Free CISI CMP Sec/Deriv Practice Questions: Derivatives: Underlying Markets

CISI means Chartered Institute for Securities & Investment. CMP means Capital Markets Programme, and this page is for the Securities/Derivatives unit. Use this focused CISI CMP Securities/Derivatives page as a short practice test for Derivatives: Underlying Markets. The items are original Finance Prep sample exam questions built for scenario-based practice, not trivia, puzzle questions, official CISI questions, copied live-exam content, or exam dumps.

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These are original Finance Prep practice questions aligned to this topic area. They are not official CISI questions, copied live-exam content, or exam dumps. Use them to preview question style and explanation depth before continuing with topic drills, mixed sets, and timed mock exams in Finance Prep.

Question 1

Topic: Derivatives: Underlying Markets

A derivatives dealer is quoting a 3-month GBP/USD forward. The quote is expressed as USD per £1.

Using covered interest parity, the dealer multiplies the spot rate by the quote-currency interest factor and divides by the base-currency interest factor. What is the 3-month forward GBP/USD rate, rounded to four decimal places?

• A. 1.2504
• B. 1.2463
• C. 1.2650
• D. 1.2537

Best answer: D

What this tests: Derivatives: Underlying Markets

Explanation: For a foreign exchange quote stated as quote currency per one unit of base currency, covered interest parity adjusts the spot rate for the relative financing return in the two currencies over the forward period. Here, GBP is the base currency and USD is the quote currency. The USD period factor is higher than the GBP period factor, so the GBP/USD forward should be above the spot rate. The calculation is 1.2500 × 1.0130 ÷ 1.0100 = 1.253712…, which rounds to 1.2537.

• 1.2463 reverses the interest-rate adjustment and would put the forward below spot despite the higher USD period factor.
• 1.2504 understates the adjustment by applying only a very small differential rather than the supplied period factors.
• 1.2650 applies too large an adjustment, consistent with using an annual differential rather than the 3-month factors.

The forward rate is 1.2500 × 1.0130 ÷ 1.0100 = 1.2537, rounded to four decimal places.

Question 2

Topic: Derivatives: Underlying Markets

An asset manager reviews the effect of a 50 basis point rise in benchmark rates. Assume annualised cash-flow estimates are sufficient.

• Floating-rate loan: a borrower owes £20 million at benchmark + 1.20%; the bank receives the loan interest.
• Interest-rate swap: the borrower pays fixed 4.10% and receives the benchmark on £20 million notional.
• Fixed-rate bond: its yield rises by the same 50 basis points; current price is 100; modified duration is 6; ignore convexity.

The benchmark rate rises from 4.00% to 4.50%. Which statement correctly estimates the effects of the rate rise?

• A. The loan cost and lender income rise by about £10,000; the swap’s floating receipt rises by about £10,000; the fixed-rate bond price falls by about 0.3%.
• B. The loan cost and lender income rise by about £100,000; the swap’s floating receipt rises by about £100,000; the fixed-rate bond price falls by about 3%.
• C. The loan cost and lender income fall by about £100,000; the swap’s floating receipt falls by about £100,000; the fixed-rate bond price rises by about 3%.
• D. The loan cost and lender income rise by about £100,000; the swap’s fixed payment rises by about £100,000; the fixed-rate bond price rises by about 3%.

Best answer: B

What this tests: Derivatives: Underlying Markets

Explanation: A rise in benchmark interest rates normally increases cash payments for floating-rate borrowers and increases interest income for floating-rate lenders. Here, 50 basis points is 0.50%, so the annualised change on £20 million is £100,000. The borrower’s pay-fixed, receive-floating swap receives more on its floating leg when the benchmark rises, so that swap cash flow improves by the same £100,000 before considering the separate loan margin. Fixed-rate bond prices move inversely to yields. Using modified duration, a 6-year duration and a 0.50% yield increase gives an approximate 3% price fall, from 100 to about 97, ignoring convexity.

• Treating higher rates as reducing floating-rate loan costs reverses the borrower and lender cash-flow effect.
• A pay-fixed, receive-floating swap benefits from a higher floating benchmark; the fixed leg does not reset upward.
• Fixed-rate bond prices fall when yields rise; duration gives the approximate percentage price change.
• A 50 basis point move is 0.50%, not 0.05%, so the cash-flow change on £20 million is £100,000, not £10,000.

A 0.50% rise on £20 million is £100,000, and a duration estimate gives a bond-price fall of about 6 × 0.50% = 3%.

Question 3

Topic: Derivatives: Underlying Markets

A UK exporter will receive USD 5 million in 90 days from an overseas customer.

