Deck 15: Futures and Risk Management

Question 1

You take a long position in a futures contract of one maturity and a short position in a contract of a different maturity, both on the same commodity. This is called ________.

A)a cross hedge
B)a reversing trade
C)a spread position
D)a straddle

Answer 1

C

Question 2

The daily settlement of obligations on futures positions is called ________.

A)a margin call
B)marking to market
C)a variation margin check
D)initial margin requirement

Answer 2

B

Question 3

Margin requirements for futures contracts can be met by ________.

A)cash only
B)cash or highly marketable securities such as Treasury bonds
C)cash or any marketable securities
D)cash or warehouse receipts for an equivalent quantity of the underlying commodity

Answer 3

B

Question 4

A futures contract ________.

A)is a contract to be signed in the future by the buyer and the seller of a commodity
B)is an agreement to buy or sell a specified amount of an asset at a predetermined price on the expiration date of the contract
C)is an agreement to buy or sell a specified amount of an asset at whatever the spot price happens to be on the expiration date of the contract
D)gives the buyer the right, but not the obligation, to buy an asset at some time in the future

Question 5

An established value below which a trader's margin may not fall is called the ________.

A)daily limit
B)daily margin
C)maintenance margin
D)convergence limit

Question 6

Which one of the following refers to the daily settlement of obligations on future positions?

A)Marking to market
B)The convergence property
C)The open interest
D)The triple witching hour

Question 7

An investor who goes short in a futures contract will ________ any increase in value of the underlying asset and will ________ any decrease in value in the underlying asset.

A)pay; pay
B)pay; receive
C)receive; pay
D)receive; receive

Question 8

A wheat farmer should ________ in order to reduce his exposure to risk associated with fluctuations in wheat prices.

A)sell wheat futures
B)buy wheat futures
C)buy a contract for delivery of wheat now and sell a contract for delivery of wheat at harvest time
D)sell wheat futures if the basis is currently positive and buy wheat futures if the basis is currently negative

Question 9

Which one of the following is a true statement?

A)A margin deposit can only be met by cash.
B)All futures contracts require the same margin deposit.
C)The maintenance margin is the amount of money you post with your broker when you buy or sell a futures contract.
D)The maintenance margin is the value of the margin account below which the holder of a futures contract receives a margin call.

Question 10

The fact that the exchange is the counter-party to every futures contract issued is important because it eliminates ________ risk.

A)market
B)credit
C)interest rate
D)basis

Question 11

The clearing corporation has a net position equal to ________.

A)the open interest
B)the open interest times two
C)the open interest divided by two
D)zero

Question 12

Initial margin is usually set in the region of ________ of the total value of a futures contract.

A)5-15%
B)10-20%
C)15-25%
D)20-30%

Question 13

Which one of the following contracts requires no cash to change hands when initiated?

A)Listed put option
B)Short futures contract
C)Forward contract
D)Listed call option

Question 14

A person with a long position in a commodity futures contract wants the price of the commodity to ________.

A)decrease substantially
B)increase substantially
C)remain unchanged
D)increase or decrease substantially

Question 15

The advantage that standardisation of futures contracts brings is that ________ is improved because ________.

A)liquidity; all traders must trade a small set of identical contracts
B)credit risk; all traders understand the risk of the contracts
C)pricing; convergence is more likely to take place with fewer contracts
D)trading cost; trading volume is reduced

Question 16

The open interest on silver futures at a particular time is the number of ________.

A)all outstanding silver futures contracts
B)long and short silver futures positions counted separately on a particular trading day
C)silver futures contracts traded during the day
D)silver futures contracts traded the previous day

Question 17

Synthetic stock positions are commonly used by ________ because of their ________.

A)market timers; lower transaction cost
B)banks; lower risk
C)wealthy investors; tax treatment
D)money market funds; limited exposure

Question 18

An investor who is hedging a corporate bond portfolio using a T-bond futures contract is said to have a(n) ________.

A)arbitrage
B)cross-hedge
C)over-hedge
D)spread-hedge

Question 19

Which of the following provides the profit to a short position at contract maturity?

A)Original futures price - Spot price at maturity
B)Spot price at maturity - Original futures price
C)Zero
D)Basis

Question 20

Futures contracts have many advantages over forward contracts except that ________.

A)futures positions are easier to trade
B)futures contracts are tailored to the specific needs of the investor
C)futures trading preserves the anonymity of the participants
D)counterparty credit risk is not a concern on futures

Question 21

You are currently long in a futures contract. You then instruct a broker to enter the short side of a futures contract to close your position. This is called ________.

A)a cross hedge
B)a reversing trade
C)a speculation
D)marking to market

Question 22

If you expect a stock market downturn, one potential defensive strategy would be to ________.

A)buy stock index futures
B)sell stock index futures
C)buy stock index options
D)sell foreign exchange futures

Question 23

An investor establishes a long position in a futures contract now (time 0) and holds the position until maturity (Time T). The sum of all daily settlements will be ________.

A)F₀ - F_T
B)F₀ - S₀
C)F_T - F₀
D)F_T - S₀

Question 24

At contract maturity the basis should equal ________.

