Errata for 9th Edition of Exam FM/2 Manual

(Last updated 8/7/13)

[8/7/13 !ote on "han#es in Learnin# $%&e"ti'es for $"to%er 2(13)

Starting with the October 2013 exam, some topics were removed and some were added to the list of Learning Objectives. owever, there were no changes in the !ext "eferences. #$or example, altho%gh the topic of &investment 'ear allocation methods( was removed, the !ext "eferences still cover this topic.) *e emailed the $+,2 exam committee in earl' -%l' 2013 to tr' to clarif' this sit%ation, b%t we have not heard bac. from them. /nless we receive information to the contrar', the a%thors of 0S+1s 2xam $+,2 man%al s%ggest that 'o% contin%e to learn certain topics that are no longer specificall' listed on the Learning Objectives. *e have noted what these topics are in the %pdates below dated 3,4,13. #Other topics that were added to the Learning Objectives are alread' covered b' the man%al or b' the %pdates below.)

[7/17/11 *mportant note on immuni+ation, -tudents ha'e reported that

there ha'e %een a surprisin# num%er of .uestions on immuni+ation (in"ludin# the topi"s of duration and "on'exit/) on re"ent exams0 1he 2 pra"ti"e exams in this manual "ontain 'er/3 'er/ fe4 .uestions on these topi"s0 5e su##est that /ou thorou#hl/ re'ie4 -e"tions 9" to 9n %efore /ou ta6e the exam0
56,21,137 8age 21, 9. 6. 0nswer choice #:) sho%ld be 1;1;. 5;,23,107 8age 21, 9. 4. !his problem sho%ld act%all' appear at the end of Sections 1a#vi) to 1a#ix). 56,21,137 8age 2<. !he &=ote( at the end sho%ld refer to #1 > i)2n. 56,21,137 8age 34, sol%tion to 9. <. =ote that there is act%all' no need to explicitl' calc%late i,2. $rom 1000#1 > i,2)23 ? 1,@30, we have #1 > i,2)10 ? 1.@310,23, A ? 1000#1 > i,2)10 ? 1000#1.@310,23) ? 1,24<. 53,26,127 8age 63, sol%tion to 9. 1. 0dd the following note after the sol%tionB &Some st%dents interpretB C is acco%nt is credited with interest at a nominal rate of i convertible semiann%all'1 to mean that :r%ce1s acco%nt earns interest onl' at the end of each <Dmonth period. !herefore, the' reason that after 4.26 'ears, :r%ce has onl' 100#1 > i,2)1; in his acco%nt. owever, it is ver' important to note that in 2xam $+,2, an acco%nt is alwa's ass%med to grow with interest contin%o%sl', no matter how the interest rate is stated #e.g., as an ann%al effective rate, as a nominal rate compo%nded mDthl', as a force of interest, etc.). Ef there is an exception to this ass%mption, it sho%ld be clearl' stated in the F%estion.( 53,4,137 8age <4, sol%tion to 9. 3. 0dd the following note at the beginning of the sol%tionB =oteB Occasionall', 'o% ma' see the term &c%rrent val%e(, as in this F%estion. !his simpl' means the val%e of a series of pa'ments on a specified date, some of which are made before that date and some after that date. !h%s, &c%rrent val%e( is the s%m of the 0G and 8G of the pa'ments on the specified date.