Hedge need:

• The company reports in sterling.
• It is concerned that sterling may strengthen against the dollar before the receipt date.
• It wants to reduce uncertainty in the sterling value of the USD cash flow.
• It has no exposure to equity prices, bond prices, or floating-rate interest payments.

Which derivative underlying is the single best match for this hedge need?

• A. GBP/USD foreign exchange rate
• B. UK government bond price
• C. FTSE 100 equity index
• D. Three-month SONIA interest rate

Best answer: A

What this tests: Derivatives: Underlying Markets

Explanation: A derivative hedge should be linked to the market variable that creates the risk. Here, the exporter will receive US dollars but reports in sterling, so the uncertain outcome is the GBP value of a future USD cash flow. That is foreign exchange risk, specifically the GBP/USD rate. A forward, future, swap, or option could be structured using that currency pair as the underlying, depending on the desired hedge profile. The facts exclude interest-rate exposure, bond-price exposure, and equity-market exposure, so those underlyings would not directly offset the risk being managed.

• Three-month SONIA would relate to sterling money-market interest-rate exposure, not the GBP value of a dollar receipt.
• A UK government bond price would hedge gilt price or yield exposure, not a transactional currency exposure.
• The FTSE 100 would relate to UK equity-market exposure and would not directly hedge USD/GBP conversion risk.

The exposure is to the sterling value of a future US dollar receipt, so the relevant underlying is the sterling-dollar exchange rate.

Question 4

Topic: Derivatives: Underlying Markets

A corporate treasurer wants to hedge the cost of rolling over a £10 million 3-month sterling borrowing starting in June.

A June short-term interest rate futures contract is quoted at 94.72. The market convention for this contract is:

• Futures price = 100 minus the annualised 3-month money-market interest rate for the contract period

Which underlying and estimated rate does this contract refer to?

• A. A 3-month Treasury bill price, about £94.72 per £100 nominal
• B. A 10-year gilt yield, about 94.72% per annum
• C. A 3-month sterling money-market interest rate, about 5.28% per annum
• D. A GBP/USD forward exchange rate, about 1.0528

Best answer: C

What this tests: Derivatives: Underlying Markets

Explanation: Short-term interest rate futures are derivatives on money-market interest rates, not on the price of a bond or an exchange rate. Under the stated convention, the quoted futures price is converted into an annualised implied rate by subtracting it from 100. A price of 94.72 therefore implies 5.28% per annum for the relevant 3-month sterling money-market period. Similar short-term interest-rate underlyings can also appear in forwards, swaps, and options, where the economic exposure is to a reference interest rate rather than to an equity, commodity, or FX rate.

• Treating 94.72 as a Treasury bill price confuses a money-market instrument price with an interest-rate futures quotation.
• A 10-year gilt is a bond-market underlying, not the 3-month money-market rate described in the contract.
• GBP/USD is a foreign exchange underlying; no spot rate, forward points, or currency pair exposure is given here.

The quoted price implies an annualised short-term rate of 100 - 94.72 = 5.28%, so the underlying is a money-market interest rate.

Question 5

Topic: Derivatives: Underlying Markets

A UK asset manager holds bitcoin for an institutional client and is considering one-month bitcoin futures to reduce short-term NAV volatility.

Decisive facts:

• The bitcoin is held with a crypto custodian.
• The proposed futures contract is exchange-traded, centrally cleared, and cash-settled.
• Settlement is against a published bitcoin reference index calculated from several crypto spot venues.
• The underlying bitcoin market trades continuously, including weekends, and liquidity can vary sharply by venue.
• The fund values the holding at a London business-day NAV point and can adjust hedges only during its dealing window.

Which market-specific risk should be given the greatest weight when deciding whether this futures hedge is suitable?

• A. Basis risk between the cash-settled futures/reference index and the fund’s executable spot bitcoin value
• B. Uncleared bilateral counterparty risk because the contract relies on an OTC dealer’s performance
• C. Equity corporate-action risk because holders may face rights issues and stock splits
• D. Private-key transfer risk because bitcoin must be delivered to the futures exchange at expiry

Best answer: A

What this tests: Derivatives: Underlying Markets

Explanation: For a cash-settled crypto future, hedge suitability depends heavily on whether the contract tracks the exposure being hedged. Bitcoin spot trading is continuous and fragmented across venues, while the fund values and adjusts its hedge only during a London dealing window. Even with an exchange-traded, centrally cleared contract, the futures price and settlement reference may not match the fund’s executable spot value at the time it measures NAV or rebalances. That mismatch is basis risk and can leave residual exposure despite using a derivative hedge.

• Private-key transfer risk is not the main issue because the futures contract is cash-settled and does not require bitcoin delivery at expiry.
• Uncleared bilateral counterparty risk does not fit an exchange-traded, centrally cleared futures contract.
• Rights issues and stock splits are equity corporate actions, not a normal market-specific risk of holding or hedging bitcoin.

