JUN18L1EQU/C01

Question 1
Which of the following is least likely an example of an arbitrage trade?
a) Buying stock from a foreign exchange and selling it on the local exchange.
b) Selling equity call options in a contract market and buying the underlying shares in the stock market.
c) Buying debt instruments from clients at lower prices and selling them when the prices rise.
Arbitragers trade when they can identify opportunities to buy and sell identical or essentially similar instruments at
different prices in different markets. They may trade securities or contracts whose values depend on the same
underlying factors, such as equity call options and its underlying shares. Dealers provide liquidity to buyers and sellers
who arrive at the same market at different times.

Question 2
Which of the following least describes the fundamental weighting of indices?
a) There may be a tilt in the value of the constituent security because the measure/ratio used to weight the
assets is way higher or lower than its market capitalization weight.
b) The weighting used in fundamental weighting is independent of the price of the security.
c) This method has a momentum effect because those who increased in relative value will get even higher
weights moving forward.
This method of weighting has a contrarian effect where the weight of those who increase in relative value will lessen
and those who decrease in relative value will have greater weighting..

Question 3
One month ago an investor sold shares of Huge Co. that he did not own, but had borrowed. Currently, his existing
position is still outstanding and the investor decides to write call options on the shares of Huge Co. The options are on
the same number of shares as he has borrowed sold. Given these two positions, the investor's exposure to the risk of
Huge Co. is:
a) long.
b) short.
c) neutral.
The investor has shorted the shares and he gains if the stock falls and he loses if the stock rises. By writing call
options, he will lose if the shares rise. As the writer, he is paid an option premium. In total, he loses if the shares rise
and benefits if the share drop, which means his risk exposure is short.

Question 4
A short seller of a stock will generally:
a) Sell the stock when the price is rising.
b) Deposit collateral when he borrows stock.
c) Benefit from the price fall when a stock goes ex-dividend.
The first choice is not correct since he is anticipating falls in prices in the future, so current prices could be rising or
falling. The third is not correct since he must pay the dividends to the lender of the stock. Usually, the lender of stock
will require collateral as protection against the borrower failing to return the stock.

Question 5
Michael Starc, CFA, constructed an equal-weighted index from five securities at the beginning of Period 1. The
beginning index portfolio value was 5,000. The following information relates to the initial period of the index:
Security Beginning Price Dividends per Share Ending Price
A 8.00 0.00 10.00
B 12.50 2.00 10.00
C 40.00 5.00 50.00
D 25.00 5.00 20.00
E 50.00 2.00 40.00
Michael rebalances the index at the beginning of the next period. Which of the following statements is most
accurate about the index?
a) The rebalancing will decrease the number of Security B shares in the index.
b) The rebalancing will increase the weight of Security C in the index.
c) The weight of Security D would have been lower in Period 2 if price weighting were used.
 Beginning Beginning Ending Ending Ending Rebalanced
Security Price Shares* Price Value** Weight Shares***
A $ 8.00 125 $10.00 1,250 0.25 100
B 12.50 80 10.00 800 0.16 100
C 40.00 25 50.00 1,250 0.25 20
D 25.00 40 20.00 800 0.16 50
E 50.00 20 40.00 800 0.16 25
Total $130.00 4,900 1.00
* (5,000 × 1 / 5) / Beginning price
** Ending price × Beginning shares
*** (5,000 × 1 / 5) / Ending price
If price weighting were used, the index would not be rebalanced because the weight of each constituent security is
determined by its price. Therefore, the weight of Security D would have been 15.38% ($20 / $130) in Period 2.

Question 6
Given the following information:
Shares purchased 800
Purchase price per share $ 70
Annual dividend per share $ 1.50
Initial margin requirement 35%
Call money rate 2.5%
Commission per share $ 0.08
Stock price after one year $ 74.50
Based on the information given, which statement is false?
a) The leverage ratio is 2.86.
b) The total initial equity investment is $19,964
c) The return on the equity investment is 47.36%.
Stock value, gain: $14.5 × 800 = 11,600
Commission: $0.08 × 800 = (64)
Dividends received: $1.50 × 800 = 1,200
Interest paid: $65,000 × 0.025 = (1,625)
Total return = 11,111
Return on equity investment $11,111/19,964 = 55.66%

Question 7
Use the following information regarding an equal-weighted equity index
Security Price at the End of 2009 ($) Price at the End of 2010 ($) Dividends per Share ($)
A 20 25 0.5
B 50 45 0.2
C 31.25 36 0.4
D 100 135 0.5
Assume that all dividend payments are made at the end of the year.
Note: The dollar value of the index on December 31, 2009 is $10,000 and using a divisor of 10, the index level equals
1,000.
The number of shares of Security C in the index on December 31, 2009 is closest to:
a) 80
b) 50
c) 125
Value assigned to Security C = 10,000 / 4 = $2,500
Number of shares of Security C = 2,500 / 31.25 = 80

Question 8
Being a qualified analyst, you are to assess the performance of financial markets and implement market regulations to
mitigate risks associated with the issues you noted. Which of the following will not be one of the issues you will take
note of?
a) Agency problems
b) Existence of fraud
c) Low return of investments
The variability of returns is inherent in a market. One cannot control the return of risky investments through market
regulation.

Question 9
A call market refers to a market where:
a) Trades are done by open outcry.
b) It is attempted to match all the bids and asks at a specified time.
c) All the trading is done by computer rather than on a trading floor.
In a call market, all the bids and asks for a stock are collected and a stock price that will best match buyers and sellers
is decided.

Question 10
Which of the following positions on options will most likely result in a benefit?
Position Option Underlying
A. Long Call Falls in value
B. Short Put Rises in value
C. Short Call Rises in value
a) Row A
b) Row B
c) Row C
The long position on an options contract is the party that holds the right to exercise the option. The short side refers to
the writer of the option, who must satisfy any obligations arising from the contract. The long position on a call option
will benefit when the underlying financial instrument rises in value. The short position on a call option will benefit when
the underlying financial instrument falls in value. The long position on a put option will benefit when the underlying
financial instrument falls in value. The short position on a put option will benefit when the underlying financial
instrument rises in value.