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NISM Series IV (Interest Rate Derivatives) study materials
NISM Series IV (Interest Rate Derivatives) study resources

NISM Series IV (Interest Rate Derivatives) practice questions

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Question 1Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

In an overnight indexed swap (OIS) referencing a benchmark such as MIBOR, what does the fixed-rate payer agree to do?

  1. Exchange the notional principal at both inception and maturity
  2. Pay the fixed rate only if the overnight rate stays below the fixed rate
  3. Pay a single fixed rate on the notional and receive the compounded overnight rate on the same notional Correct answer.
  4. Pay the compounded overnight rate and receive nothing in return

Explanation

An OIS exchanges a fixed leg for a floating leg where the floating leg is the geometric compounding of the overnight benchmark over the accrual period. No principal is exchanged, and both legs are settled net on the notional. The fixed-rate payer therefore pays fixed and receives the compounded overnight rate.

Question 2Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

A dealer quotes an interest rate swap as '6.45 bid, 6.48 offer' against MIBOR. A client wants to pay the fixed rate. Which rate applies and what is the dealer's spread?

  1. 6.45 and a spread of 3 basis points
  2. 6.45 and a spread of 0.03 percent of notional upfront
  3. 6.48 and a spread of 3 basis points Correct answer.
  4. 6.48 and a spread of 0.03 percent per annum of notional as commission

Explanation

A client paying fixed pays the dealer's offer (ask) side, here 6.48 percent. The bid-offer spread is the difference between the two quoted rates, 6.48 minus 6.45, which equals 3 basis points. The spread is embedded in the rates, not charged separately as commission or upfront.

Question 3Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

A forward rate agreement is struck at 7.00 percent on a 6x9 basis for a notional of Rs. 10 crore. At settlement the reference rate fixes at 7.40 percent. Who pays whom, ignoring discounting?

  1. No payment arises because the contract settles only at maturity of the deposit
  2. The floating-rate payer receives approximately Rs. 4,00,000 from the counterparty
  3. The fixed-rate payer receives approximately Rs. 1,00,000 from the counterparty Correct answer.
  4. The fixed-rate payer pays approximately Rs. 1,00,000 to the counterparty

Explanation

The FRA cash-settles the difference between the contracted rate and the reference rate on the notional for the contract period. Here 0.40 percent on Rs. 10 crore for three months is about Rs. 1,00,000, received by the party that pays the fixed rate. Settlement occurs at the start of the contract period, discounted for the period.

Question 4Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

Which statement best describes the credit exposure profile of a plain vanilla interest rate swap over its life, assuming no collateral?

  1. Exposure rises monotonically and is highest at maturity
  2. Exposure starts near zero, peaks around the middle of the tenor, and declines toward maturity Correct answer.
  3. Exposure is zero throughout because only net interest is exchanged
  4. Exposure is highest at inception and declines steadily to zero at maturity

Explanation

At inception the swap has near-zero value, so current exposure is minimal. As rates move, the replacement value builds up and typically peaks around the mid-life of the swap, then amortises back toward zero as remaining cash flows shrink. This hump-shaped profile drives collateral and counterparty limits.

Question 5Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

In the Indian market, which authority regulates interest rate derivatives traded on recognised stock exchanges and, separately, over-the-counter interest rate swaps?

  1. The RBI for both exchange-traded and OTC interest rate derivatives
  2. IRDAI for exchange-traded contracts and SEBI for OTC swaps
  3. SEBI for exchange-traded contracts and the RBI for OTC interest rate swaps Correct answer.
  4. SEBI for both exchange-traded and OTC interest rate derivatives

Explanation

The regulatory framework divides interest rate derivatives by venue: SEBI regulates exchange-traded interest rate futures and options, while the RBI regulates OTC products such as interest rate swaps and forward rate agreements. This split is a core part of the Indian regulatory architecture for rates.

Question 6Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

An interest rate futures contract on a notional bond is priced at 94.50. What does this price convention imply about the underlying yield?

  1. The yield is approximately 5.50 percent Correct answer.
  2. The yield is approximately 94.50 basis points
  3. The yield is 94.50 percent
  4. The price and yield are unrelated in this convention

Explanation

Interest rate futures on notional bonds are quoted as 100 minus the yield in percent. A price of 94.50 therefore corresponds to a yield of about 5.50 percent. This inverse convention means a rise in the futures price signals a fall in yields.

