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IFoA CB1 practice questions

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Question 1Financial institutions and markets

A UK building society demutualises and lists its shares on the London Stock Exchange. Which change best describes the effect on its ownership and governance?

  1. Ownership is transferred to the Financial Conduct Authority, which supervises the society as a listed entity.
  2. Ownership remains with depositors and borrowers, but the Prudential Regulation Authority appoints the board.
  3. Ownership transfers from members to shareholders, and control is exercised through the general meeting and board rather than member voting rights. Correct answer.
  4. Ownership passes to the Bank of England, which then holds the shares on behalf of retail depositors.

Explanation

A building society is owned by its members, whereas a listed bank is owned by shareholders who exercise control through voting at general meetings and by appointing directors. Demutualisation therefore converts member rights into share ownership and shifts governance to the standard corporate model.

Question 2Financial institutions and markets

Which function of a financial intermediary is best illustrated by a bank pooling many small deposits to fund a single large corporate loan?

  1. Denomination intermediation Correct answer.
  2. Maturity transformation
  3. Risk pooling across insurance policyholders
  4. Payment services

Explanation

Denomination intermediation means combining small-denomination savings into large-denomination lending that individual savers could not arrange alone. Maturity transformation concerns the mismatch of contract lengths, not the size of the units.

Question 3Financial institutions and markets

An investor buys a UK government bond with a fixed coupon. Which risk is most directly reduced by holding the bond to maturity rather than selling early?

  1. Default risk of the issuer
  2. Price risk arising from changes in market yields Correct answer.
  3. Liquidity risk in the secondary market
  4. Inflation risk affecting real returns

Explanation

If a bond is held to redemption, interim yield-driven price fluctuations do not crystallise, so market price risk is largely removed. Default risk, inflation risk and liquidity risk are unaffected by the holding period.

Question 4Financial institutions and markets

In a money market transaction, a UK bank agrees to sell gilts to another bank today and buy them back at a higher price in one week. What is this arrangement?

  1. An interest rate swap
  2. A reverse yield gap
  3. A repurchase agreement Correct answer.
  4. A forward rate agreement

Explanation

A repurchase agreement, or repo, is a sale of securities combined with a commitment to repurchase later at a specified price, effectively secured short-term borrowing. The price difference represents the repo interest.

Question 5Financial institutions and markets

Which statement best describes the role of a central counterparty (CCP) in securities clearing?

  1. It acts as lender of last resort to clearing members facing liquidity shortages.
  2. It matches orders on the exchange trading system and sets the opening price each morning.
  3. It provides custody and safekeeping of securities on behalf of institutional investors.
  4. It becomes the buyer to every seller and the seller to every buyer, novating trades and managing counterparty credit risk through margin. Correct answer.

Explanation

Central clearing involves novation, so the CCP interposes itself between the original parties and guarantees performance, collecting initial and variation margin to control credit exposure. Order matching and custody are separate functions.

Question 6Financial institutions and markets

A life insurer sells a with-profits policy. Which description best matches the with-profits mechanism?

  1. The policyholder receives a guaranteed annuity rate fixed at outset with no investment participation.
  2. Premiums are pooled and policyholders receive bonuses reflecting the fund's investment performance, with smoothing of returns over time. Correct answer.
  3. Premiums are invested in a unit-linked fund and the policyholder bears the full investment risk directly.
  4. The policy pays a lump sum only on death, with no savings element.

Explanation

With-profits policies pool premiums in a fund and add bonuses that reflect performance, with smoothing to reduce year-to-year volatility in payouts. Unit-linked contracts, by contrast, pass investment risk directly to the policyholder.

Question 7Financial institutions and markets

Which of the following best describes the primary market in equities?

  1. The market in which existing shares are traded between investors
  2. The market in which new shares are issued by a company to raise capital Correct answer.
  3. The market in which derivatives on shares are traded
  4. The market in which companies buy back their own shares from investors

Explanation

The primary market is where new securities are issued and the issuer receives the proceeds, for example through an initial public offering. Trading of already-issued shares occurs in the secondary market.

Question 8Financial institutions and markets

A retail investor wants exposure to a diversified portfolio of UK equities but has only a small sum to invest. Which vehicle most directly meets this need?

  1. A single share in a large UK bank
  2. A UK government gilt
  3. A bank current account
  4. An open-ended investment company (OEIC) investing in UK equities Correct answer.

