Chapter 22 - Futures Markets

Chapter 22 Futures Markets

Multiple Choice Questions 1. A futures contract A. is an agreement to buy or sell a specified amount of an asset at the spot price on the expiration date of the contract. B. is an agreement to buy or sell a specified amount of an asset at a predetermined price on the expiration date of the contract. C. gives the buyer the right but not the obligation to buy an asset some time in the future. !. is a contract to be signed in the future by the buyer and the seller of the commodity. ". none of the above. A futures contract locks in the price of a commodity to be delivered at some future date. #oth the buyer and seller of the contract are committed.

Difficulty: Easy

2. $he terms of futures contracts %%%%%%%%%% standardi&ed and the terms of for'ard contracts %%%%%%%%%% standardi&ed. A. are( are #. are not( are C. are( are not !. are not( are not ". are( may or may not be Futures contracts are standardi&ed and are traded on organi&ed exchanges( for'ard contracts are not traded on organi&ed exchanges the participant negotiates for the delivery of any )uantity of goods and banks and brokers negotiate contracts as needed.

Difficulty: Easy

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Chapter 22 - Futures Markets

*. Futures contracts %%%%%%%%%% traded on an organi&ed exchange and for'ard contracts %%%%%%%%%% traded on an organi&ed exchange. A. are not( are #. are( are C. are not( are not D. are( are not ". are( may or may not be +ee rationale for test bank )uestion 22.2.

Difficulty: Easy

,. -n a futures contract the futures price is A. determined by the buyer and the seller 'hen the delivery of the commodity takes place. #. determined by the futures exchange. C. determined by the buyer and the seller 'hen they initiate the contract. !. determined independently by the provider of the underlying asset. ". none of the above. $he futures exchanges specify all the terms of the contracts except price( as a result the traders bargain over the futures price.

Difficulty: Moderate

.. $he buyer of a futures contract is said to have a %%%%%%%%%% position and the seller of a futures contract is said to have a %%%%%%%%%% position in futures. A. long( short #. long( long C. short( short !. short( long ". margined( long $he trader taking the long position commits to purchase the commodity on the delivery date. $he trader taking the short position commits to delivering the commodity at contract maturity. $he trader in the long position is said to /buy/ the contract( the trader in the short position is said to /sell/ the contract. 0o'ever no money changes hands at this time.

Difficulty: Moderate

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Chapter 22 - Futures Markets

1. -nvestors 'ho take long positions in futures agree to %%%%%%%%%% of the commodity on the delivery date and those 'ho take the short positions agree to %%%%%%%%%% of the commodity. A. make delivery( take delivery B. take delivery( make delivery C. take delivery( take delivery !. make delivery( make delivery ". negotiate the price( pay the price $he trader taking the long position commits to purchase the commodity on the delivery date. $he trader taking the short position commits to delivering the commodity at contract maturity. $he trader in the long position is said to /buy/ the contract( the trader in the short position is said to /sell/ the contract. 0o'ever no money changes hands at this time.

Difficulty: Moderate

2. $he terms of futures contracts such as the )uality and )uantity of the commodity and the delivery date are A. specified by the buyers and sellers. #. specified only by the buyers. C. specified by the futures exchanges. !. specified by brokers and dealers. ". none of the above. $he futures exchanges specify all the terms of the contracts except price( as a result the traders bargain over the futures price.

Difficulty: Moderate

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Chapter 22 - Futures Markets

3. A trader 'ho has a %%%%%%%%%% position in 'heat futures believes the price of 'heat 'ill %%%%%%%%%% in the future. A. long( increase #. long( decrease C. short( increase !. long( stay the same ". short( stay the same $he trader holding the long position 4the person 'ho 'ill purchase the goods5 'ill profit from a price increase. 6rofit to long position 7 +pot price at maturity - 8riginal futures price.

Difficulty: Moderate

9. A trader 'ho has a %%%%%%%%%% position in gold futures 'ants the price of gold to %%%%%%%%%% in the future. A. long( decrease B. short( decrease C. short( stay the same !. short( increase ". long( stay the same 6rofit to short position 7 8riginal futures price - +pot price at maturity. $hus the person in the short position profits if the price of the commodity declines in the future.

Difficulty: Moderate

1:. $he open interest on silver futures at a particular time is the A. number of silver futures contracts traded during the day. #. number of outstanding silver futures contracts for delivery 'ithin the next month. C. number of silver futures contracts traded the previous day. D. number of all silver futures outstanding contracts. ". none of the above. 8pen interest is the number of contracts outstanding. ;hen contracts begin trading open interest is &ero( as time passes more contracts are entered. Most contracts are li)uidated before the maturity date.

Difficulty: Moderate

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Chapter 22 - Futures Markets

11. ;hich one of the follo'ing statements regarding delivery is true? A. Most futures contracts result in actual delivery. B. 8nly one to three percent of futures contracts result in actual delivery. C. 8nly fifteen percent of futures contracts result in actual delivery. !. Approximately fifty percent of futures contracts result in actual delivery. ". Futures contracts never result in actual delivery. <irtually all traders enter reversing trades to cancel their original positions thereby reali&ing profits or losses on the contract.