A)1
B)0
C)risk-free interest rate
D)-1

Question 25

A company which mines bauxite decides to short aluminum futures. This is an example of ________ to limit its risk.

A)cross hedging
B)long hedging
C)spreading
D)speculating

Question 26

Violation of the spot-futures parity relationship results in ________.

A)fines and other penalties imposed by the SEC
B)arbitrage opportunities for investors who spot them
C)suspension of delivery privileges
D)suspension of trading

Question 27

You believe that the spread between the September T-bond contract and the June T-bond futures contract is too large and will soon correct. This market exhibits positive cost of carry for all contracts. To take advantage of this you should ________.

A)buy the September contract and sell the June contract
B)sell the September contract and buy the June contract
C)sell the September contract and sell the June contract
D)buy the September contract and buy the June contract

Question 28

A hog farmer decides to sell hog futures. This is an example of ________ to limit its risk.

A)cross hedging
B)short hedging
C)spreading
D)speculating

Question 29

On 1 January you sold one April S&P 500 index futures contract at a futures price of 1300. If the April futures price is 1250 on 1 February, your profit would be ________ if you close your position. (The contract multiplier is 250.)

A)-$12 500
B)-$15 000
C)$15 000
D)$12 500

Question 30

On 25 February 2008 you could have purchased a futures contract from Intrade that would pay you $1 if Barack Obama wins the 2008 Democratic Party nomination. At a price of $0.81, the contract for Obama carried the highest price of any Democratic candidate. This tells you ________.

A)that the market believed that Obama had 81% chance of winning
B)that the market believed that Obama had the least chance of winning
C)nothing about the market's belief concerning the odds of Obama winning
D)that the market believed Obama's chances of winning were about 19%

Question 31

A long hedge is a simultaneous ________ position in the spot market and a ________ position in the futures market.

A)long; long
B)long; short
C)short; long
D)short; short

Question 32

Forward contracts ________ traded on an organised exchange and futures contracts ________ traded on an organised exchange.

A)are; are
B)are; are not
C)are not; are
D)are not; are not

Question 33

In the context of a futures contract, the basis is defined as ________.

A)the futures price minus the spot price
B)the spot price minus the futures price
C)the futures price minus the initial margin
D)the profit on the futures contract

Question 34

An investor would want to ________ to hedge a long position in treasury bonds.

A)buy interest rate futures
B)buy treasury bonds in the spot market
C)sell interest rate futures
D)sell S&P 500 futures

Question 35

A long hedger will ________ from an increase in the basis a short hedger will ________.

A)be hurt; be hurt
B)be hurt; profit
C)profit; be hurt
D)profit; profit

Question 36

The current level of the S&P 500 is 1250. The dividend yield on the S&P 500 is 3%. The risk-free interest rate is 6%. The futures price quote for a contract on the S&P 500 due to expire 6 months from now should be ________.

A)1274.33
B)1286.95
C)1268.61
D)1291.29

Question 37

Futures contracts are said to exhibit the property of convergence because ________.

A)the profits from long positions and short positions must ultimately be equal
B)the profits from long positions and short positions must ultimately net to zero
C)price discrepancies would open arbitrage opportunities for investors who spot them
D)the futures price and spot price of any asset must ultimately net to zero

Question 38

A short hedge is a simultaneous ________ position in the spot market and a ________ position in the futures market.

A)long; long
B)long; short
C)short; long
D)short; short

Question 39

When dividend paying assets are involved, the spot-futures parity relationship can be stated as ________.

A)F₁ = S₀(1 + r_f)
B)F₀ = S₀(1 + r_f - d)^T
C)F₀ = S₀(1 + r_f + d)^T
D)F₀ = S₀(1 + r_f)^T

Question 40

The spot price for is $650. The dividend yield on the S&P 500 is 2.5%. The risk-free interest rate is 5%. The futures price for gold for a one year contract should be ________.

A)$658.58
B)$675.43
C)$682.50
D)$666.25

Question 41

The price of a corn futures contract is $2.65 per bushel when the contract is issued and the commodity spot price is $2.55. When the contract expires, the two prices are identical. What principle is represented by this price behavior?

A)Convergence
B)Margin
C)Basis
D)Volatility

Question 42

If r_f is greater than d then we know that ________.

A)the futures price will be higher as contract maturity increases
B)F₀ < S₀
C)F_T > S_T
D)arbitrage profits are possible

Question 43

You own a $15 million bond portfolio with a modified duration of 11 years and you want to limit your risk but institutional constraints prohibit trading the bond portfolio. T-bond futures are available with a modified duration of the deliverable instrument of 8 years. The futures are priced at $105 000. The proper hedge ratio to use is ________.

A)104
B)143
C)196
D)213

Question 44

Sahali Trading Company has issued $100 million worth of long-term bonds at a fixed rate of 9%. Sahali Trading Company then enters into an interest rate swap where they will pay LIBOR and receive a fixed 8.00% on a notional principal of $100 million. After all these transactions are considered, Sahali's cost of funds is ________.