The fragmented, continuous crypto spot market can cause the futures price or settlement index to track imperfectly against the value the fund is trying to hedge.

Question 6

Topic: Derivatives: Underlying Markets

A UK pension scheme expects a £40 million contribution in three months. The trustees have already decided to use the cash to buy long-dated UK government bonds.

Hedge objective:

• The scheme is worried that UK gilt yields may fall before the cash is received.
• If yields fall, the gilts it plans to buy will become more expensive.
• The hedge should track long-dated sterling government bond prices, not equity-market or commodity-price exposure.

Which underlying market is the single best match for the hedge?

• A. Long-dated UK government bond market, accessed through gilt futures
• B. Single-company equity market, accessed through options over a UK bank share
• C. UK blue-chip equity index market, accessed through FTSE 100 index futures
• D. Energy commodity market, accessed through Brent crude oil futures

Best answer: A

What this tests: Derivatives: Underlying Markets

Explanation: A planned purchase of long-dated gilts creates exposure to movements in gilt prices before the cash is available. If yields fall, gilt prices rise, making the future purchase more expensive. The appropriate underlying should therefore be the market whose price behaviour is most closely linked to long-dated UK government bonds. Gilt futures are designed to provide exposure to sterling government bond price movements and are commonly used to manage this type of interest-rate and bond-price risk. Equity index, single-share, and commodity underlyings respond to different risk drivers and would not closely hedge the scheme’s planned gilt purchase.

• FTSE 100 index futures would hedge broad UK equity-market exposure, not long-dated gilt price risk.
• Options over a single bank share introduce company-specific equity exposure, which is unrelated to the trustees’ planned bond purchase.
• Brent crude oil futures track energy commodity prices and would not offset changes in sterling government bond prices.

The exposure is to future gilt purchase prices, so the closest underlying is the long-dated sterling government bond market.

Question 7

Topic: Derivatives: Underlying Markets

A derivatives broker is reviewing a proposed three-month futures contract for institutional clients on a non-traditional cryptoasset, Arc token.

Product file:

• Spot market: Arc trades mainly on two unregulated venues; daily volume is low and order books are thin.
• Concentration: a small number of wallets hold most of the free float.
• Settlement price: the proposed final price is the last trade on one venue at 16:00, with no independent benchmark or fallback.
• Delivery: the client requested physical token delivery, but the clearing house allows only cash settlement for this product group and will not custody tokens.
• Legal: counsel has not confirmed that an exchange-traded contract on Arc is permitted under the exchange’s regulated derivatives rulebook.

Which assessment should the broker give to the product committee?

• A. Proceed as a professional-only listed contract; professional-client access removes the need for benchmark controls and legal confirmation.
• B. Proceed with physical settlement; transferring the token at expiry removes reliance on market depth and makes the final-price benchmark less important.
• C. Proceed if initial margin is increased; collateral can compensate for thin trading, benchmark weakness, custody limits, and uncertain listing permission.
• D. Do not proceed as proposed; thin trading, a weak benchmark, incompatible physical delivery, and unconfirmed rulebook treatment create valuation, settlement, and regulatory risks.

Best answer: D

What this tests: Derivatives: Underlying Markets

Explanation: For non-traditional underlyings, the quality of the underlying market often drives whether a derivative can be priced, margined, settled, and supervised safely. A thin spot market with concentrated holdings is vulnerable to sharp moves and potential manipulation, so final settlement based on a single last trade is unreliable. An independently administered, transaction-based benchmark with fallbacks would reduce valuation and settlement disputes. Physical delivery of a cryptoasset also introduces wallet, custody, operational and control issues, particularly where the clearing house cannot accept the asset. Exchange listing also depends on confirmed regulatory and rulebook treatment; limiting access to professional clients does not remove that requirement.

• Physical delivery does not solve benchmark and market-depth weaknesses; it adds custody and transfer risk where the clearing house will not hold tokens.
• Higher margin reduces counterparty exposure, but it cannot make a poor benchmark reliable or create exchange-listing permission.
• Restricting access to professional clients does not remove conduct, benchmark, settlement, or rulebook requirements.

The proposal fails on market depth, benchmark reliability, settlement feasibility, and confirmed regulatory treatment.

Question 8

Topic: Derivatives: Underlying Markets

A UK importer must pay a supplier €5 million in 90 days.

The treasurer wants to:

• Fix the GBP/EUR exchange rate today.
• Match the exact invoice amount and payment date.
• Avoid paying an option premium.
• Use a bilateral bank transaction rather than an exchange-traded contract.
• Make one currency exchange on the invoice date.

Which instrument is the single best fit?