Difficulty: Moderate

12. ;hich one of the follo'ing statements regarding delivery is false? A. Most futures contracts result in actual delivery. #. 8nly one to three percent of futures contracts result in actual delivery. C. 8nly fifteen percent of futures contracts result in actual delivery. !. A and # E. A and C <irtually all traders enter reversing trades to cancel their original positions thereby reali&ing profits or losses on the contract.

Difficulty: Moderate

1*. =ou hold one long corn futures contract that expires in April. $o close your position in corn futures before the delivery date you must A. buy one May corn futures contract. #. buy t'o April corn futures contract. C. sell one April corn futures contract. !. sell one May corn futures contract. ". none of the above. $he long position is considered the buyer( to close out the position one must take a reversing position or sell the contract.

Difficulty: Moderate

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Chapter 22 - Futures Markets

1,. ;hich one of the follo'ing statements is true? A. $he maintenance margin is the amount of money you post 'ith your broker 'hen you buy or sell a futures contract. B. $he maintenance margin determines the value of the margin account belo' 'hich the holder of a futures contract receives a margin call. C. A margin deposit can only be met 'ith cash. !. All futures contracts re)uire the same margin deposit. ". $he maintenance margin is set by the producer of the underlying asset. $he maintenance margin applies to the value of the account after the account is opened( if the value of this account falls belo' the maintenance margin re)uirement and the holder of the contract 'ill receive a margin call. A margin deposit can be made 'ith cash or interestearning securities( the margin deposit amounts depend on the volatility of the underlying asset.

Difficulty: Moderate

1.. ;hich one of the follo'ing statements is false? A. $he maintenance margin is the amount of money you post 'ith your broker 'hen you buy or sell a futures contract. #. $he maintenance margin determines the value of the margin account belo' 'hich the holder of a futures contract receives a margin call. C. A margin deposit can only be met 'ith cash. !. All futures contracts re)uire the same margin deposit. E. A C and ! $he maintenance margin applies to the value of the account after the account is opened( if the value of this account falls belo' the maintenance margin re)uirement and the holder of the contract 'ill receive a margin call. A margin deposit can be made 'ith cash or interestearning securities( the margin deposit amounts depend on the volatility of the underlying asset.

Difficulty: Moderate

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Chapter 22 - Futures Markets

11. Financial futures contracts are actively traded on the follo'ing indices except A. the +>6 .:: -ndex. #. the ?e' =ork +tock "xchange -ndex. C. the ?ikkei -ndex. !. the !o' @ones -ndustrial -ndex. E. all of the above indices have actively traded futures contracts. $he indices are listed in $able 22.1.

Difficulty: Moderate

12. Financial futures contracts are actively traded on the follo'ing indices A. the +>6 .:: -ndex. #. the ?e' =ork +tock "xchange -ndex. C. the ?ikkei -ndex. !. the !o' @ones -ndustrial -ndex. E. all of the above. $he indices are listed in $able 22.1.

Difficulty: Moderate

13. Agricultural futures contracts are actively traded on A. corn. #. oats. C. pork bellies. !. A and #. E. all of the above. $he indices are listed in $able 22.1.

Difficulty: Moderate

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Chapter 22 - Futures Markets

19. Agricultural futures contracts are actively traded on A. soybeans. #. oats. C. 'heat. !. A and #. E. all of the above. $he indices are listed in $able 22.1.

Difficulty: Moderate

2:. Agricultural futures contracts are actively traded on A. milk. #. orange Auice. C. lumber. !. A and #. E. all of the above. $he indices are listed in $able 22.1.

Difficulty: Moderate

21. Agricultural futures contracts are actively traded on A. rice. #. sugar. C. canola. !. A and #. E. all of the above. $he indices are listed in $able 22.1.

Difficulty: Moderate

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Chapter 22 - Futures Markets

22. Foreign currency futures contracts are actively traded on the A. "uro. #. #ritish pound. C. !rachma. D. A and #. ". all of the above. $he indices are listed in $able 22.1.

Difficulty: Moderate

2*. Foreign currency futures contracts are actively traded on the A. @apanese yen. #. Australian dollar. C. #ra&ilian real. !. A and #. E. all of the above. $he indices are listed in $able 22.1.

Difficulty: Moderate

2,. Metals and energy currency futures contracts are actively traded on A. gold. #. silver. C. propane. !. A and #. E. all of the above. $he indices are listed in $able 22.1.

Difficulty: Moderate

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Chapter 22 - Futures Markets

2.. Metals and energy currency futures contracts are actively traded on A. copper. #. platinum. C. 'eather. !. A and #. E. all of the above. $he indices are listed in $able 22.1.

Difficulty: Moderate

21. -nterest rate futures contracts are actively traded on the A. "urodollars. #. "uroyen. C. +terling. !. A and #. E. all of the above. $he indices are listed in $able 22.1.

Difficulty: Moderate

22. $o exploit an expected increase in interest rates an investor 'ould most likely A. sell $reasury bond futures. #. take a long position in 'heat futures. C. buy +>6 .:: index futures. !. take a long position in $reasury bond futures. ". none of the above. -f interest rates rise bond prices decrease. As bond prices decrease the short position gains. $hus if you are bearish about bond prices you might speculate by selling $-bond futures contracts.

