CAIA Prerequisite Diagnostic Review ( PDR) and Answer Key

Form B ---------------------------------------------------------------------------------

All candidates of the CAIA program need to have an understanding of the prerequisite material. However, you are NOT required to demonstrate such an understanding to the CAIA Association prior to becoming a Level I candidate. We recommend that you read through the prerequisite outline, that you spend time studying in any area where your background is insufficient, and that you take this Prerequisite Diagnostic Review (PDR). Completing this voluntary evaluation is not compulsory but merely a tool to help you determine your readiness for Level I.

We recommend that you take the review under CAIA exam conditions -- a two hour (120 minute) time limit and using no outside reference materials.

You will need a calculator to work through the prerequisite materials. The calculations you are required to perform range from simple mathematical operations to more complex methods of valuation. For your information, the CAIA Association allows candidates to bring into the examination the TI BA II Plus (as well as the Professional model) or the HP 12C (as well as the Platinum edition). For Level I and Level II CAIA Exams, no other calculators will be allowed in the testing center. ---------------------------------------------------------------------------------

Posted on October 1, 2007

CAIA Prerequisite Diagnostic Review and Answer Key

Form B

Question 1 Which of the following is TRUE regarding the ratio of the yield on municipal bonds (tax free bonds) to the yield on otherwise similar taxable bonds?

A. The lower this ratio, the more advantageous it is to hold municipal debt. B. One minus this ratio defines the tax bracket that would make the yield on

municipal bonds equal to the yield on otherwise similar taxable bonds. C. One minus this ratio defines the maximum tax bracket of investors. D. One multiplied by this ratio defines the tax bracket that would make the yield on

municipal bonds equal to the yield on otherwise similar taxable bonds.

Question 2 If market prices for each of the 30 stocks in the Dow Jones Industrial Average (DJIA) all change by the same percentage amount during a given day, which stock will have the greatest impact on the value of the DJIA index?

A. The stock trading at the highest dollar price per share. B. The stock with the highest total market value of equity. C. The stock with the highest number of shares outstanding. D. The stock having the greatest amount of equity in its capital structure.

Question 3 What is the price-weighted index of these three stocks?

Stock Price Number of shares outstanding Stock A $40 200 Stock B $70 500 Stock C $10 600

A. 30 B. 40 C. 50 D. 60

Question 4 Which of the following describes a firm commitment arrangement?

A. An investment banker who buys the stock from the company and then resells the stock to the public.

B. An investment banker who agrees to help the firm sell the stock at a favorable price.

C. An investment banker who finds the best marketing arrangement for the firm. D. An investment banker who agrees to sell small amounts of a firms issue without

incurring substantial floatation costs.

Question 5 Which of the following statements about Initial Public Offerings (IPOs) is FALSE?

A. Underpricing of IPOs is a universal phenomenon. B. The evidence shows that first day returns for IPOs are positive in countries

throughout the world. C. The evidence shows that in the long term the performance of IPOs has been

greater than other non-IPO firms of the same size. D. The Dutch-auction procedure for issuing new shares has now captured a sizable

(greater than 25%) share of the underwriting market.

Question 6 Suppose you purchased XYZ stock at $50 per share. The stock is currently selling at $65. Which of the following types of orders will protect your gains?

A. A stop-buy order B. A limit-sell order C. A stop-loss order D. A limit market order

Question 7 You purchase 200 shares of common stock on margin at a price of $70 per share from your broker. If the initial margin is set at 55%, how much did you borrow from the broker?

A. $6,000 B. $6,300 C. $7,000 D. $7,700

Question 8 Suppose you purchased 100 shares of common stock on margin at $45 per share. The initial margin is 50%. Which of the following comes closest to the maintenance margin if a margin call is made at a stock price of $30?

A. 25% B. 33% C. 45% D. 55%

Question 9 Suppose you sell short 100 shares of common stock at $45 per share with initial margin at 50%. Which of the following comes closest to your rate of return if you repurchase the stock at $40 per share?

A. 18% B. 20% C. 22% D. 25%

Question 10 A mutual fund reported year-end assets of $825 million, a net asset value (NAV) of $32.20, and 24.860 million shares outstanding. Which of the following comes closest to the funds year-end liabilities?

A. $10 million B. $15 million C. $20 million D. $25 million

Question 11 What must investors in closed-end funds do to liquidate their positions?

A. Sell their shares to other investors. B. Sell their shares to the issuer at a discount to its net asset value. C. Sell their shares to the underlying firm. D. Sell their shares to the issuer at the net asset value.

