FIN 431 Midterm

A company enters into a short futures contract to sell 20,000 units of a commodity for 60 cents per unit. The initial margin is $5,000 and the maintenance margin is $3,000. What is the futures price per unit above which there will be a margin call?

$0.70 (20000*.01)=200 200*10=2000(if 2000 is lost then initial margin is down to maintenance margin. so 10 cent increase to 70 cents

On March 1 the price of a commodity is $1,000 and the December futures price is $1,015. On November 1 the price is $980 and the December futures price is $981. A producer of the commodity entered into a December futures contracts on March 1 to hedge the sale of the commodity on November 1. It closed out its position on November 1. What is the effective price (after taking account of hedging) received by the company for the commodity?

$1,014

You sell one December futures contracts when the futures price is $1,150 per unit. Each contract is on 100 units and the initial margin per contract that you provide is $2,500. The maintenance margin per contract is $1,600. During the next day the futures price rises to $1,158 per unit. What is the balance of your margin account at the end of the day?

$1,700 2500-100(1158-1150)

The spot price of the market index is $900. A 3-month forward contract on this index is priced at $930. What is the profit or loss to a short position if the spot price of the market index rises to $920 by the expiration date?

$10 gain (930-920)

A swap is: Highly regulated. A series of forward contracts. The exchange of one asset for another.

A series of forward contracts

The spot price of the market index is $900. A 3-month forward contract on this index is priced at $930. The market index rises to $920 by the expiration date. The annual rate of interest on treasuries is 2.4% (0.2% per month). What is the difference in the payoffs between a long index investment and a long forward contract investment? (Assume monthly compounding.)

$24.59 (920-900x(1+0,2%)^3) - (920-930)

The spot price of the market index is $1,000. A 3-month forward contract on this index is priced at $1,050. The market index rises to $1,020 by the expiration date. The annual rate of interest on treasuries is 3.6% (0.3% per month). What is the difference in the payoffs between a long index investment and a long forward contract investment? (Assume monthly compounding.)

$40.97

On March 1 a commodity's spot price is $60 and its August futures price is $59. On July 1 the spot price is $64 and the August futures price is $63.50. A company entered into futures contracts on March 1 to hedge its purchase of the commodity on July 1. It closed out its position on July 1. What is the effective price (after taking account of hedging) paid by the company?

$59.50

It is July 16. A company has a portfolio of stocks worth $100 million. The beta of the portfolio is 1.2. The company would like to use the December futures contract on a stock index to change the beta of the portfolio to 0.5 during the period July 16 to November 16. The index futures price is 2,000, and each contract is on $250 times the index. a) What position should the company take? b) Suppose that the company changes its mind and decides to increase the beta of the portfolio from 1.2 to 1.5. What position in futures contracts should it take?

(a) The company should short (1.2 - 0.5) x 100,000,000 / (2,000 x 250) = 140. (b) The company should take a long position in (1.5 - 0.2) x 100,000,000 / (2,000 x 250) = 60.

A one-year long forward contract on a non-dividend-paying stock is entered into when the stock price is $40 and the risk-free rate of interest is 10% per annum with continuous compounding. a) What are the forward price and the initial value of the forward contract? b) Six months later, the price of the stock is $45 and the risk-free interest rate is still 10%. What are the forward price and the value of the forward contract?

(a) The forward price, F0, is F0 = 40 x e0.1x1 = $ 44.21. The initial value of the forward contract is zero. (b) The delivery price K in the contract is $ 44.21. The value of the contract, f, after six months is f = 45 - 44.21 x e-0.1x0.5 = $ 2.95 The forward price is 45 x e0.1x0.5 = $ 47.31

(CFA) Three 125,000 euro futures contracts are sold at a price of $1.0234. The next day the price settles at $1.018. The mark-to-market for this account changes the previous dayâ s margin by:

+$2,025 Mark-to-market Change to the Margin account = (1.0234-1.0180) x 3 x $125000 = $2025

Four 100,000 euro futures contracts are sold at a price of $1.052. The next day the price settles at $1.053. The mark-to-market for this account changes the previous dayâ s margin of long position by:

+$400

Suppose that the standard deviation of monthly changes in the price of commodity A is $2. The standard deviation of monthly changes in a futures price for a contract on commodity B (which is similar to commodity A) is $3. The correlation between the futures price and the commodity price is 0.9. What hedge ratio should be used when hedging a one month exposure to the price of commodity A?