Difficulty: Difficult

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Chapter 22 - Futures Markets

23. An investor 'ith a long position in $reasury notes futures 'ill profit if A. interest rates decline. #. interest rate increase. C. the prices of $reasury notes increase. !. the price of the long bond increases. ". none of the above. 6rofit to long position 7 +pot price at maturity - original futures price.

Difficulty: Moderate

29. $o hedge a long position in $reasury bonds an investor most likely 'ould A. buy interest rate futures. #. sell +>6 futures. C. sell interest rate futures. !. buy $reasury bonds in the spot market. ". none of the above. #y taking the short position the hedger is obligated to deliver $-bonds at the contract maturity date for the current futures price 'hich locks in the sales price for the bonds and guarantees that the total value of the bond-plus-futures position at the maturity date is the futures price.

Difficulty: Difficult

*:. An increase in the basis 'ill %%%%%%%%%% a long hedger and %%%%%%%%%% a short hedger. A. hurt( benefit #. hurt( hurt C. benefit( hurt !. benefit( benefit ". benefit( have no effect upon -f a contract and an asset are to be li)uidated early basis risk exists and futures price and spot price need not move in lockstep before delivery date. An increase in the basis 'ill hurt the short hedger and benefit the long hedger.

Difficulty: Difficult

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Chapter 22 - Futures Markets

*1. ;hich one of the follo'ing statements regarding /basis/ is not trueB A. the basis is the difference bet'een the futures price and the spot price. #. the basis risk is borne by the hedger. C. a short hedger suffers losses 'hen the basis decreases. !. the basis increases 'hen the futures price increases by more than the spot price. ". none of the above. -f you think one asset is overpriced relative to another you sell the overpriced asset and buy the other one.

Difficulty: Difficult

*2. ;hich one of the follo'ing statements regarding /basis/ is trueB A. the basis is the difference bet'een the futures price and the spot price. #. the basis risk is borne by the hedger. C. a short hedger suffers losses 'hen the basis decreases. !. the basis increases 'hen the futures price increases by more than the spot price. E. A # and !. -f you think one asset is overpriced relative to another you sell the overpriced asset and buy the other one.

Difficulty: Difficult

**. -f you determine that the +>6 .:: -ndex futures is overpriced relative to the spot +>6 .:: -ndex you could make an arbitrage profit by A. buying all the stocks in the +>6 .:: and selling put options on the +>6 .:: index. #. selling short all the stocks in the +>6 .:: and buying +>6 -ndex futures. C. selling all the stocks in the +>6 .:: and buying call options on the +>6 .:: index. D. selling +>6 .:: -ndex futures and buying all the stocks in the +>6 .::. ". none of the above. -f you think one asset is overpriced relative to another you sell the overpriced asset and buy the other one.

Difficulty: Moderate

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Chapter 22 - Futures Markets

*,. 8n @anuary 1 the listed spot and futures prices of a $reasury bond 'ere 9*.3 and 9*.1*. =ou purchased C1:: ::: par value $reasury bonds and sold one $reasury bond futures contract. 8ne month later the listed spot price and futures prices 'ere 9, and 9,.:9 respectively. -f you 'ere to li)uidate your position your profits 'ould be A. C12. loss. #. C12. profit. C. C12..: loss. !. C1 2.: loss. ". none of the above. 8n bondsD C9, ::: - C9* 2.: 7 C2.:( 8n futuresD C9* ,:1.2. - C9, 231.2. 7 -C32.( ?et profitsD C2.: - C32. 7 -C12..

Difficulty: Difficult

*.. =ou purchased one silver future contract at C* per ounce. ;hat 'ould be your profit 4loss5 at maturity if the silver spot price at that time is C,.1: per ounceB Assume the contract si&e is . ::: ounces and there are no transactions costs. A. C...: profit B. C. .:: profit C. C...: loss !. C. .:: loss ". none of the above. C,.1: - C*.:: 7 C1.1: E . ::: 7 C. .::.

Difficulty: Moderate

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Chapter 22 - Futures Markets

*1. =ou sold one silver future contract at C* per ounce. ;hat 'ould be your profit 4loss5 at maturity if the silver spot price at that time is C,.1: per ounceB Assume the contract si&e is . ::: ounces and there are no transactions costs. A. C...: profit #. C. .:: profit C. C...: loss D. C. .:: loss ". none of the above. C*.:: - C,.1: 7 -C1.1: E . ::: 7 -C. .::.

Difficulty: Moderate

*2. =ou purchased one corn future contract at C2.29 per bushel. ;hat 'ould be your profit 4loss5 at maturity if the corn spot price at that time 'ere C2.1: per bushelB Assume the contract si&e is . ::: ounces and there are no transactions costs. A. C9.: profit #. C9. profit C. C9.: loss !. C9. loss ". none of the above. C2.1: - C2.29 7 -C:.19 E . ::: 7 -C9.:.

Difficulty: Moderate

*3. =ou sold one corn future contract at C2.29 per bushel. ;hat 'ould be your profit 4loss5 at maturity if the corn spot price at that time 'ere C2.1: per bushelB Assume the contract si&e is . ::: ounces and there are no transactions costs. A. C9.: profit #. C9. profit C. C9.: loss !. C9. loss ". none of the above. C2.29 - C2.1: 7 C:.19 E . ::: 7 C9.:.