Question 12 A mutual fund had a net asset value per share of $6.25 on January 1 of the current year. One year later, on December 31 of the same year, the fund's NAV was $6.85. Income distributions were $0.25 and the fund had capital gain distributions of -$0.10. What amount comes closest to the rate of return on the fund?

A. 7.2% B. 10.9% C. 12.0% D. 13.6%

Question 13 What is the current yield of a 7% coupon bond that has a par value of $1,000 and is trading for $975?

A. 6.53% B. 7.00% C. 7.18% D. 7.85%

Question 14 Which of the following statements about callable bonds is TRUE?

A. The call feature provides an extra benefit to the bond investor. B. Callable bonds with the highest coupon rates are more likely to be called away. C. As compared to similar non-callable bonds, callable bonds have lower yields to

maturity. D. Callable bonds are more likely to be called when interest rates increase

appreciably.

Question 15 Which of the following comes closest to the market conversion value of a convertible bond that has a par value of $1,000, a current market price of $850, a conversion ratio of 30, and whose stock trades currently for $29 per share?

A. $ 729 B. $ 810 C. $ 870 D. $1,720

Question 16 An 8% coupon 30-year annual pay bond whose par value is $1,000 is selling for $1,275.30. Which of the following comes closest to the bonds yield to maturity?

A. 6% B. 7% C. 8% D. 9%

Question 17 The total future value of the cash flows of a 3-year bond investment, including reinvested coupons, is $1,417. The initial investment in the bond was $1,000. Which of the following comes closest to the bonds realized compound yield?

A. 10.00% B. 12.32% C. 12.82% D. 13.62%

Question 18 What characteristic is associated with a high rating from the bond rating agency?

A. A low times interest earned ratio B. A high fixed coverage ratio C. A high quick ratio D. A low current ratio

Question 19 What is the main purpose of the subordination clause in a bond indenture?

A. It restricts the amount of dividends the firm may pay. B. It provides for a sinking fund. C. It specifies the collateral for the bond. D. It restricts the amount of future additional debt the firm may take.

Question 20 An 8% coupon bond with 3 years to maturity has a par value of $1,000. This bond pays coupon interest annually, and returns the par value at maturity. Zero coupon bond yields are given by 1 Year = 8.25%, 2 Years = 8.35%, and 3 Years = 8.65%. Which of the following comes closest to the price of the bond?

A. $ 984.09 B. $ 994.60 C. $1,000.00 D. $1,080.60

The following is a list of prices for zero coupon bonds with different maturities and par values of $1,000. Use this table to answer the next two questions.

Maturity (Years) Price 1 $943.40 2 $881.68 3 $808.88 4 $742.09

Question 21 Which of the following comes closest to the yield to maturity on a 3-year zero coupon bond?

A. 6.37% B. 7.33% C. 9.00% D. 10.00%

Question 22 According to the expectations theory, which of the following comes closest to the expected one-year forward rate in the third year?

A. 7.00% B. 7.33% C. 9.00% D. 11.19%

Question 23 With regard to the term structure of interest rates, which of the following is consistent with the expectations theory?

A. Forward rates are determined by investors' expectations of future interest rates. B. Forward rates, for reasons best explained by risk, exceed expected future interest

rates. C. Forward rates, for reasons best explained by risk, are below expected future

interest rates. D. Forward rates are determined by the supply and demand for the securities.

Question 24 Holding other factors constant, which one of the following bonds would you expect to have the smallest price volatility due to a change in interest rates?

A. The 5-year 0% coupon bond B. The 25-year 0% coupon bond C. The 5-year, 10% coupon bond D. The 25-year 10% coupon bond

Question 25 Which of the following statements about duration is FALSE?

A. Holding other things constant, the duration of a bond increases as time to maturity increases.

B. Given a particular time to maturity, the duration of a zero-coupon bond increases as the bonds yield to maturity decreases.

C. Given a particular time to maturity and yield to maturity, the duration of a bond increases as the bonds coupon rate decreases.

D. Given a particular time to maturity, the duration of a coupon bond increases as yield to maturity decreases.

Question 26 Generally speaking, why is high positive convexity considered a desirable trait in bonds?

A. With high positive convexity, the bonds price will stay relatively constant for any shift in interest rates.

B. With high positive convexity, the bonds price will rise more when yields rise. C. With high positive convexity, the bonds price will not fall when yields stay

constant. D. With high positive convexity, the bonds price will rise more when yields decline.