0.60

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

6

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 When the balance in the margin account(MA) declines below the upkeep margin level after a loss of more than $1,000, a margin call(MC) will be issued. Due to the company's short position, any increase in the cost of one cent results in a loss of 1,000 Calculation of future price(FP) per unit- 50,000×(x-0.7) = $1000 (loss) x-0.7 = 0.02 x = 0.72 Therefore, an MC will occur if the FP increases by more than 2 cents. Currently, the cost for the future is 70 cents. An MC occurs when the price increases by more than 72 cents.

A futures contract is least likely: Exchange-traded. A contingent claim. Adjusted for profits and losses daily.

A contingent claim

A stock when it is first issued provides funds for a company. Is the same true of an exchange-traded stock option? Discuss.

An exchange-traded stock option provides no funds for the company. It is a security sold by one investor to another. The company is not involved. By contrast, a stock when it is first issued is sold by the company to investors and does provide funds for the company.

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

Daily

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? No change Decrease by one Decrease by two Increase by one

Decrease by one

Which of the following increases basis risk? A large difference between the futures prices when the hedge is put in place and when it is closed out Dissimilarity between the underlying asset of the futures contract and the hedgerâ s exposure A reduction in the time between the date when the futures contract is closed and its delivery month None of the above

Dissimilarity between the underlying asset of the futures contract and the hedgerâ s exposure

(CFA) Which of the following statements regarding early termination of a forward contract is most accurate? A party who enters into an offsetting contract to terminate has no risk. A party who terminates a forward contract early must make a cash payment. Early termination through an offsetting transaction with the original counterparty eliminates default risk.

Early termination through an offsetting transaction with the original counterparty eliminates default risk.

Which of the following describes European options? Sold in Europe Priced in Euros Exercisable only at maturity Calls (there are no puts)

Exercisable only at maturity

Which of the following is true Both forward and futures contracts are traded on exchanges. Forward contracts are traded on exchanges, but futures contracts are not. Futures contracts are traded on exchanges, but forward contracts are not. Neither futures contracts nor forward contracts are traded on exchanges.

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

Which of the following are cash settled All futures contracts All option contracts Futures on commodities Futures on stock indices

Futures on stock indices

(CFA) A dealer in the forward contract market: Cannot be a bank. May enter into a contract with another dealer. Gets a small payment for each contract at initiation.

Gets a small payment for each contract at initiation.

(CFA) Which of the following statements about futures market is least accurate? Hedgers trade to reduce some preexisting risk exposure. The clearinghouse guarantees that traders in the futures market will honor their obligations. If an account rises to or exceeds the maintenance margin, the trader must make a deposit.

If an account rises to or exceeds the maintenance margin, the trader must make a deposit.

(CFA) Which of the following statements regarding forward contracts on 90-day T-bills is most accurate? The face value must be paid by the long at settlement. There is no default risk on these forwards because T-bills are government-backed. If short-term yields increase unexpectedly after contract initiation, the short will profit on the contract.

If short-term yields increase unexpectedly after contract initiation, the short will profit on the contract.

(CFA) Party A has entered a currency forward contract to purchase 10 million euros at an exchange rate of $0.98 per euro. At settlement, the exchange rate is $0.97 per euro. If the contract is settled in cash, Party A will: Make a payment of $100,000. Receive a payment of $100,000. Receive a payment of $103,090.

Make a payment of $100,000.

(CFA) The daily process of adjusting the margin in a futures account is called: Variation margin. Marking-to-market. Maintenance margin.

Marking to market

A one-year forward contract is an agreement where: One side has the right to buy an asset for a certain price in one year's time One side has the obligation to buy an asset for a certain price in one year's time One side has the obligation to buy an asset for a certain price at some time during the next year One side has the obligation to buy an asset for the market price in one year's time

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

(CFA) Party A has entered a currency forward contract to purchase 15 million euros at an exchange rate of $0.96 per euro. At settlement, the exchange rate is $0.97 per euro. If the contract is settled in cash, Party A will: Make a payment of $100,000. Make a payment of $150,000. Receive a payment of $150,000.

Receive a payment of $150,000.

A company has a $36 million portfolio with a beta of 1.2. The futures price for a contract on an index is 900. Futures contracts on $250 times the index can be traded. What trade is necessary to reduce beta to 0.9?

Short 48 contracts

During the growing season, a corn farmer sells short corn futures contracts in an amount equal to her crop. If upon harvesting and selling her crop she maintains the contracts, she is then considered a(n): Hedger Speculator Arbitrager None of the above

Speculator

The price of gold is currently $1,200 per ounce. Forward contracts are available to buy or sell gold at $1,400 per ounce for delivery in one year. An arbitrageur can borrow money at 5% per annum. What should the arbitrageur do? Assume that the cost of storing gold is zero and that gold provides no income.

The arbitrageur should borrow money to buy a certain number of ounces of gold today and short forward contracts on the same number of ounces of gold for delivery in one year. This means that gold is purchased for $1,200 per ounce and sold for $1,400 per ounce. The cost of the borrowing is $60 per ounce. A riskless profit of $140 per ounce is generated.

Which of the following is true about a long forward contract? The contract becomes more valuable as the price of the asset declines The contract becomes more valuable as the price of the asset rises The contract is worth zero if the price of the asset declines after the contract has been entered into The contract is worth zero if the price of the asset rises after the contract has been entered into

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

A cattle farmer expects to have 120,000 pounds of live cattle to sell in three months. The live-cattle futures contract on the Chicago Mercantile Exchange is for the delivery of 40,000 pounds of cattle. How can the farmer use the contract for hedging? From the farmerâ s viewpoint, what are the pros and cons of hedging?

The farmer can short 3 contracts that have 3 months to maturity. If the price of cattle falls, the gain on the futures contract will offset the loss on the sale of the cattle. If the price of cattle rises, the gain on the sale of the cattle will be offset by the loss on the futures contract. Using futures contracts to hedge has the advantage that it can at no cost reduce risk to almost zero. Its disadvantage is that the farmer no longer gains from favorable movements in cattle prices.

A company wishes to hedge its exposure to a new fuel whose price changes have a 0.6 correlation with gasoline futures price changes. The company will lose $1 million for each 1 cent increase in the price per gallon of the new fuel over the next three months. The new fuel's price change has a standard deviation that is 50% greater than price changes in gasoline futures prices. If gasoline futures are used to hedge the exposure what should the hedge ratio be? What is the company's exposure measured in gallons of the new fuel? What position measured in gallons should the company take in gasoline futures? How many gasoline futures contracts should be traded? Each futures contract is on 42,000 gallons.

The hedge ratio should be 0.6 × 1.5 = 0.9. The company has an exposure to the price of 100 million gallons of the new fuel. It should therefore take a position of 90 million gallons in gasoline futures. Each futures contract is on 42,000 gallons. The number of contracts required is therefore 9,000,000/42,000 = 2142.9 or, rounding to the nearest whole number, 2143.

The basis is defined as spot minus futures. A trader is hedging the sale of an asset with a short futures position. The basis increases unexpectedly. Which of the following is true? The hedger's position improves. The hedger's position worsens. The hedger's position sometimes worsens and sometimes improves. The hedger's position stays the same

The hedger's position improves.

As the convenience yield increases, which of the following is true? The one-year futures price as a percentage of the spot price increases The one-year futures price as a percentage of the spot price decreases The one-year futures price as a percentage of the spot price stays the same Any of the above can happen

The one-year futures price as a percentage of the spot price decreases

Which of the following is true? The optimal hedge ratio is the slope of the best fit line when the spot price (on the y-axis) is regressed against the futures price (on the x-axis). The optimal hedge ratio is the slope of the best fit line when the futures price (on the y-axis) is regressed against the spot price (on the x-axis). The optimal hedge ratio is the slope of the best fit line when the change in the spot price (on the y-axis) is regressed against the change in the futures price (on the x-axis). The optimal hedge ratio is the slope of the best fit line when the change in the futures price (on the y-axis) is regressed against the change in the spot price (on the x-axis).

The optimal hedge ratio is the slope of the best fit line when the change in the spot price (on the y-axis) is regressed against the change in the futures price (on the x-axis).

The current price of silver is $30 per ounce. The storage costs are $0.48 per ounce per year payable quarterly in advance. Assuming that interest rates are 10% per annum for all maturities, calculate the futures price of silver for delivery in nine months.

The present value of the storage costs for nine months are 0.12 + 0.12 x e-0.1x0.25 + 0.12 x e-0.1x0.5 = $ 0.351 The futures price is F0, F0 = (30 + 0.351) x e0.1 x 0.75 = $ 32.72 per ounce.

Which of the following best describes the term "spot price" The price for immediate delivery The price for delivery at a future time The price of an asset that has been damaged The price of renting an asset

The price for immediate delivery

Which of the following is NOT true about call and put options: An American option can be exercised at any time during its life A European option can only be exercised only on the maturity date Investors must pay an upfront price (the option premium) for an option contract The price of a call option increases as the strike price increases

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

A call option gives the holder: The right to sell at a specific price. The right to buy at a specific price. An obligation to sell at a certain price.

The right to buy at a specific price.

Suppose that the risk-free interest rate is 10% per annum with continuous compounding and that the dividend yield on a stock index is 4% per annum. The index is standing at 400, and the futures price for a contract deliverable in four months is 405. What arbitrage opportunities does this create?

The theoretical future price is 400 x e(0.1 - 0.04)x4/12 = $ 408.08 The actual future price is only $ 405. This shows that the index futures price is too low relative to the index. The correct arbitrage strategy is (a) buy futures contracts, (b) short the shares underlying the index.

What should a trader do when the one-year forward price of an asset is too low? Assume that the asset provides no income. The trader should borrow the price of the asset, buy one unit of the asset and enter into a short forward contract to sell the asset in one year. The trader should borrow the price of the asset, buy one unit of the asset and enter into a long forward contract to buy the asset in one year. The trader should short the asset, invest the proceeds of the short sale at the risk-free rate, enter into a short forward contract to sell the asset in one year The trader should short the asset, invest the proceeds of the short sale at the risk-free rate, enter into a long forward contract to buy the asset in one year

The trader should short the asset, invest the proceeds of the short sale at the risk-free rate, enter into a long forward contract to buy the asset in one year

A company enters into a short futures contract to sell 5,000 bushels of wheat for 250 cents per bushel. The initial margin is $3,000 and the maintenance margin is $2,000. What price change would lead to a margin call? Under what circumstances could $1,500 be withdrawn from the margin account?

There is a margin call if $1000 is lost on the contract. This will happen if the price of wheat futures rises by 20 cents from 250 cents to 270 cents per bushel. $1500 can be withdrawn if the futures price falls by 30 cents to 220 cents per bushel.

A trader buys two July futures contracts on frozen orange juice. Each contract is for the delivery of 15,000 pounds. The current futures price is 120 cents per pound, the initial margin is $6,000 per contract, and the maintenance margin is $4,500 per contract. What price change would lead to a margin call? Under what circumstances could $2,000 be withdrawn from the margin account?

There is a margin call if more than $1,500 is lost on one contract. This happens if the futures price of frozen orange juice falls by more than 10 cents to below 110 cents per lb. $2,000 can be withdrawn from the margin account if there is a gain on one contract of $1,000. This will happen if the futures price rises by 6.67 cents to 126.67 cents per lb.

Which of the following statements about exchange-traded derivatives is least accurate? They are liquid. They are standardized contracts. They carry significant default risk.

They carry significant default risk.

Suppose that there are no storage costs for crude oil and the interest rate for borrowing or lending is 5% per annum. How could you make money if the June and December futures contracts for a particular year trade at $60 and $66, respectively.

You could go long one June oil contract and short one December contract. In June you take delivery of the oil borrowing $60 per barrel at 5% to meet cash outflows. The interest accumulated in six months is about 60×0.05×0.5 or $1.50. In December the oil is sold for $66 per barrel and $61.50 is repaid on the loan. The strategy therefore leads to a profit of $4.50. Note that this profit is independent of the actual price of oil in June or December. It will be slightly affected by the daily settlement procedures.

(CFA) The short in a deliverable forward contract: Has no default risk. is obligated to deliver the specified asset. Makes a cash payment to the long at settlement.

is obligated to deliver the specified asset