Free CAIA Level I Introduction to Alternative Investments Practice Questions

D is correct. The law of one price states that two assets (or portfolios) that produce identical cash flows in every state of the world must have the same price. Any price discrepancy would create a riskless arbitrage opportunity.
Choice A is incorrect because assets within the same class can have different expected returns based on their individual risk characteristics.
Choice B is incorrect because while no-arbitrage pricing relates to fundamental value, the law of one price specifically addresses identical cash flow streams, not fundamental valuation broadly.
Choice C is incorrect because under no-arbitrage conditions, identical cash flow streams must trade at the same price regardless of transaction costs; the law of one price is a theoretical condition that assumes frictionless markets.

B is correct. Gamma measures the rate of change of delta with respect to the underlying price. Gamma is maximized for at-the-money options near expiration because small price movements cause the largest shifts in the probability of finishing in or out of the money, producing rapid changes in delta.
Choice A is incorrect because deep in-the-money options have delta close to 1 that changes very little with the underlying price, resulting in low gamma regardless of time to expiration.
Choice D is incorrect because deep out-of-the-money options have delta close to 0 that changes very little, also resulting in low gamma. These options are unlikely to move into the money before expiration.
Choice C is incorrect because while at-the-money options generally have higher gamma than in- or out-of-the-money options, longer time to expiration disperses gamma more evenly across strike prices, reducing the peak gamma compared to short-dated at-the-money options.

B is correct. With quarterly compounding, the periodic rate is 12%/4 = 3%. The EAR = $(1 + 0.03)^4 - 1 = (1.03)^4 - 1$. Computing: $(1.03)^2 = 1.0609$; $(1.0609)^2 = 1.12551$. So EAR = 12.55%. The account value after 2 years (8 quarters): \$25,000 \times (1.03)^8 = \$25,000 \times 1.26677 = \$31,669 \approx \$31,670.
Choice A is incorrect because an EAR of 12.00% applies only under simple annual compounding with no intra-year periods, and \$31,360 is the result of annual compounding (\$25,000 \times 1.12^2 = \$31,360).
Choice C is incorrect because an EAR of 12.36% results from semi-annual compounding ($(1.06)^2 - 1 = 12.36\%$), not quarterly, yielding a different account value.
Choice D is incorrect because an EAR of 12.68% results from monthly compounding ($(1.01)^{12} - 1 = 12.68\%$), not quarterly.