8006 Exam Dumps : Exam I: Finance Theory Financial Instruments Financial Markets - 2015 Edition

A utility function provides a description of an individual or a firm's risk attitude. It expresses how risk seeking or risk averse a firm or an individual is. The utility function would explain differences between risk seeking and risk averse behavior, for example, as an individual becomes richer, he may seek (or shun) risk more than before. A utility function incorporates all of this, and therefore Choice 'd' is the correct answer.

All the choices list inputs into the determination of futures prices. Therefore volatility in any of them affects the volatility of futures prices. Of course, the largest contributor to the volatility is the volatility of the spot price of the underlying. Choice 'd' is the correct answer.

The effect of higher convexity is that when yields rise, the price decrease is lower than the increase in yields, and when yields fall, the increase in price is greater than the fall in yield. In either case, it benefits the holder of the fixed income instrument that carries such positive convexity. The converse is true for someone short a bond - such an investor would prefer lower convexity to higher convexity. Therefore statement I is not true for an investor who is short a bond.

An increase in yields makes bond prices decrease, something that would benefit the short. Therefore statement II is true for an investor short a bond.

Negative convexity has exactly the opposite effect as the one described for positive convexity for statement I above. An investor short a bond would prefer negative convexity (which by the way is exhibited by very few fixed income instruments such as mortgages) to positive convexity, therefore statement III is true for such an investor.

Choice 'b' is the correct answer.