Question 7Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

A trader buys 200 interest rate futures contracts, each with a notional value of Rs. 2,00,000, when the price is 95.00 and sells them at 95.60. Ignoring costs, what is the profit or loss?

  1. Profit of Rs. 24,000
  2. Profit of Rs. 1,20,000
  3. Profit of Rs. 2,40,000 Correct answer.
  4. Loss of Rs. 2,40,000

Explanation

A move from 95.00 to 95.60 is 0.60, which in this quotation equals a 0.60 percent change on notional. On Rs. 2,00,000 per contract that is Rs. 1,200, and across 200 contracts the gain is Rs. 2,40,000. The long position profits because the futures price rose.

Question 8Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

A government securities dealer holds a long bond portfolio and expects yields to rise sharply. Which exchange-traded interest rate futures position would hedge the portfolio?

  1. Sell interest rate futures Correct answer.
  2. Buy a receiver swaption
  3. Buy interest rate futures
  4. Buy a payer interest rate swap on the exchange

Explanation

Interest rate futures prices move inversely to yields, so a rise in yields lowers futures prices. Selling futures therefore offsets losses on a long bond portfolio when yields rise. Swaps and swaptions are OTC instruments and are not exchange-traded.

Question 9Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

Which best describes the role of a central counterparty in interest rate derivatives clearing?

  1. It matches trades but leaves counterparty risk with the original parties
  2. It sets the reference interest rates used for floating legs
  3. It guarantees settlement by becoming the buyer to every seller and the seller to every buyer through novation Correct answer.
  4. It provides margin funding loans to members at the policy rate

Explanation

A central counterparty interposes itself between trade counterparties through novation, becoming the legal counterparty to each side. This mutualises counterparty credit risk and is supported by margining and a default fund. It does not match trades while leaving risk bilateral, nor does it set benchmarks.

Question 10Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

A clearing member collects an initial margin of Rs. 50,000 per contract and a client holds 4 short contracts. The futures price rises by an adverse 1.5 percent on a notional of Rs. 2,00,000 per contract. What is the mark-to-market loss and the resulting margin balance before any call?

  1. Loss of Rs. 12,000, margin balance Rs. 2,12,000
  2. Loss of Rs. 5,000, margin balance Rs. 1,95,000
  3. Loss of Rs. 3,000, margin balance Rs. 1,97,000
  4. Loss of Rs. 12,000, margin balance Rs. 1,88,000 Correct answer.

Explanation

An adverse move of 1.5 percent on Rs. 2,00,000 notional is Rs. 3,000 per contract, and across 4 short contracts the loss is Rs. 12,000. Total initial margin posted was Rs. 2,00,000, so the balance falls to Rs. 1,88,000. If this breaches the maintenance margin, a variation margin call follows.

Question 11Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

When the yield curve is upward sloping, which relationship between the fixed rate on a plain vanilla swap and the par yield curve typically holds?

  1. The swap rate exceeds every par yield on the curve
  2. The swap rate is unrelated to the par yield curve
  3. The swap rate lies above the short-end par yield and below the long-end par yield Correct answer.
  4. The swap rate equals the shortest maturity par yield

Explanation

A par swap rate is a weighted average of the forward rates implied by the curve, so with an upward-sloping curve it sits above short maturities and below long maturities. It equals the par yield only at a single maturity where the curve crosses it. This relationship links swap pricing to the bond curve.

Question 12Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

What is the primary economic function of a swaption in interest rate risk management?

  1. To convert a floating-rate loan into a fixed-rate loan with no premium
  2. To transfer the credit risk of a bond issuer to a swap counterparty
  3. To give the holder the right, but not the obligation, to enter a swap at a future date on agreed terms Correct answer.
  4. To lock in a fixed rate today for a loan that will be drawn immediately

Explanation

A swaption grants the buyer the right, without obligation, to enter into an interest rate swap on predetermined terms at a future expiry. It is used to hedge or position for future rate moves while limiting downside to the premium paid. It is optional, not a mandatory conversion.

Question 13Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

A bank has a floating-rate asset book funded by fixed-rate liabilities. Which swap position aligns its interest rate sensitivity?

  1. Pay floating and pay fixed on the same notional
  2. Pay fixed and receive floating
  3. Enter a receiver swaption and sell a payer swaption
  4. Receive fixed and pay floating Correct answer.