Explanation

A collective investment vehicle such as an OEIC pools investors' money to hold a diversified portfolio, allowing small investors to obtain broad exposure at low minimum amounts. A single share or a gilt does not provide equity diversification.

Question 9Financial institutions and markets

A UK bank's assets have an average duration of five years while its liabilities have an average duration of two years. Which risk is most clearly indicated?

  1. Operational risk arising from system failures
  2. Credit risk arising from borrower defaults
  3. Liquidity risk arising from insufficient reserves
  4. Interest rate risk arising from a positive duration gap Correct answer.

Explanation

When asset duration exceeds liability duration, the value of assets is more sensitive to interest rate changes than liabilities, creating a positive duration gap and exposure to interest rate risk. The other risks are distinct sources of loss.

Question 10Financial institutions and markets

An investor holds a bond with a modified duration of 6. If market yields rise by 0.5 percentage points, what is the approximate percentage change in the bond price?

  1. A fall of about 0.5%
  2. A fall of about 3% Correct answer.
  3. A rise of about 3%
  4. A rise of about 6%

Explanation

The approximate price change equals minus modified duration multiplied by the change in yield, so −6 × 0.005 = −0.03, a fall of about 3%. Duration measures sensitivity, and higher yields reduce bond prices.

Question 11Financial institutions and markets

A company issues a bond that can be converted into a fixed number of its ordinary shares at the holder's option. Which feature does this instrument combine?

  1. A derivative contract settled only in cash
  2. A short-term money market instrument with no coupon
  3. A debt obligation with an embedded equity option Correct answer.
  4. A pure equity claim with no repayment obligation

Explanation

A convertible bond is debt that pays coupons and is repayable, but it also embeds an option for the holder to convert into equity. The conversion feature gives the holder participation in share price rises.

Question 12Financial institutions and markets

The Bank of England conducts an open market operation by buying gilts from banks. Which is the most likely immediate effect?

  1. Bank reserves increase and short-term interest rates come under downward pressure Correct answer.
  2. Bank reserves decrease and short-term interest rates rise
  3. The government's fiscal deficit is reduced directly
  4. The exchange rate appreciates immediately through higher gilt yields

Explanation

Purchasing gilts injects central bank money into the banking system, raising reserves and pushing short-term rates down as liquidity expands. The operation is monetary, not fiscal, and its exchange rate effect is indirect.

Question 13Financial institutions and markets

Which statement best explains why banks are exposed to liquidity risk even when their assets exceed their liabilities in value?

  1. Their capital adequacy ratio is always above the regulatory minimum, which limits their ability to lend.
  2. They hold no government securities, which prevents them from obtaining central bank funding.
  3. Their assets are marked to market daily, so accounting losses are realised automatically.
  4. Deposits are typically repayable on demand while loans are illiquid and long-term, so a sudden withdrawal can force asset sales at a loss. Correct answer.

Explanation

The core of bank liquidity risk is the mismatch between short-notice liabilities and long-dated illiquid assets. Solvency in value terms does not guarantee that cash can be raised quickly without loss.

Question 14Financial institutions and markets

An investor wishes to hedge against a fall in the value of an equity portfolio without selling the shares. Which strategy is most appropriate?

  1. Selling put options on a suitable equity index
  2. Buying put options on a suitable equity index Correct answer.
  3. Buying additional shares in the same portfolio
  4. Buying call options on a suitable equity index

Explanation

A put option gives the right to sell at a set strike, so its value rises as the underlying falls, offsetting portfolio losses. Buying calls or selling puts gains when markets rise and adds rather than removes downside exposure.

Question 15Financial institutions and markets

A pension scheme promises a defined benefit based on final salary. Which risk is borne by the employer rather than the member?

  1. The risk that the member changes employer
  2. The risk that the member's salary rises over their career
  3. Investment risk that the fund's assets fall short of the promised benefits Correct answer.
  4. The risk that the member's personal savings are inadequate

Explanation

In a defined benefit scheme the employer underwrites the promised pension, so investment and longevity risk fall on the employer if assets underperform. Salary and career choices are member-side factors outside the scheme's risk allocation.

Question 16Financial institutions and markets

Which best describes the function of a custodian in the securities market?

  1. Setting the official interest rate for the market
  2. Guaranteeing the issuer's repayment of bond principal
  3. Underwriting new issues and setting the offer price
  4. Safekeeping of securities and processing of corporate actions and settlement on behalf of clients Correct answer.

