Question 1

Interest rate parity is a key concept in managing risk in the commodities market.

Accepted Answer

Interest rate parity is a financial theory primarily used to predict exchange rate movements and to price foreign exchange forward contracts, not specifically for managing risk in the commodities market.

Question 2

According to the cost of carry model the futures price is the present value of the spot price discounted at the risk free rate.

Accepted Answer

According to the cost of carry model, the futures price is the present value of the spot price plus the cost of carry, which includes storage costs, interest, and dividends, minus the income earned on the asset.

Question 3

Stock index futures are useful in providing a hedge against movements in an underlying financial asset.

Accepted Answer

Stock index futures can be used as a hedge against movements in the underlying financial asset, as they allow investors to lock in a future price for the index and protect against potential losses.

Question 4

Exhibit 22.8
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Consider the following information on put and call options for a common stock
 
-Like future contracts, all forward contracts are processed by a clearing corporation.

Accepted Answer

The statement is not relevant to the given information and is therefore considered false. The information provided only pertains to put and call options for a common stock, and does not discuss forward contracts or clearing corporations.

Question 5

Exhibit 22.8
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Consider the following information on put and call options for a common stock
 
-The goal of a hedge transaction is to increase expected returns of a fundamental holding.

Accepted Answer

The goal of a hedge transaction is to reduce risk, not necessarily increase expected returns.

Question 6

In the absence of arbitrage opportunities, the forward price should be equal to the spot price plus the cost of carry.

Accepted Answer

This is known as the cost-of-carry model, which assumes that futures prices reflect the expected spot price at expiration along with the cost of holding the underlying asset (carrying costs). In the absence of arbitrage opportunities, this relationship should hold true, and the forward price should be equal to the spot price plus the cost of carry.

Question 7

The cost-of-carry model is useful for pricing future contracts.

Accepted Answer

The cost-of-carry model takes into account the cost of holding a physical asset in inventory and the interest rates associated with financing that inventory. This information can be used to determine the fair price of a futures contract.

Question 8

If you have entered into a currency futures hedge for the Japanese yen in connection with buying Japanese equipment, if the yen goes from 110 yen/$1 to 100 yen/$1, you will lose in the spot market but have an offsetting gain in the futures market.

Accepted Answer

When the spot exchange rate depreciates (yen goes from 110 yen/$1 to 100 yen/$1), you would lose in the spot market (since you need more dollars to purchase the same amount of yen) but you would have an offsetting gain in the futures market since the yen futures contract would increase in value as the yen depreciates. This is the purpose of a currency futures hedge – to offset losses in the spot market with gains in the futures market.

Question 9

Exhibit 22.8
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Consider the following information on put and call options for a common stock
 
-Forward contracts are individually designed agreements, and can be tailored to the specific needs of the ultimate end-user.

Accepted Answer

Forward contracts can be customized to meet the specific needs of the parties involved, making them individually designed agreements.

Question 10

The basis (B_t,T) at time t between the spot price (S_t) and a futures contract expiring at time T (F_t,T) is: S_t -F_t,T.

Accepted Answer

This is a true statement and reflects the relationship between the spot price and futures contract prices for an underlying asset. The basis represents the difference between the spot price and futures price and can be used to calculate arbitrage opportunities.

Question 11

In the cost of carry model the inclusion of storage costs will increase the futures price.

Accepted Answer

In the cost of carry model, the futures price is calculated as the spot price plus the cost of carry, which includes storage costs. Therefore, the inclusion of storage costs will increase the futures price.

Question 12

Exhibit 22.8
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Consider the following information on put and call options for a common stock
 
-Some forward contracts, particularly in the foreign exchange market, are quite standard and liquid.

Accepted Answer

The statement is true, as stated in the information provided.

Question 13

The number of future contracts needed to hedge a unit of the spot assets is solely a function of the variance of the spot prices.

Accepted Answer

The number of future contracts needed to hedge a unit of the spot assets is determined by the hedge ratio, which depends not only on the variance of the spot prices but also on the covariance between the spot and future prices, as well as the variance of the future prices.

Question 14

The pure expectations hypothesis suggests futures prices serve as unbiased forecasts of future spot prices.

Accepted Answer

The pure expectations hypothesis states that the expected future spot price is equal to the futures price. Therefore, futures prices are unbiased forecasts of future spot prices.

Question 15

The inclusion of dividends in the cost of carry model will increase the futures price.

Accepted Answer

Including dividends in the cost of carry model actually decreases the futures price, because dividends represent an income stream to the holder of the underlying asset, thus reducing the net cost of carrying or holding the asset.

Question 16

Like hedging, arbitrage results in increased returns with a disproportional increase in risk.

Accepted Answer

Arbitrage involves exploiting pricing differences in different markets to make a risk-free profit. It does not necessarily result in increased returns or risk.

Question 17

If you were bearish on the near term outlook for the stock market but did not want to sell your portfolio, you could hedge against the decline by selling stock index futures.

Accepted Answer

Selling stock index futures would allow an investor to offset potential losses in their portfolio if the market declines. This is a common hedging strategy employed by investors who want to protect their portfolio but still maintain their long-term investments.

Question 18

Exhibit 22.8
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Consider the following information on put and call options for a common stock
 
-Since futures contracts are "marked-to-market" daily, the gains and losses are settled daily.

Accepted Answer

Futures contracts are indeed marked-to-market daily, meaning the gains and losses are settled on a daily basis. This is in contrast to options contracts, where the gains and losses are settled at expiration.

Question 19

The basis is the spot price minus the future price.

Accepted Answer

The answer of The basis is the spot price minus...

Question 20

A riskless stock index arbitrage profit is possible if the following condition holds: F_0,T = S₀(1 + r_f - d)^T, where spot price now is S₀, value now of a futures contract expiring at time T is (F_0,T), r_f is the risk free rate and d is the dividend.

Accepted Answer

The answer of A riskless stock index arbitrage profit is...

Quiz 21: Forward and Futures Contracts

Interest rate parity is a key concept in managing risk in the commodities market.

According to the cost of carry model the futures price is the present value of the spot price discounted at the risk free rate.

Stock index futures are useful in providing a hedge against movements in an underlying financial asset.

Exhibit 22.8 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Consider the following information on put and call options for a common stock -Like future contracts, all forward contracts are processed by a clearing corporation.

Exhibit 22.8 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Consider the following information on put and call options for a common stock -The goal of a hedge transaction is to increase expected returns of a fundamental holding.