NISM Series IV: Interest Rate Derivative Mock Test – Free Demo

Explanation:

Stochastic changes in a bond’s market price refer to random fluctuations in the price of the bond, primarily influenced by changes in interest rates and credit ratings of the issuer. When interest rates or credit ratings change, they can affect the perceived risk and return associated with the bond, leading to changes in its market price. These changes are stochastic because they are unpredictable and driven by various factors affecting the bond market. Therefore, both changes in interest rates and changes in the credit ratings of the issuer contribute to stochastic changes in a bond’s market price.

Explanation:

The daily settlement price is the price at which margining and mark-to-market processes are implemented in financial markets. It is determined based on the closing prices of securities or derivatives contracts traded during the day. This price serves as a reference for calculating profits or losses and settling obligations between counterparties involved in trading activities. Margin requirements are adjusted based on changes in the daily settlement price to ensure that participants maintain adequate collateral to cover potential losses. Therefore, the daily settlement price plays a crucial role in risk management and maintaining market integrity.

Explanation:

The relationship between real (r) and nominal (i) interest rates is given by the Fisher equation, which states that the real interest rate is equal to the nominal interest rate adjusted for inflation. Mathematically, it can be expressed as:

(1 + r) x (1 + i) = (1 + R)

Where:

• r is the real interest rate,

• i is the nominal interest rate,

• R is the inflation rate.

This equation shows that the nominal interest rate is the sum of the real interest rate and the inflation rate, adjusted for compounding. Therefore, to find the real interest rate, one must adjust the nominal interest rate by subtracting the inflation rate.

Explanation:

SGL (Subsidiary General Ledger) accounts are maintained by banks and financial institutions with the Reserve Bank of India (RBI) for the purpose of holding government securities. These accounts are used for settlement and custody of government securities transactions. On the other hand, depository participants (DPs) are entities authorized by central depositories (like NSDL and CDSL in India) to offer depository services to investors. They facilitate the holding, transfer, and settlement of securities in dematerialized form. While both SGL account holders and DPs are involved in securities custody and settlement, they serve different purposes and operate within different systems (RBI’s SGL system vs. central depositories). Therefore, the statement that SGL account holders are the equivalent of depository participants is false.

Explanation:

For zero-coupon bonds, there are no interim coupon payments, and the entire return is realized at maturity. Additionally, the yield to maturity (YTM) is calculated using a single zero rate, as there are no periodic coupon payments to consider. Therefore, the YTM serves as the true measure of return for zero-coupon bonds because it accounts for both the absence of interim returns and the use of a single zero rate for calculating the bond’s yield.

Explanation:

Coupon instruments generally have lower reinvestment risk compared to zero-coupon instruments because they provide investors with periodic cash flows that can be reinvested at prevailing market rates.

Explanation:

Changes in yield, especially in the case of fixed-income securities like bonds, directly impact the price of the bonds. When yields increase, bond prices generally decrease, and when yields decrease, bond prices generally increase. This inverse relationship between bond yields and prices is fundamental to bond valuation. Therefore, changes in yield will drive changes in the price of deliverable bonds.

Explanation:

Swaps are derivative contracts that involve the exchange of cash flows or returns from one financial instrument or asset class for another. In the context described, a swap contract allows parties to exchange returns from an underlying asset (such as stocks, bonds, commodities, or indices) with returns from cash over a specified period. These swaps are typically traded over-the-counter (OTC), meaning they are customized contracts negotiated directly between parties rather than being traded on an exchange. Therefore, swaps are the derivative contracts that match the description provided.

Explanation:

The Value at Risk (VaR) for each security is a measure of potential loss under normal market conditions within a specified confidence interval over a given time horizon. To convert VaR into a scan range for futures contracts, it can be multiplied by either the contract amount (the value of one futures contract) or the market lot (the number of units of the underlying asset represented by one futures contract). Both methods are commonly used depending on the specific context and requirements of the risk management strategy. Therefore, the correct answer is either 1 or 2, as both methods are valid for converting VaR into scan range for futures contracts.

Explanation:

The market value of a security is typically calculated by multiplying the face value of the security by its market price as a percentage of face value. This calculation reflects the current worth of the security in the market. The face value represents the nominal or par value of the security, while the market price indicates its actual trading price in the market. Multiplying the face value by the market price (expressed as a percentage) gives the market value of the security. Therefore, the correct formula for calculating the market value of a security is Face value × (Market price / 100).

