Free CFA Level II Derivatives Practice Questions

A is correct. An FRA described as 'AxB' (e.g., 6x12) means:
- The FRA settlement date is in A months (6 months from today).
- The underlying loan period ends in B months (12 months from today).
- The FRA covers the period from month 6 to month 12 (a 6-month borrowing period).

So a 6x12 FRA is a forward agreement on the 6-month interest rate, starting 6 months from now.

B is incorrect because this would describe a spot loan for the first 6 months, not a forward rate agreement. An FRA by definition involves a future start date.

C is incorrect because this would describe a 12x18 FRA (starting in 12 months, covering the period from month 12 to month 18). The first number indicates the start date, not the second.

A is correct. A payer swaption gives the holder the right to pay fixed. It is in the money when the current market swap rate exceeds the exercise rate. The market 3-year swap rate is 4.35%, which exceeds the exercise rate of 4.00%. If the swap rate remains above 4.00% at expiration, the swaption will be in the money, and Park would exercise it to lock in a below-market fixed rate.

B is incorrect because it reverses the moneyness logic. The exercise rate (4.00%) is below the market rate (4.35%), which makes the payer swaption in the money, not out of the money.

C is incorrect because swaptions do not reset to zero at expiration. Like any option, they either have intrinsic value (in the money) or they do not (out of the money). There is no automatic resetting mechanism.

Using covered interest rate parity with continuous compounding. The quote is EUR per USD, so EUR is the domestic currency and USD is the foreign currency:
$$F_0 = S_0 \times e^{(r_{EUR} - r_{USD}) \times T}$$
$$= 1.0800 \times e^{(0.0320 - 0.0510) \times 0.5}$$
$$= 1.0800 \times e^{-0.0095}$$
$$= 1.0800 \times 0.99054 = 1.0698$$

B is correct (approximately 1.0697).

A is incorrect because 1.0903 reverses the interest rate differential, computing $e^{+0.0095}$ instead of $e^{-0.0095}$. Since EUR rates are lower than USD rates, the EUR/USD forward rate should be below the spot rate (EUR appreciates forward), not above it.

C is incorrect as a close distractor with slightly different rounding.