Explanation

A custodian holds securities in safekeeping, administers corporate actions such as dividends and rights issues, and handles settlement instructions for clients. It does not set rates, guarantee issuers or underwrite issues.

Question 17Financial institutions and markets

An investor compares a conventional gilt with an index-linked gilt of similar maturity. Which risk is largely removed by the index-linked gilt?

  1. Liquidity risk in the secondary market
  2. Default risk of the UK government
  3. Inflation risk to the real value of coupon and principal payments Correct answer.
  4. Interest rate risk from changes in real yields

Explanation

Index-linked gilts link coupons and redemption payments to a price index, so the real purchasing power of the cash flows is protected against inflation. Real yield changes still create price risk, and credit and liquidity risk remain.

Question 18Financial institutions and markets

A firm's trading desk holds a large position in an illiquid corporate bond. A sudden market shock forces the desk to sell. Which risk is most directly realised?

  1. Funding liquidity risk, because the firm cannot roll over its short-term borrowing
  2. Market liquidity risk, because the sale price is depressed by the lack of buyers Correct answer.
  3. Operational risk, because the trading system failed
  4. Legal risk, because the bond documentation is unclear

Explanation

Market liquidity risk is the risk that an asset cannot be sold quickly without moving its price adversely. Funding liquidity risk concerns the ability to raise cash, which is a related but distinct exposure.

Question 19Financial institutions and markets

Which statement best captures the difference between a forward contract and a futures contract?

  1. Forwards are standardised and exchange-traded, while futures are bespoke and traded over the counter.
  2. Futures are standardised and exchange-traded with daily margining, while forwards are bespoke and traded over the counter. Correct answer.
  3. Forwards carry no counterparty risk, while futures carry significant counterparty risk.
  4. Futures always require physical delivery, while forwards are always cash settled.

Explanation

Futures contracts are standardised, traded on organised exchanges and marked to market daily through margin. Forwards are privately negotiated, tailored contracts that carry bilateral counterparty risk.

Question 20Financial institutions and markets

A bank's assets are mostly long-dated fixed-rate mortgages funded by short-term deposits. If short-term interest rates rise sharply, which outcome is most likely, all else equal?

  1. Net interest income falls because funding costs reprice faster than mortgage income Correct answer.
  2. The bank's liquidity position improves because deposits become cheaper
  3. Net interest income rises because mortgage rates reprice immediately
  4. The bank's capital position improves because asset values rise

Explanation

When liabilities reprice more quickly than assets, a rise in short-term rates squeezes the net interest margin. This is a classic repricing gap exposure that reduces net interest income.

Question 21Financial institutions and markets

An insurer writes a large book of policies covering earthquake damage in a single region. Which risk management concern is most acute?

  1. Moral hazard from policyholders taking fewer precautions
  2. Currency risk from premiums denominated abroad
  3. Concentration risk from correlated claims in a single geographic area Correct answer.
  4. Adverse selection from healthy applicants buying cover

Explanation

A single-event catastrophe can trigger many claims at once, so geographic concentration creates correlated losses that threaten solvency. Reinsurance and diversification across regions are the standard responses.

Question 22Financial institutions and markets

A central bank raises the countercyclical capital buffer for banks. Which transmission channel to the real economy is most direct?

  1. Banks raise lending rates or restrict credit, reducing investment and consumption Correct answer.
  2. Banks lower deposit rates, encouraging households to save more
  3. Banks increase dividend payments, boosting household incomes
  4. Banks reduce their holdings of government bonds, lowering gilt yields

Explanation

Higher capital requirements raise the cost of lending, so banks may tighten credit conditions, which dampens investment and consumption. This is the macroprudential transmission channel intended to lean against credit growth.

Question 23Financial institutions and markets

A company's share price is £4.00 and it announces a 1-for-4 rights issue at £3.00. What is the theoretical ex-rights price per share?

  1. £3.75
  2. £3.50
  3. £4.00
  4. £3.80 Correct answer.

Explanation

Four existing shares at £4.00 plus one new share at £3.00 gives a total value of £19.00 for five shares, so the theoretical ex-rights price is £19.00 ÷ 5 = £3.80. The rights issue price is below the market price, diluting the average value.

Question 24Financial institutions and markets

Which statement best explains why a central bank acting as lender of last resort can create moral hazard?

  1. Regulators may impose stricter liquidity rules on banks
  2. Banks may hold more capital to avoid needing support
  3. Banks may take on more liquidity risk in the expectation of emergency support Correct answer.
  4. Depositors may withdraw funds more quickly during a panic

Explanation

If banks expect to be rescued in a liquidity crisis, they may underprice liquidity risk and hold thinner buffers. This is why lender of last resort support is typically accompanied by penalty rates and supervisory conditions.