56,21,137 8age 32, diagram in the middle of the page. 3H applies to a period of I of a 'ear. #!he arrows ma.e it appear as if 3H applies to I of a period, which is J of a 'ear.) 54,14,117 8age 113, sol%tion to 9. 4, 2nd line. " ? 160.30 #based on the n%mber of decimal places %sed), not 160.03. !he sol%tion is based on the correct val%e. 53,13,107 8age 12@, sol%tions to 9. 4. On the last line, the denominator sho%ld be 1 D .461316. !he answer is based on the correct denominator. 51,22,107 8age 130, sol%tion to 9. 13, first line. On the rightDhand side of the eF%ation, the term of the ann%it' sho%ld be 20, not 10. !he correct term is %sed in the sol%tion. 51,22,107 8age 203, items #2)#b) and #2)#c). !here sho%ld be a 9 in front of the second term of the 0G. 53,13,107 8age 216, sol%tion to 9. 11. !he wa' the F%estion is worded, the correct answer is #0), not #:). 0s noted in the sol%tion, the acco%nt balance at the end of the 3th 'ear is K;<,@21.<<. -%st after the 14th f%ll scholarship of K6,000 is awarded, the acco%nt balance is eF%al to #;<,@21.<<)#1.03)14 D 6,000#s angle 14) at 3H ? K;,36@.3<. 0ccording to the F%estion, if there is less than K6,000 in the acco%nt at the end of an' 'ear, the remaining amo%nt #K;,36@.3<) is immediatel' awarded as a smaller scholarship. !h%s, onl' 14 f%ll scholarships of K6,000 are awarded. =ote that the acco%nt balance of K;,36@.3< at the end of the 14th 'ear wo%ld have grown to K6,2;3.<6 at the end of the 13th 'ear at 3H. !his wo%ld have permitted an 13th f%ll scholarship to have been awarded, b%t this wo%ld not follow the reF%irements of the F%estion. 53,4,137 8age 230. =ote that the October 2013 Learning Objectives removed &investment 'ear allocation methods( as an explicit learning objective. owever, this topic has often appeared on past $+,2 exams. 0lso, F%estion 3 of the 64 sample F%estions on www.:e0n0ct%ar'.org covers this topic. 0ccordingl', the a%thors advise 'o% to learn the concepts in Section 6f. 53,26,127 8age 33@, sol%tion to 9. @, last line. 1,033.24 sho%ld be 1,0@@.3;. 54,14,117 8age 2@;, first line %nder &b. /sing the !G+ registers(. ;,32@.;3 sho%ld be ;,32@.33. 53,4,137 8age ;10. 0dd the following paragraph at the end of Section 3aB 0 convertible bond is a bond that the holder can convert into a predetermined n%mber of shares of common stoc. at mat%rit', instead of receiving the mat%rit' val%e in cash. 0 mandatorily convertible bond is a bond that a%tomaticall' converts to common stoc. at mat%rit'. 0 convertible bond is often called a &h'brid sec%rit'(, since it has both debt and eF%it' feat%res 5<,26,127 8age ;16, sol%tion to 9. 2, 1st line. !he reference sho%ld be to Section 3#b), not Section 4#g). 54,14,117 8age ;;2, 3 lines from the bottom. 0dd the following sentence to the parenthesisB &En fact, in &=otation and terminolog' %sed for 2xam $+,2xam 2(, which 'o% can find on www.:e0n0ct%ar'.org, the SO0,L0S sa's that, %nless otherwise stated, &d%ration( means +aca%la' d%ration.( 54,14,117 8age ;;;, sol%tion to #c), 3rd line. !he reference to footnote 2 sho%ld be to footnote 3. 56,21,137 8age ;;3, sol%tion to 2xample 1. !he 2nd sentence sho%ld refer to 2xample 2, not 2xample 3. 54,14,117 8age ;6<, footnote 6. Ensert the following sentence j%st after the 2nd sentence of the footnoteB &En fact, in &=otation and terminolog' %sed for 2xam $+,2xam 2, which 'o% can find on www.:e0n0ct%ar'.org, the SO0,L0S sa's that, %nless otherwise stated, &convexit'( means

