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JSE FX Trader study materials
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JSE FX Trader practice questions

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Question 1Equities

An FX trader is quoting a two-way price in a stock CFD. Which statement correctly describes the bid price in that quote?

  1. The midpoint between the trader's buy and sell prices
  2. The last traded price on the primary exchange
  3. The price at which the trader is willing to sell the underlying stock to the client
  4. The price at which the trader is willing to buy the underlying stock from the client Correct answer.

Explanation

In any two-way market the bid is the price at which the market maker will buy the asset, so a client selling receives the bid. The offer (ask) is the price at which the trader sells. The midpoint and last traded price are reference levels, not executable sides of the quote.

Question 2Equities

A client wants to buy 5,000 shares of a stock CFD when the trader's quote is 24.10 / 24.14. At which price does the trade execute and what is the spread in cents?

  1. 24.12, spread 2 cents
  2. 24.14, spread 2 cents
  3. 24.14, spread 4 cents Correct answer.
  4. 24.10, spread 4 cents

Explanation

A buying client pays the offer, which is the higher side of the two-way price, so the trade prints at 24.14. The spread is the difference between the two quoted sides, 24.14 minus 24.10, equal to 4 cents. The size of the order does not change which side applies for a standard quote.

Question 3Equities

Which statement best explains why an equity index future can trade at a price above the cash index?

  1. The future price reflects the cash index minus the cost of financing plus expected dividend income
  2. Index futures are priced purely by supply and demand and have no link to the cash index
  3. The future price reflects the cash index plus the cost of financing the position minus expected dividend income Correct answer.
  4. The future always converges to the index only at expiry, so before expiry the two prices are unrelated

Explanation

The fair value of an index future equals the cash index plus carry, where carry is financing cost less dividends received on the constituent basket over the life of the contract. When financing exceeds dividends the future trades at a premium. Arbitrage links the two prices continuously, not only at expiry.

Question 4Equities

A trader is delta hedging a long call position in a single stock. What does delta represent in this context?

  1. The change in option value for a one-unit change in the underlying price Correct answer.
  2. The change in implied volatility for a one-unit change in the underlying price
  3. The change in option value for a one-day passage of time
  4. The probability that the option finishes in the money, expressed as a percentage

Explanation

Delta measures the sensitivity of the option's price to a small move in the underlying, so it also gives the hedge ratio in shares. For a long call delta lies between zero and one. Time decay is theta and volatility sensitivity is vega.

Question 5Equities

An equity market maker holds a large long position in a stock and wishes to reduce inventory risk without selling shares outright. Which action achieves this most directly?

  1. Selling index futures or single stock futures against the holding Correct answer.
  2. Writing put options on the same stock
  3. Buying additional shares to average down the position
  4. Increasing the position size to benefit from expected upside

Explanation

Selling futures against a long cash holding creates an offsetting short exposure, reducing net delta while keeping the shares. This is the standard hedge for inventory risk. Buying more shares or writing puts adds rather than removes directional exposure.

Question 6Equities

A stock trades at 50.00 and pays no dividend. A one-year forward is quoted at 52.00. The one-year financing rate is 3 percent. Which statement about the forward is most accurate?

  1. The forward is cheap relative to fair value, so a cash-and-carry arbitrage would buy the forward and sell the stock
  2. The forward is rich relative to fair value, so an arbitrageur would sell the forward and buy the stock Correct answer.
  3. The forward is fairly valued because it exceeds spot
  4. No arbitrage is possible because the stock pays no dividend

Explanation

Fair value is spot compounded at the financing rate, 50.00 times 1.03, equal to 51.50. The quoted 52.00 is above fair value, so the forward is rich. An arbitrageur sells the rich forward, borrows to buy the stock, and locks in the difference at expiry.

Question 7Equities

A trader says a stock has a beta of 1.4 against the benchmark index. How should this be interpreted?