Explanation

The bank earns floating on assets and pays fixed on liabilities, so it is hurt when rates fall. Receiving fixed and paying floating on a swap converts the fixed liability cost into a floating cost, matching the floating asset income. This reduces the mismatch in repricing behaviour.

Question 14Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

Which benchmark reform issue most directly affects the valuation of legacy interest rate swaps referencing an interbank offered rate?

  1. The introduction of a securities transaction tax on bond trades
  2. The revision of margin ratios for equity derivatives
  3. The change in exchange trading hours for interest rate futures
  4. The transition to alternative near-risk-free reference rates and the resulting basis between old and new benchmarks Correct answer.

Explanation

Legacy swaps reference interbank offered rates that are being replaced by alternative near-risk-free rates, and the two are not identical. Valuations must account for the fallback provisions and the basis between the old and new benchmarks. Trading hours, equity margins and transaction taxes do not affect swap valuation in this way.

Question 15Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

In an interest rate futures contract, what does the conversion factor applied to a deliverable bond achieve?

  1. It sets the daily price limit for the contract
  2. It adjusts the invoice price so deliverable bonds with different coupons and maturities are comparable to the notional bond Correct answer.
  3. It converts the futures price into a yield
  4. It determines the margin percentage for the contract

Explanation

The conversion factor normalises deliverable bonds with different coupons and maturities to the notional coupon of the futures contract. It is used to compute the invoice price the buyer pays on delivery. It does not set price limits or margin levels, nor does it convert price into yield.

Question 16Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

An interest rate swap has a fixed leg of 8.00 percent paid annually and a floating leg of MIBOR paid annually. At the first reset, MIBOR fixes at 8.60 percent. What net payment does the fixed-rate payer make or receive on a notional of Rs. 5 crore, ignoring day-count differences?

  1. Pays Rs. 3,00,000
  2. Receives Rs. 3,00,000 Correct answer.
  3. Receives Rs. 30,000
  4. Pays Rs. 30,00,000

Explanation

The fixed payer pays 8.00 percent and receives 8.60 percent, giving a net receipt of 0.60 percent. On Rs. 5 crore that equals Rs. 3,00,000 for the annual period. The direction follows from the floating rate exceeding the fixed rate.

Question 17Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

Which risk does a plain vanilla interest rate swap expose a party to that an exchange-traded interest rate futures contract largely removes through daily settlement?

  1. Basis risk between the swap and the underlying
  2. Liquidity risk in rolling over the hedge
  3. Counterparty credit risk arising from accumulated mark-to-market gains Correct answer.
  4. Interest rate risk from yield curve shifts

Explanation

Bilateral swaps accumulate unrealised gains that create counterparty credit exposure if the other side defaults. Exchange-traded futures are marked to market daily and cleared through a CCP, which largely removes this exposure. Interest rate, basis and rollover risks remain in both structures.

Question 18Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

What is the standard settlement convention for an interest rate swap's periodic payments between two financial institutions?

  1. Only the net difference between the two legs is paid on each payment date Correct answer.
  2. Only the fixed leg is paid, with the floating leg deferred to maturity
  3. Both legs are paid in full on each payment date with no netting
  4. The entire swap is settled as a single lump sum at maturity

Explanation

Swap payments are netted, so only the difference between the fixed and floating legs changes hands on each payment date. This reduces settlement amounts and operational burden. Full payment of both legs, lump-sum settlement at maturity, and deferral of the floating leg are not standard.

Question 19Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

A trader expects the yield curve to steepen, with short rates unchanged and long rates rising. Which position expresses this view using swaps?

  1. Receive fixed on both short and long tenors
  2. Pay fixed on a short-tenor swap and receive fixed on a long-tenor swap
  3. Pay fixed on both short and long tenors
  4. Receive fixed on a short-tenor swap and pay fixed on a long-tenor swap Correct answer.

Explanation

A curve steepener gains when long rates rise relative to short rates. Receiving fixed at the short tenor benefits if short rates stay unchanged, while paying fixed at the long tenor gains if long rates rise. The combined position isolates the slope view.

Question 20Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

What does the 'notional principal' of an interest rate swap represent?

  1. The collateral posted with the clearing house
  2. The maximum loss the fixed-rate payer can incur
  3. The reference amount on which interest payments are calculated but which is not exchanged Correct answer.
  4. The amount actually lent by one party to the other

Explanation

The notional principal is the reference amount used to compute the interest cash flows on each leg. It is not lent or exchanged between the parties. It does not cap losses or represent collateral, although the mark-to-market value depends on it.