Question 27 Suppose that a callable bond with a call price of $1,050 has a current market price of $980. Suppose also that if the yield to maturity increases by 50 basis points, the bonds price will fall to $930, and if the yield to maturity decreases by 50 basis points, the bonds price will rise to $1,010. Which of the following comes closest to the bonds effective duration?

A. 10.56 B. 9.86 C. 9.36 D. 8.16

Question 28 Which term describes the cash flow matching of bonds on a multiperiod basis?

A. A substitution SWAP B. Dedication C. Subordination D. Passive bond management

Question 29 A substitution swap is an exchange of bonds undertaken for what purpose?

A. To change the credit risk of a portfolio. B. To extend the duration of a portfolio. C. To best prepare for an expected change in the term structure. D. To profit from apparent mispricing between two bonds.

Question 30 What term is used to represent the present value of all cash proceeds to an investor?

A. Book value B. Intrinsic value C. Liquidation value D. Tobins Q

Question 31 Other things equal, what is typically associated with a high growth rate in a firms earnings?

A. A low dividend payout ratio B. A low degree of earnings variability C. A low plowback ratio D. A low research and development to sales ratio

Question 32 A preferred stock will pay a dividend of $2.75 in the upcoming year and does not expect to change its dividend in the future. If you require a return of 10% on this stock, which of the following comes closest to an estimate of the value of the stock?

A. $ 2.75 B. $27.50 C. $30.25 D. $55.00

Question 33 At the end of the next year a particular company will pay a $2.00 dividend per share. The company expects to increase the dividend at a constant rate of 5%. Which of the following comes closest to an estimate of the value of the stock per share if you require a 12% return on the stock?

A. $28.57 B. $28.79 C. $30.00 D. $31.78

Question 34 A particular company is expected to pay a dividend of $1.00 in exactly one year. Dividends are then expected to grow at the rate of 6% per year forever. The risk-free rate of return is 5% and the expected return on the market portfolio is 13%. Which of the following comes closest to an estimate of the value of the company per share if the companys beta is 1.2?

A. $11.62 B. $12.33 C. $13.23 D. $14.29

Question 35 Which of the following defines the free cash flow valuation approach?

A. Cash flow in the form of dividends as a percent of revenues. B. Cash flow available to pay interest on debt. C. Cash flow available to equityholders net of capital expenditures. D. Cash flow in the form of equity retires (repurchased) by the firm.

Question 36 Suppose you purchased a share of stock for $20 and sell the stock one year later for $29. Suppose also that you receive a $1 dividend just before you sell. Which of the following comes closest to the holding period return?

A. 5% B. 10% C. 25% D. 50%

Question 37 Which of the following comes closest to the continuously compounded rate that provides an effective annual rate of 8.5%?

A. 8.16% B. 8.50% C. 8.84% D. 9.05%

Use the following probability distribution for the holding period return for a stock to answer the following three (3) questions.

State of the Economy Probability HPR Boom .40 22% Normal growth .35 11% Recession .25 - 9%

Question 38 Which of the following comes closest to the expected rate of return on the stock?

A. 8.00% B. 10.40% C. 12.25% D. 14.00%

Question 39 Which of the following comes closest to the standard deviation of returns for this stock?

A. 8.00% B. 9.96% C. 11.74% D. 12.17%

Question 40 If the Treasury bill rate is 3%, which of the following comes closest to the stocks Sharpe ratio?

A. 0.08 B. 0.35 C. 0.62 D. 0.89

Question 41 Which of the following defines the geometric average return on a stock if the stock earned an arithmetic return of 10% each year for 10 consecutive years?

A. The geometric average return will be greater than the arithmetic average return. B. The geometric average return will be equal to the arithmetic average return. C. The geometric average return will be less than the arithmetic average return. D. The geometric average return will be close to zero.

Question 42 Which of the following is TRUE about skewness?

A. The standard deviation of a negatively skewed distribution will overestimate risk. B. It is a measure of the degree of fat tails in a distribution. C. If the distribution is skewed to the left, extreme negative values will dominate. D. It is referred to as the fourth moment.

Question 43 Which of the following provides the correct ranking of the arithmetic average (high to low) of the following asset classes?

A. World large stocks > US small stocks > US Treasury bills > World bonds B. World large stocks > World bonds > US small stocks > US Treasury bills C. US small stocks > World large stocks > World bonds > US Treasury bills D. US small stocks > World bonds > World large stocks > US Treasury bills

Question 44 Which of the following measures of risk best highlights downside risk?

A. Value at Risk (VaR) B. Conditional Tail Expectation (CTE) C. Lower Partial Standard Deviation (LPSD) D. Serial correlation

Question 45 Which one of the following statements is TRUE regarding the indifference curve of a risk-averse investor?

