Question 1

The bond that maximises the difference between the invoice price and the delivery price is referred to as the

Accepted Answer

The "cheapest-to-deliver" bond is the one that maximizes the difference between the invoice price and the delivery price in a futures contract, making it the most cost-effective option for delivery.

Question 2

As a relationship officer for a money-centre commercial bank, one of your corporate accounts has just approached you about a one-year loan for £3 000 000. The customer would pay a quarterly interest expense based on the prevailing level of LIBOR at the beginning of each quarter. As is the bank's convention on all such loans, the amount of the interest payment would then be paid at the end of the quarterly cycle when the new rate for the next cycle is determined. You observe the following LIBOR yield curve in the cash market: 90-day LIBOR 4.70%
180-day LIBOR 4.85%
270-day LIBOR 5.10%
360-day LIBOR 5.40%
If 90-day LIBOR rises to the levels 'predicted' by the implied forward rates, what will the pound level of the bank's interest receipt be at the end of the first quarter?

Accepted Answer

The correct answer is A because the bank will receive £35,250.00 in interest at the end of the first quarter. This is calculated by multiplying the loan amount of £3,000,000 by the 90-day LIBOR rate of 4.70% and dividing by 4 (since there are 4 quarters in a year).

Question 3

In late January 2014, The Union Cosmos Company is considering the sale of €100 million in 10-year debentures that will probably be rated AAA like the firm's other bond issues. The firm is anxious to proceed at today's rate of 10.5 per cent. As treasurer, you know that it will take until sometime in April to get the issue registered and sold. Therefore, you suggest that the firm hedge the pending issue using Treasury bond futures contracts each representing €100,000.  Explain how you would go about hedging the bond issue?

Accepted Answer

A

Question 4

Refer to the previous question. What is the euro gain or loss assuming that future conditions described in Case 1 actually occur? (Ignore commissions and margin costs, and assume a naive hedge ratio.)

Accepted Answer

The answer of Refer to the previous question. What is...

Question 5

The process by which invest on margin accounts are credited or debited to reflect daily trading gains or losses is referred to as the ____ process.

Accepted Answer

The marked-to-market process involves revaluing positions regularly based on current market prices, resulting in either a credit or debit to the margin account to reflect daily trading gains or losses. This helps ensure that the account maintains the required margin level and reduces the risk of default. Hedge rationing and book-to-market are not terms commonly used in the context of margin trading, while daily settlement and account realisation do not accurately describe the specific process of adjusting margin accounts based on market value fluctuations.

Question 6

According to the cost of carry model the relationship between the spot (S0) and futures price (F0,T) is

Accepted Answer

According to the cost of carry model, the relationship between the spot (S0) and futures price (F0,T) is S0 = F0,T/(1 + rf)T. This formula takes into account the cost of financing the underlying asset over the life of the futures contract, which is represented by the risk-free rate (rf). Therefore, the best choice is A.

Question 7

In your portfolio you have €1 million of 20 year, 8 5/8 per cent bonds which are selling at 83.15 (or 83 15/32) against this position. Because you feel interest rates will rise you sell 10 bond futures at 81.15 (or 81 15/32) against this position. Two months later you decide to close your position. The bonds have fallen to 78 and the futures contracts are at 75.16 (75 16/32). Disregarding margin and transaction costs, what is your gain or loss?

Accepted Answer

The answer of In your portfolio you have €1 million...

Question 8

The major difference between valuing futures versus forward contracts stems from the fact that future contracts are

Accepted Answer

Futures contracts are marked-to-market daily, meaning the gains and losses are settled on a daily basis, whereas forward contracts do not have daily settlements. This difference in settlement makes futures contracts more flexible and frequently traded than forward contracts. Additionally, futures contracts are standardized and traded on exchanges, backed by clearinghouses, which reduces credit risk for both parties involved. Therefore, choice C is the correct answer as it highlights the most significant difference between valuing futures versus forward contracts.

Question 9

Refer to the previous question. What is the implied 90-day forward rate at the beginning of the second quarter?

Accepted Answer

The answer of Refer to the previous question. What is...

Question 10

Which of the following is true when F0,T < E(ST)?

Accepted Answer

When F0,T < E(ST), it means that the price of the futures contract is lower than the expected spot price at expiration. This usually happens when there are more short hedgers than long hedgers in the market, who are willing to sell the futures contract in order to lock in a price for their future sale. This situation is known as a market in backwardation, which is the opposite of contango. Therefore, choices A, C, D, and E are incorrect.

Question 11

Refer to the previous two questions. What is the euro gain or loss assuming that future conditions described in Case 2 actually occur? (Ignore commissions and margin costs, and assume a naive hedge ratio.)

Accepted Answer

The answer of Refer to the previous two questions. What...

Question 12

The main tradeoff between forward and future contracts is

Accepted Answer

Forward and futures contracts are both derivative contracts that allow investors to hedge against price risk. However, there are some key differences between the two types of contracts. Forward contracts are customized contracts that are traded over-the-counter (OTC), while futures contracts are standardized contracts that are traded on an exchange. This difference in trading venue leads to several key differences between the two types of contracts.First, forward contracts offer more design flexibility than futures contracts. This is because forward contracts can be customized to meet the specific needs of the parties involved. For example, the parties can agree on the underlying asset, the contract size, the delivery date, and the settlement price. Futures contracts, on the other hand, are standardized contracts that are traded on an exchange. This means that the parties have less flexibility in terms of the contract terms.Second, forward contracts carry more credit risk than futures contracts. This is because forward contracts are not centrally cleared, which means that there is no guarantee that the counterparty will fulfill its obligations under the contract. Futures contracts, on the other hand, are centrally cleared, which means that there is a third party that guarantees the performance of the contract.Third, forward contracts have less liquidity than futures contracts. This is because forward contracts are traded OTC, which means that there is no central market for the contracts. Futures contracts, on the other hand, are traded on an exchange, which means that there is a central market for the contracts. This makes it easier to buy and sell futures contracts, which leads to greater liquidity.

Question 13

An investor who wants a long position in a ____ must first place the order with a broker, who then passes it on to the trading pit or electronic network. Details of the order are then passed on to the exchange clearinghouse.

Accepted Answer

Futures contracts are traded on exchanges, and orders are placed through brokers who execute the trade on the exchange. Therefore, an investor wanting a long position in a futures contract must place the order through a broker who will pass it on to the exchange clearinghouse. Options and forward contracts are typically traded over-the-counter rather than on exchanges, so they would not involve the exchange clearinghouse in the same way as futures contracts.

Question 14

Refer to the previous two questions. If 90-day LIBOR rises to the levels 'predicted' by the implied forward rates, what will the dollar level of the bank's interest receipt be at the end of the third quarter?

Accepted Answer

Using the formula provided, the bank's interest receipt would be:

Interest receipt = principal x (new rate - old rate) x (days in period / 360)

= £2,500,000 x (3.8% - 3.45%) x (90 / 360)

= £41,005.50

Therefore, the best choice is D.

Question 15

In the absence of arbitrage opportunities, the forward contract price should be equal to the current price plus

Accepted Answer

The cost of carry is the cost incurred to hold an asset until the maturity of the forward contract, which includes the financing cost, storage cost, and insurance cost. Therefore, in the absence of arbitrage opportunities, the forward contract price should be equal to the current price plus the cost of carry.

Quiz 18: Forward and Futures Contracts