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.
B.
C.
D.

The stock trading at the highest dollar price per share.

The stock with the highest total market value of equity.
The stock with the highest number of shares outstanding.
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
Stock A
Stock B
Stock C
A.
B.
C.
D.

30
40
50
60

Price
$40
$70
$10

Number of shares outstanding

200
500
600

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.
B.
C.
D.

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

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

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

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

$10 million
$15 million
$20 million
$25 million

Question 11
What must investors in closed-end funds do to liquidate their positions?
A.
B.
C.
D.

Sell their shares to other investors.

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

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

$ 729
$ 810
$ 870
$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.
B.
C.
D.

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

10.00%
12.32%
12.82%
13.62%

Question 18
What characteristic is associated with a high rating from the bond rating agency?
A.
B.
C.
D.

A low times interest earned ratio

A high fixed coverage ratio
A high quick ratio
A low current ratio

Question 19
What is the main purpose of the subordination clause in a bond indenture?
A.
B.
C.
D.

It restricts the amount of dividends the firm may pay.

It provides for a sinking fund.
It specifies the collateral for the bond.
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.
B.
C.
D.

$ 984.09
$ 994.60
$1,000.00
$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)
1
2
3
4

Price
$943.40
$881.68
$808.88
$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.
B.
C.
D.

The 5-year 0% coupon bond

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

A substitution SWAP
Dedication
Subordination
Passive bond management

Question 29
A substitution swap is an exchange of bonds undertaken for what purpose?
A.
B.
C.
D.

To change the credit risk of a portfolio.

To extend the duration of a portfolio.
To best prepare for an expected change in the term structure.
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.
B.
C.
D.

Book value
Intrinsic value
Liquidation value
Tobins Q

Question 31
Other things equal, what is typically associated with a high growth rate in a firms
earnings?
A.
B.
C.
D.

A low dividend payout ratio

A low degree of earnings variability
A low plowback ratio
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.
B.
C.
D.

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

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

$11.62
$12.33
$13.23
$14.29

Question 35
Which of the following defines the free cash flow valuation approach?
A.
B.
C.
D.

Cash flow in the form of dividends as a percent of revenues.

Cash flow available to pay interest on debt.
Cash flow available to equityholders net of capital expenditures.
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.
B.
C.
D.

8.16%
8.50%
8.84%
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
Boom
Normal growth
Recession

Probability
.40
.35
.25

HPR
22%
11%
- 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.
B.
C.
D.

0.08
0.35
0.62
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.
B.
C.
D.

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

Question 42
Which of the following is TRUE about skewness?
A.
B.
C.
D.

The standard deviation of a negatively skewed distribution will overestimate risk.

It is a measure of the degree of fat tails in a distribution.
If the distribution is skewed to the left, extreme negative values will dominate.
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.
B.
C.
D.

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

Value at Risk (VaR)

Conditional Tail Expectation (CTE)
Lower Partial Standard Deviation (LPSD)
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.
B.
C.
D.

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

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

The line that intersects at the highest expected return.

The line with the steepest slope.
The line that intersects at the lowest standard deviation.
The line with a zero slope.

Question 50
Which of the following statements is consistent with the separation property?
A.
B.
C.
D.

The determination of the optimal risky portfolio is investor specific.

The optimal risky portfolio is the same for all investors.
The degree of risk aversion is the same for all investors.
There is no role for the risk free rate in the complete portfolio.

Question 51
How is beta different from standard deviation?
A.
B.
C.
D.

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

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

You should buy the stock because it is underpriced.

You should sell the stock short because it is overpriced.
You should do nothing because the stock is fairly priced.
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.
B.
C.
D.

The risk premium is not related to beta.

The risk premium varies directly with beta.
The risk premium varies indirectly with beta.
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.
B.
C.
D.

The definition of efficiency differs.

The definition of excess return differs.
The definition of prices differs.
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.
B.
C.
D.

The weak form

The semistrong form
The strong form
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.
B.
C.
D.

Earnings
Dividends
Trend lines
The companys management team

Question 59
What do proponents of the efficient market hypothesis advocate?
A.
B.
C.
D.

Trading based on overconfidence

Technical analysis
Searching for anomalies
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.
B.
C.
D.

Regret avoidance
Selection bias
Framing
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.
B.
C.
D.

Close to positive one

Close to 0.50
Zero
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.
B.
C.
D.

There is persistence in good performance but not bad performance.

There is persistence in bad performance but not good performance.
There is some evidence of persistence related to extreme investment performance.
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.
B.
C.
D.

Overconfidence
Conservatism
Forecasting error
Sample size neglect

Question 65
Which of the following would NOT be a behavioral bias in the context of market
efficiency?
A.
B.
C.
D.