  1. The stock's price is 1.4 times the index level
  2. The stock has historically moved about 1.4 percent for each 1 percent move in the index Correct answer.
  3. The stock has 1.4 times the volatility of the index in absolute terms
  4. The stock's dividend yield is 1.4 times the index yield

Explanation

Beta measures sensitivity of the stock's return to the benchmark return, so a beta of 1.4 implies roughly a 1.4 percent move per 1 percent index move. It is a regression slope, not a price ratio or a yield comparison. Absolute volatility is measured by standard deviation, not beta.

Question 8Equities

A portfolio manager wants to reduce the portfolio beta from 1.2 to 0.8 using index futures. The portfolio is worth 40 million and one futures contract has a notional value of 200,000. How many contracts should be sold?

  1. 80 contracts Correct answer.
  2. 40 contracts
  3. 160 contracts
  4. 120 contracts

Explanation

The number of contracts equals portfolio value times the beta change divided by futures notional: 40,000,000 times 0.4 divided by 200,000, which equals 80. Selling futures lowers beta because the short futures position offsets market exposure. The sign of the adjustment follows the direction of the desired beta change.

Question 9Equities

Which event most directly increases the dividend income component used in pricing a single stock forward?

  1. A special dividend declared with an ex-date inside the forward's life Correct answer.
  2. A rise in the risk-free financing rate
  3. A widening of the stock's bid-ask spread
  4. An increase in the stock's implied volatility

Explanation

Dividends expected during the forward's life reduce fair value because the holder of the forward does not receive them, so a special dividend with an ex-date before expiry lowers the forward. Financing rates affect the carry term, not the dividend term. Spread and volatility do not enter the basic cost-of-carry formula.

Question 10Equities

A trader observes that a stock's implied volatility has fallen sharply while realised volatility remains high. Which position benefits most directly from this move, all else equal?

  1. A long call held from before the volatility fall
  2. A long put held from before the volatility fall
  3. A short straddle held from before the volatility fall Correct answer.
  4. A long straddle held from before the volatility fall

Explanation

A short straddle is short vega, so a fall in implied volatility raises its mark-to-market value. Long option positions are long vega and lose value when implied volatility drops. Realised volatility matters only through the gamma path, not the immediate repricing.

Question 11Equities

Which statement correctly describes the role of a stock's free float in index construction?

  1. Free float weighting gives equal weight to every constituent
  2. Free float weighting counts all issued shares regardless of ownership
  3. Free float weighting counts only shares available for public trading, excluding strategic holdings Correct answer.
  4. Free float weighting is based on the number of shareholders rather than shares

Explanation

Free float weighting uses only shares that are freely tradable, excluding stakes held by governments, founders, or strategic investors. This makes the index more investable and reflects actual market supply. It is not equal weighting and does not count all issued shares.

Question 12Equities

A trader is long 10,000 shares at 30.00 and buys 100 put contracts, each covering 100 shares, with a strike of 29.00. What is the maximum loss on the combined position at expiry, ignoring premiums?

  1. 1,000
  2. 10,000 Correct answer.
  3. 30,000
  4. Zero

Explanation

The protective put covers all 10,000 shares because 100 contracts times 100 shares equals 10,000. Below the 29.00 strike the loss is capped at 1.00 per share, which is 10,000 in total before premium. Ignoring premiums, the floor is the strike, so the loss is the gap between purchase price and strike.

Question 13Equities

An index arbitrageur notices the futures trades below its fair value while financing costs are unchanged. Which trade expresses the arbitrage?

  1. Buy both the futures and the basket
  2. Sell both the futures and the basket
  3. Sell the futures and buy the constituent basket
  4. Buy the futures and sell the constituent basket Correct answer.

Explanation

When the future is cheap relative to fair value, the arbitrageur buys the future and shorts the basket, then unwinds at expiry when prices converge. The reverse trade applies when the future is rich. Buying or selling both legs leaves the mispricing unhedged.