A. It is the locus of portfolios that have the same expected rates of return and different standard deviations.

B. It is the locus of portfolios that have the same standard deviations and different rates of return.

C. It is the locus of portfolios that offer the same utility according to returns and standard deviations.

D. It is the locus of portfolios that have rates of return that are greater than the risk free rate of return.

Question 46 Suppose you invest $100 in a risky asset with an expected rate of return of 12% and a standard deviation 15%. Suppose also that a risk-free asset exists with a rate of return of 5%. Which of the following comes closest to the percentage of your money that must be invested in the risky asset to form a portfolio with an expected return of 9%?

A. 85% B. 75% C. 67% D. 57%

Question 47 Consider a risk-free asset with a rate of return of 5% and the following risky securities:

Security A: E(r) = 0.15; Variance = 0.04 Security B: E(r) = 0.10; Variance = 0.0225 Security C: E(r) = 0.12; Variance = 0.01 Security D: E(r) = 0.13; Variance = 0.0625

From which security, formed with the T-bill and any one of the 4 risky securities, would a risk-averse investor always choose for his portfolio?

A. Security A B. Security B C. Security C D. Security D

Question 48 What is the effect on the portfolio standard deviation when two risky securities that are positively correlated but not perfectly correlated are held in a portfolio?

A. The portfolio standard deviation will be greater than the weighted average of the individual security standard deviations.

B. The portfolio standard deviation will be less than the weighted average of the individual security standard deviations.

C. The portfolio standard deviation will be equal to the weighted average of the individual security standard deviations.

D. The portfolio standard deviation will always be equal to the securities' covariance.

Question 49 When borrowing and lending at a risk-free rate are allowed, which Capital Allocation Line (CAL) should the investor choose to combine with the efficient frontier?

A. The line that intersects at the highest expected return. B. The line with the steepest slope. C. The line that intersects at the lowest standard deviation. D. The line with a zero slope.

Question 50 Which of the following statements is consistent with the separation property?

A. The determination of the optimal risky portfolio is investor specific. B. The optimal risky portfolio is the same for all investors. C. The degree of risk aversion is the same for all investors. D. There is no role for the risk free rate in the complete portfolio.

Question 51 How is beta different from standard deviation?

A. Beta measures total risk while standard deviation measures only systematic risk. B. Beta measures systematic risk while standard deviation measures total risk. C. Beta measures unsystematic risk while standard deviation measures total risk. D. Beta measures total risk while standard deviation measures only unsystematic

risk.

Question 52 How is beta defined?

A. The covariance between the security's return and the market return divided by the variance of the market's returns.

B. The covariance between the security and market returns divided by the standard deviation of the market's returns.

C. The variance of the security's returns divided by the covariance between the security and market returns.

D. The variance of the security's returns divided by the variance of the market's returns.

Question 53 Which of the following represents the equation for expected return as given by the Capital Asset Pricing Model (CAPM)?

A. E(ri ) = Rf + [E(RM)] B. E(ri ) = Rf + [E(RM) - Rf] C. E(ri ) = [E(RM) - Rf] D. E(ri ) = E(RM) + Rf

Question 54 Suppose that the risk-free rate is 7% and that the expected market rate of return is 15%. According to the capital asset pricing model, what action should you take if you expect a stock with a beta of 1.3 to offer a rate of return of 12%?

A. You should buy the stock because it is underpriced. B. You should sell the stock short because it is overpriced. C. You should do nothing because the stock is fairly priced. D. You should buy the stock because there is little demand for it.

Question 55 According to the Capital Asset Pricing Model (CAPM), what is the relationship between the risk premium an investor expects to receive and beta?

A. The risk premium is not related to beta. B. The risk premium varies directly with beta. C. The risk premium varies indirectly with beta. D. The risk premium is related to beta but only through the standard deviation.

Question 56 What is the main difference between the three forms of market efficiency?

A. The definition of efficiency differs. B. The definition of excess return differs. C. The definition of prices differs. D. The definition of information differs.

Question 57 Which form of the efficient market hypothesis states that stock prices reflect all available information, including information that is available only to insiders?

A. The weak form B. The semistrong form C. The strong form D. The superstrong form

Question 58 When forming expectations about future stock prices, which of the following would NOT be considered by a fundamental analyst?

A. Earnings B. Dividends C. Trend lines D. The companys management team

Question 59 What do proponents of the efficient market hypothesis advocate?

