Question 1

Settlement of stock index futures contracts occurs through delivery of the underlying securities.

Accepted Answer

Settlement of stock index futures contracts does not occur through delivery of the underlying securities, instead, cash settlement is used where the difference between the contracted price and the final settlement price is settled in cash.

Question 2

Bill Baher, a private investor, purchased a futures contract on Treasury bonds at a price of 102-12. Two months later, Baher sells the same futures contract in order to close out the position. At that time, the futures contract specifies 103-15. What is Baher's nominal profit? The par value of the futures contract is $100,000.

Accepted Answer

To calculate Baher's nominal profit, we need to use the following formula:

Profit = (Settlement Price - Purchase Price) x Contract Size

where:
- Settlement Price = 103-15 = 103.46875
- Purchase Price = 102-12 = 102.375
- Contract Size = $100,000

Profit = (103.46875 - 102.375) x 100,000
Profit = $1,093.75

Since Baher's profit is positive, we select the answer choice with "profit" in it. Therefore, the correct answer is (C) $1,093.75; profit.

Question 3

___________ involves the buying or selling of stock index futures with a simultaneous opposite position in the stocks that the index comprises.

Accepted Answer

This is a definition of index arbitrage. Dynamic asset allocation refers to a strategy of constantly adjusting a portfolio's allocation based on market conditions. Cross-hedging involves hedging a position with a different but related security, such as using oil futures to hedge against fluctuations in gas prices. Net hedging involves offsetting risks in a portfolio through a combination of long and short positions.

Question 4

Some specialized futures contracts are sold over the counter, whereas standardized financial futures contracts are traded on exchanges.

Accepted Answer

This statement is true. Over the counter (OTC) futures contracts are privately negotiated contracts between two parties, whereas standardized financial futures contracts are traded on exchanges such as the Chicago Mercantile Exchange (CME) and are subject to standardized rules and regulations.

Question 5

Credit risk exists for futures contracts traded on exchanges, but it is normally not a concern for over-the-counter futures transactions.

Accepted Answer

Credit risk can exist in both futures contracts traded on exchanges and over-the-counter futures transactions. In over-the-counter transactions, there may be less transparency and less regulation compared to exchange-traded contracts, which can increase the potential for credit risk.

Question 6

Clarke plans to satisfy cash needs in nine months by selling its Treasury bond holdings for $4 million. However, Clarke is concerned that interest rates might increase over the next three months. To hedge against this possibility, Clarke plans to sell Treasury bond futures. Thus, Clarke sells ____ futures contract for a price of 99-12. Assuming that the actual price of the futures contract declined to 97-20, Clarke would make a ____ of $____ from closing out the futures position.

Accepted Answer

Clarke sells 40 futures contracts. The initial price is 99-12 (or 99.375 in decimal), and the closing price is 97-20 (or 97.625 in decimal). The profit per contract is (99.375 - 97.625) = 1.75. Since each contract represents $100,000, the total profit is 1.75 * $100,000 * 40 = $70,000.

Question 7

Which of the following is not a type of risk associated with futures contracts?

Accepted Answer

Postpayment risk is not a type of risk associated with futures contracts. The other options, basis risk, liquidity risk, and market risk, are all risks that can be associated with futures contracts.

Question 8

Financial futures contracts on U.S. securities are commonly traded by non-U.S. financial institutions that maintain holdings of U.S. securities.

Accepted Answer

This is true. Non-U.S. financial institutions often use financial futures contracts to hedge their positions in U.S. securities, and these contracts are commonly traded on various exchanges.

Question 9

Stock index futures are priced ____ than the stock index itself.

Accepted Answer

Stock index futures can be priced either higher or lower than the stock index itself depending on several factors such as market sentiment, economic indicators, interest rates, and geopolitical events. There is no fixed relationship between the two, and their prices can fluctuate independently.

Question 10

The price of stock index futures may reflect investor expectations about the market more rapidly than stock prices.

Accepted Answer

Stock index futures allow investors to make bets on the future direction of the market, and the prices of these futures can quickly reflect investor expectations. The prices of individual stocks, on the other hand, can be influenced by a variety of factors beyond just market expectations, such as company-specific news and events. Therefore, stock index futures can be a more sensitive and timely measure of market sentiment.

Question 11

__________ occurs when a firm does not have adequate controls to monitor the employees responsible for its futures positions and those employees take more speculative positions than the firm desires.

Accepted Answer

This scenario describes operational risk, as it is a risk arising from inadequate or failed processes, systems, or controls within a business. The other options - credit risk, control risk, and management risk - are not as applicable to this particular scenario.

Question 12

A financial institution that wishes to reduce its exposure to the possibility of declining interest rates might use:

Accepted Answer

The answer of A financial institution that wishes to reduce...

Question 13

_________ take positions in financial futures to reduce their exposure to future movements in interest rates or stock prices; ________ commonly take the opposite position and thus serve as counterparties on many transactions.

Accepted Answer

Hedgers take positions in financial futures to reduce their exposure to future movements in interest rates or stock prices. They do this to protect themselves from financial risk. In contrast, speculators take on risk in hopes of making a profit. They commonly take the opposite position of hedgers and thus serve as counterparties on many transactions. Therefore, B is the correct answer.

Question 14

An unexpected ____ in the consumer price index tends to create expectations of ____ interest rates and places ____ pressure on Treasury bond futures prices.

Accepted Answer

An unexpected increase in the consumer price index (CPI) suggests rising inflation, which often leads to expectations of higher interest rates to combat inflation. Higher interest rates, in turn, typically result in lower prices for existing bonds, including Treasury bond futures, hence the downward pressure on their prices.

Question 15

Which of the following statements is incorrect regarding organized futures exchanges?

Accepted Answer

Organized exchanges do not serve as market makers for futures contracts. Instead, they provide a marketplace for buyers and sellers to trade with each other. Market makers are typically specialized firms or individuals who provide liquidity by buying and selling futures contracts on their own account.

Question 16

Purchasers of currency futures contracts are required to hold the contract until the settlement date and accept delivery of the foreign currency at that time.

Accepted Answer

Purchasers of currency futures contracts do not have to accept delivery of the foreign currency at the settlement date. Most currency futures contracts are settled in cash, meaning the gains or losses on the contract are settled in cash rather than through the physical delivery of the currency.

Quiz 13: Financial Futures Markets