Difficulty: Moderate

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Chapter 22 - Futures Markets

*9. =ou sold one 'heat future contract at C*.:, per bushel. ;hat 'ould be your profit 4loss5 at maturity if the 'heat spot price at that time 'ere C2.93 per bushelB Assume the contract si&e is . ::: ounces and there are no transactions costs. A. C*: profit B. C*:: profit C. C*:: loss !. C*: loss ". none of the above. C*.:, - C2.93 7 C:.:1 E . ::: 7 C*::.

Difficulty: Moderate

,:. =ou purchased one 'heat future contract at C*.:, per bushel. ;hat 'ould be your profit 4loss5 at maturity if the 'heat spot price at that time 'ere C2.93 per bushelB Assume the contract si&e is . ::: ounces and there are no transactions costs. A. C*: profit #. C*:: profit C. C*:: loss !. C*: loss ". none of the above. C2.93 - C*.:, 7 -C:.:1 E . ::: 7 -C*::.

Difficulty: Moderate

,1. 8n @anuary 1 you sold one April +>6 .:: index futures contract at a futures price of ,2:. -f on February 1 the April futures price 'ere ,*: 'hat 'ould be your profit 4loss5 if you closed your position 4'ithout considering transactions costs5B A. C2 .:: loss #. C1: loss C. C2 .:: profit !. C1: profit ". none of the above C,2: - C,*: 7 -C1: E 2.: 7 -C2 .::

Difficulty: Difficult

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Chapter 22 - Futures Markets

,2. 8n @anuary 1 you bought one April +>6 .:: index futures contract at a futures price of ,2:. -f on February 1 the April futures price 'ere ,*: 'hat 'ould be your profit 4loss5 if you closed your position 4'ithout considering transactions costs5B A. C2 .:: loss #. C1: loss C. C2 .:: profit !. C1: profit ". none of the above C,*: - C,2: 7 C1: E 2.: 7 C2 .::

Difficulty: Difficult

,*. =ou sold one soybean future contract at C..1* per bushel. ;hat 'ould be your profit 4loss5 at maturity if the 'heat spot price at that time 'ere C..21 per bushelB Assume the contract si&e is . ::: ounces and there are no transactions costs. A. C1. profit #. C1.: profit C. C1.: loss !. C1. loss ". none of the above. C..1* - C..21 7 -C:.1* E . ::: 7 -C1.:.

Difficulty: Moderate

,,. =ou bought one soybean future contract at C..1* per bushel. ;hat 'ould be your profit 4loss5 at maturity if the 'heat spot price at that time 'ere C..21 per bushelB Assume the contract si&e is . ::: ounces and there are no transactions costs. A. C1. profit B. C1.: profit C. C1.: loss !. C1. loss ". none of the above. C..21 - C..1* 7 C:.1* E . ::: 7 C1.:.

Difficulty: Moderate

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Chapter 22 - Futures Markets

,.. 8n April 1 you bought one +>6 .:: index futures contract at a futures price of 9.:. -f on @une 1.th the futures price 'ere 1:12 'hat 'ould be your profit 4loss5 if you closed your position 4'ithout considering transactions costs5B A. C1 ..: loss #. C1. ..: loss C. C1. ..: profit !. C1 ..: profit ". none of the above C1:12 - C9.: 7 C12 E 2.: 7 C1. .::

Difficulty: Difficult

,1. 8n April 1 you sold one +>6 .:: index futures contract at a futures price of 9.:. -f on @une 1.th the futures price 'ere 1:12 'hat 'ould be your profit 4loss5 if you closed your position 4'ithout considering transactions costs5B A. C1 ..: loss B. C1. ..: loss C. C1. ..: profit !. C1 ..: profit ". none of the above C9.: - C1:12 7 -C12 E 2.: 7 -C1. .::

Difficulty: Difficult

,2. $he expectations hypothesis of futures pricing A. is the simplest theory of futures pricing. #. states that the futures price e)uals the expected value of the future spot price of the asset. C. is not a &ero sum game. D. A and #. ". A and C. $he expectations hypothesis relies on the concept of risk neutrality( i.e. if all market participants are risk neutral they should agree on a futures price that provides an expected profit of &ero to all parties.

Difficulty: Easy

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Chapter 22 - Futures Markets

,3. ?ormal back'ardation A. maintains that for most commodities there are natural hedgers 'ho desire to shed risk. #. maintains that speculators 'ill enter the long side of the contract only if the futures price is belo' the expected spot price. C. assumes that risk premiums in the futures markets are based on systematic risk. D. A and #. ". # and C. Fisk premiums in this theory are based on total variability.

Difficulty: Easy

,9. Contango A. holds that the natural hedgers are the purchasers of a commodity not the suppliers. #. is a hypothesis polar to back'ardation. C. holds that F8 must be less than 46$5. !. A and C. E. A and #. Contango holds that the natural hedgers are the purchasers of a commodity not the suppliers and is a hypothesis polar to back'ardation.

Difficulty: Easy

.:. !elivery of stock index futures A. is never made. B. is made by a cash settlement based on the index value. C. re)uires delivery of 1 share of each stock in the index. !. is made by delivering 1:: shares of each stock in the index. ". is made by delivering a value-'eighted basket of stocks. +tock index futures are cash-settled similar to the procedure used for index options.