modified convexit'. 51,22,107 8age ;<3, j%st above the middle of the page, sentence beginning &:%t the first condition M &. !his sentence sho%ld read &:%t the second condition of "edington imm%niNation is that 801 ? 8L1 M &. 53,4,137 8age ;<3, Sections @n#ii) and @n#iii). =ote that the October 2013 Learning Objectives removed &effective d%ration( as an explicit learning objective. *e have not seen an' reports from st%dents that this topic has appeared on past exams. 5;,23,0@7 8age ;<@, sol%tion to 2xample 1. !he coefficient of #a angle 3) in the form%las for both 8#.0;6) and 8#.066) sho%ld be 5, not 3. !he n%merical res%lts shown are correct. 53,4,137 8age ;30. =ote that the October 2013 Learning Objectives removed &as. price(, &bid price( and &bidDas. spread( as explicit learning objectives. owever, these terms are basic to the process of b%'ing and selling assets. 0ccordingl', the a%thors advise 'o% to learn the concepts in Section 10c. 54,14,117 8ages ;32D;33, &*hat abo%t interestO( =ote that the F%estion of interest on the proceeds of a short sale is still not covered b' the St%d' =otes. owever, in a repl' to an email sent b' a st%dent in 2010, the 2d%cation Staff noted that new exam F%estions will be based on +cPonald, which ass%mes that this interest is paid. 0 n%mber of F%estions on the 6 practice exams in this man%al are based on the &noDinterest( ass%mption. See the errata list below for pages <6; and s%bseF%ent. 51,22,107 8age ;@3, first sentence. 0dd &which does not pa' dividends( to the end of this sentence. 51,22,107 8age ;@<, footnote 1. "evise the first sentence to readB &*e are going to ass%me that the forward price for a nonDdividendDpa'ing stoc. is determined as the c%rrent spot price of K100 acc%m%lated with interest at the ris.Dfree rate.( 54,14,117 8age ;@4, $ig. 11.2 and page ;@@, $ig. 11.3. !he line showing the pa'off on the long forward sho%ld intersect the ' axis at D10;, not D100. 53,4,137 8age 604, <th line. =ote that &:erm%dian( is also spelled &:erm%dan(. 51,22,107 8age 620, Section 13c, 3rd sentence beginning &$or this reason M &. Pelete &$or this reason( and insert &Ef we own the %nderl'ing asset(. 0lso, in the &Loncl%sion( two sentences later, add &in the %nderl'ing asset( at the end of the sentence. 5;,23,0@7 8age 623, item #1)#a). Sho%ld sa' &in which the short position is obligated to sell(, not &b%'(. 51,22,107 8age 630, last col%mn of the table #&8osition(). 0dd &in /nderl'ing 0sset( to the heading. 51,22,107 8age 631, 2nd line. En the parentheses, add &at expiration(. 3rd line. 0dd &in the %nderl'ing asset( at the end of the paragraph. 51,22,107 8age 631, 4th line. En the parentheses, add &at expiration(. 0t the end of the next sentence, add &in the %nderl'ing asset(. 51,22,107 8age 631, Section 1;c, 2nd line. 0dd &at expiration( j%st after &spot price(. 51,22,107 8age 632, table at the top of the page. En the first col%mn, the position shown in parentheses is with respect to the underlying asset. 51,22,107 8ages 632D633, sol%tion to 2xample 1. !he positions shown in parentheses in #E), EE), #EEE) and

