

C. 332.

48. In her explanation regarding Industrie des Eaux’ currency risk, Michael should

focus on what type of exposure?

A. economic

B. translation

C. transaction