Question 14Equities

A trader holds a long call and a short call on the same stock with different strikes and the same expiry. Which strategy is this?

  1. A covered call
  2. A straddle
  3. A vertical spread Correct answer.
  4. A calendar spread

Explanation

Combining a long and a short option of the same type and expiry but different strikes is a vertical spread. A calendar spread uses different expiries, a straddle uses the same strike for a call and a put, and a covered call requires a short call against long stock.

Question 15Equities

A trader expects a large directional move but is unsure of the direction, and wants limited loss. Which position best fits this view?

  1. A covered call
  2. A short put
  3. A long straddle Correct answer.
  4. A short strangle

Explanation

A long straddle buys a call and a put at the same strike and expiry, profiting from a large move in either direction with loss limited to the premium paid. Short strangle, covered call and short put positions all cap upside and carry larger downside risk. The view requires long gamma rather than short gamma.

Question 16Equities

A stock goes ex-dividend tomorrow. What is the typical effect on a single stock forward expiring after the ex-date, all else equal?

  1. The forward price falls by roughly the dividend amount Correct answer.
  2. The forward price falls only if the dividend is paid in a foreign currency
  3. The forward price is unchanged because the dividend accrues to the forward holder
  4. The forward price rises by roughly the dividend amount

Explanation

The forward holder does not receive the dividend, so the fair forward price is reduced by the present value of dividends paid before expiry. This adjustment happens as the ex-date approaches. The currency of the dividend does not determine whether the adjustment occurs.

Question 17Equities

Which measure best captures the total market risk of an equity position over a one-day horizon at a stated confidence level?

  1. Bid-ask spread
  2. Earnings per share
  3. Dividend yield
  4. Value at risk Correct answer.

Explanation

Value at risk estimates the loss threshold that will not be exceeded with a given probability over a specified horizon. It is a standard summary of market risk for a position or portfolio. Spread, dividend yield and earnings per share describe other attributes of the stock.

Question 18Equities

A trader is short 200 futures contracts, each with a notional of 50,000, and the index rises 1 percent. What is the approximate mark-to-market loss?

  1. 10,000
  2. 200,000
  3. 1,000,000
  4. 100,000 Correct answer.

Explanation

Total notional is 200 times 50,000, equal to 10,000,000. A 1 percent move against a short position produces a loss of 1 percent of notional, which is 100,000. The direction matters: a short futures position loses when the index rises.

Question 19Equities

A stock's price is 80.00. A one-year call with a strike of 80.00 is priced at 6.00 and the one-year put with the same strike at 4.00, with a risk-free rate of 2 percent. Which statement is most consistent with put-call parity?

  1. The prices are inconsistent because the put should always exceed the call
  2. The prices are consistent because the call exceeds the put by roughly the present value of the strike difference from spot Correct answer.
  3. The prices cannot be assessed without knowing implied volatility
  4. The prices are inconsistent because the call and put should be equal at the money

Explanation

Put-call parity states that call minus put equals spot minus the present value of the strike. Here that is 80.00 minus 80.00 divided by 1.02, about 1.57, and the observed difference is 2.00, close enough to suggest a small deviation rather than a gross violation. Parity does not require equal prices at the money, and implied volatility does not enter the parity relationship.

Question 20Equities

An equity trader wants to express a view that one stock will outperform another while limiting exposure to the overall market. Which trade fits?

  1. Buy both stocks in equal amounts
  2. Buy the first stock and buy index futures
  3. Buy the first stock and short the second stock in matched notional amounts Correct answer.
  4. Short both stocks in equal amounts

Explanation

A long-short pair trade isolates relative performance because matched long and short exposures largely cancel market beta. Buying or shorting both stocks leaves the trade exposed to the market direction. Adding index futures to a long stock position increases rather than neutralises market exposure.

Question 21Foreign Exchange

In the FX market, which quotation convention is described by a dealer quoting EUR/USD as 1.0850/1.0852?