Difficulty: Moderate

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Chapter 22 - Futures Markets

.1. $he establishment of a futures market in a commodity should not have a maAor impact on spot prices because A. the futures market is small relative to the spot market. #. the futures market is illi)uid. C. futures are a &ero-sum game !. the futures market is large relative to the spot market. ". most futures contracts do not take delivery. Gosses and gains to futures contracts net to &ero and thus should not impact spot prices.

Difficulty: Moderate

.2. $he most recently established category of futures contracts is A. agricultural commodities. #. metals and minerals. C. foreign currencies. D. financial futures. ". both # and C. Financial futures 'ere first introduced in 192. and this segment of the market has seen rapid innovation.

Difficulty: Moderate

.*. -f a trader holding a long position in corn futures fails to meet the obligations of a futures contract the party that is hurt by the failure is A. the offsetting short trader. #. the corn farmer. C. the clearinghouse. !. the broker. ". the commodities dealer. $he clearinghouse acts as a middle party to every transaction and bears any losses arising from failure to meet contractual obligations.

Difficulty: Moderate

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Chapter 22 - Futures Markets

.,. 8pen interest includes A. only contracts 'ith a specified delivery date. #. the sum of short and long positions. C. the sum of short long and clearinghouse positions. !. the sum of long or short positions and clearinghouse positions. E. only long or short positions but not both. 8pen interest is the number of contracts outstanding across all delivery dates for a given contract. Gong and short positions are not counted separately and the clearinghouse position is not counted because it nets to &ero.

Difficulty: Moderate

... $he process of marking-to-market A. posts gains or losses to each account daily. #. may result in margin calls. C. impacts only long positions. !. all of the above are true. E. both A and # are true. Marking-to-market effectively puts futures contracts on a /pay as you go/ basis.

Difficulty: Easy

.1. Futures contracts are regulated by A. the Commodity Futures $rading Corporation. #. the Chicago #oard of $rade. C. the Chicago Mercantile "xchange. !. the Federal Feserve. ". the +ecurities and "xchange Commission. $he CF$C a federal agency sets rules and re)uirements for futures trading.

Difficulty: Easy

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Chapter 22 - Futures Markets

.2. $axation of futures trading gains and losses A. is based on cumulative year-end profits or losses. #. occurs based on the date contracts are sold or closed. C. can be timed to offset stock portfolio gains and losses. !. is based on the contract holding period. ". none of the above. Futures profits and losses are taxed based on cumulative year-end value due to marking-tomarket procedures.

Difficulty: Moderate

.3. +peculators may use futures markets rather than spot markets because A. transactions costs are lo'er in futures markets. #. futures markets provide leverage. C. spot markets are less efficient. !. futures markets are less efficient. E. both A and # are true. Futures markets allo' speculators to benefit from leverage and minimi&e transactions costs. #oth markets should be e)ually price-efficient.

Difficulty: Moderate

.9. Hiven a stock index 'ith a value of C1 ::: an anticipated dividend of C*: and a risk-free rate of 1I 'hat should be the value of one futures contract on the indexB A. C9,*.,: #. C92:.:: C. C91*.,: !. C91..:9 ". C1:::.:: F 7 1:::J41.:15 - *:( F 7 91*.,:.

Difficulty: Difficult

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Chapter 22 - Futures Markets

1:. Hiven a stock index 'ith a value of C1 12. an anticipated dividend of C** and a risk-free rate of ,I 'hat should be the value of one futures contract on the indexB A. C1:,3.2* #. C1:2:.:: C. C99*.,: !. C99..:9 ". C1:::.:: F 7 112.J41.:,5 - **( F 7 1:,3.2*.

Difficulty: Difficult

11. Hiven a stock index 'ith a value of C11:: an anticipated dividend of C22 and a risk-free rate of *I that should be the value of one futures contract on the indexB A. C9,*.,: #. C92:.:: C. C91*.,: D. C1:,:.91 ". C1:::.:: F 7 11::J41.:*5 - 22( F 7 1:,:.91.

Difficulty: Difficult

12. Hiven a stock index 'ith a value of C1 2:: an anticipated dividend of C,. and a risk-free rate of 1I 'hat should be the value of one futures contract on the indexB A. C1:32.:3 #. C1:2:.:: C. C99*.,: !. C99..:9 ". C1:::.:: F 7 12::J41.:15 - ,.( F 7 1:32.:3.

Difficulty: Difficult

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Chapter 22 - Futures Markets

1*. ;hich of the follo'ing items is specified in a futures contractB -5 the contract si&e --5 the maximum acceptable price range during the life of the contract ---5 the acceptable grade of the commodity on 'hich the contract is held -<5 the market price at expiration <5 the settlement price A. - -- and -< B. - --- and < C. - and < !. - -< and < ". - -- --- -< and < $he maximum price range and the market price at expiration 'ill be determined by the market rather than specified in the contract.

Difficulty: Moderate

1,. ;hich of the follo'ing items is not specified in a futures contractB -5 the contract si&e --5 the maximum acceptable price range during the life of the contract ---5 the acceptable grade of the commodity on 'hich the contract is held -<5 the market price at expiration <5 the settlement price A. -- and -< #. - --- and < C. - and < !. - -< and < ". - -- --- -< and < $he maximum price range and the market price at expiration 'ill be determined by the market rather than specified in the contract.

