Finance 445 - Exam 1

Clearing houses are: -Always used in both futures and OTC markets. -Always used in OTC markets, but not in futures markets. -Never used in futures markets and sometimes used in OTC markets. -Always used in futures markets and sometimes used in OTC markets

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

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: -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. -Borrow the price of the asset, buy one unit of the asset, enter into a long forward contract to buy the asset in one year. -Borrow the price of the asset, buy one unit of the asset, enter into a short forward contract to sell the asset in one year. -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.

-Borrow the price of the asset, buy one unit of the asset, enter into a long forward contract to buy the asset in one year.

Which entity in the United States takes primary responsibility for regulating futures markets? Federal Reserve Board -Security and Exchange Commission (SEC) -US Treasury -Commodities Futures Trading Commission (CFTC)

-Commodities Futures Trading Commission (CFTC)

Which of the following is a consumption asset? -Copper -Canadian dollar -S&P 500 Index -IBM stock

-Copper

Which of the following best describes "stack and roll"? -Creates long-term hedges from short-term futures contracts. Involves two different exposures simultaneously. -Can avoid losses on futures contracts by entering into further futures contracts. -Involves buying a futures contract with one maturity and selling a futures contract with a different maturity.

-Creates long-term hedges from short-term futures contracts.

Which of the following increases basis risk? -A reduction in the time between the date and when the futures contract is closed and its delivery month. -Dissimilarity between the underlying asset of the futures contract and the hedger's exposure. -A large difference between the futures price when the hedge is put in place and when it is closed out.

-Dissimilarity between the underlying asset of the futures contract and the hedger's exposure.

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

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

Which of the following is not true? -Forward contracts usually have one specified delivery date; futures contract often have a range of delivery dates. -Futures contracts nearly always last longer than forward contracts. -Delivery or final cash settlement usually takes place with forward contracts; the same is not true of futures contracts. -Futures contracts are standardized; forward contracts are not.

-Futures contracts nearly always last longer than forward contracts.

A silver mining company has used futures markets to hedge the price it will receive for everything it will produce over the next 5 years. Which of the following is true? -The operation of futures markets protects it from liquidity problems. -It is liable to experience liquidity problems if the price of silver rises or falls dramatically. -It is liable to experience liquidity problems if the price of silver falls dramatically. -It is liable to experience liquidity problems if the price of silver rises dramatically.

-It is liable to experience liquidity problems if the price of silver rises dramatically.

A company due to pay a certain amount of a foreign currency in the future decides to hedge with futures contracts. which of the following best describes the advantage of hedging? -It provides a floor for the exchange rate that will be paid. -It leads to a more predictable exchange rate being paid. -It leads to a more predictable exchange rate being paid. -It caps the exchange rate that will be paid.

-It leads to a more predictable exchange rate being paid.

Given a choice between 5-year and 1-year instruments most people would choose 5-year instruments when borrowing and 1-year instruments when lending. Which of the following is a theory consistent with this observation? -Maturity Preference Theory -Liquidity Preference Theory -Market Segmentation Theory -Expectations Theory

-Liquidity Preference Theory

After the credit crisis that started in 2007 and up through 2021, which of the following have derivatives traders used as the risk-free rate? -Repo Rate -Treasury Rate -LIBOR Rate -Overnight Indexed Swap Rate

-Overnight Indexed Swap Rate

Which of the following best describes central clearing parties (CCP)? -Are used for futures transactions. -Must be used for all OTC derivative transactions. -Perform a similar function to exchange clearing houses. -Help market participants to value derivative transactions.

-Perform a similar function to exchange clearing houses.

Farmer Bob will harvest his soybeans crop in 6 months, but wants to lock in a price today. Farmer Bob will most likely: - Buy a soybeans futures contract. -Sell a soybeans futures contract. -Buy a soybeans forward contract.

-Sell a soybeans futures contract.

Which of the following is true? -Gold producers should always hedge the price they will receive for their production of gold over the next one year. -Gold producers can hedge by buying gold in the forward market. -Gold producers should always hedge the price they will receive for their production of gold over the next three years. -The hedging strategies of a gold producer should depend on whether its shareholders want exposure to the price of gold.

