Question 1

Which of the following is not generally considered a benefit of hedging?
A)It reduces one or more aspects of business risk
B)It allows prices to be locked in advance
C)The costs of hedging are paid by the speculators
D)It can stabilize profits

Accepted Answer

The costs of hedging are typically paid by the company hedging, not by speculators. As such, this option is not generally considered a benefit of hedging. The other options listed are common benefits of hedging.

Question 2

A farmer stores his fall harvest of corn and sells corn futures for March delivery at $2.50 per bushel.In March the spot price of corn is $2.20 per bushel.Which of the following is correct?
A)The farmer is obligated to deliver corn to the futures buyer at $2.20
B)The farmer has locked in an effective price of $2.50 per bushel
C)The farmer would have been better off without the futures contact
D)The farmer will receive $4.70 per bushel, which more than doubles the profit obtained without futures

Accepted Answer

B

Question 3

A soybean oil contract calls for delivery of 60,000 pounds.What happens to the seller of a soybean futures contract at 16 cents per pound if the futures price closes the next day at 18 cents per pound?
A)The contract is marked to market with a $1,200 loss
B)The contract is marked to market with a $1,200 gain
C)Futures contracts are voided if price increases before expiration
D)Nothing happens until the expiration of the contract

Accepted Answer

The seller of a soybean futures contract would experience a loss if the price increases from 16 cents to 18 cents per pound. Since each contract is for 60,000 pounds, the price increase of 2 cents per pound results in a total loss of $1,200 (60,000 pounds * $0.02/pound). Futures contracts are marked to market daily, meaning the seller's account would be debited for the loss.

Question 4

How might a firm such as General Mills use options to control raw material prices for breakfast cereals?
A)Buy call options on commodities
B)Sell call options on commodities
C)Buy put options on commodities
D)Sell put options on commodities

Accepted Answer

By buying call options on commodities, General Mills could secure the right to buy the raw materials at a specified price, regardless of how much the price of the commodity may rise in the future. This allows General Mills to protect themselves from unexpected price increases, which in turn protects their profit margin on breakfast cereals.

Question 5

The spot price of silver closes at $7 per ounce at the expiration of an option contract.Which one of the following option positions will have value?
A)The buyer of a call with $5 strike price
B)The seller of a call with $5 strike price
C)The buyer of a put with $5 strike price
D)The seller of a put with $5 strike price

Accepted Answer

The answer of The spot price of silver closes at...

Question 6

The customary delivery procedure at the expiration of a commodity futures contract is:
A)Delivering the commodity to the futures buyer
B)Delivering the commodity to the futures exchange
C)Offsetting the initial futures position and settling in cash
D)Adding the profit or loss to your margin account and continuing to trade

Accepted Answer

The customary delivery procedure at the expiration of a commodity futures contract is to offset the initial futures position and settle in cash. This means that the buyer and seller do not physically exchange the commodity, but rather settle their contract in cash based on the price at expiration. This is the most common method of fulfilling futures contracts as it is easier and more efficient than physical delivery.

Question 7

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:
A)Buying a futures contract
B)Selling a futures contract
C)Buying a put option
D)Selling a call option

Accepted Answer

A producer can hedge against a future price decline by selling a futures contract, locking in a price for their product.

Question 8

The purpose of a margin account for a futures contract is to:
A)Guarantee a minimum margin of profit for the contract holder
B)Allow futures traders to have more than one contract at once
C)Provide a cushion for the exchange against defaults on the contract
D)Hold interest payments until expiration

Accepted Answer

The purpose of a margin account for a futures contract is to provide a cushion for the exchange against defaults on the contract. This means that if the contract holder is unable to fulfill their obligations, the margin account can be used to cover the losses incurred by the exchange. It does not guarantee a minimum margin of profit for the contract holder, allow for multiple contracts at once, or hold interest payments until expiration.

Question 9

Which of the following would not be regulated in a standardized futures contract?
A)Quantity of asset to be traded
B)Quality of asset to be traded
C)The spot price
D)Date of settlement

Accepted Answer

The spot price at the time of trading may vary and is not standardized, so it would not be regulated in a futures contract. However, the other options - quantity, quality, and settlement date - are all standard elements that are regulated in a futures contract.

Question 10

Selling a futures contract may be appropriate for one who wishes to:
A)Lock in a future sales price
B)Lock in a future purchase price
C)Speculate that future spot prices are going down
D)Have a ready market in which to sell product

Accepted Answer

Selling a futures contract allows the seller to lock in a future sales price for a commodity or financial instrument. This can be a useful tool for producers or sellers who want to protect themselves against potential price declines.

Question 11

What happens to the price of a futures contract as expiration draws closer?
A)It exceeds the spot price of the asset
B)It is exceeded by the spot price of the asset
C)It approaches the spot price of the asset
D)There is no relationship between futures price and spot price as the contract approaches expiration

Accepted Answer

As the expiration date approaches, the price of a futures contract begins to converge towards the spot (or current) price of the underlying asset. This is because as the expiration date nears, there is less time remaining for any unexpected changes in the price of the underlying asset to occur, reducing the risk of holding the futures contract. As a result, the futures price approaches the spot price.

Question 12

The process of marking a futures contract to market means that:
A)The profitability of the contract is locked in from the onset of the contract
B)The amount of commodity to be delivered changes as prices change
C)Contracts are closed out as soon as they become unprofitable
D)Profits or losses are posted to the contract daily

Accepted Answer

Marking a futures contract to market means that profits or losses are posted to the contract daily according to changes in the price of the underlying asset. This allows traders to keep track of their performance and adjust their positions accordingly. A is incorrect because profitability is not locked in at the onset of the contract - it fluctuates based on market conditions. B is incorrect because the amount of commodity to be delivered is set at the outset of the contract and does not change. C is incorrect because contracts are not necessarily closed out as soon as they become unprofitable - traders may choose to hold onto losing positions in the hope of turning a profit in the future.

