If you will be unable to attend the Live Schweser Mock Exam, please contact customer service immediately at [email protected] or call Additional charges may apply. Free cfa level 1 sample questions and answers free download to pass cfa level 1 test bank pdf. For cfa level 1 past papers pdf you must go through real exam.
We discuss in these cfa level 1 questions from different topics like cfa mock exam pdf, cfa level 1 mock exam pdf with By Christine Martinez To access our free mock exams for other levels, check out our Guides section. Hi subha! Please send level 1 exam books to [email protected].
If anyone has CFA Level 1 books, please share on [email protected]. Thank You. Please share cfa level 1 pdf to me my email is [email protected] , please. Save my name, email, and website in this browser for the next time I comment. Exam Updates.
Books Download. By Exam Updates Last updated Oct 23, Content in this Article. Related Posts. Other types of swaps, such as currency swaps and equity swaps, are introduced at Level II. Options An option contract gives its owner the right, but not the obligation, to either buy or sell an underlying asset at a given price the exercise price or strike price.
While an option buyer can choose whether to exercise an option, the seller is obligated to perform if the buyer exercises the option.
The owner of a call option has the right to purchase the underlying asset at a specific price for a specified time period. The owner of a put option has the right to sell the underlying asset at a specific price for a specified time period. The seller of an option is also called the option writer. There are four possible options positions: 1.
Long call: the buyer of a call option—has the right to buy an underlying asset. Short call: the writer seller of a call option—has the obligation to sell the underlying asset. Long put: the buyer of a put option—has the right to sell the underlying asset.
Short put: the writer seller of a put option—has the obligation to buy the underlying asset. The price of an option is also referred to as the option premium.
At expiration, an American option and a European option on the same asset with the same strike price are identical. They may either be exercised or allowed to expire. Before expiration, however, they are different and may have different values.
In those cases, we must distinguish between the two. Credit Derivatives A credit derivative is a contract that provides a bondholder lender with protection against a downgrade or a default by the borrower. The most common type of credit derivative is a credit default swap CDS , which is essentially an insurance contract against default. A bondholder pays a series of cash flows to a credit protection seller and receives a payment if the bond issuer defaults. The profit potential to the buyer of the option is unlimited, and, conversely, the potential loss to the writer of the call option is unlimited.
The sum of the profits between the buyer and seller of the call option is always zero; thus, options trading is a zero-sum game. There are no net profits or losses in the market. The long profits equal the short losses. Figure The potential loss to the writer of the put is the same amount. The sum of the profits between the buyer and seller of the put option is always zero.
Trading put options is a zero-sum game. Answer: Profit will be computed as ending option valuation — initial option cost. The option finished out-of-the-money, so the premium is lost. Hence, your net profit is zero. A buyer of puts or a seller of calls will profit when the price of the underlying asset decreases.
A buyer of calls or a seller of puts will profit when the price of the underlying asset increases. Because of the high leverage involved in derivatives payoffs, they are sometimes likened to gambling. The benefits of derivatives markets are that they: Provide price information. Allow risk to be managed and shifted among market participants.
Reduce transactions costs. In its purest sense, arbitrage is riskless. If a return greater than the risk-free rate can be earned by holding a portfolio of assets that produces a certain riskless return, then an arbitrage opportunity exists. Arbitrage opportunities arise when assets are mispriced. Trading by arbitrageurs will continue until they affect supply and demand enough to bring asset prices to efficient no-arbitrage levels. There are two arbitrage arguments that are particularly useful in the study and use of derivatives.
The first is based on the law of one price. Two securities or portfolios that have identical cash flows in the future, regardless of future events, should have the same price.
You have an immediate profit, and the payoff on A will satisfy the future liability of being short on B. The second type of arbitrage requires an investment. If a portfolio of securities or assets will have a certain payoff in the future, there is no risk in investing in that portfolio. In order to prevent profitable arbitrage, it must be the case that the return on the portfolio is the risk free rate. If the certain return on the portfolio is greater than the risk free rate, the arbitrage would be to borrow at Rf, invest in the portfolio, and keep the excess of the portfolio return above the risk free rate that must be paid on the loan.