  1. A forward quote where the second figure is the settlement date
  2. A cross rate where neither currency is the base currency
  3. A direct quote where the base currency is EUR and the quote currency is USD Correct answer.
  4. An indirect quote where the base currency is USD and the quote currency is EUR

Explanation

In a standard FX quotation the first currency is the base and the second is the quote (term) currency, so EUR/USD prices one euro in US dollars. For a US-based trader this is a direct quote because the domestic currency is the term currency. The bid of 1.0850 is where the dealer buys euros and the offer of 1.0852 is where the dealer sells euros.

Question 22Foreign Exchange

A trader buys 1,000,000 EUR against USD at 1.0900 and later closes the position at 1.0950. Ignoring fees and interest, what is the profit or loss in USD?

  1. USD 500 profit
  2. USD 50,000 profit
  3. USD 5,000 profit Correct answer.
  4. USD 5,000 loss

Explanation

The position gains 0.0050 USD per euro because the rate rose from 1.0900 to 1.0950. Multiplying 0.0050 by the notional of 1,000,000 EUR gives USD 5,000. The long euro position profits when EUR/USD rises.

Question 23Foreign Exchange

Which statement best describes the role of a spot FX trade's value date?

  1. It is the date on which the currencies are actually exchanged, typically two business days after the trade date for most pairs Correct answer.
  2. It is the date on which the trade is agreed between the two counterparties
  3. It is the date on which the trade is reported to the regulator
  4. It is the date on which the trade is confirmed by the back office

Explanation

The value date determines when the two currency legs settle and cash actually changes hands. Under the standard T+2 convention for most major pairs, settlement occurs two business days after execution. Trade date, confirmation, and reporting are separate operational steps from settlement.

Question 24Foreign Exchange

A dealer quotes USD/JPY 145.20/145.25. A client wants to sell USD 1,000,000 to the dealer. Which price applies and how much JPY does the client receive?

  1. 145.25, receiving JPY 145,250,000
  2. 145.20, receiving JPY 145,200,000 Correct answer.
  3. 145.25, receiving JPY 145,200,000
  4. 145.20, receiving JPY 1,452,000

Explanation

The dealer buys dollars at its bid, which is the lower figure of 145.20. The client selling dollars therefore receives the bid rate. Multiplying 1,000,000 by 145.20 gives JPY 145,200,000.

Question 25Foreign Exchange

In FX market terminology, what is a pip for most currency pairs quoted to four decimal places?

  1. A one-unit move in the second decimal place, equal to 0.01
  2. A one-unit move in the fifth decimal place, equal to 0.00001
  3. A one-unit move in the third decimal place, equal to 0.001
  4. A one-unit move in the fourth decimal place, equal to 0.0001 Correct answer.

Explanation

For pairs conventionally quoted to four decimals, one pip is 0.0001, the last quoted decimal. Yen pairs are the main exception because they are quoted to two decimals, where one pip is 0.01. The fifth decimal, when shown, is a fractional pip or pipette.

Question 26Foreign Exchange

Which counterparty arrangement is settled through CLS (Continuous Linked Settlement) rather than bilateral correspondent banking?

  1. Any trade where one leg is a non-deliverable currency
  2. Eligible FX transactions between CLS settlement members and their clients, where both currency legs are settled simultaneously Correct answer.
  3. Cash-settled FX options that expire in the money
  4. All retail margin FX trades executed on a broker's platform

Explanation

CLS provides payment-versus-payment settlement for eligible currencies, reducing principal risk by settling both legs together. Access is through settlement members and their sponsored clients. Retail margin trades, NDFs, and cash-settled options do not settle both legs through CLS in this way.

Question 27Foreign Exchange

The EUR/USD spot rate is 1.1000 and the one-year EUR interest rate is 4.0% while the one-year USD rate is 2.0%. Using covered interest parity, what is the approximate one-year EUR/USD forward rate?