Question 21Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

A payer swaption on a 5-year swap with a 7.00 percent strike is exercised when the prevailing 5-year swap rate is 7.80 percent. What is the approximate intrinsic value per Rs. 1 crore notional, ignoring discounting and annuity detail?

  1. Zero, because the swaption expires worthless
  2. Rs. 80,000 per year for five years, worth about Rs. 4,00,000 undiscounted Correct answer.
  3. Rs. 8,000 in total
  4. Rs. 80,000 in total

Explanation

A payer swaption gains when the swap rate exceeds the strike, here by 0.80 percent. On Rs. 1 crore that is Rs. 80,000 per year, and over five years the undiscounted value is about Rs. 4,00,000. Discounting reduces this to the present value of the annuity.

Question 22Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

Which of the following is a key eligibility condition typically imposed on participants dealing in exchange-traded interest rate derivatives in India?

  1. Compliance with SEBI's eligibility norms and exchange membership or client registration requirements Correct answer.
  2. Registration with a commodity exchange
  3. Approval from the insurance regulator
  4. A minimum holding of government securities in the demat form

Explanation

Participation in exchange-traded interest rate derivatives requires compliance with SEBI's eligibility norms and appropriate registration as a member or client of the exchange. Commodity exchange registration, insurance approval and a mandatory G-sec holding are not the governing conditions. These requirements form part of the market's investor protection framework.

Question 23Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

A bond portfolio has a modified duration of 6.5 and a market value of Rs. 20 crore. The dealer wants to hedge with interest rate futures whose contract value is Rs. 2,00,000 and whose modified duration is 5.0. How many contracts are needed, approximately?

  1. 650 contracts
  2. 65 contracts
  3. 130 contracts Correct answer.
  4. 13 contracts

Explanation

The hedge ratio equals portfolio value times portfolio duration divided by contract value times contract duration. That is (20 crore x 6.5) divided by (2,00,000 x 5.0), which gives 130 contracts. This duration-based approach matches the interest rate sensitivity of the two positions.

Question 24Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

What is the purpose of a variation margin call in a centrally cleared interest rate futures position?

  1. To cover the initial good-faith deposit required to open the position
  2. To pay the exchange's brokerage charges
  3. To fund the clearing house's default fund
  4. To settle the daily mark-to-market loss so that the margin balance is restored to the required level Correct answer.

Explanation

Variation margin settles the daily profit or loss from marking the position to market. When losses erode the margin balance below the maintenance level, a call restores it. Initial margin is the separate opening deposit, while default fund contributions and brokerage are distinct items.

Question 25Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

An overnight indexed swap curve is trading below the corresponding MIBOR swap curve at the five-year point. What does this spread most likely reflect?

  1. The absence of any term premium in the market
  2. The credit and liquidity premium embedded in the interbank offered rate relative to the near-risk-free overnight rate Correct answer.
  3. A regulatory ban on interbank offered rate swaps
  4. The expectation that overnight rates will never change

Explanation

Overnight indexed swaps reference a near-risk-free overnight rate, while MIBOR-based swaps embed bank credit and term liquidity premia. The spread between the two curves therefore reflects that premium and related basis effects. It is not caused by an expectation of static rates or by a regulatory prohibition.

Question 26Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

Under the NISM framework for interest rate derivatives, which instrument is a cash-settled exchange-traded contract whose underlying is a notional government security?

  1. Interest rate swap
  2. Interest rate futures Correct answer.
  3. Interest rate cap
  4. Forward rate agreement

Explanation

Interest rate futures are standardised, exchange-traded contracts referencing a notional government security and are cash settled at expiry against the final settlement price. Swaps, FRAs and caps are over-the-counter instruments negotiated bilaterally.

Question 27Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

A trader wants to hedge the interest rate risk of a government bond portfolio using exchange-traded contracts. Which feature of interest rate futures makes them suitable for this purpose?

  1. They are customised to match the exact maturity of the bond portfolio
  2. They eliminate all credit risk of the underlying bonds
  3. They can be bought or sold quickly in a liquid market without renegotiating terms Correct answer.
  4. They require the physical delivery of the underlying bond at expiry

Explanation

Exchange-traded interest rate futures are standardised and liquid, so a dealer can establish or unwind a hedge rapidly at a transparent market price. They do not remove the credit risk of the underlying bonds and are not customised to the portfolio's exact maturity.