Question 25Financial institutions and markets

An investment fund reports a Sharpe ratio of 1.2 and a Treynor ratio of 0.08. Which interpretation is most appropriate?

  1. The fund's returns are risk-free because both ratios are positive
  2. The fund has outperformed the market because both ratios exceed one
  3. The Sharpe ratio and Treynor ratio measure the same thing and should be equal
  4. The fund has delivered excess return per unit of total risk and per unit of systematic risk, but the two measures use different risk denominators Correct answer.

Explanation

The Sharpe ratio divides excess return by total volatility, while the Treynor ratio divides excess return by beta, a measure of systematic risk. Different denominators mean the values are not directly comparable and need not exceed one.

Question 26Financial institutions and markets

A UK building society holds a portfolio of residential mortgages funded largely by retail savings accounts. Which financial intermediary function is it primarily performing?

  1. Denomination transformation
  2. Risk transformation
  3. Liquidity transformation
  4. Maturity transformation Correct answer.

Explanation

Maturity transformation involves borrowing short-term (retail deposits) and lending long-term (mortgages). While other transformations occur, the core function described is matching different maturity preferences of savers and borrowers.

Question 27Financial institutions and markets

An investor buys a UK government bond with a clean price of £98 and accrued interest of £2. The bond has a coupon of 4% paid semi-annually and matures in 10 years. If the investor holds the bond for exactly one year and reinvests coupons at 3% annual yield, what is the total return assuming the bond is sold at a clean price of £99?

  1. 5.1% Correct answer.
  2. 6.2%
  3. 4.0%
  4. 3.5%

Explanation

Total return includes coupon income, reinvestment income, and capital gain/loss. Purchase price is dirty price £100. Coupons: two payments of £2 each, reinvested at 3% for half-year gives approximately £0.03. Sale price dirty at end: clean £99 plus accrued £2 = £101. Total proceeds = £4 coupons + £0.03 reinvestment + £101 sale = £105.03. Return = (105.03 - 100)/100 = 5.03%, approximately 5.1%.

Question 28Financial institutions and markets

Which of the following best describes the role of a central counterparty (CCP) in over-the-counter (OTC) derivative markets?

  1. It regulates the conduct of investment banks in OTC trading.
  2. It guarantees settlement of trades by interposing itself between counterparties. Correct answer.
  3. It sets the interest rates used for discounting collateral.
  4. It acts as a market maker to provide liquidity to all participants.

Explanation

A CCP novates trades, becoming the buyer to every seller and seller to every buyer, thereby reducing counterparty risk. It does not set discount rates, act as a market maker, or regulate conduct.

Question 29Financial institutions and markets

A UK pension fund holds a portfolio of equities and wants to reduce its exposure to a potential market downturn over the next six months without selling the shares. Which derivative strategy would achieve this?

  1. Sell put options on the FTSE 100 index.
  2. Buy call options on the FTSE 100 index.
  3. Enter a payer interest rate swap.
  4. Buy put options on the FTSE 100 index. Correct answer.

Explanation

Buying put options gives the right to sell the index at a set price, providing downside protection while retaining the shares. Selling puts would increase exposure to falls, buying calls benefits from rises, and an interest rate swap hedges interest rate risk, not equity risk.

Question 30Financial institutions and markets

A bank has assets with an average duration of 5 years and liabilities with an average duration of 3 years. If interest rates rise by 1%, what is the approximate impact on the bank's net worth, assuming the market value of assets is £100 million and liabilities £80 million?

  1. Net worth falls by approximately £1.6 million. Correct answer.
  2. Net worth falls by approximately £2.0 million.
  3. Net worth rises by approximately £1.6 million.
  4. Net worth rises by approximately £2.0 million.

Explanation

The duration gap approach: change in net worth ≈ -[DA×A - DL×L] × Δi. Here DA×A = 3×100 = 300; DL×L = 2.8×50 = 140; difference = 160. With Δi = 0.01, change = -160×0.01 = -1.6 million. Thus net worth falls by about £1.6 million.

Question 31Financial products and their valuation

A zero-coupon bond with a redemption value of 100 is due in exactly 5 years. If the continuously compounded risk-free rate is 4% per annum, what is the bond's present value?