A. Trading based on overconfidence B. Technical analysis C. Searching for anomalies D. Investing in an index fund

Question 60 Suppose a college professor uncovers a stock-trading rule that generates consistent excess risk-adjusted returns. Which of the following would describe the professors actions if she chooses not to publish the results but instead keep the trading rule to herself?

A. Regret avoidance B. Selection bias C. Framing D. The lucky event issue

Question 61 What would you expect the value of the correlation coefficient between stock returns for two non-overlapping time periods to be in an efficient market?

A. Close to positive one B. Close to 0.50 C. Zero D. Close to negative one

Question 62 What is one result of event studies on earnings announcements?

A. A positive abnormal return on the very day of a negative earnings surprise. B. A positive drift in the stock price on the days following a positive earnings

surprise. C. A negative abnormal return on the very day of a positive earnings surprise. D. No abnormal returns earned on the day of either positive or negative earnings

surprises.

Question 63 What have studies examining the issue of consistency in mutual fund performance (sometimes referred to as the hot hands phenomenon) found to be TRUE?

A. There is persistence in good performance but not bad performance. B. There is persistence in bad performance but not good performance. C. There is some evidence of persistence related to extreme investment performance. D. There is significant persistence across all types of performance, both good and

bad.

Question 64 Which of the following errors in information processing is described by people who give too much weight to recent experience as compared to prior beliefs?

A. Overconfidence B. Conservatism C. Forecasting error D. Sample size neglect

Question 65 Which of the following would NOT be a behavioral bias in the context of market efficiency?

A. Framing B. Trend analysis C. Regret avoidance D. Mental accounting

Question 66 Which of the following describes the law of one price?

A. An assets price should be quoted on a net basis. B. An assets price should be quoted in only one currency. C. Identical assets should have identical prices. D. Identical prices should not exist in a well functioning economy.

Question 67 On a particular day of trading there were 1,031 NYSE stocks that advanced and 610 that declined. The volume in advancing issues was 112,866,000 and the volume in declining issues was 58,188,000. What would the trin ratio signal be for this day?

A. The signal would be positive because it indicates selling pressure. B. The signal would be positive because it indicates buying pressure. C. The signal would be negative because it indicates selling pressure. D. The signal would be negative because it indicates buying pressure.

Question 68 Suppose a particular investment earns an arithmetic return of 10% in year 1, 20% in year 2 and 30% in year 3. How will the geometric average return over this period compare with the arithmetic average return?

A. The geometric return will be greater than the arithmetic average return. B. The geometric return will be equal to the arithmetic average return. C. The geometric return will be less than the arithmetic average return. D. You cannot determine the answer from the information given.

Question 69 Suppose two portfolios have the same average return and the same standard deviation of returns, but Portfolio A has a higher beta than Portfolio B. How does the performance of the two portfolios compare according to the Sharpe measure?

A. The performance of Portfolio A is greater than Portfolio B. B. The performance of Portfolio A is less than Portfolio A. C. The performance of the two portfolios is the same. D. The answer depends upon the magnitudes of the betas.

Use the data below to answer to following four questions.

Alpha Fund Market Portfolio Average Return 20% 11% Standard Deviation of Returns 44% 19% Beta 1.8 1.0 Residual standard deviation 2.0% 0.0%

The risk-free return during the sample period was 3%.

Question 70 Which of the following is closest to Alphas Sharpe measure?

A. 8.67 B. 20.45 C. 38.64 D. 45.45

Question 71 Which of the following is closest to Alphas Treynor measure?

A. 9.44 B. 11.11 C. 20.45 D. 38.64

Question 72 Which of the following comes closest to Alphas Jensen measure?

A. 2.6 B. 4.00 C. 8.67 D. 38.64

Question 73 Which of the following comes closest to Alphas information ratio?

A. -1.53 B. 1.30 C. 8.67 D. 31.43

Question 74 A perfect market timer earns the risk free rate when the market is down and the market return when the market is up. The pattern of returns of a perfect market timer resembles what type of security?

A. A put option B. A call option C. A long position in the market. D. A short position in the market.

Question 75 In a Sharpe style analysis, fund returns are regressed on indexes representing a range of asset classes. What does the R-square of such a regression measure?

A. The percent of return variability explained by security selection. B. The percent of return variability explained by asset allocation. C. The percent of return variability explained by market timing. D. The percent of return variability explained by the benchmark return.

Question 76 Which of the following is TRUE of exchange rate risk?