#EG) are with respect to the underlying asset. 51,22,107 8age 633, first table. En the first col%mn, the position shown in parentheses is with respect to the underlying asset. 51,22,107 8age 63;, Section 1;e, 3rd, ;th and 6th paragraphs. "eplace these paragraphs b' the following three paragraphsB &S%ppose we have a short position in an asset #for example, we sell the asset short). *e wo%ld lose mone' if the price of the asset increases. Ef we b%' a call, it1s ins%rance against price increases, since the pa'off %nder the long call increases as the price of the %nderl'ing asset increases. !h%s, we can sa' that the strateg' behind a long call #when we have a short position in the %nderl'ing asset) is ins%rance against a high price.( &0 written call is li.e selling ins%rance against a high price.( &0s we saw in Section 13c, a long p%t is ins%rance against a decrease in the price of the %nderl'ing asset. !h%s, we can sa' that the strateg' behind a long p%t #when we have a long position in the %nderl'ing asset, s%ch as when we own it) is ins%rance against a low price.( 5;,23,0@7 8age 636, footnote #a) %nder the table at the top. Sho%ld sa' &as discussed in Section 13a(, not &as j%st disc%ssed(. 51,22,107 8age 634, first b%llet #!axes), ;th line. Pelete &spot price at the time of exercise( and replace b' &stri.e price(. 51,22,107 8age 6;4, 1st paragraph. 0dd the following sentence to the end of the paragraphB &*e will ass%me that the %nderl'ing asset does not pa' dividends. ;th paragraph, 2nd line. "eplace &Section 1;d( b' &Section 13a(. 51,22,107 8age 66@. -%st before 9.1, insert the statementB &0ss%me that an' stoc.s in the following F%estions do not pa' dividends.( 5;,23,0@7 8age 6<0, 9. 13. 0ss%me that interest is credited on the proceeds of the short sale. 51,22,107 8age 6<1, Sol%tion to 9. 2. 0dd the following note after the sol%tionB En Section 1<b, we will cover a ver' important principle in option pricing .nown as put-call parity. Qo% will find that %sing this principle, it is possible to determine A #the premi%m for a ;3Dstri.e call) directl'B 8%tDcall parit'B Lall#R, !) S 8%t#R, !) ? S0 S 8G#R) Lall#;3, 1 'ear) S ;.13 ? ;3 D #1.0<<D1)#;3) Lall#;3, 1 'ear) ? ;3 S ;6.03 > ;.13 ? 4.16 #ro%nding difference) 8%tDcall parit' co%ld also be %sed to solve several other problems in this set. 53,4,137 8age 6<3, Section 1<a. =ote that the October 2013 Learning Objective removed &s'nthetic forwards( as an explicit learning objective. owever, this is a basic concept which is central to demonstrating p%tDcall parit' #Section 1<b), one of the most important relations in options. 0ccordingl', the a%thors advise 'o% to learn the concepts in Section 1<a. 51,22,107 8age 644, 9. 1, 1st line. 0fter &forward contract(, insert &with a nonDdividendDpa'ing stoc. as the %nderl'ing asset and(. 0lso, delete the sentence beginning &!he ris.Dfree rate M(, since this information is not reF%ired.

