Deck 11: Derivatives Markets

Question 1

Speculators can be described as individuals or firms that engage in financial-market transactions to reduce price risk.

Answer 1

False

Question 2

Novation in futures exchange is the process of setting up a contract with a new party,such as occurs when clearinghouses insert themselves between the buyer and seller of a futures contract.

Answer 2

True

Question 3

The purpose of the margin requirements in futures contracts is to ensure that holders of contracts minimise price risk.

Answer 3

False

Question 4

The risks involved in a swap can be huge.

Question 5

A forward contract involves two parties agreeing today on a price,called the spot price at which the purchaser will buy a specified amount of an asset from the seller at a fixed date sometime in the future.

Question 6

A swap works because the market has aligned the risk ratings of the parties in two markets.

Question 7

Naked options are similar to covered options.

Question 8

The buyer of a forward contract is said to have a short position while the seller of a forward contract is said to have a long position.

Question 9

Cash settlement price is the price at which all derivative contracts are settled in lieu of delivery or physical purchase.

Question 10

By taking a position in a derivative security that offsets the firm's risk profile,the firm can limit how much its value is affected by changes in the risk factors.

Question 11

APRA regulations allow Investment banks to serve as swap dealers but they prohibit Commercial banks from any involvement in swaps.

Question 12

Margin requirements relate to the amount of cash down payment or equity one must have deposited before participating in any trade.

Question 13

Non-deliverable or mandatory-settled contracts,such as for electricity or treasury bonds are settled by means of a futures contract.

Question 14

An important function of derivatives markets is the transmission of information.

Question 15

A forward contract is:

A)a contract to buy (or sell)a particular type of security or commodity from (or to)the futures exchange during a predetermined future time.
B)a contract that guarantees delivery of a certain amount of goods,such as foreign currency,for exchange into a specific amount of another currency,such as dollars,on a specific day in the future.
C)an exchange of assets or income streams for equivalent assets or income streams with slightly different characteristics.
D)short financial contact to hedge market risk.

Question 16

The buyer of a forward contract is said to have a short position and is obligated to pay the forward price for the asset.

Question 17

Derivatives can increase liquidity in any given market by increasing turnover and trading depth.

Question 18

Share-index futures can be used to control the unsystematic risk in an investor's portfolio.

Question 19

A hedger in the financial futures market:

A)only buys futures contracts.
B)only sells futures contracts.
C)aims to reduce their price risk.
D)either buys or sells future contracts in the expectation of earning a high return.

Question 20

Basis risk exists because the spot rate of an underlying asset always keeps the same price relationship to contracts purchased or sold in the futures market for that asset.

Question 21

Systematic risk:

A)measures a share portfolio's tendency to vary relative to the market as a whole.
B)measures the tendency of a share's price to change because of factors particular to that specific share.
C)is a risk that exists because the value of an item being hedged may not always keep the same price relationship to contracts purchased or sold in the futures markets.
D)none of the above responses are correct.

Question 22

A European option is an option contract that allows the holder to:

A)exercise the option only on the expiration date.
B)exercise the option on or before the expiration date.
C)exercise the option before the expiration date.
D)none of the above.

Question 23

Futures contracts differ from forward contracts in all of the following ways except:

A)forward contracts involve an intermediary or exchange.
B)futures contracts are standardised; forward contracts are not.
C)futures markets are more formal than forward markets.
D)delivery is made most often in forward contracts.

Question 24

What are forward contracts?

Question 25

Cross hedging is:

A)currently not permitted by the ASX
B)designed to eliminate systematic risk
C)used by companies to eliminate foreign currency risk
D)Hedging with a traded futures contract whose characteristics do not exactly match those of the hedger's risk exposure

Question 26

An intraday margin calls is:

A)margins called for daily after marking to market.
B)a margin call made during the day rather than at the end of the day's trading.
C)a margin call made at the end of the day's trading.
D)a margin call made at the opening of the day's trading.

