CFAI Practice: M01 — Market Organization and Structure
Source: CFAI Official Practice Problems 2026 Total: 37 questions (20 key questions included below)
Questions
1. A trader who obtains new information and buys before prices fully adjust is best described as:
- A. A value-motivated trader
- B. A liquidity-motivated trader
- C. An information-motivated trader ✓
Information-motivated traders act on new information quickly before prices adjust. They have high time sensitivity because information advantage is temporary.
2. An individual who purchases a stock expecting to benefit from price appreciation is best described as:
- A. A hedger
- B. An investor ✓
- C. An information-motivated trader
An investor buys securities expecting to earn a return (capital gain and/or income). A hedger seeks to reduce risk from an existing exposure.
3. A Brazilian coffee producer selling BRL futures to protect against currency depreciation is best described as:
- A. A hedger ✓
- B. An investor
- C. An information-motivated trader
The producer uses futures to offset existing currency risk — this is hedging. Selling BRL futures locks in an exchange rate to protect export revenue.
4. Which is least likely a function of the financial system?
- A. Regulating arbitrageurs ✓
- B. Helping people achieve their purposes in using the financial system
- C. Determining the rates of return that equate aggregate saving with aggregate borrowing
The financial system facilitates saving/borrowing, determines rates of return, and allocates capital. Regulating arbitrageurs is not a core function — arbitrageurs actually help keep markets efficient.
5. Real estate investments are best classified as being in which market?
- A. Capital market
- B. Money market
- C. Alternative market ✓
Real estate is classified as an alternative investment/market. Capital markets include stocks and bonds; money markets are short-term debt instruments.
6. Which of the following is best described as a money market instrument?
- A. Corporate bond maturing in 5 years
- B. Treasury bill maturing in 90 days ✓
- C. Common stock of a large-cap company
Money market instruments are short-term debt securities with maturity year. T-bills are the most common example. Corporate bonds and stocks are capital market instruments.
7. The market in which newly issued securities are sold to investors is best described as the:
- A. Secondary market
- B. Primary market ✓
- C. Third market
Primary market is where new securities are first issued and sold (IPOs, new bond issues). Secondary market is where previously issued securities trade among investors.
8. A fixed-income mutual fund would least likely hold:
- A. Warrants ✓
- B. Corporate bonds
- C. Government bonds
Warrants are equity-linked instruments (options to buy stock) and are not fixed-income securities. A fixed-income fund holds bonds and other debt instruments.
9. A key difference between open-end and closed-end funds is that:
- A. Open-end funds trade on exchanges
- B. Closed-end funds always trade at NAV
- C. Open-end funds issue and redeem shares at NAV; closed-end funds trade at market price ✓
Open-end funds create/redeem shares at NAV on demand. Closed-end funds have a fixed number of shares trading on an exchange, often at a premium or discount to NAV.
10. Standard & Poor’s Depositary Receipts (SPDRs) trading on an exchange are best described as:
- A. Primary market individual securities
- B. Secondary market pooled investment vehicles ✓
- C. Primary market pooled investment vehicles
SPDRs are ETFs — pooled investment vehicles that trade on the secondary market (exchange). They are not individual securities and trade in the secondary market after initial creation.
11. Exchange-traded fund (ETF) companies are best described as:
- A. Broker-dealers
- B. Financial intermediaries ✓
- C. Investment banks
ETF companies (sponsors) are financial intermediaries that pool assets from investors and invest them according to a stated strategy. They stand between investors and securities.
12. A forward contract is least likely easy to exit before expiration because:
- A. Forward contracts are customized private agreements ✓
- B. Forward contracts are standardized
- C. Forward contracts are exchange-traded
Forwards are customized OTC contracts between two parties. Their non-standardized, bilateral nature makes them difficult to transfer or close before expiration. (B and C describe futures, not forwards.)
13. Futures contracts least likely expose the holder to:
- A. Counterparty risk ✓
- B. Market risk
- C. Liquidity risk
Futures are exchange-traded with a clearinghouse (CCP) guaranteeing performance, which virtually eliminates counterparty risk. Daily mark-to-market and margin requirements further reduce this risk.
14. An investor wanting to hedge a long stock position against a price decline would most likely use:
- A. A call option
- B. A put option ✓
- C. A forward contract to buy
A put option gives the right to sell at a specified price, providing downside protection for a long position. A call option benefits from price increases. A forward to buy would add to long exposure.
15. An agreement between two parties to exchange an asset at a future date at a price determined today is best described as:
- A. An option contract
- B. A forward contract ✓
- C. A swap agreement
A forward contract is a bilateral agreement to buy/sell an asset at a future date at a predetermined price. Unlike options, both parties are obligated to transact.
16. An investor holds a call option on a stock with an exercise price of $305. The option will most likely be exercised if the stock price is:
- A. Below $305
- B. Above $305 ✓
- C. Exactly $305
A call option gives the right to buy at the exercise price. It is profitable to exercise when the stock price exceeds the exercise price (P > \305$), making the option in-the-money.
17. A strategy that involves buying a convertible bond and simultaneously shorting the underlying stock is best described as:
- A. A hedge fund strategy
- B. Convertible bond arbitrage ✓
- C. A long-short equity strategy
Convertible bond arbitrage exploits perceived mispricing between a convertible bond and the underlying stock. The investor goes long the bond (undervalued conversion option) and short the stock to hedge equity risk.
18. An investor who buys stock or buys a futures contract on stock has:
- A. Long exposure to the stock ✓
- B. Short exposure to the stock
- C. No net exposure to the stock
Both buying stock directly and buying a futures contract create long exposure — the investor profits when the stock price rises.
19. If the initial margin requirement is 55%, the maximum leverage ratio is closest to:
- A. 1.55
- B. 1.82 ✓
- C. 2.00
20. An investor buys 15,000. The return on the margin investment (ignoring borrowing costs) is closest to:
- A. 25%
- B. 50%
- C. 100% ✓
- Equity invested = 10{,}000 \times 50\% = \5{,}000$
- Gain = 15{,}000 - 10{,}000 = \5{,}000$
- Return on margin =
The asset returned 50%, but 2x leverage doubled it to 100%.