Difficulty: Moderate

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Chapter 22 - Futures Markets

1.. ;ith regard to futures contracts 'hat does the 'ord /margin/ meanB A. -t is the amount of the money borro'ed from the broker 'hen you buy the contract. #. -t is the maximum percentage that the price of the contract can change before it is marked to market. C. -t is the maximum percentage that the price of the underlying asset can change before it is marked to market. D. -t is a good-faith deposit made at the time of the contractKs purchase or sale. ". -t is the amount by 'hich the contract is marked to market. $he exchange guarantees the performance of each party so it re)uires a good-faith deposit. $his helps avoid the cost of credit checks.

Difficulty: Easy

11. ;hich of the follo'ing is true about profits from futures contractsB A. $he person 'ith the long position gets to decide 'hether to exercise the futures contract and 'ill only do so if there is a profit to be made. #. -t is possible for both the holder of the long position and the holder of the short position to earn a profit. C. $he clearinghouse makes most of the profit. D. $he amount that the holder of the long position gains must e)ual the amount that the holder of the short position loses. ". 0olders of short positions can recogni&e profits by making delivery early. $he net profit on the contract is &ero - it is a &ero-sum game.

Difficulty: Moderate

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Chapter 22 - Futures Markets

12. ;hich of the follo'ing is false about profits from futures contractsB A. $he person 'ith the long position gets to decide 'hether to exercise the futures contract and 'ill only do so if there is a profit to be made. #. -t is possible for both the holder of the long position and the holder of the short position to earn a profit. C. $he clearinghouse makes most of the profit. !. $he amount that the holder of the long position gains must e)ual the amount that the holder of the short position loses. E. A # and C $he net profit on the contract is &ero - it is a &ero-sum game.

Difficulty: Moderate

13. +ome of the ne'er futures contracts include -5 fashion futures. --5 'eather futures. ---5 electricity futures. -<5 entertainment futures. A. - and -B. -- and --C. --- and -< !. - -- and --". - --- and -< ;eather and electricity futures are mentioned in the textbook as recent innovations.

Difficulty: Easy

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Chapter 22 - Futures Markets

19. ;ho guarantees that a futures contract 'ill be fulfilledB A. the buyer #. the seller C. the broker D. the clearinghouse ". nobody 8nce t'o parties have agreed to enter the transaction the clearinghouse becomes the buyer and seller of the contract and guarantees its completion.

Difficulty: Easy

2:. -f you took a long position in a pork bellies futures contract and then forgot about it 'hat 'ould happen at the expiration of the contractB A. ?othing - the seller understands that these things happen. #. =ou 'ould 'ake up to find the pork bellies on your front la'n. C. =our broker 'ould send you a nasty letter. D. =ou 'ould be notified that you o'e the holder of the short position a certain amount of cash. ". =ou 'ould be notified that you have to pay a penalty in addition to the regular cost of the pork bellies. $he item is usually not delivered but cash settlement can be made through the use of 'arehouse receipts. =ou are still obligated to fulfill the contract and give the holder of the short position the value of the pork bellies.

Difficulty: Easy

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Chapter 22 - Futures Markets

21. 0edging a position using futures on another commodity is called A. surrogate hedging. B. cross hedging. C. alternative hedging. !. correlative hedging. ". proxy hedging. Cross-hedging is used in some cases because no futures contract exists for the item you 'ant to hedge. $he t'o commodities should be highly correlated.

Difficulty: Easy

22. A trader 'ho has a %%%%%%%%%% position in oil futures believes the price of oil 'ill %%%%%%%%%% in the future. A. short( increase #. long( increase C. short( decrease !. long( stay the same E. # and C $he trader holding the long position 4the person 'ho 'ill purchase the goods5 'ill profit from a price increase. 6rofit to long position 7 +pot price at maturity - 8riginal futures price.

Difficulty: Moderate

2*. A trader 'ho has a %%%%%%%%%% position in gold futures 'ants the price of gold to %%%%%%%%%% in the future. A. long( decrease B. short( decrease C. short( stay the same !. short( increase ". long( stay the same 6rofit to short position 7 8riginal futures price - +pot price at maturity. $hus the person in the short position profits if the price of the commodity declines in the future.

Difficulty: Moderate

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Chapter 22 - Futures Markets

2,. =ou hold one long oil futures contract that expires in April. $o close your position in oil futures before the delivery date you must A. buy one May oil futures contract. #. buy t'o April oil futures contract. C. sell one April oil futures contract. !. sell one May oil futures contract. ". none of the above. $he long position is considered the buyer( to close out the position one must take a reversing position or sell the contract.

Difficulty: Moderate

2.. Financial futures contracts are actively traded on the follo'ing indices except A. the All ordinary index. #. the !AE *: index. C. the CAC ,: -ndex. !. the $oronto *. -ndex. E. all of the above indices have actively traded futures contracts. $he indices are listed in $able 22.1.

Difficulty: Moderate

21. Financial futures contracts are actively traded on the follo'ing indices A. the All ordinary index. #. the !AE *: index. C. the CAC ,: -ndex. !. the $oronto *. -ndex. E. all of the above. $he indices are listed in $able 22.1.