Question 28Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

Which regulatory body in India is primarily responsible for the regulation and development of the interest rate derivatives market?

  1. Insurance Regulatory and Development Authority of India
  2. Securities and Exchange Board of India
  3. Pension Fund Regulatory and Development Authority
  4. Reserve Bank of India Correct answer.

Explanation

The Reserve Bank of India regulates the interest rate derivatives market, including OTC products such as swaps and FRAs, and sets eligibility and participation norms. SEBI regulates securities markets and exchanges but the RBI is the primary regulator for interest rate derivatives.

Question 29Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

In a centrally cleared interest rate futures position, what does the initial margin collected by the clearing corporation represent?

  1. The interest accrued on the notional value of the contract
  2. A performance deposit held to cover potential future losses on the position Correct answer.
  3. A fee paid to the broker for executing the trade
  4. The final settlement amount payable at contract expiry

Explanation

Initial margin is a performance bond deposited with the clearing corporation to cover potential adverse price moves before the position is marked to market. It is returned when the position is closed or offset, subject to variation margin adjustments.

Question 30Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

What does the daily mark-to-market process in interest rate futures achieve for a clearing member?

  1. It guarantees that the underlying bond will be delivered at expiry
  2. It fixes the interest rate on the contract for its entire life
  3. It removes the need for any margin to be posted
  4. It resets the contract price to the market each day and settles the resulting profit or loss in cash Correct answer.

Explanation

Mark-to-market revalues open positions at the daily settlement price and credits or debits the resulting gain or loss to the member's margin account. This prevents losses from accumulating unchecked over the life of the contract.

Question 31Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

A plain vanilla interest rate swap involves two parties. Which statement correctly describes the fixed-rate payer's position?

  1. The fixed-rate payer receives both fixed and floating rates from the counterparty
  2. The fixed-rate payer pays both fixed and floating rates to the counterparty
  3. The fixed-rate payer pays a fixed rate and receives a floating rate, benefiting when floating rates rise Correct answer.
  4. The fixed-rate payer pays a floating rate and receives a fixed rate, benefiting when rates fall

Explanation

The fixed-rate payer in a swap pays the fixed leg and receives the floating leg, so its net position gains when the floating benchmark rises above the fixed rate. This position is used by parties wanting to convert fixed-rate exposure into floating-rate exposure.

Question 32Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

Which document typically governs the bilateral legal terms of an over-the-counter interest rate swap between two institutions?

  1. The settlement instruction form
  2. The exchange rulebook
  3. The ISDA Master Agreement Correct answer.
  4. The clearing member agreement

Explanation

The ISDA Master Agreement and its schedules set out the standard legal and credit terms for OTC derivatives such as interest rate swaps. Exchange rulebooks and clearing member agreements govern exchange-traded and cleared products instead.

Question 33Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

A corporate treasurer expects short-term interest rates to fall over the next quarter and wants to benefit from that view using exchange-traded interest rate futures. Which position should the treasurer take?

  1. Enter a pay-fixed interest rate swap
  2. Buy a payer swaption
  3. Buy interest rate futures Correct answer.
  4. Sell interest rate futures

Explanation

Interest rate futures prices move inversely to yields, so a fall in short-term rates raises futures prices and a long futures position profits. Selling futures would profit from rising rates, not falling ones.

Question 34Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

A dealer holds a portfolio of government bonds and wants to hedge against a rise in yields using interest rate futures. Which position should the dealer take?

  1. Sell interest rate futures Correct answer.
  2. Enter a receive-fixed interest rate swap
  3. Buy interest rate futures
  4. Buy a receiver swaption

Explanation

A rise in yields causes bond prices and futures prices to fall, so a short futures position offsets losses on the bond portfolio. Buying futures would add to losses if yields rise.

Question 35Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

A bank has a floating-rate loan book funded by fixed-rate deposits and wants to align its interest rate sensitivity using a swap. Which swap position should the bank take?

  1. Pay floating and receive floating
  2. Pay fixed and receive fixed
  3. Pay floating and receive fixed
  4. Pay fixed and receive floating Correct answer.

Explanation

The bank earns floating on assets and pays fixed on liabilities, so it is exposed to falling rates. Paying fixed and receiving floating on a swap converts the fixed funding cost into a floating one, aligning the sensitivity of assets and liabilities.

