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

A zero coupon bond has a Macaulay duration equal to its maturity, ie in this case 5 years. We can calculate modified duration from Macaulay duration by using the following relationship:

Modified duration = Macaulay duration/(1 + y) where y is the yield.

Therefore the correct answer is 5 / (1.05) = 4.76.

Or intuitively, all the other answers appear clearly incorrect: 5 and 5.25 are too high, and 4 is too low. Therefore the only reasonable choice is 4.76.

A portfolio loses its delta neutrality if the delta of the portfolio changes but the underlying hedge is unchanged. The portfolio that will require the most rebalancing will be one whose delta changes by larger amounts in response to a given change in the price of the underlying. The sensitivity of the changes in delta in response to changes in the price of the underlying is measured by gamma. The higher the gamma, the more the portfolio will go out of delta neutrality given a change in the price of the underlying. Therefore Choice 'b' is the correct answer.

A portfolio with a low gamma will maintain its delta over a larger price range for the underlying, and is therefore likely to require less frequent rebalancing. The absolute level of the delta itself does not matter, what matters is the gamma. Vega is irrelevant to the delta hedging decision. Therefore the other choices are incorrect.

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.