A. Exchange rate risk represents a small part of the risk of international investing. B. Exchange rate risk cannot be diversified. C. Interest rate parity models the hedging of exchange rate risk. D. Passive investors with well diversified international portfolios would need to

hedge 100% of their exposures to foreign currencies to remove exchange rate risk.

Question 77 What is the effect of adding international stocks to a domestic portfolio?

A. Raising the risk relative to holding only U.S. stocks B. Reducing the risk relative to the risk of holding only U.S. stocks C. Increasing expected return but at the expense of taking more risk D. No significant impact on either the risk or the return of her portfolio

Question 78 In which of the following situations would a put option on a share of common stock be out-of-the-money?

A. The exercise price is higher than the stock price. B. The exercise price is lower than the stock price. C. The exercise price is equal to the stock price. D. The premium is higher than the exercise price.

Question 79 Which describes the potential loss for a writer of a naked call option on a stock?

A. The loss is limited to the difference between the exercise price and zero. B. The loss is unlimited. C. The loss is limited to the difference between the stock price and zero. D. The loss is limited to the call premium.

Question 80 In a protective put strategy, a long position in a put option is combined with what other asset?

A. A long position in the underlying asset B. A long call option on the same underlying asset C. A short put option on the same underlying asset D. A short position on the underlying asset

Question 81 You buy one Xerox June call contract (on 100 shares of stock) and one June put contract (on 100 shares of stock), both with an exercise price of $25 and both with an expiration time of two months. The call premium is $5 and the put premium is $3. What is the maximum loss on the position?

A. $250 B. $500 C. $800 D. $900

Question 82 According to the put-call parity relationship, how is the value of a European put option on a non-dividend paying stock best expressed?

A. The call value plus the present value of the exercise price plus the stock price B. The call value plus the present value of the exercise price minus the stock price C. The present value of the stock price minus the exercise price minus the call price D. The present value of the stock price plus the exercise price minus the call price

Question 83 Consider a one-year maturity call option and a one-year put option on the same stock, both with a strike price of $45. Suppose that the risk-free rate is 4%, the stock price is $48, and the put sells for $1.50. According to put-call parity, which of the following comes closest to the price of the call?

A. $ 4.38 B. $ 5.60 C. $ 6.23 D. $12.26

Question 84 Warrants are essentially call options with what distinguishing characteristic?

A. They have an exercise price of zero B. They offer no protection against stock splits C. They require new shares of stock to be issued upon exercise. D. They have no expiration date.

Question 85 Collateralized loans can be thought of as providing what type of implicit position to the borrower?

A. A put option B. A straddle C. A call option D. A collar

Question 86 Which of the following describes one important distinguishing characteristic of an Asian option?

A. An expiration date that does not stay fixed over at least some portion of the life of the option

B. A payoff that is determined by the average price of the underlying asset over at least some portion of the life of the option

C. A payoff that is determined by the volatility of the underlying asset over at least some portion of the life of the option

D. The ability to turn from a call to a put, or from a put to a call, over at least some portion of the life of the option

Question 87 Which of the following is TRUE about barrier options?

A. They have payoffs that only depend on the minimum price of the underlying asset during the life of the option.

B. They have payoffs that depend both on the assets price at expiration and on whether the underlying assets price has crossed through some barrier.

C. They have payoffs that are known in advance. D. They have payoffs that only depend on the maximum price of the underlying asset

during the life of the option.

Question 88 What describes the time value of an at-the-money call option before expiration?

A. Positive B. Equal to zero C. Negative D. Equal to the stock price minus the exercise price

Question 89 The price of a put option is NOT positively correlated with the following factors?

A. The stock price B. The time to expiration C. The stock volatility D. The exercise price

Question 90 Relative to European puts, which of the following is true of an otherwise identical American put option?

A. They are less valuable. B. They are more valuable. C. They are equal in value. D. They will always be exercised earlier.

Question 91 Assuming all else the same, a cut in the dividend payout will have what effect on the value of a call option?

A. Negative B. Positive C. No effect D. Positive or negative, depending on the magnitude of the dividend cut

Question 92 What does a hedge ratio of 0.70 imply for a hedged stock portfolio?

A. Holding long 0.70 calls for each short stock B. Selling short 0.70 calls for each long stock C. Holding long 0.70 shares for each short call D. Holding long 0.70 shares for each long call

Question 93 The hedge ratio for a call will have what value or range of values?

A. The hedge ratio will always be equal to one. B. The hedge ratio will always be greater than one. C. The hedge ratio will always be between zero and one D. The hedge ratio will always between minus one and zero.

Question 94 Which of the following describes a long position in a futures contract?