• A. A currency option giving the right to buy €5 million against sterling
• B. A currency futures contract on an exchange with daily margining
• C. A forward FX contract to buy €5 million against sterling for 90-day settlement
• D. A spot FX transaction to buy €5 million against sterling

Best answer: C

What this tests: Derivatives: Underlying Markets

Explanation: A forward FX contract is used when two parties agree today to exchange specified currencies at an agreed rate on a future value date. It is normally OTC, so the amount and settlement date can be tailored to match the commercial exposure. That fits a known euro payable in 90 days where the treasurer wants certainty and a single future exchange of currencies. Spot FX is for near-immediate settlement, commonly two business days. Currency futures are standardised exchange-traded contracts with margining, so they are less tailored to the exact invoice. A currency option would preserve upside by giving a right rather than an obligation, but it normally involves paying a premium, which the treasurer wants to avoid.

• Spot FX fails because it is for near-immediate value rather than a 90-day invoice date.
• Currency futures fail because they are exchange-traded, standardised and subject to margining.
• A currency option fails because it gives optionality and normally requires a premium, which is not wanted here.

A forward FX contract is a bilateral OTC agreement that fixes an exchange rate today for a specified amount and future value date.

Question 9

Topic: Derivatives: Underlying Markets

A commodity futures desk is checking whether a three-month futures quote is consistent with the economics of holding the underlying. Ignore taxes, transaction costs, and credit risk.

Market-data snapshot:

Which interpretation is best supported?

• A. The futures quote is unaffected by carry factors because spot price alone determines a commodity futures valuation.
• B. The futures quote should be above the full-carry value because convenience yield is an additional cash income received by the futures buyer.
• C. The futures quote may be consistent with fair value because convenience yield reduces the futures valuation and can offset financing and storage costs.
• D. The futures quote is necessarily too low because storage and insurance costs always reduce the value of holding the physical asset.

Best answer: C

What this tests: Derivatives: Underlying Markets

Explanation: Cost-of-carry valuation starts with the spot price and adjusts for the economics of holding the underlying until expiry. Financing, storage and insurance are holding costs, so they tend to increase the fair futures price. Benefits from holding the physical asset reduce the fair futures price. For commodities, convenience yield is the non-cash benefit of having inventory available, for example during tight prompt supply. A high convenience yield can therefore explain why a futures quote is below a simple spot-plus-financing-plus-storage value.

• Treating storage and insurance as price-reducing reverses the carry effect; they are holding costs and normally increase fair futures value.
• Treating convenience yield as cash income to the futures buyer misstates it; it is a benefit of holding physical inventory.
• Using spot price alone ignores financing costs, storage costs and benefits of carry that derivative valuation must reflect.

Convenience yield is a benefit of holding the physical commodity, so it reduces the fair futures price relative to a full-carry value.

Question 10

Topic: Derivatives: Underlying Markets

A derivatives desk is reviewing a proposed OTC cash-settled call on a recently issued cryptoasset token. The risk manager wants to know whether the unusual underlying creates a concern that must be escalated before quotation.

Proposed trade and controls:

Other facts:

• Settlement is in USD cash against an approved two-venue index.
• Operations confirms that the token identifier and price feed are supported in trade capture.
• No other limits are binding.

Assuming the desk hedges the initial delta in the underlying, which assessment is best supported by the estimate?

• A. Escalate an operational-control concern because the token cannot be identified or priced in trade capture.
• B. Escalate a settlement concern because physical delivery of 1,200,000 tokens will be required at expiry.
• C. Escalate a liquidity concern because the initial hedge is about 420,000 tokens, or 28% of reliable daily volume.
• D. Escalate a valuation concern because a two-venue index is not sufficient for any cryptoasset derivative.

Best answer: C

What this tests: Derivatives: Underlying Markets

Explanation: Unusual underlyings can create several types of concern, but the facts point to liquidity. The hedge estimate is the option size multiplied by delta: 1,200,000 tokens × 0.35 = 420,000 tokens. Compared with reliable aggregate average daily volume of 1,500,000 tokens, that is 28%. The desk’s escalation threshold is breached when the initial hedge exceeds 20% of reliable daily volume, so the proposed trade should be escalated for liquidity review before quotation. The cash settlement index and confirmed trade-capture support reduce the force of settlement and operational-control objections under the stated facts.

• A valuation escalation is not supported merely because the underlying is a cryptoasset; the stem states that an approved two-venue index is available.
• A physical settlement concern is inconsistent with USD cash settlement against the approved index.
• An operational-control concern is not supported because the token identifier and price feed are already supported in trade capture.

The estimated delta hedge is 1,200,000 × 0.35 = 420,000 tokens, which exceeds the 20% liquidity threshold.

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