Free CFA Level III: Portfolio Management Derivatives & Risk Management Practice Questions
Derivatives and risk management on CFA Level III tests hedging strategies using futures and options, overlay management, volatility trading, and tail risk management techniques for institutional portfolios.
Sample Questions
Question 1
Easy
A calendar spread is constructed by:
Solution
C is correct.
A calendar spread (also called a time spread or horizontal spread) involves options at the same strike but different expirations. The long position is in the farther-dated option, and the short position is in the nearer-dated option. The strategy benefits from time decay because the shorter-dated option loses value faster.
A calendar spread (also called a time spread or horizontal spread) involves options at the same strike but different expirations. The long position is in the farther-dated option, and the short position is in the nearer-dated option. The strategy benefits from time decay because the shorter-dated option loses value faster.
Question 2
Medium
A covered call strategy is best described as:
Solution
B is correct.
A covered call is primarily a yield enhancement (income) strategy. The writer earns premium income in exchange for capping the upside at the strike price. It works best when the writer expects the stock to remain flat or rise slightly, as the premium provides additional return above the stock's performance.
A covered call is primarily a yield enhancement (income) strategy. The writer earns premium income in exchange for capping the upside at the strike price. It works best when the writer expects the stock to remain flat or rise slightly, as the premium provides additional return above the stock's performance.
Question 3
Hard
A variance swap has a strike volatility of 18% and a vega notional of . Realized volatility over the period is 22%. The payoff to the long position is closest to:
Solution
B is correct.
Variance notional = vega notional / (2 * strike vol) = . Payoff = variance notional (realized variance - strike variance) = .
The variance swap pays on the difference in squared volatilities (variance), scaled by the variance notional derived from the vega notional.
Variance notional = vega notional / (2 * strike vol) = . Payoff = variance notional (realized variance - strike variance) = .
The variance swap pays on the difference in squared volatilities (variance), scaled by the variance notional derived from the vega notional.