-The hedging strategies of a gold producer should depend on whether its shareholders want exposure to the price of gold.

Which of the following is NOT true? -A put option gives the holder the right to sell an asset by a certain date for a certain price. -The holder of a call or put option must exercise the right to sell or buy an asset. -The holder of a forward contract is obligated to buy or sell an asset. -A call option gives the holder the right to buy an asset by a certain date for a certain price.

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

A repo rate is: -The rate implicit in a transaction where securities are sold and bought back at a higher price. -An uncollaterized rate. -A rate where the credit risk is relatively high.

-The rate implicit in a transaction where securities are sold and bought back at a higher price.

Open interest includes: -The sum of short or long positions and clearinghouse positions. -The sum of short and long positions. -The sum of short, long, and clearinghouse positions. - Only contracts with a specified delivery date. -Only short or long positions, but not both.

-The sum of short and long positions.

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 may increase or decrease the futures price. -This flexibility tends to decrease the futures price. -This flexibility has no effect on the futures price. -This flexibility tends to increase the futures price.

-This flexibility tends to decrease the futures price.

At what interest rate does a government borrow in its own currency? -Treasury rate -SOFR -LIBOR -Repo rate

-Treasury rate

The basis is defined as spot minus futures. A trader is hedging the sale of an asset with a short futures position. The basis strengthens unexpectedly. The hedger's position: -sometimes worsens and sometimes improves -stays the same -improves -worsens

-improves

The basis is defined as spot minus futures. A trader is hedging the purchase of an asset with a long futures position. The basis strengthens unexpectedly. The hedger's position: -improves -worsens -stays the same -sometimes worsens and sometimes improves

-worsens

With bilateral clearing, the number of agreements between 4 dealers who trade with each other is:

12. 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. Use combination formula: C(4,2) = 4! / [2!*(4-2)!] = 4! / 2!*2! = [4*3*2*1] / [(2*1)*(2*1)] = 24/4 = 6

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.

Margin accounts have the effect of: (I) Reducing the risk of one party regretting the deal and backing out. (II) Ensuring funds are available to pay traders when they make a profit. (III) Reducing systemic risk due to collapse of futures markets.

All of the above are true.

Which of the following parties to an option contract on a company's shares has the right to buy shares at the exercise price? -Call buyer -Put seller -Call seller

Call Buyer

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

Daily

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

FUtures on stock indices

Which of the following is NOT true about forward and futures contracts? -Taxes and transaction costs can lead to forward and futures prices being different. -Forward contracts are more liquid than futures contracts. -The futures contracts are traded on exchanges while forward contracts are traded in OTC. -In theory forward prices and futures prices are equal when there is no uncertainty about future interest rates.

Forward contracts are more liquid than futures contracts.

Under liquidity preference theory, which of the following is always true? -Forward rates are higher than expected future spot rates. -The forward rate is higher than the spot rate when both have the same maturity. -Forward rates are unbiased predictors of expected future spot rates. -The spot rate for a certain maturity is higher than the par yield for that maturity.

Forward rates are higher than expected future spot rates.

Counterparty risk is most likely lowest for: -Forward contracts -Swap contracts -Futures contracts

Futures Contracts

Swap contracts:

Have an initial net value of zero.

Which of the following is true? -If all companies in an industry hedge, a company in the industry can reduce its risk by choosing not to hedge. -If all companies in an industry do not hedge, a company in the industry can reduce its risk by hedging. -Hedging can always be done more easily by a company's shareholders than by the company itself. -If all companies in an industry do not hedge, a company is liable to increase its risk by hedging.

If all companies in an industry do not hedge, a company is liable to increase its risk by hedging.

Which of the following is NOT true? -Gold and silver are investment assets. Correct Answer: -Investment assets are held by significant numbers of investors for investment purposes. -The forward price of an investment asset can be obtained from the spot price, interest rates, and the income paid on the asset. -Investment assets are never held for consumption.

Investment assets are never held for consumption.

