Question 1

Use the following information to answer questions .On October 1,the one-month LIBOR rate is 4.50 percent and the two month LIBOR rate is 5.00 percent.The November Fed funds futures is quoted at 94.50.The contract size is $5,000,000.
-All of the following are limitations to Fed funds futures arbitrage,except
A)Fed funds rates are determined by Federal Reserve Bank policy
B)basis risk between Fed funds and LIBOR
C)repo rate is variable for the trading horizon
D)settlement is based on average in delivery month
E)transaction costs

Accepted Answer

The limitations to Fed funds futures arbitrage include basis risk between Fed funds and LIBOR, variable repo rates, settlement based on average in delivery month, and transaction costs. The Fed funds rate is determined by Federal Reserve Bank policy, but this is not a limitation to Fed funds futures arbitrage as it is a key driver of the futures contracts.

Question 2

The conversion factor is the price of a bond with a face value of $1,coupon and maturity equal to that of the deliverable bond,and yield of 6 percent.

Accepted Answer

The conversion factor is calculated as the price of a bond with a face value of $1, coupon and maturity equal to that of the deliverable bond, and yield of 6 percent. Therefore, the statement is true.

Question 3

A cash-and-carry arbitrage is not risk free unless a repo is available with a maturity equal to the entire life of the transaction.

Accepted Answer

A cash-and-carry arbitrage involves buying an asset in the spot market and simultaneously selling a futures contract on the same asset. This strategy is designed to capture the difference between the spot price and futures price, but it is not risk-free unless a repo (repurchase agreement) is available with a maturity equal to the entire life of the transaction. Without a repo, there is a risk that the borrowed funds used to finance the cash portion of the transaction will need to be rolled over at a higher cost, potentially eroding the profits of the arbitrage.

Question 4

The cheapest bond to deliver is the one that has the lowest spot price.

Accepted Answer

The cheapest bond to deliver is the one that has the highest implied repo rate, which is not necessarily correlated with the spot price.

Question 5

The wild card option exists because of the difference in the closing times of the spot and futures markets for Treasury bills.

Accepted Answer

The answer of The wild card option exists because of...

Question 6

The opportunity to exercise the quality option will occur when one deliverable bond becomes more favorably priced than another.

Accepted Answer

This statement is true. The quality option allows the holder of a bond to exercise the option to switch to a higher quality bond if the deliverable bond becomes more expensive than a predetermined level. This occurs when one deliverable bond becomes more favorably priced than another.

Question 7

Much of the volume of stock transactions in program trading occurs through the New York Stock Exchange's DOT system.

Accepted Answer

The NYSE's DOT (Designated Order Turnaround) system is a widely used platform for program trading, allowing for high-volume automated trades.

Question 8

Transaction costs in program trading are so small that they are not much of a factor.

Accepted Answer

While transaction costs in program trading may be lower than in traditional trading, they are still a factor to consider. The accumulation of small transaction costs can impact overall profitability in the long term.

Question 9

The unusual volatility that sometimes occurs at stock index futures expirations is because of the greater uncertainty.

Accepted Answer

The unusual volatility often observed at stock index futures expirations, known as "triple witching" or "quadruple witching," is primarily due to the simultaneous expiration of stock index futures, stock index options, stock options, and in some cases, single stock futures. This leads to increased trading volume as traders adjust or close their positions, not necessarily because of greater uncertainty.

Question 10

It is important to identify the cheapest bond to deliver because it is the one the futures contract is priced off of.

Accepted Answer

The cheapest-to-deliver (CTD) bond is the one that the futures contract is priced off of. It is important to identify the CTD because it affects the overall pricing of the futures contract.

Question 11

Which of the following is a form of program trading?
A)index arbitrage
B)wild card arbitrage
C)triangular arbitrage
D)timing arbitrage
E)none of the above

Accepted Answer

Index arbitrage is a form of program trading where traders simultaneously buy and sell securities in the stock indices and their underlying stocks to profit from pricing discrepancies. Wild card arbitrage and triangular arbitrage are types of currency arbitrage, not program trading. Timing arbitrage is not a recognized type of arbitrage or program trading.

Question 12

The invoice price of a Treasury bond futures contract is based on the settlement price on position day and the conversion factor.

Accepted Answer

The answer of The invoice price of a Treasury bond...

Question 13

Fed fund futures arbitrage is based on the assumption that LIBOR and Fed funds are perfect substitutes.

