FI 301 Ch. 13 - Financial Futures Markets

Bill Baher, a private investor, purchased a futures contract on Treasury bonds at a price of 102-12. Two months later, Baher sells the same futures contract in order to close out the position. At that time, the futures contract specifies 103-15. What is Baher's nominal profit? The par value of the futures contract is $100,000.

$1,093.75; profit

Assume that a futures contract on Treasury bonds with a face value of $100,000 is purchased at 93-00. If the same contract is later sold at 94-18, what is the gain, ignoring transactions costs?

$1,562.50

The value of an S&P 500 futures contract is $500 times the index. Assume the futures price on the S&P 500 index is 1612 at the time of purchase. If the index price is $1619 when the position is closed out, the gain is

$3,500

Assume that a T-bill futures contract with a face value of $1 million is purchased at a price of $95.00 per $100 face value. At settlement, the price of T-bills is $95.50. What is the difference between the selling and purchase price of the futures contract?

$5,000

Marcia buys an S&P 500 futures contract with a September settlement date when the index is 1,750. By the settlement date, the S&P 500 index falls to 1,400. The return on Marcia's position in the S&P 500 futures contract is ____ percent.

-20%

Laura sells an S&P 500 futures contract with a September settlement date when the index is 1,750. By the settlement date, the S&P 500 index falls to 1,400. The return on Laura's position in the S&P 500 futures contract is ____ percent.

25%

Clarke plans to satisfy cash needs in nine months by selling its Treasury bond holdings for $4 million. However, Clarke is concerned that interest rates might increase over the next three months. To hedge against this possibility, Clarke plans to sell Treasury bond futures. Thus, Clarke sells ____ futures contract for a price of 99-12. Assuming that the actual price of the futures contract declined to 97-20, Clarke would make a ____ of $____ from closing out the futures position.

40; profit; $70,000

The initial margin of a futures contract is typically between ____ percent of a futures contract's full value.

5 and 18

A financial institution that wishes to reduce its exposure to the possibility of declining interest rates might use:

a long hedge

A savings and loan association has long-term fixed-rate mortgages financed by short-term funds. It hedges by selling Treasury bond futures. If interest rates decline, and many mortgages are prepaid

a loss on the futures contracts more than offsets the favorable effect on the mortgage portfolio

According to the text, when a financial institution sells futures contracts on securities in order to hedge against a change in interest rates, this is referred to as

a short hedge

Municipal Bond Index (MBI) futures

are settled in cash

____ risk is the risk that the position being hedged by a futures contract is not affected in the same manner as the instrument underlying the futures contract.

basis

The risk that the position being hedged by a futures position is not affected in the same manner as the instrument underlying the financial futures contract, is referred to as

basis risk

The actions of numerous institutional investors to sell stock index futures instead of selling stocks to prepare for a market decline would likely cause the index futures price to be

below the prevailing stock prices

Trading restrictions imposed on specific stocks or stock indices are referred to as

circuit breakers

Financial futures contracts on U.S. securities are ____ by non-U.S. financial institutions.

commonly traded

According to the text, a futures contract on one financial instrument to protect a position in a different financial instrument is known as

cross-hedging

Speculators in futures contracts that normally close out their futures positions on the same day that the positions were initiated are referred to as

day traders

If the prices of Treasury bonds ____, the value of an existing Treasury bond futures contract should ____.

decrease; decrease

A financial institution that maintains some Treasury bond holdings sells Treasury bond futures contracts. If interest rates increase, the market value of the bond holdings will ____ and the position in futures contracts will result in a ____.

decrease; gain

The basis is the

difference between the price of a security and the price of a futures contract on the security

Stock index futures are priced ____ than the stock index itself.

either higher or lower

T/F: Futures exchanges take buy or sell positions on futures contracts.

false

Assume that a bank obtains most of its funds from large CDs with a one-year maturity. Its assets are in the form of loans with rates that adjust every six months. The bank would be ____ affected if interest rates increase. To partially hedge its position, it could ____ futures contracts.

favorably; purchase

A(n) ____ is a standardized agreement to deliver or receive a specified amount of a specified financial instrument at a specified price and date.

