- CFA Exams
- CFA Level I Exam
- Topic 1. Quantitative Methods
- Learning Module 4. Probability Trees and Conditional Expectations
- Subject 1. Expected Value and Variance
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.
User Contributed Comments 7
| 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 |
| RoL9833Y | 15% is viewed as holding period return in this question ! CFA question may be like this one! |