A)17%
B)LIBOR
C)LIBOR + 1%
D)LIBOR - 1%

Question 45

A farmer sells futures contracts at a price of $2.75 per bushel. The spot price of corn is $2.55 at contract expiration. The farmer harvested 12 500 bushels of corn and sold futures contracts on 10 000 bushels of corn. What are the farmer's proceeds from the sale of corn?

A)$27 500
B)$31 875
C)$33 875
D)$35 950

Question 46

On Monday morning you sell one June T-bond futures contract at 97: 27 or for $97 843.75. The contract's face value is $100 000. The initial margin requirement is $2 700 and the maintenance margin requirement is $2 000 per contract. Use the following price data to answer the question. Your cumulative rate of return on your investment after Wednesday is a/an ________.

A)79.9% loss
B)2.6% loss
C)33.0% gain
D)53.9% loss

Question 47

You purchase an interest rate futures contract that has an initial margin requirement of 15% and a futures price of $115 098. The contract has a $100 000 underlying par value bond. If the futures price falls to $108 000 you will experience a ________ per cent loss on your money invested.

A)31
B)41
C)52
D)64

Question 48

On Monday morning you sell one June T-bond futures contract at 97: 27 or for $97 843.75. The contract's face value is $100 000. The initial margin requirement is $2 700 and the maintenance margin requirement is $2 000 per contract. Use the following price data to answer the question. At the close of day Tuesday your cumulative rate of return on your investment is

A)16.2%
B)-5.8%
C)-0.16%
D)-2.2%

Question 49

From the perspective of determining profit and loss, the long futures position most closely resembles a levered investment in a ________.

A)long call
B)short call
C)short stock position
D)long stock position

Question 50

A market timer now believes that the economy will soften over the rest of the year as the housing market slump continues and he also believes that foreign investors will stop buying US fixed income securities in such large quantities as they have in the past. One way the timer could take advantage of this forecast is to ________.

A)buy T-bond futures and sell stock index futures
B)sell T-bond futures and but stock index futures
C)buy stock index futures and buy T-bond futures
D)sell stock index futures and sell T-bond futures

Question 51

A one-year gold futures contract is selling for $641. Spot gold prices are $600 and the one year risk free rate is 6%. Which of the following set of transactions will yield positive riskless arbitrage profits?

A)Buy gold in the spot with borrowed money and sell the futures contract.
B)Buy the futures contract and sell the gold spot and invest the money earned.
C)Buy gold spot with borrowed money and buy the futures contract.
D)Buy the futures contract and buy the gold spot using borrowed money.

Question 52

A corporation will be issuing bonds in 6 months and the Treasurer is concerned about unfavorable interest rate moves in the interim. The best way for her to hedge the risk is to ________.

A)buy T-bond futures
B)sell T-bond futures
C)buy stock index futures
D)sell stock index futures

Question 53

Interest rate swaps involve the exchange of ________.

A)fixed rate bonds for floating rate bonds
B)floating rate bonds for fixed rate bonds
C)net interest payments and an actual principal swap
D)net interest payments based on notional principal, but no exchange of principal

Question 54

Ignoring the transaction costs, how much did the farmer improve his cash flow by hedging sales with the futures contracts?

A)$0
B)$2 000
C)$31 875
D)$33 875

Question 55

On Monday morning you sell one June T-bond futures contract at 97: 27 or for $97 843.75. The contract's face value is $100 000. The initial margin requirement is $2 700 and the maintenance margin requirement is $2 000 per contract. Use the following price data to answer the question. After Monday's close the balance on your margin account will be ________.

A)$2 700.00
B)$2 000.00
C)$3 137.50
D)$2 262.50

Question 56

On Monday morning you sell one June T-bond futures contract at 97: 27 or for $97 843.75. The contract's face value is $100 000. The initial margin requirement is $2 700 and the maintenance margin requirement is $2 000 per contract. Use the following price data to answer the question. On which of the given days do you get a margin call?

A)Monday
B)Tuesday
C)Wednesday
D)None

Question 57

A hypothetical futures contract on a non-dividend-paying stock with current spot price of $100 has a maturity of four years. If the T-bond rate is 7% what should the futures price be?

A)$76.29
B)$93.46
C)$107.00
D)$131.08

Question 58

A bank has made long-term fixed rate mortgages and has financed them with short-term deposits. To hedge out the bank's interest rate risk they could ________.

A)sell T-bond futures
B)buy T-bond futures
C)buy stock index futures
D)sell stock index futures

Question 59

A one-year gold futures contract is selling for $641. Spot gold prices are $600 and the one year risk free rate is 6%. The arbitrage profit implied by these prices is ________.

A)$3
B)$4
C)$5
D)$6

Question 60

The Student Loan Marketing Association (SLMA) has short term student loans funded by long-term debt. To hedge out this interest rate risk SLMA could ________.
I) engage in a swap to pay fixed and receive variable interest payments II. engage in a swap to pay variable and receive fixed interest payments
III. buy T-bond futures
IV) sell T-bond futures

A)I and II only
B)I and IV only
C)II and III only
D)II and IV only