Question 13

What must happen to prices over the course of a contract for the seller of a futures contract to maximize benefits of the hedge?
A)Prices must decrease
B)Prices must increase
C)Prices must remain constant
D)The seller will profit on the hedge regardless of the direction of price movements

Accepted Answer

The seller of a futures contract wants to lock in a higher price now by selling a contract and then buying it back later when the price decreases. Thus, the seller wants prices to decrease over the course of the contract in order to realize the highest benefit from the hedge.

Question 14

A farmer who sells a futures contract is betting that prices will _____ at the expiration of the contract.
A)Decrease
B)Increase
C)Remain constant
D)Guarantee high profits

Accepted Answer

The answer of A farmer who sells a futures contract...

Question 15

A futures contract seller is obligated to deliver 5,000 bushels of soybeans for $5.00 per bushel at expiration.If soybean futures close at $5.10 the next day, the seller:
A)Has a profit of $500 thus far on the contract
B)Has a loss of $500 thus far on the contract
C)Has no profit or loss, but is still obligated to deliver 5,000 bushels at $5.00
D)Will receive a cheque for $500 from the buyer of the contract

Accepted Answer

Since the futures price increased to $5.10, the seller now has a loss on the contract. The loss can be calculated as the difference between the contract price and the current market price multiplied by the quantity of bushels specified in the contract: 
($5.10 - $5.00) x 5,000 bushels = $500 loss. So, the correct choice is B - the seller has a loss of $500 thus far on the contract.

Question 16

A hedger who buys a futures contract is betting that prices will _____ at the expiration of the contract.
A)Decrease
B)Increase
C)Remain constant
D)Guarantee high profits

Accepted Answer

A hedger buys a futures contract to protect themselves from potential losses due to price increases. Therefore, they are betting that prices will increase in the future, and the futures contract will allow them to buy at the lower price agreed upon in the contract.

Question 17

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?
A)Buy a call option on the asset
B)Sell a call option on the asset
C)Buy a put option on the asset
D)Sell a put option on the asset

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 18

A hedger buys a futures contract that obligates the owner to take delivery of 5,000 bushels of wheat at a price of $3.30 per bushel.At expiration the spot price of wheat is $3.80 per bushel.The hedger has:
A)Saved 50' per bushel through hedging
B)Gained peace of mind at a price of 50' per bushel
C)The opportunity to avoid taking delivery, since price declined
D)Locked in an effective price of $3.05 per bushel

Accepted Answer

The hedger saved 50 cents per bushel because they locked in a price of $3.30 per bushel, while the spot price at expiration is $3.80 per bushel.

Question 19

Which of the following is not correct concerning futures contracts?
A)Entails an obligation rather than an option
B)Contract price is set at the beginning of the contract
C)Contracts are exchange-traded
D)Gains or losses are recorded at contract expiration

Accepted Answer

Futures contracts involve marking to market, where gains or losses are recorded daily, not just at contract expiration.

Question 20

A hedger buys a futures contract that obligates the owner to take delivery of 5,000 bushels of wheat at a price of $3.30 per bushel.At expiration the spot price of wheat is $2.80 per bushel.The hedger has:
A)Saved 50' per bushel through hedging
B)Gained peace of mind at a price of 50' per bushel
C)The opportunity to avoid taking delivery, since price declined
D)Locked in an effective price of $3.05 per bushel

Accepted Answer

The hedger gained peace of mind by locking in a price of $3.30 per bushel, even though the market price fell to $2.80, effectively paying 50 cents more per bushel than the market price.

Quiz 26: What We Do and Do Not Know About Finance

Which of the following is not generally considered a benefit of hedging?

A farmer stores his fall harvest of corn and sells corn futures for March delivery at $2.50 per bushel.In March the spot price of corn is $2.20 per bushel.Which of the following is correct?

A soybean oil contract calls for delivery of 60,000 pounds.What happens to the seller of a soybean futures contract at 16 cents per pound if the futures price closes the next day at 18 cents per pound?

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

The spot price of silver closes at $7 per ounce at the expiration of an option contract.Which one of the following option positions will have value?

The customary delivery procedure at the expiration of a commodity futures contract is:

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:

The purpose of a margin account for a futures contract is to:

Which of the following would not be regulated in a standardized futures contract?

Selling a futures contract may be appropriate for one who wishes to:

What happens to the price of a futures contract as expiration draws closer?

The process of marking a futures contract to market means that:

What must happen to prices over the course of a contract for the seller of a futures contract to maximize benefits of the hedge?

A farmer who sells a futures contract is betting that prices will _____ at the expiration of the contract.

A futures contract seller is obligated to deliver 5,000 bushels of soybeans for $5.00 per bushel at expiration.If soybean futures close at $5.10 the next day, the seller:

A hedger who buys a futures contract is betting that prices will _____ at the expiration of the contract.

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?

A hedger buys a futures contract that obligates the owner to take delivery of 5,000 bushels of wheat at a price of $3.30 per bushel.At expiration the spot price of wheat is $3.80 per bushel.The hedger has:

Which of the following is not correct concerning futures contracts?

A hedger buys a futures contract that obligates the owner to take delivery of 5,000 bushels of wheat at a price of $3.30 per bushel.At expiration the spot price of wheat is $2.80 per bushel.The hedger has: