Options and Futures Midterm Review

A short forward contract on an asset plus a long position in a European call option on the asset with a strike price equal to the forward price is equivalent to:

A long position in a put option.

Clearing houses are:

Always used in futures markets and sometimes used in OTC markets.

Which of the following is true about a long forward contract?

The contract becomes more valuable as the price of the asset rises.

You sell one December futures contracts when the futures price is $1,010 per unit. Each contract is on 100 units and the initial margin per contract that you provide is $2,000. The maintenance margin per contract is $1,500. During the next day, the futures price rises to $1,012 per unit. What is the balance of your margin account at the end of the day?

$1,800 The price has increased by $2. Because you have a short position you lose 2 × 100 or $200. The balance in the margin account therefore goes down from $2,000 to $1,800.

A one-year call option on a stock with a strike price of $30 costs $3; a one-year put option on the stock with a strike price of $30 costs $4. Suppose that a trader buys two call options and one put option. The breakeven stock price below which the trader makes a profit is:

$20 When the stock price is $20, the two call options provide no payoff. The put option provides a payoff of 30 − 20 or $10. The total cost of the options is 2 × 3 + 4 or $10. The stock price in D, $20, is therefore the breakeven stock price below which the position is profitable because it is the price for which the cost of the options equals the payoff.

A speculator takes a long position in a futures contract on a commodity on November 1, 2012, to hedge an exposure on March 1, 2013. The initial futures price is $60. On December 31, 2012, the futures price is $61. On March 1, 2013, it is $64. The contract is closed out on March 1, 2013. What gain is recognized in the accounting year January 1 to December 31, 2013? Each contract is on 1,000 units of the commodity.

$3,000 In this case, there is no hedge accounting. Gains or losses are accounted for as they are accrued. The price per unit increases by $3 in 2013. The total gain in 2013 is therefore $3,000.

The price of a stock on July 1 is $57. A trader buys 100 call options on the stock with a strike price of $60 when the option price is $2. The options are exercised when the stock price is $65. The trader's net profit is:

$300 The payoff from the options is 100 × (65 − 60) or $500. The cost of the options is 2 × 100 or $200. The net profit is therefore 500 − 200 or $300.

A one-year call option on a stock with a strike price of $30 costs $3; a one-year put option on the stock with a strike price of $30 costs $4. Suppose that a trader buys two call options and one put option. The breakeven stock price above which the trader makes a profit is:

$35 When the stock price is $35, the two call options provide a payoff of 2 × (35 − 30) or $10. The put option provides no payoff. The total cost of the options is 2 × 3 + 4 or $10. The stock price in A, $35, is therefore the breakeven stock price above which the position is profitable because it is the price for which the cost of the options equals the payoff.

A hedger takes a long position in a futures contract on a commodity on November 1, 2012, to hedge an exposure on March 1, 2013. The initial futures price is $60. On December 31, 2012, the futures price is $61. On March 1, 2013, it is $64. The contract is closed out on March 1, 2013. What gain is recognized in the accounting year January 1 to December 31, 2013? Each contract is on 1,000 units of the commodity.

$4,000 Hedge accounting is used. The whole of the gain or loss on the futures is therefore recognized in 2013. None is recognized in 2012. In this case, the gain is $4 per unit or $4,000 in total.

A speculator can choose between buying 100 shares of a stock for $40 per share and buying 1000 European call options on the stock with a strike price of $45 for $4 per option. For second alternative to give a better outcome at the option maturity, the stock price must be above:

$50 When the stock price is $50, the first alternative leads to a position in the stock worth 100 × 50 or $5000. The second alternative leads to a payoff from the options of 1000 × (50 − 45) or $5000. Both alternatives cost $4000. It follows that the alternatives are equally profitable when the stock price is $50. For stock prices above $50, the option alternative is more profitable.

With bilateral clearing, the number of agreements between four dealers, who trade with each other, is:

6 Suppose the dealers are W, X, Y, and Z. The agreements are between W and X, W and Y, W and Z, X and Y, X and Z, and Y and Z. There are therefore a total of 6 agreements.

A company enters into a short futures contract to sell 50,000 units of a commodity for 70 cents per unit. The initial margin is $4,000 and the maintenance margin is $3,000. What is the futures price per unit above which there will be a margin call?

72 cents There will be a margin call when more than $1,000 has been lost from the margin account so that the balance in the account is below the maintenance margin level. Because the company is short, each one cent rise in the price leads to a loss or 0.01 × 50,000 or $500. A greater than 2 cent rise in the futures price will therefore lead to a margin call. The futures price is currently 70 cents. When the price rises above 72 cents, there will be a margin call.

A haircut of 20% means that:

A bond with a market value of $100 is considered to be worth $80 when used to satisfy a collateral request.