Difficulty: Moderate

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Chapter 22 - Futures Markets

22. $o exploit an expected decrease in interest rates an investor 'ould most likely A. buy $reasury bond futures. #. take a long position in 'heat futures. C. buy +>6 .:: index futures. !. take a short position in $reasury bond futures. ". none of the above. -f interest rates decrease bond prices increase. As bond prices increase the long position gains. $hus if you are bullish about bond prices you might speculate by buying $-bond futures contracts.

Difficulty: Difficult

23. An investor 'ith a short position in $reasury notes futures 'ill profit if A. interest rates decline. B. interest rate increase. C. the prices of $reasury notes increase. !. the price of the long bond increases. ". none of the above. 6rofit to long position 7 +pot price at maturity - original futures price.

Difficulty: Moderate

29. $o hedge a short position in $reasury bonds an investor most likely 'ould A. ignore interest rate futures. #. buy +>6 futures. C. buy interest rate futures. !. sell $reasury bonds in the spot market. ". none of the above. #y taking the long position the hedger is obligated to accept delivery of $-bonds at the contract maturity date for the current futures price 'hich locks in the sales price for the bonds and guarantees that the total value of the bond-plus-futures position at the maturity date is the futures price.

Difficulty: Difficult

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Chapter 22 - Futures Markets

3:. A decrease in the basis 'ill %%%%%%%%%% a long hedger and %%%%%%%%%% a short hedger. A. hurt( benefit #. hurt( hurt C. benefit( hurt !. benefit( benefit ". benefit( have no effect upon -f a contract and an asset are to be li)uidated early basis risk exists and futures price and spot price need not move in lockstep before delivery date. A decrease in the basis 'ill benefit the short hedger and hurt the long hedger.

Difficulty: Difficult

31. ;hich one of the follo'ing statements regarding /basis/ is trueB A. the basis is the difference bet'een the futures price and the spot price. #. the basis risk is borne by the hedger. C. a short hedger suffers losses 'hen the basis decreases. !. the basis increases 'hen the futures price increases by more than the spot price. E. A # and !. -f you think one asset is overpriced relative to another you sell the overpriced asset and buy the other one.

Difficulty: Difficult

32. -f you determine that the !AE-*: index futures is overpriced relative to the spot !AE-*: index you could make an arbitrage profit by A. buying all the stocks in the !AE-*: and selling put options on the !AE-*: index. #. selling short all the stocks in the !AE-*: and buying !AE-*: futures. C. selling all the stocks in the !AE-*: and buying call options on the !AE-*: index. D. selling !AE-*: index futures and buying all the stocks in the !AE-*:. ". none of the above. -f you think one asset is overpriced relative to another you sell the overpriced asset and buy the other one.

Difficulty: Moderate

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Chapter 22 - Futures Markets

3*. -f you determine that the !AE-*: index futures is under priced relative to the spot !AE*: index you could make an arbitrage profit by A. buying all the stocks in the !AE-*: and selling put options on the !AE-*: index. #. selling short all the stocks in the !AE-*: and buying !AE-*: futures. C. selling all the stocks in the !AE-*: and buying call options on the !AE-*: index. D. buying !AE-*: index futures and selling all the stocks in the !AE-*:. ". none of the above. -f you think one asset is overpriced relative to another you sell the overpriced asset and buy the other one.

Difficulty: Moderate

3,. 8n @anuary 1 the listed spot and futures prices of a $reasury bond 'ere 9.., and 9..1. =ou sold C1:: ::: par value $reasury bonds and purchased one $reasury bond futures contract. 8ne month later the listed spot price and futures prices 'ere 9. and 9,., respectively. -f you 'ere to li)uidate your position your profits 'ould be A. C12. loss. #. C12. profit. C. C1 :1:..: loss. !. C1 :12..: profit. E. none of the above. 8n bondsD C9. 12. - C9. ::: 7 C12.( 8n futuresD C9, 12..:: - C9. 132..: 7 -C1 :12..:( ?et profitsD C12. - C1 :12..:( 7 -C9*2..:.

Difficulty: Difficult

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Chapter 22 - Futures Markets

3.. =ou purchased one oil future contract at C2: per barrel. ;hat 'ould be your profit 4loss5 at maturity if the oil spot price at that time is C2*.12 per barrelB Assume the contract si&e is 1 ::: barrels and there are no transactions costs. A. C*.12 profit #. C*1.2: profit C. C*.12 loss !. C*1.2: loss E. none of the above. C2*.12 - C2:.:: 7 C*.12 E 1 ::: 7 C* 12:.

Difficulty: Moderate

31. =ou sold one oil future contract at C2: per barrel. ;hat 'ould be your profit 4loss5 at maturity if the oil spot price at that time is C2*.12 per barrelB Assume the contract si&e is 1 ::: barrels and there are no transactions costs. A. C*.12 profit #. C*1.2: profit C. C*.12 loss !. C*1.2: loss E. none of the above. C2:.:: - C2*.12 7 -C*.12 E 1 ::: 7 -C* 12:.

Difficulty: Moderate

32. -f a trader holding a long position in oil futures fails to meet the obligations of a futures contract the party that is hurt by the failure is A. the offsetting short trader. #. the oil producer. C. the clearinghouse. !. the broker. ". the commodities dealer. $he clearinghouse acts as a middle party to every transaction and bears any losses arising from failure to meet contractual obligations.

Difficulty: Moderate

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Chapter 22 - Futures Markets

33. Hiven a stock index 'ith a value of C1 .:: an anticipated dividend of C12 and a risk-free rate of ..2.I 'hat should be the value of one futures contract on the indexB A. C1*,*.,: #. C12.:: C. C1 ,13.,, !. C1 *11.,, ". ?one of the above F 7 1.::J41.:.2.5 - 12( F 7 1 *.1.,,.

Difficulty: Difficult

Short Answer Questions 39. !escribe the differences bet'een futures and for'ard contracts. Futures contracts are traded on the organi&ed exchanges and are standardi&ed as to the contract si&e the acceptable grade of the commodity and the contract delivery date. A for'ard contract is only a commitment to contract in the future. ?o money exchanges hands initially. $he contract is for a deferred delivery of an asset at an agreed upon price. FeedbackD $he purpose of this )uestion is to insure that the student understands the basic differences bet'een futures and for'ard contracts.

Difficulty: Easy

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Chapter 22 - Futures Markets

9:. !istinguish bet'een the short and long positions in futures transactions. $he trader taking the long position commits to purchase the commodity on the delivery date. $he trader taking the short position commits to delivery of the commodity at contract maturity. $he trader in the long position /buys/ the contract( the trader in short position /sells/ the contract. 0o'ever no money exchanges hands 'hen the contract is initiated. $he trader holding the long position profits from price increases. $he trader in the short position profits from price decreases. $he profits and losses of the t'o positions exactly offset each other( the futures market in the aggregate is a &ero sum game. $he terms short and long have different meanings for different investment alternatives. FeedbackD $he purpose of this )uestion is to insure that the student understands the meanings of these terms as related to the futures markets.

Difficulty: Moderate

91. !iscuss marking to market and margin accounts in the futures market. ;hen opening an account the trader establishes a margin account. $he margin deposit may be cash or near cash such as $-bills. #oth sides of the contract must post margin. $he initial margin is bet'een . and 1.I of the total value of the contract. $he more volatile the asset the higher the margin re)uirement. $he clearinghouse recogni&es profits and losses at the end of each trading day( this daily settlement is marking to market thus proceeds accrue to the traderKs account immediately( maturity date does not govern the reali&ation of profits or losses. FeedbackD Margin re)uirements and marking to market differ in the futures markets from that of the markets previously studied. $his )uestion is designed to ascertain 'hether the student understands these differences.

Difficulty: Moderate

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Chapter 22 - Futures Markets

92. =ou purchased the follo'ing futures contract today at the settlement price listed in the ;all +treet @ournal. Ans'er the )uestions belo' regarding the contract.

- ;hat is the total value of the futures contractB - -f there is a 1:I margin re)uirement ho' much do you have to depositB - +uppose the price of the futures contract changes as sho'n in the follo'ing table. - "nter the relevant information into the table. +ho' your calculations. - "xplain 'hy the account is marked-to-market daily.

22-*.

Chapter 22 - Futures Markets

$he ans'ers are sho'n belo'.

$he total value of the contract is C9 12, as sho'n in the table. -f there is a 1:I margin re)uirement you 'ill have to deposit C912.,: in cash or securities. $he contract is marked to market daily and profits or losses are posted in the account. $he contract keeps pace 'ith market activity and doesnKt change value all at once at the maturity date. $he marking-to-market process protects the clearinghouse because the margin percentage is calculated daily and if it falls belo' the maintenance margin a margin call can be issued. -f the investor doesnKt meet the call the clearinghouse can close out enough of the traderKs position to restore the margin. FeedbackD $his )uestion tests 'hether the student understands marking to market.

Difficulty: Moderate

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Chapter 22 - Futures Markets

9*. !escribe the types of traders that are active in the futures markets. "xplain 'hy each type is in the markets and ho' their goals differ. Hive an example of ho' each might use the market. $he t'o types of traders are hedgers and speculators. 0edgers use the markets to protect themselves by limiting their risk. $hey take long or short positions to lock in the most favorable purchase price or selling price at the time they enter the contract. An example of a hedger 'ould be a Ae'elry company that anticipates a need for a large )uantity of gold in the future. $he company 'ill have to purchase the gold and if it 'ants to protect itself from large price increases it can take a long position in a gold futures contract today. -f gold prices fall rather than rising the company can sell an e)uivalent contract before the maturity date. -f prices rise the company can take delivery of the gold at a more favorable price than the spot price at the time of maturity. +peculators dominate the futures market. 8nly 1I to *I of futures market participants actually plan to take delivery of the asset. $he rest are speculators 'ho plan to offset their positions prior to expiration of the contract. A speculator 'ill take a long position if he expects prices to increase. As the value of the futures contract rises the holder of the long position gains and the holder of the short position loses. $he speculator can sell the contract for more than he paid in this case. +peculators buy futures contracts rather than the underlying assets because transaction costs are much lo'er. $he speculator also benefits from leverage since only a small percentage of the total contract value is re)uired to be posted as margin. FeedbackD $his )uestion tests 'hether the student understands the main characters in the futures markets the reasons they use the markets and the role each of them plays in the marketKs operation.

Difficulty: Moderate

22-*2