Question 36Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

A 3-month MIBOR-OIS swap is quoted at 25 basis points. What does this spread most directly reflect?

  1. The liquidity premium in the government bond market
  2. The market's expectation of the average spread between MIBOR and overnight rates over the swap tenor Correct answer.
  3. The expected inflation rate over the next three months
  4. The credit risk of the government of India

Explanation

A MIBOR-OIS spread reflects the expected average difference between the term interbank rate and the compounded overnight rate over the swap tenor, which captures bank credit and liquidity premia embedded in MIBOR. It is not a direct measure of sovereign credit risk or inflation.

Question 37Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

An interest rate futures contract has a price of 94.25. What does this quotation convention imply about the implied yield?

  1. The implied yield is 5.75 percent per annum Correct answer.
  2. The implied yield cannot be determined from the price alone
  3. The implied yield is 4.25 percent per annum
  4. The implied yield is 94.25 percent per annum

Explanation

Interest rate futures on a notional bond are quoted as 100 minus the implied yield, so a price of 94.25 implies a yield of 5.75 percent. The price and yield move inversely.

Question 38Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

A trader buys 50 interest rate futures contracts, each with a notional value of Rs. 2,00,000, at a price of 95.00 and sells them at 95.50. Ignoring transaction costs, what is the profit?

  1. Rs. 25,000
  2. Rs. 5,000
  3. Rs. 2,50,000
  4. Rs. 50,000 Correct answer.

Explanation

A 0.50 point move on a notional of Rs. 2,00,000 equals Rs. 1,000 per contract, and 50 contracts give Rs. 50,000. The calculation multiplies the price change by the notional and the number of contracts.

Question 39Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

What is the primary purpose of the conversion factor applied to a deliverable bond in an interest rate futures contract?

  1. To adjust the invoice price so that deliverable bonds with different coupons and maturities are comparable Correct answer.
  2. To convert the bond's accrued interest into a clean price
  3. To convert the notional value of the contract into a market value
  4. To convert the futures price into a yield-to-maturity

Explanation

The conversion factor normalises deliverable bonds with different coupons and maturities to a common notional coupon so that the invoice price reflects relative value. It does not convert prices into yields or adjust for accrued interest.

Question 40Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

A bond portfolio has a modified duration of 5.0 and a market value of Rs. 10 crore. The dealer wants to hedge with interest rate futures whose contract value is Rs. 2,00,000 and whose implied modified duration is 4.0. How many contracts are needed?

  1. 80 contracts
  2. 100 contracts
  3. 160 contracts
  4. 125 contracts Correct answer.

Explanation

The hedge ratio equals portfolio value times portfolio duration divided by contract value times contract duration, giving (10 crore times 5.0) divided by (2,00,000 times 4.0) = 125 contracts. This equates the rupee duration of the hedge with that of the portfolio.

Question 41Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

A bank has issued a floating-rate note and expects the benchmark rate to rise sharply. Which swap position would convert its interest cost into a fixed cost?

  1. Pay fixed and receive floating Correct answer.
  2. Pay floating and receive fixed
  3. Receive floating and pay floating
  4. Pay fixed and receive fixed

Explanation

The bank already pays floating on the note; paying fixed and receiving floating on a swap offsets the floating payment and leaves a net fixed cost. Receiving fixed would add to the floating exposure.

Question 42Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

Which feature distinguishes a swaption from a plain vanilla interest rate swap?

  1. The swaption gives the buyer a right, but not an obligation, to enter a swap on agreed terms Correct answer.
  2. The swaption settles only through physical delivery of a bond
  3. The swaption obliges both parties to exchange fixed and floating payments
  4. The swaption is always exchange-traded and centrally cleared

Explanation

A swaption is an option granting the buyer the right, but not the obligation, to enter into a specified swap on or before a future date. A plain vanilla swap, by contrast, obliges both parties to exchange payments.

Question 43Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

A payer swaption on a 5-year swap with a 7.00 percent strike is exercised when the prevailing 5-year swap rate is 7.80 percent. What is the intrinsic value of the swaption in rate terms?

  1. 7.80 percent
  2. Zero, because the swaption is out of the money
  3. 70 basis points
  4. 80 basis points Correct answer.

Explanation

A payer swaption gains when the swap rate exceeds the strike, and the difference is 7.80 percent minus 7.00 percent, or 80 basis points. The intrinsic value is positive because the swaption is in the money.

