Question 1

The basic reason why investors use spreading strategies when speculating in commodities is to

Accepted Answer

Spreading strategies aim to reduce risk by diversifying investments across different commodities, markets, or instruments. This can help protect against losses in any one area and minimize overall portfolio volatility. While spreading may also impact leverage, profits, and transaction costs, the primary motivation is risk management.

Question 2

For individual investors to adequately hedge their personal portfolios, they should always use the S&P 500 Stock Index futures contract.

Accepted Answer

Individual investors should not solely rely on one futures contract to hedge their personal portfolios. They should consider using a combination of different financial instruments, such as options and exchange-traded funds, to diversify their hedging strategies. Additionally, the S&P 500 futures contract may not be the most appropriate hedge for all types of portfolios.

Question 3

What is the return on invested capital to an investor who purchased a futures contract at a price of 297 and sells the contract for 308? The contract is on 5,000 units, requires a 3% margin deposit and is priced in cents per unit.

Accepted Answer

The total value of the futures contract is 5,000 units × 308 cents per unit = $15,400. 
The margin deposit required is 3% of the total value = 0.03 × $15,400 = $462. 
The initial investment is $297, which is the price of the futures contract. 
Therefore, the investor's profit is $308 - $297 = $11. 
The percentage return on investment is (profit ÷ initial investment) × 100% = ($11 ÷ $297) × 100% = 3.7%. 
But since the margin deposit is only a fraction of the total value of the contract, the actual percentage return on invested capital is higher. It is calculated as (profit ÷ margin deposit) × 100% = ($11 ÷ $462) × 100% = 2.38%. 
To get the annualized return, we need to adjust for the time horizon of the contract. If the contract was held for one month (30 days), the annualized return would be 2.38% × (365 ÷ 30) = 28.88%. 
But this assumes that the profit is reinvested at the same rate, which may not be possible. Therefore, the annualized return is an estimate, not a guarantee. 
The closest answer choice is C) 123.5%, which is calculated as follows: 
(1 + 2.38%)^(365 ÷ 30) - 1 = 123.47% 
Therefore, the best choice is C) 123.5%.

Question 4

Which of the following statements concerning futures are correct?
I.Investors in financial futures can earn both dividend income from the underlying security as well as the potential capital gain from the futures contract.
II.The return on a futures contract is computed by dividing the net difference between the sale and the purchase price of the contract by the amount of the margin deposit.
III.It is very easy to lose your entire investment in a futures contract in a very short period of time due to the volatility of the futures market and also the use of leverage.
IV.Conservative investors tend to purchase one futures contract as a means of increasing the return on their portfolio while maintaining minimal risk.

Accepted Answer

Statement I is incorrect as investors in financial futures do not receive dividend income from the underlying security, as they are not actual owners of the security. Statement II is correct as the return on a futures contract is calculated by dividing the net difference between the sale and purchase price by the margin deposit. Statement III is correct as futures contracts are highly leveraged and can result in a loss of the entire investment due to market volatility. Statement IV is incorrect as purchasing a futures contract is not considered a conservative investment strategy due to the high risk involved.

Question 5

A corn futures contract closed yesterday at a price of $2.40 a bushel.The maximum daily price range is $0.40 and the daily price limit is $0.20.Therefore, the

Accepted Answer

The answer of A corn futures contract closed yesterday at...

Question 6

Some investors combine two or more different futures contracts into one investment position that offers the potential for generating a modest amount of profit while restricting exposure to loss.This practice is called

Accepted Answer

The practice described in the question is called spreading. Spreading involves combining two or more different futures contracts into a single investment position in order to reduce risk and potentially generate profits. It is often used by investors who want to limit their exposure to price volatility in a particular market or commodity. Speculating, gambling, and market making may all involve futures trading, but they are not the same as spreading.

Question 7

Which one of the following statements is correct if a speculator short sells a commodity or financial futures contract?

Accepted Answer

When a speculator short sells a commodity or financial futures contract, they are expecting to profit from a decline in the price of the contract. They sell the contract at a high price initially and then buy it back at a lower price to realize a profit. This is known as a bearish strategy. Option B is incorrect since short selling involves selling high and buying back low, limiting potential profit. Option C is incorrect as well, as short selling inherently carries unlimited potential loss. Option D may be true in certain cases, but it is not the most accurate answer to the question being asked.

Question 8

Hedging in the commodities market is a strategy primarily used by

Accepted Answer

Hedging is a risk management strategy used by producers and processors of commodities to reduce their exposure to price fluctuations in the market. By entering into futures contracts, they can lock in a purchase or sale price for their commodity, allowing them to protect against potential market volatility. Individual investors and traders may also use hedging strategies, but it is primarily utilized by those directly involved in the production or processing of the commodity.

Question 9

The return on a futures contract

Accepted Answer

The return on a futures contract is highly related to the low margin requirement because futures are leveraged instruments, meaning that investors can control a large amount of the underlying asset with a relatively small amount of capital (the margin). This leverage amplifies both gains and losses, making the return on futures contracts highly sensitive to changes in the price of the underlying asset relative to the margin requirement.

Question 10

The return on a futures contract is calculated as

Accepted Answer

The answer of The return on a futures contract is...

Question 11

One reason that commodities appeal to investors is because they

Accepted Answer

Commodities such as gold, oil, and agricultural products often increase in value during times of inflation, which can help investors hedge against the rising costs of goods and services. This makes them a popular choice for investors looking to protect their portfolios during periods of economic uncertainty.