A company knows it will have to pay a certain amount of a foreign currency to one of its suppliers in the future. Which of the following is true?

A forward contract can be used to lock in the exchange rate.

A company enters into a long futures contract to buy 1,000 units of a commodity for $60 per unit. The initial margin is $6,000 and the maintenance margin is $4,000. What futures price will allow $2,000 to be withdrawn from the margin account?

B. $62 Amounts in the margin account in excess of the initial margin can be withdrawn. Each $1 increase in the futures price leads to a gain of $1,000. When the futures price increases by $2 the gain will be $2,000 and this can be withdrawn. The futures price is currently $60. The answer is therefore $62.

Which entity in the United States takes primary responsibility for regulating futures market?

Commodities Futures Trading Commission (CFTC)

One futures contract is traded where both the long and short parties are closing out existing positions. What is the resultant change in the open interest?

Decrease by one

Margin accounts have the effect of: A) Reducing the risk of one party regretting the deal and backing out. B)Ensuring funds are available to pay traders when they make a profit. C) Reducing systemic risk due to collapse of futures markets. D) All of the above

D)All of the above.

The frequency with which futures margin accounts are adjusted for gains and losses is:

Daily

Which of the following describes European options?

Exercisable only at maturity

Which of the following is true?

Futures contracts are traded on exchanges, but forward contracts are not.

Which of the following is NOT true?

Futures contracts nearly always last longer than forward contracts.

Which of the following are cash settled?

Futures on stock indices

The price of a stock on February 1 is $48. A trader sells 200 put options on the stock with a strike price of $40 when the option price is $2. The options are exercised when the stock price is $39. The trader's net profit or loss is:

Gain of $200 The payoff is 40 − 39 or $1 per option. For 200 options, the payoff is therefore 1 × 200 or $200. However, the premium received by the trader is 2 × 200 or $400. The trader therefore has a net gain of $200.

For a futures contract trading in April, the open interest for a June contract, when compared to the open interest for Sept contract, is usually:

Higher

A limit order:

Is an order that can be executed at a specified price or one more favorable to the investor.

Which of the following best describes a central clearing party (CCP)?

It stands between two parties in the over-the-counter market.

The price of a stock on February 1 is $84. A trader buys 200 put options on the stock with a strike price of $90 when the option price is $10. The options are exercised when the stock price is $85. The trader's net profit or loss is:

Loss of $1,000 The payoff is 90 − 85 or $5 per option. For 200 options, the payoff is therefore 5 × 200 or $1000. However, the options cost 10 × 200 or $2000. There is therefore a net loss of $1000.

The price of a stock on February 1 is $124. A trader sells 200 put options on the stock with a strike price of $120 when the option price is $5. The options are exercised when the stock price is $110. The trader's net profit or loss is:

Loss of $1,000 The payoff that must be made on the options is 200 × (120 − 110) or $2000. The amount received for the options is 5 × 200 or $1000. The net loss is therefore 2000 − 1000 or $1000.

A one-year forward contract is an agreement where:

One side has the obligation to buy an asset for a certain price in one year's time.

Which of the following best describes central counterparties?

Perform a similar function to exchange clearing houses.

A trader has a portfolio worth $5 million that mirrors the performance of a stock index. The stock index is currently 1,250. Futures contracts trade on the index with one contract being on 250 times the index. To remove market risk from the portfolio the trader should:

Sell 16 contracts One futures contract protects a portfolio worth 1250 × 250. The number of contracts required is therefore 5,000,000/(1250 × 250) = 16. To remove market risk, we need to gain on the contracts when the market declines. A short futures position is therefore required.

Which of the following is NOT true?

The holder of a call or put option must exercise the right to sell or buy an asset.

An investor sells a futures contract an asset when the futures price is $1,500. Each contract is on 100 units of the asset. The contract is closed out when the futures price is $1,540. Which of the following is true?

The investor has made a loss of $4,000. An investor who buys (has a long position) has a gain when a futures price increases. An investor who sells (has a short position) has a loss when a futures price increases.

Which of the following is approximately true when size is measured in terms of the underlying principal amounts or value of the underlying assets?

The over-the-counter market is about ten times as big as the exchange-traded market.

Who initiates delivery in a corn futures contract?

The party with the short position.

Which of the following is NOT true about call and put options?

The price of a call option increases as the strike price increases.

In the corn futures contract, a number of different types of corn can be delivered (with price adjustments specified by the exchange) and there are a number of different delivery locations. Which of the following is true?

This flexibility tends to decrease the futures price.

Which of the following is NOT true?

When a CBOE call option on IBM is exercised, IBM issues more stock.

Which of the following best describes the term "spot price"?

the price for immediate delivery