  1. 1.1000
  2. 1.1216
  3. 1.0784 Correct answer.
  4. 1.0600

Explanation

Covered interest parity implies the forward rate equals spot multiplied by the ratio of the term-currency rate factor to the base-currency rate factor. Here that is 1.1000 times 1.02 divided by 1.04, which is about 1.0784. The higher-yielding currency trades at a forward discount, so EUR/USD forward is below spot.

Question 28Foreign Exchange

A trader observes USD/CHF spot at 0.9000 and the three-month forward at 0.8940. Which interpretation is correct?

  1. The Swiss franc trades at a forward discount, consistent with higher CHF interest rates
  2. The forward points reflect expected spot appreciation of the dollar
  3. The forward is mispriced because forwards must trade above spot
  4. The Swiss franc trades at a forward premium against the dollar, consistent with lower CHF interest rates than USD rates Correct answer.

Explanation

A forward below spot means the base currency, USD, is at a forward discount and the term currency, CHF, is at a forward premium. Under covered interest parity this occurs when CHF interest rates are lower than USD rates. Forward points reflect the interest rate differential, not a forecast of spot.

Question 29Foreign Exchange

A corporate treasurer will receive EUR 5,000,000 in three months and wants protection against EUR weakening. Which FX hedge best matches the exposure?

  1. Buy EUR/USD forward for the expected receivable amount and value date
  2. Sell EUR/USD forward for the expected receivable amount and value date Correct answer.
  3. Buy a EUR/USD call option and pay the premium upfront
  4. Enter a EUR/USD spot purchase now and hold the euros

Explanation

A future euro receivable creates a long EUR exposure, which is hedged by selling euros forward so the proceeds are locked in dollars. The hedge should match the amount and the value date to avoid residual or mismatched risk. Buying euros forward would double the exposure rather than offset it.

Question 30Foreign Exchange

A trader holds a long USD/JPY position. Which development most directly increases the mark-to-market loss on that position?

  1. USD/JPY falls because US yields decline relative to Japanese yields Correct answer.
  2. Implied USD/JPY volatility falls ahead of a central bank meeting
  3. USD/JPY rises because US data surprises stronger than expected
  4. The bid-offer spread in USD/JPY narrows during active trading

Explanation

A long USD/JPY position loses value when the dollar weakens against the yen, that is, when USD/JPY falls. A narrowing yield advantage for the US is a common driver of such a move. Narrower spreads and lower volatility affect transaction costs and option values but not the direction of a spot position.

Question 31Foreign Exchange

A trader expects EUR/USD to remain range-bound but wants protection against a sharp euro rally. Which strategy fits this view?

  1. Buy a EUR/USD strangle with both strikes far from spot
  2. Sell a EUR/USD call and buy a EUR/USD put at a lower strike
  3. Buy a EUR/USD straddle at the money
  4. Sell a EUR/USD put and buy a EUR/USD call at a higher strike to limit upside risk Correct answer.

Explanation

A risk reversal that is long a call and short a put collects premium from the put while capping the cost of upside protection. It profits if the euro stays range-bound or weakens modestly and still protects against a sharp rally. The structure suits a neutral-to-bearish view with tail protection on the upside.

Question 32Foreign Exchange

An FX option has a delta of 0.55 for a EUR/USD call. What does this delta indicate for a trader hedging the position?

  1. The option's value is insensitive to changes in implied volatility
  2. The option's premium equals 55% of the notional amount
  3. The option's value changes by about 0.55 dollars per one-dollar change in the euro, and 55% of the notional is the equivalent spot exposure Correct answer.
  4. The option has a 55% probability of expiring worthless

Explanation

Delta measures the change in option value for a unit change in the underlying and is also used as the equivalent spot exposure for hedging. A 0.55 delta call behaves like a long position of 55% of the notional. Probability of exercise is a separate concept approximated by delta only loosely.

Question 33Foreign Exchange

A trader quotes a two-way price in USD/TRY as 30.00/30.20. A client sells USD 10,000,000 to the trader. What is the trader's resulting position and cash flow?