Interest rate swaps are: A. A call option is: A. At expiration, the exercise value of a put option is: A. At expiration, the exercise value of a call option is: A.
The investor will realize: A. Derivatives are least likely to: A. Exchange-traded derivatives, notably futures and some options, are traded in centralized locations exchanges and are standardized, regulated, and are free of default. Forwards and swaps are custom contracts over-the-counter derivatives created by dealers or financial institutions.
There is limited trading of these contracts in secondary markets and default counterparty risk must be considered. Forward contracts, futures contracts, and swaps are all forward commitments.
A contingent claim is an asset that has a future payoff only if some future event takes place e. Options and credit derivatives are contingent claims. Interest rate swaps contracts are equivalent to a series of forward contracts on interest rates. Futures contracts are much like forward contracts, but are exchange-traded, liquid, and require daily settlement of any gains or losses.
A call option gives the holder the right, but not the obligation, to buy an asset at a specific price at some time in the future. A put option gives the holder the right, but not the obligation, to sell an asset at a specific price at some time in the future. A credit derivative is a contract that provides a payment if a specified credit event occurs. Put value at expiration is Max 0, exercise price minus underlying price and profit loss is Max 0, exercise price minus underlying price minus option cost.
A call buyer call seller anticipates an increase decrease in the value of the underlying asset. A put buyer put seller anticipates a decrease increase in the value of the underlying asset. However, many market participants use derivatives to manage and reduce existing risk exposures.
Derivative securities play an important role in promoting efficient market prices and reducing transaction costs. Arbitrage can be expected to force the prices of two securities or portfolios of securities to be equal if they have the same future cash flows regardless of future events. Options and credit derivatives are contingent claims because one of the counterparties only has an obligation if certain conditions are met.
It is equivalent to a series of forward contracts. Its exercise value is zero if the underlying asset price is greater than or equal to the exercise price.
The exercise value of an option cannot be negative because the holder can allow it to expire unexercised. If the underlying asset price is less than the exercise price, a call option expires with a value of zero.
Derivatives improve liquidity and provide price information. If this were not the case, you could simultaneously buy the cheaper asset and sell the more expensive one for a guaranteed riskless profit. The derivation of the price in a forward contract and calculating the value of a forward contract over its life are important applications of no-arbitrage pricing. Candidates should also understand the equivalence of interest rates swaps to a series of forward rate agreements and how each factor that affects option values affects puts and calls.
Because the future price is subject to risk uncertainty , the discount rate includes a risk premium along with the risk-free rate. We assume that investors are risk-averse so they require a positive premium higher return on risky assets.
An investor who is risk-neutral would require no risk premium and, as a result, would discount the expected future value of an asset or future cash flows at the risk-free rate. In contrast to valuing risky assets as the risk-adjusted present value of expected future cash flows, the valuation of derivative securities is based on a no-arbitrage condition. Arbitrage refers to a transaction in which an investor purchases one asset or portfolio of assets at one price and simultaneously sells an asset or portfolio of assets that has the same future payoffs, regardless of future events, at a higher price, realizing a risk-free gain on the transaction.
While arbitrage opportunities may be rare, the reasoning is that when they do exist, they will be exploited rapidly. Therefore, we can use a no-arbitrage condition to determine the current value of a derivative, based on the known value of a portfolio of assets that has the same future payoffs as the derivative, regardless of future events.
Because there are transactions costs of exploiting an arbitrage opportunity, small differences in price may persist because the arbitrage gain is less than the transactions costs of exploiting it. With derivative securities, however, the risk of the derivative is entirely based on the risk of the underlying asset, so we can construct a portfolio consisting of the underlying asset and a derivative based on it that has no uncertainty about its value at some future date i.
This will be the current value of the portfolio under the no-arbitrage condition, which will force the return on a risk-free hedged portfolio to the risk-free rate. The value of an asset combined with a short forward position is simply the price of the forward contract, F0 T.