51,22,107 8age 64@, sol%tion to 9. 1. "eplace the sol%tion b' the followingB !he combination of a long call and a short p%t with a stri.e price of R creates a s'nthetic forward with a forward price of R. !he premi%m for this offDmar.et forward is eF%al to the net premi%m for the long call and short p%t. !h%s in this problem we haveB 32.@3 S A ? 13.13 A ? 1;.30 51,22,107 8age 64@, sol%tion to 9. ;. En the note to the sol%tion, delete &borrowing mone' #with no mar.et ris. involved and repa'ing( and replace b' &lending mone' at the ris.Dfree interest rate and receiving a pa'ment of(. 51,22,107 8age 63<, item : near the top of the graph. Et sho%ld sa' &afterDtax profit at a price of K130 ? K32.60(, not a price of K110. 54,14,117 8age 633D63@, table at the bottom of 633 to the top of 63@. !he first ; entries in the col%mn headed &8rofit on 100D110 Lollar( sho%ld end in .30, not .2< or .3<. !he next 3 entries in this col%mn sho%ld end in .40, not .4;. 0ll of the entries in the &Lombined 8rofit( col%mn sho%ld end in .30, not .2<. 53,4,137 8age 6@0, &8a'later(. =ote that the October 2013 Learning objectives removed &pa'later strateg'( as an explicit learning objective. *e have not seen an' reports from st%dents that this topic has appeared on past exams. 5;,23,107 8age 6@3, 9. 3. !he problem sho%ld have made it clear that A and Q represent the highest and lowest profit, respectivel', if the p%ts are purchased. 51,22,107 8age <1@, 6th line of paragraph beginning &=ote that the bro.er M &. 0dd &with an o%tside part'( j%st after &forward or f%t%res contract(. 51,22,107 8age <1@, item 1 of the table j%st below the middle of the page #&0rrangement T;(). Pelete the last sentence beginning &#:ro.er1s short forward M)( and replace b' &#:ro.er1s short position in the forward contract with the b%'er is offset b' bro.er1s long position in another forward contract with an o%tside part'.)( 54,14,117 8age <22, the line j%st before Section 1@d. !he res%lt of the calc%lation is K4.66, not K4.61. 51,22,107 8age <32, sol%tion to 9. 3. !he s'mbol f2 as %sed in this sol%tion represents the ann%al effective interest rate for the 2D'ear period from t ? 1 to t ? 3. #!his is not how f2 was defined in the text of the man%al.) 54,14,117 8age <34. *e s%ggest that 'o% do 8ractice 2xams ; and 6 first, since most st%dents thin. the' are easier than 8ractice 2xams 1 to 3. 5;,23,107 8age <;3, sol%tion to 9. 20, last 2 lines. 1036.;6 sho%ld be 1030.;6. !he final answer of 10.3< is correct. 54,14,117 8age <6;, 9.11, page <40, 9.4, page <3<, 9. 23 and page 400, 9. 24. 0ll of these F%estions sho%ld sa' that 'o% sho%ld ass%me that no interest is paid to the shortDseller on the proceeds of the short sale. =ote that if this is not stated, 'o% sho%ld ass%me that this interest is paid. #See pages ;32D;33, &*hat abo%t interestO() 5;,23,0@7 8age <63, 1st line. &2004( sho%ld be 7200880

51,22,107 8age <30, sol%tion to 9. 2@. On the 3rd line, a division bar was omitted from the 2nd term on the leftDhand side of the eF%ation, which sho%ld readB 61.21,#1 > x)2. On the ;th line, the factor #1.0@) sho%ld be #1.2@). !he res%lt for 1 > x is correct. 54,14,117 8age <31, sol%tion to 9. 3;, 3rd eF%ation. !he n%mber in the angleDbrac.et sho%ld be 232 #? 3<0 S 43), not 3<0. !he res%lt is based on the correct val%e. 5;,23,107 8age <36, 9. 16. !he p%t options in this problem are priced incorrectl', since the premi%ms sho%ld increase as the stri.e price increases. !he sol%tion is based on the premi%ms as shown. 5;,23,0@7 8age <34, 9. 33. !he first b%llet sho%ld read Rc ? Rp S 20. 54,14,117 8age <@@, 9. 1@. !he F%estion sho%ld as. for the nonDNero val%e of A. 5;,23,107 8age <@@, 9. 20. !he F%estion sho%ld ma.e it clear that the prod%ction cost of 14.60 is inc%rred at the time of sale, i.e., one 'ear from now. 54,14,117 8age 400, 9. 23. !he F%estion sho%ld ma.e it clear that the bond was originall' p%rchased to 'ield a minimum of 3H. 0lso, it sho%ld sa' that the bond mat%res at par in 30 'ears. 53,13,107 8age 406, sol%tion to 9. 14. On the last line, 8 sho%ld be eF%al to 122,216.3. !he answer is still #P). 54,14,117 8age 40<, sol%tion to 9. 23. !o find the price at which the bond was originall' p%rchased to 'ield a minim%m of 3H, we m%st find the lowest price for all possible redemption dates. !he price ass%ming mat%rit' at par in 30 'ears, as shown in the sol%tion, is K@;3.411. Ef we ass%me that the bond is called at K1,060 at the end of < to 2@ 'ears, the price wo%ld be greater than K@;3.411. #!his can be seen b' loo.ing at the premi%m,disco%nt form%la for the price, or b' a co%ple of trial calc%lations.) !h%s, the original price was K@;3.411, as shown in the sol%tion.