  1. Long USD 10,000,000 and short TRY 302,000,000 at the offer
  2. Short USD 10,000,000 and long TRY 300,000,000 at the offer
  3. Short USD 10,000,000 and long TRY 302,000,000 at the bid
  4. Long USD 10,000,000 and short TRY 302,000,000 at the bid Correct answer.

Explanation

When the client sells dollars, the dealer buys them at its bid of 30.00, so the dealer ends up long USD and short TRY. The lira amount is 10,000,000 times 30.00, which equals 302,000,000 TRY. The dealer profits from the spread when it later lays off the position at the offer.

Question 34Foreign Exchange

A forward trade in USD/KRW is executed on Thursday with standard T+2 settlement. Which statement about the value date is correct?

  1. Settlement occurs on the trade date because Korea settles same-day
  2. Settlement occurs on the second business day after the trade date, skipping weekends and Korean and US holidays Correct answer.
  3. Settlement occurs on the next business day because T+2 applies only to European currencies
  4. Settlement occurs two calendar days after the trade date regardless of holidays

Explanation

T+2 settlement counts business days in the relevant settlement calendars, so weekends and holidays in either currency's market are skipped. The value date can therefore fall later than two calendar days after the trade. The convention applies broadly to spot FX, not only to European currencies.

Question 35Foreign Exchange

A trader wants to express a view that EUR/GBP volatility will fall but wants to avoid exposure to the direction of spot. Which position best matches this view?

  1. Buy a EUR/GBP butterfly and hold it to expiry without hedging
  2. Buy an at-the-money EUR/GBP straddle and delta-hedge the spot exposure
  3. Sell an at-the-money EUR/GBP straddle and delta-hedge the spot exposure Correct answer.
  4. Buy a EUR/GBP risk reversal and leave it unhedged

Explanation

Selling a straddle collects premium that benefits from falling implied and realized volatility. Delta-hedging the spot exposure neutralizes directional risk so the position is primarily short volatility. Buying a straddle would be a long volatility position that loses when volatility falls.

Question 36Foreign Exchange

A trader holds a long USD/BRL position in a high-carry environment. Which risk most specifically erodes the carry return?

  1. A gradual narrowing of the USD/BRL bid-offer spread
  2. A sudden depreciation of BRL-hedged carry positions caused by a sharp rise in USD/BRL Correct answer.
  3. An increase in the liquidity of the BRL forward market
  4. A decline in implied volatility of USD/BRL options

Explanation

Carry strategies earn the interest differential but are exposed to abrupt spot depreciation of the funding or target currency. A sharp rise in USD/BRL means the long dollar position gains, but for a carry trade funded in dollars and invested in BRL, the real risk is BRL depreciation. The question tests that carry returns can be wiped out by a rapid adverse spot move.

Question 37Foreign Exchange

A bank's FX desk reports a net open position of long EUR 50,000,000 against USD. Which statement best describes the desk's exposure?

  1. The desk gains regardless of the direction of EUR/USD because the position is hedged
  2. The desk's exposure is limited to the bid-offer spread earned on the trade
  3. The desk gains if EUR/USD rises and loses if it falls, with the P&L approximately linear in the spot move Correct answer.
  4. The desk has no market risk because the position is denominated in two currencies

Explanation

A net long euro position has linear directional exposure: profits accrue when EUR/USD rises and losses when it falls. The magnitude is the notional times the change in rate. Being denominated in two currencies does not eliminate market risk.

Question 38Foreign Exchange

The EUR/USD spot is 1.1000, the one-year forward is 1.0800, and the one-year USD rate is 3.0%. Assuming covered interest parity holds, what is the approximate one-year EUR rate?