The asset will be delivered at the settlement date for the forward contract price, F0 T. A riskless transaction should return the riskless rate of interest. Because the payoff at time T settlement date of the forward contract is from a fully hedged position, its time T value is certain. The asset will be sold at time T at the price specified in the forward contract.
To prevent arbitrage, the above equality must hold. Another way to understand this relationship is to consider buying an asset at S0 and holding it until time T, or going long a forward contract on the asset at F0 T and buying a pure discount bond that pays F0 T at time T. Both have the same payoff at settlement.
They both result in owning the asset at time T. The proceeds of the bond, F0 T , are just enough to buy the asset at time T. F0 T is the no-arbitrage price of the forward contract. Because we know the risk-free rate, the spot price of the asset, and the certain payoff at time T, we can solve for the no-arbitrage price of the forward contract. For this reason, the determination of the no-arbitrage derivative price is sometimes called risk-neutral pricing, which is the same as no-arbitrage pricing or the price under a no-arbitrage condition.
This process is called replication because we are replicating the payoffs on one asset or portfolio with those of a different asset or portfolio.
Another example of risk-neutral pricing is to combine a risky bond with a credit protection derivative to replicate a risk-free bond. As a final example of risk-neutral pricing and replication, consider an investor who buys a share of stock, sells a call on the stock at 40, and buys a put on the stock at 40 with the same expiration date as the call.
The investor will receive 40 at option expiration regardless of the stock price because: If the stock price is 40 at expiration, the put and the call are both worthless at expiration.
As the price of the underlying asset changes during the life of the contract, the value of a futures or forward contract position may increase or decrease. If the spot price of the underlying asset increases other things equal , the value of the long contract position will increase and the value of a short position will decrease. The contract price at which the long forward will purchase the asset in the future does not change over the life of the contract, but the value of the forward contract almost surely will.
In doing this we assumed that there were no benefits of holding the asset and no costs of holding the asset, other than opportunity cost of the funds to purchase the asset the risk-free rate of interest.
There may be additional costs of owning an asset, such as storage and insurance costs. For financial assets, these costs are very low and not significant. There may also be benefits to holding the asset, both monetary and nonmonetary. Dividend payments on a stock or interest payments on a bond are examples of monetary benefits of holding an asset.
Nonmonetary benefits of holding an asset are sometimes referred to as its convenience yield. The convenience yield is difficult to measure and is only significant for some assets, primarily commodities.
If an asset is difficult to sell short in the market, owning it may convey benefits in circumstances where selling the asset is advantageous. For example, a shortage of the asset may drive prices up, making sale of the asset in the short term profitable. While the ability to look at a painting or sculpture provides nonmonetary benefits to its owner, this is unlikely with corn or other commodities. We can denote the present value of any costs of holding the asset from time 0 to settlement at time T as PV0 cost and the present value of any cash flows from the asset and any convenience yield over the holding period as PV0 benefit.
Consider first a case where there are costs of holding the asset but no benefits. Any other forward price will create an arbitrage opportunity at the initiation of the forward contract. The intuition here is that the cost of buying the asset and holding it until the forward settlement date is higher by the present value of the costs of storing the asset, so that the no- arbitrage forward price must be higher.
Again, any forward price that is not equal to the no-arbitrage forward price will create an arbitrage opportunity. The no-arbitrage forward price is lower to the extent the present value of any benefits is greater, and higher to the extent the present value of any costs incurred over the life of the forward contract is greater. When the benefits cash flow yield and convenience yield exceed the costs storage and insurance of holding the asset, we say the net cost of carry is positive.
Derivatives pricing models use the risk-free rate to discount future cash flows because these models: A. The price of a forward or futures contract: A. For a forward contract on an asset that has no costs or benefits from holding it to have zero value at initiation, the arbitrage-free forward price must equal: A. The underlying asset of a derivative is most likely to have a convenience yield when the asset: A.
The point of entering into an FRA is to lock in a certain interest rate for borrowing or lending at some future date. One party will pay the other party the difference based on an agreed-upon notional contract value between the fixed interest rate specified in the FRA and the market interest rate at contract settlement.