Question 27

Mandatory-settled contracts are:

A)contracts in which the goods involved may be delivered or purchased.
B)price at which an open futures contract is settled in lieu of delivery or physical purchases.
C)contracts which are non-deliverable and are settled in cash.
D)last day on which trading occurs in a particular contract.

Question 28

Basic risk is:

A)a risk that exists because the value of an item being hedged is insulated from market volatility.
B)a risk that exists because the value of an item being hedged may not always keep the same price relationship to contracts purchased or sold in the futures markets.
C)a risk that exists because the value of an item being hedged may keep the same price relationship to contracts purchased or sold in the futures markets.
D)a risk that exists because the value of an item being hedged is protected from market risk.

Question 29

The forward price for an asset is that price that makes the forward contract:

A)have positive net present value.
B)have negative net present value.
C)have zero net present value.
D)have zero or positive net present value.

Question 30

The ASX trades options on:

A)all commodity futures,share indices and all companies listed on the ASX.
B)all commodity futures,share indices and many companies listed on the ASX.
C)some commodity futures,share indices and all companies listed on the ASX.
D)some commodity futures,share indices and many companies listed on the ASX.

Question 31

Put options:

A)give the option buyer the right to buy a security at the strike price
B)give the option buyer the right to buy or sell a security at the strike price
C)give the option buyer the right to sell a security at the mark to market price
D)give the option buyer the right to sell a security at the strike price

Question 32

Which of the following statements best describes marking to market?

A)The process of setting up a contract with a clearinghouse to operate as a counterparty between the buyer and seller of a futures contract.
B)The process of personalizing futures contracts.
C)The requirement of a futures exchange for daily cash settlement of all contracts.
D)The final day on which trading occurs in a particular contract.

Question 33

The value of an option varies directly with:

A)the price variance of the underlying commodity.
B)the time to expiration.
C)the level of interest rates.
D)all of the above.

Question 34

The purchase of one million dollars of Treasury Bonds,delivered in 60 days,from a government securities dealer is:

A)a call.
B)a swap.
C)a forward contract.
D)a put.

Question 35

Some futures exchanges impose position limits on speculators.These are:

A)minimum numbers of contracts that speculators may hold for any individual type of commodity or asset.
B)maximum numbers of contracts that speculators may hold for any individual type of commodity or asset.
C)unlimited numbers of contracts that speculators may hold for any individual type of commodity or asset.
D)constraints which speculators face when buying futures contracts.

Question 36

Australian futures and options markets are:

A)not subject to any regulators.
B)regulated entirely by the ASX
C)subject to regulation by the ASX,ASIC and the RBA
D)subject to regulation by the ASX,ASIC,the RBA as well as international regulators.

Question 37

Settlement date in a forward contract means:

A)the contracted party that exchanges one item for another for a predetermined price at a predetermined point in time.
B)forward prices are always higher than spot prices.
C)spot prices are always higher than forward prices.
D)the future date on which the buyer pays the seller and the seller delivers the assets to the buyer.

Question 38

What action would the holder of a maturing call option take with an option which cost $300,had a strike price of $50 and the market value of the stock was $52?

A)Let the option expire unexercised
B)Exercise the option
C)Request that the $300 be returned
D)None of the above

Question 39

Share-index futures contracts are:

A)futures that derive their value from averaging the prices of all underlying shares included in the share index.
B)futures that derive their value from averaging the prices of a basket of underlying shares included in the share index.
C)currently only traded in the US.
D)the least actively traded contracts in future markets.

Question 40

Novation in futures exchange means:

A)a requirement that gains or losses on futures positions be taken into account in determining the value of all contracts each day.
B)the back office that records,clears and settles contracts and acts as counterparty in futures trading.
C)a place in which buyers and sellers can exchange futures contracts.The exchange keeps the books for buyers and sellers when contracts are initiated or liquidated.
D)the process of setting up a contract with a new party,such as occurs when clearinghouses insert themselves between the buyer and seller of a futures contract.

Question 41

What are swaps and what are they used for?

Question 42

What are the risks in the futures market?

Question 43

Discuss two major differences between futures and forward markets.

Question 44

Explain the implications for an option writer if they elect to write a covered option instead of a naked option.