Question 1

The volatility ratio is a measure of basis risk associated with a futures contract.

Accepted Answer

The volatility ratio is used to assess the risk of price changes in the underlying asset relative to the futures contract, which is a component of basis risk.

Question 2

The principle of convergence suggests that option prices tend to approach the value of the underlying futures contract as the expiration date of the options approaches.

Accepted Answer

The principle of convergence refers to the phenomenon where the price of a futures contract moves closer to the spot price of the underlying asset as the expiration date of the futures contract approaches. It does not directly relate to the relationship between option prices and the value of the underlying futures contracts.

Question 3

Stock index futures contracts are settled by the transfer of ownership of a diversified basket of stocks.

Accepted Answer

Stock index futures contracts are settled in cash, not by the transfer of ownership of any physical assets.

Question 4

Arbitrageurs hope to profit from price differences in markets around the world.

Accepted Answer

Arbitrageurs seek to exploit price discrepancies between different markets or financial instruments to make a profit without taking on significant risk.

Question 5

When an investor goes "long" in the futures market, he or she expects to profit from a decline in interest rates.

Accepted Answer

When an investor goes "long" in the futures market, they are buying futures contracts with the expectation that the price of the underlying asset will rise. In the case of interest rate futures, a decline in interest rates typically leads to an increase in the price of the futures contract, allowing the investor to profit.

Question 6

All futures contracts trade in the same quantities and have the same delivery dates.

Accepted Answer

Futures contracts vary in quantities and delivery dates depending on the commodity or financial instrument being traded. Each contract has its own specifications set by the exchange on which it trades.

Question 7

In the international money market interest-rate risk associated with large commercial loans can be dealt with using the one-month LIBOR futures contract, according to the textbook.

Accepted Answer

The one-month LIBOR (London Interbank Offered Rate) futures contract is a financial instrument used in the international money market to hedge against the risk of fluctuating interest rates, including those associated with large commercial loans. By locking in future interest rates, borrowers and lenders can manage the uncertainty and potential volatility of interest rate movements.

Question 8

Jefferson County Alabama experienced fiscal troubles due to the amount of bad swaps they engaged in.

Accepted Answer

Jefferson County, Alabama, faced significant fiscal troubles and eventually filed for bankruptcy in 2011, largely due to the financial strain caused by a series of interest rate swaps that went bad, in addition to other factors like corruption and the cost of a sewer system overhaul.

Question 9

Normally arbitrage trading based upon price difference between two different securities markets is highly risky due to the simultaneous holding of both long and short positions.

Accepted Answer

Arbitrage trading based on price differences between two different securities markets typically involves buying and selling the same or closely related securities simultaneously in different markets to exploit price discrepancies. This strategy aims to profit from the price differences while minimizing risk, as the simultaneous holding of both long and short positions in similar assets can hedge against market movements.

Question 10

The Federal funds futures contract traded on the Chicago Board of Trade's exchange covers 90 days.

Accepted Answer

The Federal funds futures contracts traded on the Chicago Mercantile Exchange (CME) are based on the overnight federal funds rate, not a 90-day period.

Question 11

Most financial futures trading centers on U.S.T-bill contracts.

Accepted Answer

Most financial futures trading centers on U.S. Treasury bill contracts, which are short-term debt obligations issued by the U.S. government.

Question 12

When interest rates rise, asset prices normally fall and this is particularly true of fixed income securities.

Accepted Answer

When interest rates rise, the present value of future cash flows from fixed income securities (like bonds) decreases, leading to a fall in their prices. This inverse relationship between interest rates and bond prices is a fundamental principle of bond investing.

Question 13

Interest rates are notoriously difficult to predict, however they do tend to follow the business cycle.

Accepted Answer

Interest rates often follow the business cycle because during periods of economic growth, central banks may raise rates to control inflation, and during downturns, they may lower rates to stimulate borrowing and investment.

Question 14

Implied market forecasts are predictions that are based on the interest rate expectations of the market.

Accepted Answer

Implied market forecasts are indeed predictions that are based on the interest rate expectations of the market, as they are derived from financial instruments such as futures and options, which reflect the market's consensus on future interest rates.

Question 15

Research has increasingly pointed towards time patterns in market interest rates that come close to a random walk, that is, it can be predicted on a consistent basis.

Accepted Answer

Research has shown that market interest rates exhibit time patterns that are close to a random walk, meaning they are essentially unpredictable and do not follow a consistent, predictable pattern.

Question 16

Derivatives have recently come under greater scrutiny due to their possible role in the great credit crisis of 2007-2009.

Accepted Answer

Derivatives were indeed a significant factor in the Great Credit Crisis of 2007-2009, as their complexity and the lack of transparency in their trading contributed to the financial system's instability.

Question 17

Investors interested in hedging may buy a futures contract in order to lock in a price on a specific asset at a future date.

Accepted Answer

Futures contracts are financial derivatives that obligate the buyer to purchase, and the seller to sell, a specific asset at a predetermined future date and price. Investors use futures contracts to hedge against price movements in the underlying asset, effectively locking in a price to manage risk.

Question 18

Hedging in the futures market reduces the overall risk in the market.

Accepted Answer

Hedging transfers risk from one party to another, but it does not reduce the overall risk in the market.

Question 19

A key feature of the futures market that allows the hedging process to transfer risk effectively is the fact that prices in the spot market are generally correlated with prices in the futures market.

Accepted Answer

The correlation between spot market prices and futures market prices is essential for effective hedging because it allows participants to anticipate and manage their risk exposure by locking in prices for future transactions.

Question 20

Hedging essentially involves adopting equal and opposite positions in the spot and futures markets for the same assets.

Accepted Answer

Hedging involves taking positions in two or more markets (such as the spot and futures markets) to reduce or eliminate risk by offsetting potential losses in one market with gains in another. Adopting equal and opposite positions in the spot and futures markets for the same asset is a common hedging strategy to protect against price fluctuations.

Quiz 9: Exploring Financial Markets and Hedging Strategies