- CFA Exams
- CFA Level I Exam
- Study Session 2. Quantitative Methods (1)
- Reading 8. Probability Concepts
- Subject 6. Expected Value, Variance, and Standard Deviation of a Random Variable

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**CFA Practice Question**

A price-linked derivative security pays $300 if the oil price over the next year increases by more than 5%, an event that can happen with a 60% probability. Otherwise, it pays $50. If the expected return on the security is 15%, how much does the security cost?

B. $180

C. $168

A. $174

B. $180

C. $168

Correct Answer: A

The expected payoff on the security equals 0.6 * 300 + 0.4 * 50 = 200. Since the expected return is 15%, the security must cost 200/1.15 = $173.9.

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**User Contributed Comments**
6

User |
Comment |
---|---|

Gina |
why divided by 1.15 (vs multiplied by it) since the 15% return increases the value? |

logicMan |
the expected payoff is the future value, and the cost is the current value. You are asked to get the cost so 200 should be divided by 1.15. |

arkot90 |
it says that the expected return is 15% which means that when you will multiply the cost of the security with 15% it will give you 200(the expected pay off). Specifically: x *1,15=200 so 200/1,15=x and x=174 |

magicchip |
or alternatively FV=200, I/Y=.15 N=1 yr therefore PV = -173.91 (174) A TVM calc. |

DonAnd |
Magicchip is definitely building on previous concepts and that what the CFA is all about.Taking knowledge gained in previous LOS and building on them or applying them in different settings. |

sgossett86 |
P(value)=.6(300)+.4(50) =200 still doesn't tell us value of it. gives us expected return, time from now. fv=200 n=1 i/y=15 cpt: pv 173.9 |