Question 44Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

A trader expects the yield curve to steepen, with short rates unchanged and long rates rising. Which position expresses this view using interest rate swaps?

  1. Pay fixed on a long-tenor swap and receive fixed on a short-tenor swap Correct answer.
  2. Receive fixed on both a long-tenor and a short-tenor swap
  3. Pay fixed on both a long-tenor and a short-tenor swap
  4. Receive fixed on a long-tenor swap and pay fixed on a short-tenor swap

Explanation

A curve steepener profits when long rates rise relative to short rates, so the trader pays fixed at the long tenor and receives fixed at the short tenor. A flattening view would use the opposite combination.

Question 45Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

A dealer is comparing a MIBOR swap curve and an OIS curve at the five-year point and finds the OIS curve is 40 basis points lower. What does this difference most likely reflect?

  1. An arbitrage opportunity that must be eliminated immediately
  2. A difference in the day-count conventions used by the two curves
  3. A credit and liquidity premium embedded in the term interbank rate relative to the overnight rate Correct answer.
  4. The expectation that overnight rates will rise above MIBOR

Explanation

The MIBOR-OIS spread mainly captures the term credit and liquidity premium in interbank lending relative to the near-risk-free overnight rate. Day-count differences are small and do not explain a 40 basis point gap.

Question 46Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

A bank holds a floating-rate asset book funded by fixed-rate liabilities and wants to hedge with a swap. Which risk does the resulting swap position introduce that the original balance sheet did not have?

  1. Credit risk on the floating-rate assets
  2. Interest rate risk on the floating leg
  3. Liquidity risk on the fixed deposits
  4. Counterparty credit risk on the swap Correct answer.

Explanation

Entering an OTC swap introduces exposure to the counterparty's creditworthiness, which the bank did not face before the hedge. The swap is designed to reduce interest rate risk, so it does not add that risk.

Question 47Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

A trader observes that the implied yield on a 3-month interest rate futures contract is 6.00 percent while the 6-month contract implies 6.50 percent. What does this curve shape suggest about market expectations?

  1. Short-term rates are expected to fall over the next six months
  2. Long-term rates are expected to fall while short-term rates rise
  3. Short-term rates are expected to rise over the next six months Correct answer.
  4. The market expects no change in short-term rates

Explanation

An upward-sloping sequence of implied futures yields indicates that the market expects short-term rates to increase over the period covered. A falling sequence would signal expected rate cuts.

Question 48Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

A clearing member's client holds a short interest rate futures position. The daily settlement price rises, and the client fails to meet the variation margin call. What is the most likely consequence under a central clearing framework?

  1. The client's position is automatically converted into a swap
  2. The initial margin is returned to the client in full
  3. The clearing corporation absorbs the loss without recourse
  4. The clearing member may close out the client's position to protect the clearing corporation Correct answer.

Explanation

When a client fails to meet variation margin, the clearing member is responsible to the clearing corporation and may close out the client's position. The clearing corporation is protected by the member's margin and default fund contributions.

Question 49Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

An interest rate swap has a fixed leg of 8.00 percent paid annually and a floating leg of MIBOR paid annually. At the first reset, MIBOR is set at 8.50 percent. Which party receives a net payment at the end of the year?

  1. The fixed-rate receiver receives 0.50 percent of notional
  2. The fixed-rate payer receives 0.50 percent of notional Correct answer.
  3. The fixed-rate payer pays 8.50 percent of notional
  4. No net payment is made because the legs offset

Explanation

The fixed-rate payer pays 8.00 percent and receives 8.50 percent, giving a net receipt of 0.50 percent of notional from the fixed-rate receiver. The receiver pays the excess of the floating rate over the fixed rate.

Question 50Interest Rate Derivatives (interest rate markets, products, trading, clearing, settlement and regulatory framework)

A dealer wants to hedge a bond portfolio against a rise in yields but is concerned that the cheapest-to-deliver bond may change before the hedge is lifted. Which risk does this concern represent?

  1. Operational risk arising from trade capture errors
  2. Liquidity risk arising from the exchange's settlement process
  3. Credit risk arising from the issuer of the bond
  4. Basis risk arising from a shift in the cheapest-to-deliver bond Correct answer.

Explanation

A change in the cheapest-to-deliver bond alters the relationship between the futures price and the hedged bond, producing basis risk. Credit, liquidity and operational risks are distinct and are not the concern described.