Framing
Trend analysis
Regret avoidance
Mental accounting

Question 66
Which of the following describes the law of one price?
A.
B.
C.
D.

An assets price should be quoted on a net basis.

An assets price should be quoted in only one currency.
Identical assets should have identical prices.
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.
B.
C.
D.

The signal would be positive because it indicates selling pressure.

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

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

The performance of Portfolio A is greater than Portfolio B.

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

Use the data below to answer to following four questions.

Average Return
Standard Deviation of Returns
Beta
Residual standard deviation

Alpha Fund
20%
44%
1.8
2.0%

Market Portfolio
11%
19%
1.0
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.
B.
C.
D.

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

The percent of return variability explained by security selection.

The percent of return variability explained by asset allocation.
The percent of return variability explained by market timing.
The percent of return variability explained by the benchmark return.

Question 76
Which of the following is TRUE of exchange rate risk?
A.
B.
C.
D.

Exchange rate risk represents a small part of the risk of international investing.
Exchange rate risk cannot be diversified.
Interest rate parity models the hedging of exchange rate risk.
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.
B.
C.
D.

Raising the risk relative to holding only U.S. stocks

Reducing the risk relative to the risk of holding only U.S. stocks
Increasing expected return but at the expense of taking more risk
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.
B.
C.
D.

The exercise price is higher than the stock price.

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

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

A long position in the underlying asset

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

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

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

$ 4.38
$ 5.60
$ 6.23
$12.26

Question 84
Warrants are essentially call options with what distinguishing characteristic?
A.
B.
C.
D.

They have an exercise price of zero

They offer no protection against stock splits
They require new shares of stock to be issued upon exercise.
They have no expiration date.

Question 85
Collateralized loans can be thought of as providing what type of implicit position to the
borrower?
A.
B.
C.
D.

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

Positive
Equal to zero
Negative
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.
B.
C.
D.

The stock price

The time to expiration
The stock volatility
The exercise price

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

They are less valuable.

They are more valuable.
They are equal in value.
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.
B.
C.
D.

Negative
Positive
No effect
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.
B.
C.
D.

Holding long 0.70 calls for each short stock

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

The hedge ratio will always be equal to one.

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

A commitment to purchase something on the delivery date

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

Buyers and sellers

Buyers
Futures exchanges
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.
B.
C.
D.

The basis must be zero at the contracts maturity.

The basis must be equal to the spot price at the contracts maturity.
The basis must be equal to the futures price at the contracts maturity.
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.
B.
C.
D.

Contango
Speculation
Normal backwardation
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.
B.
C.
D.

$1.57/BP
$1.60/BP
$1.66/BP
$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
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37

Answer

Text Reference

Study Guide Reference

B
A
B
A
C
B
B
A
C
D
A
C
C
B
C
A
B
B
D
A
B
C
A
C
B
D
D
B
D
B
A
B
A
A
C
D
A

Pages 34-36
Pages 41-42
Pages 42-43
Page 58
Pages 59-62
Pages 64-65
Pages 78-80
Pages 79-80
Pages 81-83
Page 96
Pages 97-98
Page 106
Page 458
Page 461
Page 461
Pages 466-475
Pages 468-475
Pages 481-482
Pages 483-485
Pages 496-498
Pages 496-497
Pages 496-502
Pages 505-506
Pages 524-526
Pages 527-534
Pages 534-539
Pages 538-539
Pages 550-551
Page 552
Pages 606-607
Pages 612-613
Pages 07-610
Pages 608-611
Pages 608-620
Pages 630-631
Pages 133-134
Pages 128-130

Topic 1, Chapter 2, LO2

Topic 1, Chapter 2, LO4
Topic 1, Chapter 2, LO4
Topic 1, Chapter 3, LO1
Topic 1, Chapter 3, LO1
Topic 1, Chapter 3, LO2
Topic 1, Chapter 3, LO3
Topic 1, Chapter 3, LO3
Topic 1, Chapter 3, LO4
Topic 1, Chapter 4, LO1
Topic 1, Chapter 4, LO2
Topic 1, Chapter 4, LO4
Topic 2, Chapter 14, LO1
Topic 2, Chapter 14, LO1
Topic 2, Chapter 14, LO1
Topic 2, Chapter 14, LO5
Topic 2, Chapter 14, LO5
Topic 2, Chapter 14, LO6
Topic 2, Chapter 14, LO7
Topic 2, Chapter 15, LO1
Topic 2, Chapter 15, LO1
Topic 2, Chapter 15, LO2
Topic 2, Chapter 15, LO3
Topic 2, Chapter 16, LO1
Topic 2, Chapter 16, LO2
Topic 2, Chapter 16, LO3
Topic 2, Chapter 16, LO4
Topic 2, Chapter 16, LO5
Topic 2, Chapter 16, LO6
Topic 3, Chapter 18, LO1
Topic 3, Chapter 18, LO2
Topic 3, Chapter 18, LO2
Topic 3, Chapter 18, LO2
Topic 3, Chapter 18, LO2
Topic 3, Chapter 18, LO4
Topic 4, Chapter 5, LO2
Topic 4, Chapter 5, LO2