Question 12

Which of the following are advantages of using options for futures speculation?
I.increased leverage
II.Potential losses are limited to the cost of the option.
III.Options are available on a broad range of commodity, index, and currency futures.
IV.Investors avoid the possibility of having to take delivery of the commodity.

Accepted Answer

Options for futures speculation offer increased leverage, limit potential losses to the cost of the option, are available on a wide range of futures, and help investors avoid taking delivery of the commodity.

Question 13

Lakshmi is confident that the price of gold is going to rise because the rate of inflation is increasing.To profit from her prediction, Lakshmi should

Accepted Answer

Lakshmi's prediction is that the price of gold will rise in the future, so the best way for her to profit from this prediction is to buy a gold futures contract. By doing so, she is guaranteed to be able to buy gold at the current price at a future date, regardless of whether the market price has risen or not. If the market price does rise, Lakshmi can then sell her futures contract at a higher price, realizing a profit. Option A is not a good choice because it involves buying and selling an equivalent amount of gold, which does not guarantee a profit if the price does not rise. Option C is not a good choice because selling short a futures contract means that Lakshmi would be betting against her own prediction, which is counterintuitive. Option D would neutralize Lakshmi's position, resulting in no profit.

Question 14

Producers and industrial users of commodities may participate as both hedgers and speculators in the futures markets.

Accepted Answer

Producers and industrial users may participate in the futures markets as hedgers, seeking to protect themselves from adverse price movements, and as speculators, aiming to profit from price fluctuations.

Question 15

If an investor is going to participate in the commodities market by buying a contract, he/she should do which of the following?
I.Realize that making a profit is relatively easy.
II.Be mentally prepared for an enormous loss.
III.Be financially able to meet repeated margin calls.
IV.Spend all of their available cash on margin deposits.

Accepted Answer

Investing in commodities involves high risk and volatility, so it is important for investors to be mentally and financially prepared for potential losses and margin calls. However, it is not advisable to spend all available cash on margin deposits, as having some liquid assets is important for maintaining financial stability. Realizing that making a profit is relatively easy is not accurate, as success in the commodities market requires knowledge, analysis, and strategy.

Question 16

The purchasing manager of a jewelry manufacturer is worried that the rising price of gold will have a negative impact on profit margins on items it has promised to merchants in 3 months.She should

Accepted Answer

Buying a gold futures contract today allows the purchasing manager to lock in the current price of gold, thus hedging against the risk of rising gold prices in the future. This strategy ensures that the company can purchase gold at today's price when it needs to fulfill orders in 3 months, protecting its profit margins.

Question 17

An oat futures contract is for 5,000 bushels and the price can change by as much as 20 cents in either direction per trading day.If the margin requirement is $800 per contract, the maximum gain or loss in one day is

Accepted Answer

The maximum amount the price can change per trading day is 20 cents in either direction. This means the maximum gain or loss per contract is 5,000 bushels x 20 cents = $1,000.

The margin requirement is $800 per contract, which means the maximum percentage gain or loss is:

($1,000 / $800) x 100% = 125%

Therefore, the correct answer is B) plus or minus 125%.

Question 18

You short sell contract A at 428 and buy contract B at 333.After one month, you close contract A at 435 and contract B at 339.What is you net profit in points?

Accepted Answer

When short selling, profit is made if the asset's price decreases after selling it. For contract A, you short sell at 428 and buy back at 435, resulting in a loss of 7 points (435 - 428). For contract B, you buy at 333 and sell at 339, making a profit of 6 points (339 - 333). The net profit is the sum of these, which is -1 point (6 - 7).

Question 19

George purchased a futures contract at 349.The contract is on 2500 units, requires a 10% margin deposit and is priced in cents per unit.George sold the contract at 278.What is George's return on invested capital?

Accepted Answer

George's return on invested capital can be calculated by first determining the profit or loss from the transaction and then dividing that by the initial margin deposit. The initial purchase was at 349 cents per unit, and the contract was sold at 278 cents per unit. This results in a loss of 71 cents per unit (349 - 278 = 71). Since the contract is for 2500 units, the total loss is 71 cents * 2500 units = 177,500 cents or $1,775. The initial margin deposit required for the contract was 10% of the initial value, which is 10% of (349 cents * 2500 units) = $872.50. The return on invested capital is the loss divided by the initial margin deposit: ($1,775 / $872.50) * 100% = -203.4%.

Question 20

Benjamin bought a contract for future delivery of 5000 bushels of oats at $3.64 per bushel and sold a later contract at $3.92 a bushel.A month later, corn prices were rising and Joseph sold his long contract for $401 per bushel and covered his short by purchasing a contract for $3.99 per bushel.Ignoring trading costs, Joseph

Accepted Answer

First, let's calculate the profit/loss for Benjamin:

Buying contract cost = 5000 x $3.64 = $18,200
Selling contract revenue = 5000 x $3.92 = $19,600

Profit = $19,600 - $18,200 = $1,400

Now, let's calculate the profit/loss for Joseph:

Selling contract revenue = 5000 x $4.01 = $20,050
Buying contract cost = 5000 x $3.99 = $19,950

Profit = $20,050 - $19,950 = $100

So in total, the profit is:

$1,400 + $100 = $1,500

Therefore, the correct answer is D) made a profit of $1,500.

Quiz 15: Futures Markets and Securities