LIBOR is most often used as the underlying rate. A company that expects to borrow day funds in 30 days will have higher interest costs if day LIBOR 30 days from now increases. A long position in the FRA pay fixed, receive floating will receive a payment that will offset the increase in borrowing costs from the increase in day LIBOR. FRAs are used by firms to hedge the risk of remove uncertainty about borrowing and lending they intend to do in the future.
For a firm that intends to have funds to lend invest in the future, a short position in an FRA can hedge its interest rate risk. In this case, a decline in rates would decrease the return on funds loaned at the future date, but a positive payoff on the FRA would augment these returns so that the return from both the short FRA and loaning the funds is the no-arbitrage rate that is the price of the FRA at initiation.
A bank can borrow money for days and lend that amount for 30 days. At the end of 30 days, the bank receives funds from the repayment of the day loan it made, and has use of these funds for the next 90 days at an effective rate determined by the original transactions. If gains put the margin balance above the initial margin level, any funds in excess of that level can be withdrawn. If losses put the margin value below the minimum margin level, funds must be deposited to restore the account margin to its initial required level.
Forwards, typically, do not require or provide funds in response to fluctuations in value during their lives. While this difference is theoretically important in some contexts, in practice it does not lead to any difference between the prices of forwards and futures that have the same terms otherwise. If interest rates are constant, or even simply uncorrelated with futures prices, the prices of futures and forwards are the same. A positive correlation between interest rates and the futures price means that for a long position daily settlement provides funds excess margin when rates are high and they can earn more interest, and requires funds margin deposits when rates are low and opportunity cost of deposited funds is less.
Because of this, futures prices will be higher than forward prices when interest rates and futures prices are positively correlated, and they will be lower than forward prices when interest rates and futures prices are negatively correlated.
Consider a one-year swap with quarterly payments, one party paying a fixed rate and the other a floating rate of day LIBOR. At each payment date the difference between the swap fixed rate and LIBOR for the prior 90 days is paid to the party that owes the least, that is, a net payment is made from one party to the other.
We can separate these payments into a known payment and three unknown payments which are equivalent to the payments on three forward rate agreements. Let Sn represent the floating rate payment based on day LIBOR owed at the end of quarter n and Fn be the fixed payment owed at the end of quarter n.
We can replicate each of these payments to or from the fixed rate payer in the swap with a forward contract, specifically a long position in a forward rate agreement with a contract rate equal to the swap fixed rate and a settlement value based on day LIBOR. We illustrate this separation below for a one-year fixed for floating swap with a fixed rate of F, fixed payments at time n of Fn, and floating rate payments at time n of Sn.
Thus, the forwards in our example actually pay on days 90, , and However, the amounts paid are equivalent to the differences between the fixed rate payment and floating rate payment that are due when interest is actually paid on days , , and , which are the amounts we used in the example. Therefore, we can describe an interest rate swap as equivalent to a series of forward contracts, specifically forward rate agreements, each with a forward contract rate equal to the swap fixed rate.
However, there is one important difference. Because the forward contract rates are all equal in the FRAs that are equivalent to the swap, these would not be zero value forward contracts at the initiation of the swap.
Recall that forward contracts are based on a contract rate for which the value of the forward contract at initiation is zero. There is no reason to suspect that the swap fixed rate results in a zero value forward contract for each of the future dates. When a forward contract is created with a contract rate that gives it a non-zero value at initiation, it is called an off-market forward.
The forward contracts we found to be equivalent to the series of swap payments are almost certainly all off-market forwards with non-zero values at the initiation of the swap. Because the swap itself has zero value to both parties at initiation, it must consist of some off-market forwards with positive present values and some off-market forwards with negative present values, so that the sum of their present values equals zero.
Finding the swap fixed rate which is the contract rate for our off-market forwards that gives the swap a zero value at initiation is not difficult if we follow our principle of no-arbitrage pricing.
The fixed rate payer in a swap can replicate that derivative position by borrowing at a fixed rate and lending the proceeds at a variable floating rate. For the swap in our example, borrowing at the fixed rate F and lending the proceeds at day LIBOR will produce the same cash flows as the swap.