  1. 82.19
  2. 81.87 Correct answer.
  3. 78.35
  4. 100.00

Explanation

The present value of a zero-coupon bond is the redemption payment discounted at the risk-free rate. With continuous compounding, PV = 100·e^(−0.04×5) = 100·e^(−0.20) = 81.87.

Question 32Financial products and their valuation

Which feature of an ordinary share distinguishes it from a corporate bond issued by the same company?

  1. The share promises a fixed rate of interest each year
  2. The share carries a residual claim on assets after all creditors are paid Correct answer.
  3. The share has a fixed redemption date at par
  4. The share ranks ahead of debt in a liquidation

Explanation

Equity holders are residual claimants: they receive what remains after all fixed obligations to creditors are settled. Bonds instead promise scheduled interest and repayment and rank ahead of equity in liquidation.

Question 33Financial products and their valuation

An investor holds a bond with a modified duration of 6.2 and a convexity of 48. If yields fall by 50 basis points, which estimate of the percentage price change is most accurate?

  1. +3.16% Correct answer.
  2. +3.04%
  3. +3.10%
  4. −3.10%

Explanation

The duration-plus-convexity approximation is ΔP/P ≈ −D·Δy + ½·C·(Δy)². Here −6.2×(−0.005) + 0.5×48×(0.005)² = 0.031 + 0.0006 = 3.16%.

Question 34Financial products and their valuation

In a forward rate agreement, the party paying the fixed rate benefits when:

  1. the yield curve is flat at settlement
  2. the reference rate at settlement falls below the agreed fixed rate
  3. the reference rate at settlement exceeds the agreed fixed rate Correct answer.
  4. the reference rate equals the agreed fixed rate

Explanation

The fixed-rate payer in an FRA gains when the floating reference rate rises above the contracted rate, because the settlement payment is based on the difference between the two. A fall in the reference rate produces a loss for the payer.

Question 35Financial products and their valuation

A European call option on a non-dividend-paying share has a strike of 50 and matures in one year. The share price is 55 and the continuously compounded rate is 5%. What is the option's intrinsic value and its lower bound respectively?

  1. 5.00 and 7.44
  2. 5.00 and 5.00
  3. 5.00 and 2.44 Correct answer.
  4. 0.00 and 2.44

Explanation

Intrinsic value is max(S−K,0) = 55−50 = 5.00. The no-arbitrage lower bound for a European call is max(S − K·e^(−rT), 0) = 55 − 50×0.9512 = 2.44.

Question 36Financial products and their valuation

Under put-call parity for European options on a non-dividend-paying share, which relationship must hold?

  1. C + P = S − K·e^(−rT)
  2. C + P = S + K·e^(−rT)
  3. C − P = K·e^(−rT) − S
  4. C − P = S − K·e^(−rT) Correct answer.

Explanation

Put-call parity states that a call minus a put equals the share price minus the present value of the strike. Rearranging the replicating portfolios gives C − P = S − K·e^(−rT).

Question 37Financial products and their valuation

An investor buys a share at 40 and writes a European call on it with a strike of 45 for a premium of 2. Ignoring interest, what is the maximum profit at expiry?

  1. 2
  2. Unlimited
  3. 5
  4. 7 Correct answer.

Explanation

A covered call's maximum profit occurs when the share finishes at or above the strike. Profit = (K − S₀) + premium = (45 − 40) + 2 = 7.

Question 38Financial products and their valuation

A swap in which one party pays a fixed rate and receives a floating rate is best described as:

  1. a credit default swap
  2. an equity swap
  3. an interest rate swap Correct answer.
  4. a currency swap

Explanation

An interest rate swap exchanges fixed and floating interest payments on a notional principal. The other listed instruments exchange different cash flows, such as equity returns, currencies, or credit protection.

Question 39Financial products and their valuation

A company issues a convertible bond with a face value of 100 and a conversion ratio of 4 shares per bond. If the share price is 30, what is the conversion value of the bond?

  1. 30
  2. 120 Correct answer.
  3. 400
  4. 100

Explanation

Conversion value equals the conversion ratio multiplied by the current share price. Here 4 × 30 = 120, so the bond is worth at least its conversion value.

Question 40Financial products and their valuation

Which statement about the price-yield relationship for a fixed-coupon bond is correct?

  1. Price and yield are directly related and convex
  2. Price and yield are inversely related and the relationship is convex Correct answer.
  3. Price and yield are directly related and linear
  4. Price and yield are inversely related and linear

Explanation

Bond prices fall as yields rise, giving an inverse relationship. The curve is convex, meaning price rises more for a given yield fall than it falls for an equal yield rise.