Accepted Answer

Fed fund futures arbitrage is not based on the assumption that LIBOR (London Interbank Offered Rate) and Fed funds are perfect substitutes, as they represent different borrowing costs and are influenced by different factors. Fed funds rate is the interest rate at which depository institutions lend reserve balances to other depository institutions overnight, while LIBOR is an average interest rate calculated through submissions of interest rates by major banks in London and is used for loans between banks.

Question 14

Use the following information to answer questions .On October 1,the one-month LIBOR rate is 4.50 percent and the two month LIBOR rate is 5.00 percent.The November Fed funds futures is quoted at 94.50.The contract size is $5,000,000.
-Compute the dollar profit or loss from borrowing the present value of $5,000,000 at one month LIBOR and lending the same amount at two month LIBOR while simultaneously selling one November Fed funds futures contract.Assume that rates on November 1 were 7 percent,there is no basis risk,and the position is unwound on November 1.Select the closest answer.
A)-$3,150
B)$0
C)$3,150
D)$940
E)-$940

Accepted Answer

The profit or loss from this strategy involves three components: the interest earned from lending at the two-month LIBOR rate, the interest paid for borrowing at the one-month LIBOR rate, and the gain or loss from the futures contract. 1. Borrowing at one-month LIBOR (4.50% annual rate) for one month on $5,000,000:$$ \text{Interest paid} = \$5,000,000 \times \frac{4.50\%}{12} = \$18,750 $$2. Lending at two-month LIBOR (5.00% annual rate) for one month (since we are unwinding after one month, we consider the rate for one month):$$ \text{Interest earned} = \$5,000,000 \times \frac{5.00\%}{12} = \$20,833.33 $$3. The futures contract is quoted as 94.50, which implies a rate of $100 - 94.50 = 5.50\%$. However, the actual rate on November 1 is 7%. The profit from the futures contract for a $5,000,000 contract size is:$$ \text{Profit from futures} = \$5,000,000 \times \frac{(5.50\% - 7.00\%)}{12} = -\$6,250 $$Adding these components together:$$ \$20,833.33 - \$18,750 - \$6,250 = -\$4,166.67 $$The closest answer provided is:A) -$3,150

Question 15

The implied repo rate on a spread is the implicit return on a risk-free spread transaction.

Accepted Answer

The statement accurately defines the implied repo rate on a spread as the implicit return on a risk-free spread transaction.

Question 16

The timing option will lead to early delivery if the coupon rate is higher than the repo rate.

Accepted Answer

The timing option in a repo agreement allows the seller to choose when within the repo term to repurchase the securities. This option's exercise is not directly related to the comparison between the coupon rate and the repo rate; instead, it depends on the seller's liquidity needs, market conditions, or strategic financing decisions.

Question 17

Suppose the number of days between two coupon payment dates is 181,the number of days since the last coupon payment is 100,the annual coupon rate is 8 percent and the par value is $100,000,then the accrued interest is $2,210.

Accepted Answer

The accrued interest can be calculated using the formula:

Accrued Interest = (Coupon Rate/2) x (Days since Last Coupon Payment/Number of Days between Coupon Payments) x Face Value

Here, Coupon Rate = 8% = 0.08 (annual), 
Number of Days between Coupon Payments = 181, 
Days since Last Coupon Payment = 100, and 
Face Value = $100,000.

So,

Accrued Interest = (0.08/2) x (100/181) x $100,000 
                 = 0.04 x 0.5525 x $100,000 
                 = $2,210

Hence, the statement is true.

Question 18

The implied repo rate is the return on an overnight repurchase agreement.

Accepted Answer

The implied repo rate is the theoretical return on a repo investment, calculated from the difference between the futures price and the spot price of a security, over a specific period, not just overnight.

Question 19

The most common means of financing a cash-and-carry arbitrage is a repurchase agreement.

Accepted Answer

A repurchase agreement, also known as a repo, is a common means of financing cash-and-carry arbitrage. In a repo, an investor sells securities to a counterparty with an agreement to repurchase them at a later date at a higher price, effectively borrowing money using the securities as collateral. This allows investors to finance the cash purchase of an asset in a cash-and-carry arbitrage strategy.

Question 20

If the invoice price of bond A is 122,the invoice price of bond B is 95,the adjusted spot price of bond A is 127 and the adjusted spot price of bond B is 97,the better bond to deliver is bond B.

Accepted Answer

The better bond to deliver is the one with the lower adjusted spot price, as it will result in a smaller delivery cost. Therefore, bond B is the better bond to deliver as its adjusted spot price is lower than bond A's.

Quiz 10: Futures Arbitrage Strategies