At each date the payment due on the fixed-rate loan is Fn and the interest received on lending at the floating rate is Sn. As with forward rate agreements, the price of a swap is the fixed rate of interest specified in the swap contract the contract rate and the value depends on how expected future floating rates change over time.
At initiation, a swap has zero value because the present value of the fixed-rate payments equals the present value of the expected floating-rate payments. An increase in expected short-term future rates will produce a positive value for the fixed-rate payer in an interest rate swap, and a decrease in expected future rates will produce a negative value because the promised fixed rate payments have more value than the expected floating rate payments over the life of the swap.
How can a bank create a synthetic day forward rate agreement on a day interest rate? Borrow for days and lend the proceeds for 60 days. Borrow for days and lend the proceeds for days. For the price of a futures contract to be greater than the price of an otherwise equivalent forward contract, interest rates must be: A. The price of a fixed-for-floating interest rate swap: A. If immediate exercise of the option would generate a positive payoff, it is in the money.
If immediate exercise would result in a loss negative payoff , it is out of the money. When the current asset price equals the exercise price, exercise will generate neither a gain nor loss, and the option is at the money. The following describes the conditions for a call option to be in, out of, or at the money.
S is the price of the underlying asset and X is the exercise price of the option. In-the-money call options. Out-of-the-money call options. At-the-money call options. The following describes the conditions for a put option to be in, out of, or at the money. In-the-money put options. Out-of-the-money put options.
At-the-money put options. Calculate how much these options are in or out of the money. We define the intrinsic value or exercise value of an option the maximum of zero and the amount that the option is in the money.
That is, the intrinsic value is the amount an option is in the money, if it is in the money, or zero if the option is at or out of the money. The intrinsic value is also the exercise value, the value of the option if exercised immediately. Prior to expiration, an option has time value in addition to any intrinsic value. The time value of an option is the amount by which the option premium price exceeds the intrinsic value and is sometimes called the speculative value of the option.
This is because there is some probability that the underlying asset price will change in an amount that gives the option a positive payoff at expiration greater than the current intrinsic value. When an option reaches expiration, there is no time remaining and the time value is zero. This means the value at expiration is either zero, if the option is at or out of the money, or its intrinsic value, if it is in the money. Price of the underlying asset. For call options, the higher the price of the underlying, the greater its intrinsic value and the higher the value of the option.
Conversely, the lower the price of the underlying, the less its intrinsic value and the lower the value of the call option. In general, call option values increase when the value of the underlying asset increases. For put options this relationship is reversed. An increase in the price of the underlying reduces the value of a put option. The exercise price. A higher exercise price decreases the values of call options and a lower exercise price increases the values of call options.
A higher exercise price increases the values of put options and a lower exercise price decreases the values of put options. The risk-free rate of interest. An increase in the risk-free rate will increase call option values, and a decrease in the risk-free rate will decrease call option values. An increase in the risk-free rate will decrease put option values, and a decrease in the risk-free rate will increase put option values. Volatility of the underlying.
Volatility is what makes options valuable. If there were no volatility in the price of the underlying asset its price remained constant , options would always be equal to their intrinsic values and time or speculative value would be zero. An increase in the volatility of the price of the underlying asset increases the values of both put and call options and a decrease in volatility of the price of the underlying decreases both put values and call values.
Time to expiration. Because volatility is expressed per unit of time, longer time to expiration effectively increases expected volatility and increases the value of a call option. Less time to expiration decreases the time value of a call option so that at expiration it value is simply its intrinsic value.
For most put options, longer time to expiration will increase option values for the same reasons. For some European put options, however, extending the time to expiration can decrease the value of the put. Extending the time to expiration would decrease that present value.
While overall we expect a longer time to expiration to increase the value of a European put option, in the case of a deep in-the-money put, a longer time to expiration could decrease its value. Cfa Schweser Notes. These notes helped me focus on some of the most important concepts. The reason for this is that the CFA charter is an exclusive designation, designed to prove mastery of the topics.
File Name: cfa level 2 schweser. English Pages 0 []. Contents 1. Exam Focus 2.
0コメント