Question 41Financial products and their valuation

A bond has a Macaulay duration of 7.5 years and a yield to maturity of 6%. What is its modified duration?

  1. 7.50
  2. 7.08 Correct answer.
  3. 0.71
  4. 7.95

Explanation

Modified duration equals Macaulay duration divided by (1 + yield per period). Here 7.5 / 1.06 = 7.08.

Question 42Financial products and their valuation

Which of the following best describes the payoff to a buyer of a credit default swap?

  1. A payment if interest rates rise above a threshold
  2. A payment if a specified reference entity defaults Correct answer.
  3. A fixed coupon stream from the reference bond
  4. A share of the reference entity's equity dividends

Explanation

A CDS buyer pays a premium in exchange for protection that pays out if the reference entity experiences a specified credit event such as default. The payoff is linked to credit events, not to dividends or interest rate levels.

Question 43Financial products and their valuation

A portfolio has an expected return of 12% and a standard deviation of 20%. The risk-free rate is 3%. What is the Sharpe ratio?

  1. 0.60
  2. 0.45 Correct answer.
  3. 2.22
  4. 0.15

Explanation

The Sharpe ratio is (expected return − risk-free rate) divided by standard deviation. Here (12% − 3%) / 20% = 0.45.

Question 44Financial products and their valuation

Under the Capital Asset Pricing Model, a share with a beta of 1.4 faces a risk-free rate of 4% and an expected market return of 10%. What is its required return?

  1. 14.0%
  2. 12.4% Correct answer.
  3. 8.4%
  4. 10.0%

Explanation

CAPM gives required return = rf + β(E[rm] − rf). Here 4% + 1.4×(10% − 4%) = 4% + 8.4% = 12.4%.

Question 45Financial products and their valuation

A forward contract is agreed when the spot price is 100 and the continuously compounded rate is 5%. If no income or storage cost applies, what is the one-year forward price?

  1. 110.00
  2. 100.00
  3. 105.13 Correct answer.
  4. 95.12

Explanation

The no-arbitrage forward price for an asset with no income is S·e^(rT). Here 100×e^(0.05) = 105.13.

Question 46Financial products and their valuation

Which statement correctly describes a futures contract compared with a forward contract?

  1. Futures are traded over the counter with bespoke terms
  2. Futures are standardised and marked to market daily Correct answer.
  3. Futures settle only at final maturity
  4. Futures involve no margin requirements

Explanation

Exchange-traded futures are standardised contracts that are marked to market daily through a margin account. Forwards are bespoke over-the-counter agreements settled at maturity.

Question 47Financial products and their valuation

An insurer sells a with-profits endowment policy. Which feature best characterises the policyholder's benefit?

  1. A pure protection payout with no maturity value
  2. A benefit equal to the fund's unit price at maturity
  3. A benefit linked solely to a stock market index
  4. A guaranteed sum assured plus discretionary bonuses Correct answer.

Explanation

With-profits policies provide a guaranteed minimum sum assured plus bonuses declared at the insurer's discretion from accumulated surplus. Benefits are not directly tied to an index or unit price.

Question 48Financial products and their valuation

An annuity certain provides payments for a fixed number of years regardless of survival. Which product type does this describe?

  1. A whole-life annuity
  2. A unit-linked pension
  3. A deferred life annuity
  4. A guaranteed annuity with no mortality link Correct answer.

Explanation

An annuity certain makes a fixed number of payments irrespective of whether the annuitant survives, so no mortality risk is transferred for that term. Life annuities, by contrast, depend on survival.

Question 49Financial products and their valuation

A bond is priced at 95 with an annual coupon of 6 on a face value of 100. What is its current yield?

  1. 5.70%
  2. 6.32% Correct answer.
  3. 6.00%
  4. 10.53%

Explanation

Current yield equals the annual coupon divided by the market price. Here 6 / 95 = 6.32%, which exceeds the coupon rate because the bond trades below par.

Question 50Financial products and their valuation

Which risk is most directly reduced by holding a diversified portfolio of equities?

  1. Company-specific risk Correct answer.
  2. Interest rate risk affecting all shares
  3. Inflation risk
  4. Market risk

Explanation

Diversification averages out idiosyncratic, company-specific risk because individual deviations offset. Systematic risks such as market, interest rate and inflation risk affect all shares and remain.