Question 1

In general,when deciding whether a market participant needs to buy or sell futures contracts in order to hedge,the rule could be:

Accepted Answer

Selling futures would provide a hedge for those who already own the underlying asset, as it would protect against potential price decreases in the future. Buying futures would provide a hedge for those who need the underlying asset, as it would lock in a purchase price for the future.

Question 2

Which of the following statements is correct?

Accepted Answer

In futures trading, a buyer's profit will be equal to the seller's loss, and vice versa. This is because futures contracts are a zero-sum game, meaning that for every dollar of profit that one party makes, the other party must lose a dollar. Option trading can be more complicated because of factors such as time decay and implied volatility, so A and B are incorrect. Option buyers can potentially make large profits if the underlying asset moves significantly in their favor, while option sellers have limited profit potential but face more risk. D is incorrect because, as mentioned, futures trading is a zero-sum game, so it's not possible for both parties to make a profit.

Question 3

Which of the following futures contract holders is speculating?

Accepted Answer

The answer of Which of the following futures contract holders...

Question 4

ABC Corp.entered into a currency swap with its bank,providing that ABC borrows $5 million at 10 percent and swaps for a 12 percent yen loan.The spot exchange rate is ¥105/$.If interest only is to be repaid on an annual basis,how much does ABC pay annually to the bank? (answer in millions)

Accepted Answer

ABC pays 12 percent on a yen loan equivalent to $5 million. At the spot exchange rate of ¥105/$, $5 million is ¥525 million (5 million * 105). 12 percent of ¥525 million is ¥63 million annually.

Question 5

The basic difference between speculators and hedgers in futures contracts is that speculators:

Accepted Answer

Hedgers use futures contracts to protect against price movements in the commodities they hold by taking an offsetting position, while speculators aim to profit from price movements without seeking to hedge or protect an underlying commodity holding.

Question 6

What form of hedging would you suggest for a producer that wishes to be protected from future price decreases but wants to benefit from any future price increases?

Accepted Answer

Buying a put option on the asset allows the producer to sell the asset at a predetermined price, protecting against price decreases while still allowing them to benefit from any price increases, as they are not obligated to exercise the option if the market price is more favorable.

Question 7

How might a firm such as General Mills use options to control raw material prices for breakfast cereals?

Accepted Answer

The answer of How might a firm such as General...

Question 8

A producer that is worried about the future price that will be available when the product is to be sold can hedge this price risk by:

Accepted Answer

The answer of A producer that is worried about the...

Question 9

General Mills bought September call options for wheat with an exercise price of $2.80 at a price of $0.10 per bushel.If the price of wheat at the expiration is $2.90,what is the cost of one bushel of wheat for General Mills?

Accepted Answer

The answer of General Mills bought September call options for...

Question 10

Speculators are a necessary component of well-functioning futures markets.

Accepted Answer

Speculators provide liquidity and help to transfer risk in futures markets, which allows commercial hedgers to manage their exposure to price movements. This ultimately contributes to price discovery and efficient market functioning.

Question 11

Which of the following is not correct concerning the financial futures markets?

Accepted Answer

The statement that "Trading in commodity futures significantly exceeds trading in financial futures" is not correct. In fact, trading in financial futures is significantly larger than trading in commodity futures.

Question 12

A farmer hedged his risk by buying put options on wheat with an exercise price of $2.70 at a price of $0.14 per bushel.If the price of wheat at the expiration of the contract is $2.70,what is the net revenue from each bushel of wheat?

Accepted Answer

The answer of A farmer hedged his risk by buying...

Question 13

Nestlé wishes to obtain a loan denominated in Swiss francs but considers the U.S.market to offer better terms.How can Nestlé accomplish this?

Accepted Answer

Nestlé can accomplish this by borrowing dollars in the U.S. market, where it finds better terms, then exchanging those dollars for Swiss francs to meet its needs. To manage the exchange rate risk associated with this transaction, Nestlé can arrange a currency swap, which will allow it to swap the principal and interest payments on the U.S. dollar loan for equivalent payments in Swiss francs, thus effectively obtaining a loan denominated in Swiss francs.

Question 14

Which of the following is not correct concerning forward contracts? Forward contracts:

Accepted Answer

Forward contracts set the price at the beginning of the contract, not at the end. The other options are correct - forward contracts are not standardized, not traded on organized exchanges, and are not marked to market daily.

Question 15

The seller of a pork bellies futures contract at $.41 per pound noted that the closing price of pork bellies was $0.44 today.What will happen to this contract,which requires delivery of 40,000 of pork bellies at expiration?

Accepted Answer

The seller of the futures contract is obligated to sell 40,000 pounds of pork bellies at the price of $.41 per pound. However, the closing price of pork bellies today was $0.44 per pound. Therefore, the seller will have to buy pork bellies on the open market to fulfill the contract and will have a loss of $0.03 per pound, which amounts to $1,200 total ($0.03 × 40,000). Therefore, a loss of $1,200 will be posted to the account.

Question 16

A firm can hedge the risk of upward movement in raw material prices by taking one of the following positions.

Accepted Answer

Buying a call option on raw materials allows a firm to lock in a maximum purchase price, effectively hedging against the risk of price increases.

Question 17

The swap is the arrangement by two counterparties to exchange one stream of cash flow for another.

Accepted Answer

This is the definition of a swap.

Question 18

A speculator takes a position in the futures market without holding an offsetting position in the commodity market.

Accepted Answer

A speculator taking a position in the futures market without holding an offsetting position in the commodity market is referred to as a "naked" or "uncovered" position.

Question 19

A gasoline distributor buys a gasoline futures contract that requires acceptance of 42,000 gallons of gasoline at $0.94 per gallon.How is the account marked to market if gasoline futures close the next day at $0.97?

Accepted Answer

The difference in price is $0.03 per gallon ($0.97 - $0.94), and since the contract is for 42,000 gallons, the gain is $1,260 ($0.03 x 42,000). Therefore, a gain of $1,260 is posted to the account.

Question 20

Engaging itself in a swap contract,a firm might agree to make a series of regular payments in one currency in return for receiving a series of payments in another currency.

Accepted Answer

This statement is true. A swap contract involves exchanging a series of payments in one currency for a series of payments in another currency.

Quiz 26: Risk Management