A. A commitment to purchase something on the delivery date B. A commitment to sell something on the delivery date C. An option to purchase something on the deliver date D. An option to sell something on the delivery date

Question 95 Who specifies the terms of futures contracts such as the quality and quantity of the commodity and the delivery date?

A. Buyers and sellers B. Buyers C. Futures exchanges D. Brokers and dealers

Question 96 Which one of the following statements about margin is TRUE?

A. The maintenance margin is the amount of money you post with your broker when you buy or sell a futures contract.

B. The maintenance margin determines the value of the margin account below which the holder of a futures contract receives a margin call.

C. A maintenance margin deposit can only be met with cash. D. All futures contracts are standardized to require the same maintenance margin

deposit.

Question 97 Which of the following statements about the basis is TRUE?

A. The basis must be zero at the contracts maturity. B. The basis must be equal to the spot price at the contracts maturity. C. The basis must be equal to the futures price at the contracts maturity. D. The basis must be greater than the risk free rate at the contracts maturity.

Question 98 Which of the following depicts a futures price that is less than the expected future spot price?

A. Contango B. Speculation C. Normal backwardation D. Collateral yield

Question 99 Suppose that the risk-free rates in the United States and in the United Kingdom are 4% and 6%, respectively. The spot exchange rate between the dollar and the pound is $1.60/BP. What must the futures price of the pound for a one-year contract be to prevent arbitrage opportunities, ignoring transactions costs?

A. $1.57/BP B. $1.60/BP C. $1.66/BP D. $1.70/BP

Question 100 In the context of managing exchange rate risk using futures contracts, how can the hedge ratio be defined?

A. Profit derived from one futures position for a given change in the exchange rate divided by the change in value of the unprotected position for the same exchange rate

B. The change in value of the unprotected position for a given change in the exchange rate divided by the profit derived from one futures position for the same exchange rate

C. Profit derived from one futures position for a given change in the exchange rate plus the change in value of the unprotected position for the same exchange rate

D. The change in value of the unprotected position for a given change in the exchange rate plus by the profit derived from one futures position for the same exchange rate

Answer Key for the CAIA Prerequisite Diagnostic Review Form B

Question Number

Answer Text Reference Study Guide Reference

1 B Pages 34-36 Topic 1, Chapter 2, LO2 2 A Pages 41-42 Topic 1, Chapter 2, LO4 3 B Pages 42-43 Topic 1, Chapter 2, LO4 4 A Page 58 Topic 1, Chapter 3, LO1 5 C Pages 59-62 Topic 1, Chapter 3, LO1 6 B Pages 64-65 Topic 1, Chapter 3, LO2 7 B Pages 78-80 Topic 1, Chapter 3, LO3 8 A Pages 79-80 Topic 1, Chapter 3, LO3 9 C Pages 81-83 Topic 1, Chapter 3, LO4 10 D Page 96 Topic 1, Chapter 4, LO1 11 A Pages 97-98 Topic 1, Chapter 4, LO2 12 C Page 106 Topic 1, Chapter 4, LO4 13 C Page 458 Topic 2, Chapter 14, LO1 14 B Page 461 Topic 2, Chapter 14, LO1 15 C Page 461 Topic 2, Chapter 14, LO1 16 A Pages 466-475 Topic 2, Chapter 14, LO5 17 B Pages 468-475 Topic 2, Chapter 14, LO5 18 B Pages 481-482 Topic 2, Chapter 14, LO6 19 D Pages 483-485 Topic 2, Chapter 14, LO7 20 A Pages 496-498 Topic 2, Chapter 15, LO1 21 B Pages 496-497 Topic 2, Chapter 15, LO1 22 C Pages 496-502 Topic 2, Chapter 15, LO2 23 A Pages 505-506 Topic 2, Chapter 15, LO3 24 C Pages 524-526 Topic 2, Chapter 16, LO1 25 B Pages 527-534 Topic 2, Chapter 16, LO2 26 D Pages 534-539 Topic 2, Chapter 16, LO3 27 D Pages 538-539 Topic 2, Chapter 16, LO4 28 B Pages 550-551 Topic 2, Chapter 16, LO5 29 D Page 552 Topic 2, Chapter 16, LO6 30 B Pages 606-607 Topic 3, Chapter 18, LO1 31 A Pages 612-613 Topic 3, Chapter 18, LO2 32 B Pages 07-610 Topic 3, Chapter 18, LO2 33 A Pages 608-611 Topic 3, Chapter 18, LO2 34 A Pages 608-620 Topic 3, Chapter 18, LO2 35 C Pages 630-631 Topic 3, Chapter 18, LO4 36 D Pages 133-134 Topic 4, Chapter 5, LO2 37 A Pages 128-130 Topic 4, Chapter 5, LO2