  1. 6.10%
  2. 5.04% Correct answer.
  3. 3.00%
  4. 1.00%

Explanation

Covered interest parity gives forward over spot equal to the ratio of the term-currency rate factor to the base-currency rate factor. Solving 1.0800/1.1000 = 1.03/(1+r_EUR) gives 1+r_EUR of about 1.0504, so the euro rate is roughly 5.04%. The euro forward discount reflects the higher euro interest rate.

Question 39Foreign Exchange

A trader is short a three-month USD/JPY forward at 145.00 while spot is 143.00 and the forward points are 150 pips. Which statement about the mark-to-market is correct?

  1. The position's value depends only on the spot rate and ignores forward points
  2. The position is in-the-money because the contracted forward rate exceeds the current market forward of about 144.50 Correct answer.
  3. The position has zero mark-to-market because forwards are not marked to market before settlement
  4. The position is out-of-the-money because spot is below the contracted rate

Explanation

The current market forward is spot plus forward points, about 143.00 plus 1.50, equal to 144.50. A short forward struck at 145.00 is profitable because the trader can buy at the lower market forward to close. Marking to the current forward, not spot alone, is the correct approach.

Question 40Foreign Exchange

A desk runs a portfolio of FX options with a net vega of zero but a large negative gamma in EUR/USD. Which statement best describes the risk?

  1. The portfolio gains from large spot moves because gamma is negative
  2. The portfolio is insensitive to small changes in implied volatility but loses value as spot moves away from the strikes, requiring frequent rehedging Correct answer.
  3. The portfolio's value depends only on the passage of time and not on spot
  4. The portfolio is fully hedged and has no remaining market risk

Explanation

Vega measures sensitivity to implied volatility, so a net vega of zero neutralizes that exposure. Gamma measures how delta changes with spot, and negative gamma means delta moves against the trader as spot moves, causing losses and forcing rehedging. It does not mean the portfolio has no market risk.

Question 41Preference Shares

A preference share pays a fixed dividend of 8% on a nominal value of ZAR 100. What dividend will the holder receive per share in a full year, before withholding tax?

  1. ZAR 8.00 Correct answer.
  2. ZAR 0.80
  3. ZAR 80.00
  4. ZAR 108.00

Explanation

A preference dividend quoted as a percentage is calculated on the nominal (par) value, not the market price. Here 8% of ZAR 100 nominal equals ZAR 8.00 per share per year. The market price only affects the effective yield an investor earns, not the cash dividend declared on nominal value.

Question 42Preference Shares

Which feature most clearly distinguishes preference shares from ordinary shares on a company's balance sheet?

  1. Preference shares are redeemed at par on a fixed calendar date
  2. Preference shares always participate in residual profits above the fixed dividend
  3. Preference shares rank ahead of ordinary shares for dividend payments and capital repayment Correct answer.
  4. Preference shares carry voting rights at every general meeting

Explanation

Preference shares sit between debt and ordinary equity in the capital structure, giving holders priority over ordinary shareholders for dividends and for return of capital on winding up. This ranking, not voting or participation, is their defining economic feature. Ordinary shareholders rank last and absorb residual risk and reward.

Question 43Preference Shares

A company has cumulative preference shares and skips the dividend in year one. In year two it declares an ordinary dividend. What must happen to the preference shareholders first?

  1. They receive the year one arrears plus the year two dividend before any ordinary dividend is paid Correct answer.
  2. They receive nothing until the company is wound up
  3. They convert automatically into ordinary shares
  4. They receive only the year two preference dividend and forfeit year one

Explanation

Cumulative preference shares accrue unpaid dividends as arrears, and these must be settled before ordinary shareholders can receive anything. The cumulative feature protects preference holders against temporary earnings shortfalls. Non-cumulative preference shares, by contrast, would lose the skipped year.

Question 44Preference Shares

An investor buys a perpetual preference share with a ZAR 100 nominal value and a 9% fixed dividend at a market price of ZAR 90. What is the current dividend yield on the purchase price?