Explanation:

The price value of a basis point (PVBP) measures the change in the price of a bond for a one basis point change (0.01%) in its yield. It is calculated by multiplying the modified duration of the bond by the bond’s price and dividing by 10,000 (since one basis point is 0.01%).

PVBP = Modified Duration * Bond Price / 10,000

Given: Modified Duration = 1.71 Bond Price = 101.7125

Substituting the values: PVBP = 1.71 * 101.7125 / 10,000 = 0.0174

Therefore, the price value of a basis point is 0.0174.

Explanation:

Puttable bonds provide the investor with the right to demand prepayment on specified dates before maturity. This means that the investor has the option to sell the bond back to the issuer at a predetermined price on specified dates. This feature gives investors some flexibility and protection in case they need to liquidate their investment before the bond’s maturity. In contrast, callable bonds give the issuer the right to redeem or call back the bond before its maturity date, typically to take advantage of lower interest rates. Convertible bonds allow the bondholder to convert the bond into a predetermined number of shares of the issuer’s common stock. Therefore, only puttable bonds provide investors with the right to demand prepayment on specified dates before maturity.

Explanation:

The daily settlement price in the cash NDS-OM (Negotiated Dealing System-Order Matching) market is determined differently. It is typically calculated based on the weighted average price of all trades executed during a specified period, often the last few minutes of trading before the market closes. This price is used as a reference for marking-to-market and settling contracts traded in the market. Therefore, stating that it will be the volume weighted average price during the last three hours in the absence of trading during the last 30 minutes is incorrect.

Explanation:

The maintenance margin is not a concept under the SPAN (Standard Portfolio Analysis of Risk) margining system. Instead, it is a concept used in traditional margin accounts. In traditional margin accounts, the maintenance margin is the minimum amount of equity that must be maintained in the account to continue holding positions. If the account’s equity falls below the maintenance margin level, the investor may receive a margin call requiring additional funds to be deposited into the account or positions to be liquidated. SPAN margining, on the other hand, is a risk-based margining system used in derivatives markets to calculate margin requirements based on the risk of the portfolio.

Explanation:

In the case of a certificate of deposit (CD), the minimum amount of issue is typically Rs 1 lakh, and investors can purchase CDs in multiples of this amount. This minimum and multiple of issue are set by regulatory authorities and institutions issuing CDs to ensure standardized terms for investors. It allows for ease of trading and ensures liquidity in the market for certificate of deposits.

Explanation:

When using futures contracts to hedge against price fluctuations in underlying assets, such as commodities or financial instruments, the hedger is exposed to both basis risk and yield curve spread risk simultaneously. Basis risk arises from differences in the price movements between the underlying asset and the futures contract used for hedging. Yield curve spread risk refers to the risk associated with changes in the yield spread between different maturities of futures contracts. These risks can impact the effectiveness of the hedge and may result in losses if not managed properly.

Explanation:

In bond transactions, the seller typically owns the bond from the previous coupon date until the settlement date of the transaction. During this period, the seller is entitled to receive the interest accrual for the period between the previous coupon date and the settlement date. This ensures that the seller receives compensation for holding the bond and relinquishes any future interest payments to the buyer upon settlement.

Explanation:

Basis risk arises from the discrepancy between the exposure being hedged and the characteristics of the futures contract being used for hedging. This discrepancy can include differences in the contract amount (1) and the contract maturity (2). Basis risk occurs because the futures contract may not perfectly align with the underlying exposure, leading to potential mismatches and residual risk.

Explanation:

The conversion factor for each deliverable bond makes the seller indifferent to any preference for a particular bond. It essentially represents the relative value of the bond in terms of the futures contract. By using the conversion factor, sellers can hedge their positions effectively regardless of the specific bonds delivered, thereby reducing basis risk.

Explanation:

The bond with different coupons but with the same maturity will have different Yield to Maturity (YTM), primarily due to the coupon effect. Bonds with higher coupon rates will have lower YTMs compared to bonds with lower coupon rates, assuming all other factors remain constant. This is because higher coupon payments provide more income to the investor, reducing the effective yield on the bond. Therefore, the variation in coupon rates among bonds with the same maturity results in different YTMs, illustrating the coupon effect.