A limit order

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

Which of the following is true of LIBOR? -The LIBOR rate is free of credit risk. -A LIBOR rate is lower than the Treasury rate when the two have the same maturity. -It is subject to favorable tax treatment in the U.S. -It is a rate used when borrowing and lending takes place between banks.

It is a rate used when borrowing and lending takes place between banks.

Which of the following is true about the convenience yield? -It measures the average return earned by holding futures contracts. -It is always negative for a consumption asset. -It is always positive or zero. -It is always positive for an investment asset.

It is always positive or zero.

Prior to the credit crisis that started in 2007, which of the following was the proxy used by derivatives traders for the risk-free rate? -Treasury Rate -Overnight Indexed Swap Rate -LIBOR Rate -Repo Rate

LIBOR Rate

Which of the following does NOT describe beta? -A measure of the sensitivity of the return on an asset to the return on an index. -The hedge ratio necessary to remove market risk from a portfolio. -Measures correlation between futures price and spot prices. -The slope of the best fit line when the return on an asset is regressed against the return on the market.

Measures correlation between futures price and spot prices.

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.

Forward contracts and futures contracts, with otherwise identical terms, are similar with respect to:

Payoffs at maturity

The value of a derivatives contract is most likely to be directly affected by the:

Price of the underlying Asset

Which of the following parties to an option contract on a company's shares is obligated to buy shares at the option strike price if the option is exercised? -Put buyer -Call seller -Put seller

Put Seller

Starting in 2022, which of the following have derivatives traders used as the risk-free rate? -LIBOR Rate -Repo Rate -Overnight Indexed Swap Rate -SOFR

SOFR

What way is the forward price of a foreign currency is quoted?

Some forward prices are always quoted as the number of USD per unit of the foreign currency and some are always quoted the other way round.

Relative to a futures contract, an advantage of a forward contract is:

The ability to customize the contract

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

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

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

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

The spot price of an asset is positively correlated with the market. Which of the following would you expect to be true? -The forward price is sometimes greater and sometimes less than the expected future spot price. -The forward price is less than the expected future spot price. -The forward price is greater than the expected future spot price. -The forward price equals the expected future spot price.

The forward price is less than the expected future spot price.

Which of the following describes contango? -The futures price is below the expected futures spot price. -The futures price is a declining function of the time to maturity. -The futures price is below today's spot price. -The futures price is above the expected futures spot price.

The futures price is above the expected futures spot price.

What way is the futures price of a foreign currency is quoted?

The number of US dollars (USD) per unit of the foreign currency.

As inventories of a commodity decline, which of the following is true? -The one-year futures price as a percentage of the spot price increases, decreases, or stays the same. -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 stays the same.

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

Who initiates delivery in a soybean futures contract?

The party with the short position.

Which of the following best describes the term futures price?

The price for delivery at a future time.

Which of the following best describes the term spot price?

The price for immediate delivery.

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

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

Which of the following is true for a consumption commodity? -The futures price can be determined with reasonable accuracy from the spot price and interest rates. -There is an upper limit to the futures price but no lower limit, except that the futures price cannot be negative. -There is no limit to how high or low the futures price can be, except that the futures price cannot be negative. -There is a lower limit to the futures price but no upper limit.

There is an upper limit to the futures price but no lower limit, except that the futures price cannot be negative.

Bootstrapping involves: Working from long maturity instruments to shorter maturity instruments determining zero rates at each step. Working from short maturity instruments to longer maturity instruments determining zero rates at each step. -Calculating the yield on a bond. -The calculation of par yields.

Working from short maturity instruments to longer maturity instruments determining zero rates at each step.

The basis is defined as spot minus futures. A trader is hedging the purchase of an asset with a long futures position. The basis weakens unexpectedly. The hedger's position: -stays the same -sometimes worsens and sometimes improves -improves -worsens

improves

The basis is defined as spot minus futures. A trader is hedging the sale of an asset with a short futures position. The basis weakens unexpectedly. The hedger's position: -worsens -improves -sometimes worsens and sometimes improves -stays the same

worsens