  1. 10.0% Correct answer.
  2. 8.1%
  3. 9.0%
  4. 11.1%

Explanation

The annual dividend is 9% of ZAR 100 nominal, which is ZAR 9.00. Dividing that cash dividend by the ZAR 90 purchase price gives a yield of 10.0%. The nominal coupon stays fixed while the yield moves inversely with the market price.

Question 45Preference Shares

What does the term 'perpetual' mean when applied to a preference share issue?

  1. The shares have no fixed redemption date and the issuer is not obliged to repay the nominal value Correct answer.
  2. The dividend rate resets every year to a benchmark
  3. The shares must be redeemed within twelve months of issue
  4. The holder may convert the shares into ordinary shares at any time

Explanation

Perpetual preference shares have no maturity date, so the nominal capital is only returned if the issuer chooses to call the shares or on winding up. They behave more like equity than like a bond with a fixed term. Redeemable and convertible features are separate characteristics that may or may not be attached.

Question 46Preference Shares

Which type of preference share gives the holder the right to receive a share of profits beyond the fixed dividend once ordinary shareholders have received a specified amount?

  1. Cumulative preference share
  2. Convertible preference share
  3. Participating preference share Correct answer.
  4. Redeemable preference share

Explanation

Participating preference shares combine a fixed preferential dividend with a right to share in surplus profits alongside ordinary shareholders under defined conditions. The other classes alter dividend accrual, redemption or conversion, but not profit participation. Participation makes the instrument more equity-like in its payoff.

Question 47Preference Shares

A company issues floating-rate preference shares with a dividend set at the three-month JIBAR plus 250 basis points. If JIBAR rises from 7.00% to 7.75%, by how much does the annual dividend rate on nominal value change?

  1. It rises by 2.50 percentage points
  2. It rises by 0.75 percentage points Correct answer.
  3. It is unchanged because the margin is fixed
  4. It falls by 0.75 percentage points

Explanation

The dividend rate equals the reference rate plus a fixed margin, so a 0.75 percentage point rise in JIBAR flows directly into the coupon. The 250 basis point margin stays constant and only the benchmark moves. Floating-rate preference shares therefore transfer interest rate risk partly back to the holder.

Question 48Preference Shares

An analyst values a perpetual preference share with a ZAR 100 nominal value and a 10% fixed dividend. If the required return for this risk class is 8%, what is the fair value per share?

  1. ZAR 110.00
  2. ZAR 80.00
  3. ZAR 100.00
  4. ZAR 125.00 Correct answer.

Explanation

A perpetual fixed-dividend share is valued as a perpetuity: dividend divided by the required return. The dividend is ZAR 10.00 and dividing by 0.08 gives ZAR 125.00. When the required return is below the coupon, the share trades at a premium to nominal value.

Question 49Preference Shares

A company has ZAR 5 million of preference share capital ranking ahead of ZAR 20 million of ordinary share capital. On winding up, realised assets after paying creditors are ZAR 12 million. How much do ordinary shareholders receive in total?

  1. ZAR 5 million
  2. ZAR 12 million
  3. ZAR 0
  4. ZAR 7 million Correct answer.

Explanation

Preference shareholders are repaid their ZAR 5 million nominal capital before ordinary shareholders receive anything. The remaining ZAR 7 million then goes to ordinary shareholders. This illustrates the priority ranking of preference capital in a liquidation waterfall.

Question 50Preference Shares

Why might a bank issuer prefer to fund itself with preference shares rather than senior unsecured debt?

  1. Preference dividends are tax-deductible while interest is not
  2. Preference shares never require any distribution to holders
  3. Preference shares can count towards regulatory capital while senior debt generally cannot Correct answer.
  4. Preference shareholders rank ahead of depositors on winding up

Explanation

Regulatory capital frameworks allow certain preference shares, subject to conditions, to count as additional tier capital because they absorb losses and have no fixed maturity. Senior debt is a liability that does not meet those criteria. The trade-off is that preference dividends are paid from after-tax profits and are not tax-deductible.