38
39
40
41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62
63
64
65
66
67
68
69
70
71
72
73
74
75
76
77
78
79
80
81
82

B
D
C
B
C
C
C
C
D
C
B
B
B
B
A
B
B
B
D
C
C
D
B
C
B
C
C
B
C
B
C
C
C
A
A
B
B
B
C
B
B
B
A
C
B

Pages 134-135
Pages 134-135
Pages 139-140
Pages 136-138
Pages 140-143
Pages 144-146
Pages 150-151
Pages 167-174
Pages 176-180
Pages 176-180
Pages 208-216
Pages 216-221
Pages 3226-228
Pages 302-305
Pages 299-302
Page 306
Pages 302-303
Pages 302-303
Page 361
Page 361
Page 363
Page 363-364
Page 369
Page 371
Pages 376-377
Pages 381-386
Page 397
Pages 398-399
Pages 400-407
Pages 411-412
Pages 851-853
Pages 853-856
Pages 853-856
Pages 853-856
Pages 853-856
Pages 853-856
Pages 872-875
Pages 875-879
Pages 902-905
Pages 905-908
Pages 692-698
Pages 692-698
Pages 703-711
Pages 703-711
Pages 711-713

Topic 4, Chapter 5, LO3

Topic 4, Chapter 5, LO 3
Topic 4, Chapter 5, LO5
Topic 4, Chapter 5, LO4
Topic 4, Chapter 5, LO6
Topic 4, Chapter 5, LO7
Topic 4, Chapter 5, LO8
Topic 4, Chapter 6, LO3
Topic 4, Chapter 6, LO4
Topic 4, Chapter 6, LO4
Topic 4, Chapter 7, LO2
Topic 4, Chapter 7, LO3
Topic 4, Chapter 7, LO4
Topic 4, Chapter 8, LO1
Topic 4, Chapter 8, LO2
Topic 4, Chapter 8, LO3
Topic 4, Chapter 8, LO3
Topic 4, Chapter 8, LO3
Topic 5, Chapter 11, LO2
Topic 5, Chapter 11, LO2
Topic 5, Chapter 11, LO3
Topic 5, Chapter 11, LO4
Topic 5, Chapter 11, LO6
Topic 5, Chapter 11, LO7
Topic 5, Chapter 11, LO7
Topic 5, Chapter 11, LO8
Topic 5, Chapter 12, LO2
Topic 5, Chapter 12, LO3
Topic 5, Chapter 12, LO4
Topic 5, Chapter 12, LO5
Topic 6, Chapter 24, LO1
Topic 6, Chapter 24, LO2
Topic 6, Chapter 24, LO2
Topic 6, Chapter 24, LO2
Topic 6, Chapter 24, LO2
Topic 6, Chapter 24, LO2
Topic 6, Chapter 24, LO4
Topic 6, Chapter 24, LO5
Topic 6, Chapter 25, LO2
Topic 6, Chapter 26, LO3
Topic 7, Chapter 20, LO1
Topic 7, Chapter 20, LO1
Topic 7, Chapter 20, LO3
Topic 7, Chapter 20, LO3
Topic 7, Chapter 20, LO4

83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
100

C
C
C
B
B
A
A
B
B
C
C
A
C
B
A
C
A
B

Pages 711-713
Pages 714-720
Pages 714-720
Pages 721-724
Pages 721-724
Pages 737-740
Pages 737-740
Pages 740-744
Pages 758-759
Pages 760-764
Pages 760-764
Pages 784-785
Page 790
Pages 792-793
Page 798
Page 806
Pages 814-817
Pages 818-821

Topic 7, Chapter 20, LO4

Topic 7, Chapter 20, LO5
Topic 7, Chapter 20, LO5
Topic 7, Chapter 20, LO5
Topic 7, Chapter 20, LO5
Topic 7, Chapter 21, LO1
Topic 7, Chapter 21, LO1
Topic 7, Chapter 21, LO2
Topic 7, Chapter 21, LO6
Topic 7, Chapter 21, LO7
Topic 7, Chapter 21, LO7
Topic 8, Chapter 22, LO1
Topic 8, Chapter 22, LO1
Topic 8, Chapter 22, LO1
Topic 8, Chapter 22, LO3
Topic 8, Chapter 22, LO5
Topic 8, Chapter 23, LO1
Topic 8, Chapter 23, LO2