Question 1

The coupon assumption for the conversion factor is 8 percent.

Accepted Answer

The coupon assumption for the conversion factor in bond trading typically assumes a 6 percent annual coupon, not 8 percent.

Question 2

The settlement price,conversion factor and accrued interest are necessary to calculate the invoice price.

Accepted Answer

The settlement price, conversion factor, and accrued interest are all important factors in calculating the invoice price for a financial product such as a bond or futures contract.

Question 3

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 4

Covered interest arbitrage relates to program trading and the need to cover the interest on funds borrowed.

Accepted Answer

Covered interest arbitrage involves taking advantage of the interest rate differential between two countries while hedging against exchange rate risk, not specifically about covering interest on borrowed funds in the context of program trading.

Question 5

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 6

In theory,the foreign exchange futures price is based on four parameters only,the spot foreign exchange rate,the risk-free rate in the domestic currency,the risk-free rate in the foreign currency,and time to maturity.

Accepted Answer

The foreign exchange futures price is determined by the spot foreign exchange rate, the applicable interest rates in both currencies, and the time to maturity. These factors are used to calculate the expected future value of the currency pair, which is then priced into the futures contract.

Question 7

Foreign exchange carry arbitrage is based on a trader's expectations regarding purchasing power parity.

Accepted Answer

Foreign exchange carry arbitrage is based on the differential in interest rates between two currencies, not on expectations regarding purchasing power parity.

Question 8

The implied interest rate based on Treasury bond carry arbitrage will decrease when the cheapest-to-deliver bond price increases,everything else held constant.

Accepted Answer

In Treasury bond carry arbitrage, an investor buys a lower yielding Treasury bond and sells a higher yielding Treasury bond to earn the carry (the difference between the two yields). The investor shorts the higher yielding bond by selling it and delivers the lower yielding bond at maturity. The cheapest-to-deliver bond is the bond with the lowest cost for the investor to deliver at maturity. If the price of the cheapest-to-deliver bond increases, the cost for the investor to deliver that bond decreases, making the carry more valuable. Therefore, the implied interest rate based on Treasury bond carry arbitrage will decrease.

Question 9

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

Accepted Answer

This is true. The quality option allows the issuer to redeem a higher-coupon bond in favor of a lower-coupon bond when the lower-coupon bond becomes more favorable in the market. The decision to exercise this option is based on the relative prices of the two bonds.

Question 10

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

First, calculate the daily coupon rate:
8% / 365 = 0.022%

Then, calculate the accrued interest:
0.022% * $100,000 * 100 = $2,200

Since 100 days have passed since the last coupon payment, the accrued interest is $2,200 * (100/181) = $2,210. Therefore, the statement is true.

Question 11

If a stock index futures is at 455 and the pricing model says it should be at 458,an arbitrageur should buy the futures and sell short the stock.

Accepted Answer

If the futures price is below the model price, an arbitrageur can buy the futures and sell short the stock to profit from the difference.

Question 12

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 bond with the lower adjusted spot price is the better bond to deliver, as it has a higher yield. Therefore, bond B is the better bond to deliver with an adjusted spot price of 97, compared to bond A with an adjusted spot price of 127.

Question 13

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 14

Selling an index futures and holding an undiversified portfolio would eliminate unsystematic risk.

Accepted Answer

Selling an index futures would eliminate systematic risk but holding an undiversified portfolio would still leave the investor exposed to unsystematic risk.

Question 15

The timing option results from the difference in closing times of the spot and futures market.

Accepted Answer

The answer of The timing option results from the difference...

Question 16

The implied interest rate based on stock index carry arbitrage will increase when the spot price increases,everything else held constant.

Accepted Answer

The implied interest rate based on stock index carry arbitrage is primarily determined by the cost of carry, which includes the risk-free interest rate and storage costs (if applicable), rather than the spot price of the index.

Question 17

Stock index arbitrage will earn,at no risk,the difference between the futures price and the theoretical futures price.

Accepted Answer

Stock index arbitrage exploits the price differences between stock index futures and the underlying stocks to make risk-free profits. When the futures price deviates from its theoretical price (calculated based on the current value of the underlying stocks, dividends, and the risk-free interest rate), arbitrageurs can buy the underpriced asset and sell the overpriced one, locking in a risk-free profit as the prices converge.

Question 18

The quality option is sometimes referred to as the switching option.

Accepted Answer

This statement is true. The quality option allows users to switch between different qualities (such as lower or higher resolution) whereas the switching option typically refers to the ability to switch between different audio or subtitle languages.

Question 19

An increase in dividends will lower the theoretical value of the stock index futures contract.

Accepted Answer

An increase in dividends means that the cash flows to be received from holding the underlying stocks will increase, which will decrease the demand for stock index futures contracts. This in turn will lower the theoretical value of the futures contract.

Quiz 9: Futures Arbitrage Strategies