financial futures contract

____ trade futures contracts for their own account.

floor traders

____ take positions in futures to reduce their exposure to future movements in interest rates or stock prices.

hedgers

_________ take positions in financial futures to reduce their exposure to future movements in interest rates or stock prices; ________ commonly take the opposite position and thus serve as counterparties on many transactions.

hedgers; speculators

Which of the following statements is incorrect with respect to cross-hedging?

if the futures contract value is more volatile than the portfolio value, hedging will require a greater amount of principal represented by the futures contracts

An unexpected ____ in the consumer price index tends to create expectations of ____ interest rates and places ____ pressure on Treasury bond futures prices.

increase; higher; downward

If speculators believe interest rates will ____, they would consider ____ a T-bill futures contract today.

increase; selling

Assume that speculators had purchased a futures contract at the beginning of the year. If the price of a security represented by a futures contract ____ over the year, then these speculators would likely have purchased the futures contract for ____ than they can sell it for.

increased; less

___________ involves the buying or selling of stock index futures with a simultaneous opposite position in the stocks that the index comprises.

index arbitrage

The profits of a financial institution with interest-rate sensitive liabilities and interest rate-insensitive assets are ____ with hedging than without hedging if interest rates decrease.

lower

The use of financial leverage

magnifies the positive returns of futures contracts AND magnifies losses of futures contracts

Financial leverage, when used in association with a futures contract, ____ the positive returns and ____ losses.

magnifies; magnifies

In cross-hedging, if the futures contract value is ____ volatile than the portfolio value, hedging will require a ____ amount of principal represented by the futures contracts.

more; greater

If there are ____ traders with buy offers than sell offers for a particular contract, the futures price will ____ until this imbalance is removed.

more; rise

____ risk is the risk of losses as a result of inadequate management or controls.

operational

__________ occurs when a firm does not have adequate controls to monitor the employees responsible for its futures positions and those employees take more speculative positions than the firm desires.

operational risk

Which of the following is incorrect regarding organized exchanges trading financial futures contracts?

organized exchanges ensure that the seller of the futures contract always delivers the securities covered by the contract, whether the contract was settled prior to the settlement date or not

Currency futures may be purchased to hedge ____ or to capitalize on the expected ____ of that currency against the dollar.

payables; appreciation

Companies with international trade can hedge ____ by ____ currency futures.

payables; buying

Speculators in futures contracts that normally maintain the futures position that they initiate for extended periods of time (such as weeks or months) are referred to as

position traders

Which of the following is not a type of risk associated with futures contracts?

postpayment risk

Assume a corporation is receiving a large amount of funds in the near future. The company plans to use the funds to purchase municipal bonds. Also assume that the company is concerned that interest rates decrease before the purchase date, which would make the municipal bonds more expensive. In order to hedge against this possibility, the company should ____ MBI futures contracts. If interest rates decrease, the futures contract will generate a ____.

purchase; gain

If a financial institution expects that the market value of its municipal bonds will decline because of economic conditions, it could hedge its position by ____ futures contracts on ____.

selling; a Municipal Bond Index

If a futures contract is more volatile than the portfolio value, the amount of principal represented by the futures contracts to hedge the portfolio is ____ the market value of the securities to be hedged.

smaller than

Systemic risk reflects the risk that a particular event could

spread adverse effects among several firms or among financial markets

Interest rate futures are not available on

the S&P 500 Index

The net gain or loss on a futures contract for a stock index that is not closed out is based on the difference between the futures price when the initial position was created and the futures price at

the settlement date

T/F: Dynamic asset allocation involves the switching between risky and low-risk investments by institutional investors over time in response to changing expectations.

true

T/F: The effectiveness of a cross-hedge depends on the degree of correlation between the market values of the two financial instruments.

true

Assume that corporate bond portfolio managers are concerned about the possibility of many bond defaults resulting from a future recession. A short position in Treasury bond futures ____ an effective hedge against the default risk. A short position in Treasury bill futures ____ an effective hedge against the default risk.

would not be; would not be