38 B Pages 134-135 Topic 4, Chapter 5, LO3 39 D Pages 134-135 Topic 4, Chapter 5, LO 3 40 C Pages 139-140 Topic 4, Chapter 5, LO5 41 B Pages 136-138 Topic 4, Chapter 5, LO4 42 C Pages 140-143 Topic 4, Chapter 5, LO6 43 C Pages 144-146 Topic 4, Chapter 5, LO7 44 C Pages 150-151 Topic 4, Chapter 5, LO8 45 C Pages 167-174 Topic 4, Chapter 6, LO3 46 D Pages 176-180 Topic 4, Chapter 6, LO4 47 C Pages 176-180 Topic 4, Chapter 6, LO4 48 B Pages 208-216 Topic 4, Chapter 7, LO2 49 B Pages 216-221 Topic 4, Chapter 7, LO3 50 B Pages 3226-228 Topic 4, Chapter 7, LO4 51 B Pages 302-305 Topic 4, Chapter 8, LO1 52 A Pages 299-302 Topic 4, Chapter 8, LO2 53 B Page 306 Topic 4, Chapter 8, LO3 54 B Pages 302-303 Topic 4, Chapter 8, LO3 55 B Pages 302-303 Topic 4, Chapter 8, LO3 56 D Page 361 Topic 5, Chapter 11, LO2 57 C Page 361 Topic 5, Chapter 11, LO2 58 C Page 363 Topic 5, Chapter 11, LO3 59 D Page 363-364 Topic 5, Chapter 11, LO4 60 B Page 369 Topic 5, Chapter 11, LO6 61 C Page 371 Topic 5, Chapter 11, LO7 62 B Pages 376-377 Topic 5, Chapter 11, LO7 63 C Pages 381-386 Topic 5, Chapter 11, LO8 64 C Page 397 Topic 5, Chapter 12, LO2 65 B Pages 398-399 Topic 5, Chapter 12, LO3 66 C Pages 400-407 Topic 5, Chapter 12, LO4 67 B Pages 411-412 Topic 5, Chapter 12, LO5 68 C Pages 851-853 Topic 6, Chapter 24, LO1 69 C Pages 853-856 Topic 6, Chapter 24, LO2 70 C Pages 853-856 Topic 6, Chapter 24, LO2 71 A Pages 853-856 Topic 6, Chapter 24, LO2 72 A Pages 853-856 Topic 6, Chapter 24, LO2 73 B Pages 853-856 Topic 6, Chapter 24, LO2 74 B Pages 872-875 Topic 6, Chapter 24, LO4 75 B Pages 875-879 Topic 6, Chapter 24, LO5 76 C Pages 902-905 Topic 6, Chapter 25, LO2 77 B Pages 905-908 Topic 6, Chapter 26, LO3 78 B Pages 692-698 Topic 7, Chapter 20, LO1 79 B Pages 692-698 Topic 7, Chapter 20, LO1 80 A Pages 703-711 Topic 7, Chapter 20, LO3 81 C Pages 703-711 Topic 7, Chapter 20, LO3 82 B Pages 711-713 Topic 7, Chapter 20, LO4

83 C Pages 711-713 Topic 7, Chapter 20, LO4 84 C Pages 714-720 Topic 7, Chapter 20, LO5 85 C Pages 714-720 Topic 7, Chapter 20, LO5 86 B Pages 721-724 Topic 7, Chapter 20, LO5 87 B Pages 721-724 Topic 7, Chapter 20, LO5 88 A Pages 737-740 Topic 7, Chapter 21, LO1 89 A Pages 737-740 Topic 7, Chapter 21, LO1 90 B Pages 740-744 Topic 7, Chapter 21, LO2 91 B Pages 758-759 Topic 7, Chapter 21, LO6 92 C Pages 760-764 Topic 7, Chapter 21, LO7 93 C Pages 760-764 Topic 7, Chapter 21, LO7 94 A Pages 784-785 Topic 8, Chapter 22, LO1 95 C Page 790 Topic 8, Chapter 22, LO1 96 B Pages 792-793 Topic 8, Chapter 22, LO1 97 A Page 798 Topic 8, Chapter 22, LO3 98 C Page 806 Topic 8, Chapter 22, LO5 99 A Pages 814-817 Topic 8, Chapter 23, LO1 100 B Pages 818-821 Topic 8, Chapter 23, LO2