Unit 4 - Interest Rate, Stock Index, and Foreign Currency Futures
Which of the following is not included in differences in the margin systems of stock and futures? A) Futures margins are set by the Federal Reserve Board. B) Futures margins are set by the exchanges. C) An investor in single stock futures is obligated to either make or take delivery, or to close out the position, before it goes into delivery. D) Regulation T is set at 50% for stock.
A) Futures margins are set by the Federal Reserve Board. Since 1974, the Federal Reserve sets stock margins under Regulation T at 50% of the purchase price regardless of volatility. Futures margins are set by the exchanges and are adjusted with regard to the volatility.
A customer takes a short position of 3 Dec 3-month Treasury bill contracts ($1,000,000 par, where 1 equals $2,500) at 95.24 and covers at 94.36. What is the result of the trade? A) Gain of .88 (88 basis points), or $6,600 B) Gain of .88 (88 basis points), or $2,200 C) Loss of .88 (88 basis points), or $6,600 D) Loss of .88 (88 basis points), or $2,200
A) Gain of .88 (88 basis points), or $6,600 $95.24 Selling price - 94.36 Buying price = $.88 Gain 2,500 Value per point, $2,200 Gain per contract x 3 Number of contracts = $6,600 Total gain
The final settlement price on the S&P index futures contract is established from the A) actual index value on the settlement day B) futures price on the settlement day C) actual index value on the day before the settlement day D) futures price on the day before the settlement day
A) actual index value on the settlement day Stock index futures settle in cash based upon the index value on settlement day. With no possibility of physical delivery, only cash settlement is viable. Thus the cash price becomes the logical settlement price for the futures.
A corporation plans a $20 million bond issue next May. To hedge that transaction with T-bond futures ($100,000 par value), the corporation should A) short 200 Jun B) go long 20 Jun C) go long 200 Dec D) short 20 Dec
A) short 200 Jun Hedgers usually seek a position in a futures contract that will mature close to the intended cash market transaction. Because the bonds will be issued in May, June is a better choice than December. To determine the correct number of contracts, divide the actual position ($20,000,000) by the contract size ($100,000). 200 contracts will hedge this anticipatory cash position.When a company plans to issue debt, it would be prudent for it to think about the possibility that interest rates may increase in the coming weeks or months before the issuance. A hedger would sell a futures contract to offset interest-rate risk on bonds. If interest rates rise, the price drop would be offset by a gain in the value of his short position in T-Bond futures contracts.
A customer shorts two soybean oil futures (60,000 lbs per contract) at $26.39 per cwt. If margin is $800 per contract, the ratio of margin to contract value is A) 10.10% B) 3.3% C) 5.05% D) 6.60%
C) 5.05% Value of each contract is $26.39 × 600 which equals $15,834 ($800 / 15,834 = 5.05%).
All of the following statements regarding a bearish investor who may prefer to sell a single stock futures contract rather than assume a short position in the stock are true EXCEPT A) because most single stock futures trade at a premium to the underlying stock's price, the investor is able to establish a higher sale price than that available with the underlying stock B) there is no need to borrow shares in order to establish a short stock futures position C) unlike the investor who sells a stock short, the investor who assumes a short single stock futures position assumes a limited risk D) the investor who assumes a short position in a single stock future at the market need not wait for an uptick to presume his order has been executed
C) unlike the investor who sells a stock short, the investor who assumes a short single stock futures position assumes a limited risk Both sellers of the stock and the sellers of the single stock futures contract face exposure to theoretically unlimited risk; there is no ceiling on how high the stock's price may rise. Selling the stock short in a securities account requires the seller to borrow stock to sell, as well as obligating the short seller to pay dividends to the lender. To prevent a form of market manipulation known as the bear raid, stock exchanges (including Nasdaq) enforce a rule that short sales must be established on an uptick or upbid, but no such rule operates for single stock futures. Because most single stock futures trade at a premium to the price of the underlying stock, a seller is able to establish a short position at a price higher than what would be available shorting the stock itself.
For an S&P 500 futures contract, the final settlement price on the last day is determined A) by the index value at noon rounded to the nearest .01 B) the same way as any other day C) using the opening prices of the stocks in the index on the third Friday of the contract month D) by the index value at noon rounded to the nearest .05
C) using the opening prices of the stocks in the index on the third Friday of the contract month This makes sense, as the last trading day is the third Thursday of the contract month. **This question deals with material not covered in your LEM, but it relates to recent rule changes and/or student feedback.
Mr. and Mrs. Jones, are planning a trip to England to purchase goods for their specialty shop. They anticipate the exchange rate will work against them. They establish a hedge when the spot market rate is at $1.9222 and the futures is a 1.9011. Later, as the time for the trip nears, they close out the futures position at $1.9734 and purchase British pounds in the cash market at $1.9751. Taking into consideration the result of the hedge, what is the exchange rate they received? A) $2.0474 B) $1.9416 C) $1.8499 D) $1.9028
D) $1.9028 The couple are planning to buy British pounds and they are afraid the U.S. dollar will weaken relative to the foreign currency, they lay on a long hedge. Cash 1.9222 - 1.9011 Futures (long). Then buy 1.9751 and sell the futures at 1.9734 for a profit on the futures of .0723. They buy the pounds at $1,9751, but due to the $.0723 profit on the futures, the net cost for the British pounds is $1.9028.
A corporation that is planning to issue $20 million of long-term bonds next year is concerned about rising interest rates. With T-bond futures at 96.12, they hedge their future borrowing and offset at 94.20. The hedge results in A) $175,000 gain B) $350,000 loss C) $175,000 loss D) $350,000 gain
D) $350,000 gain To hedge, the corporation shorts at 96.12 and offsets at 94.20, a gain of 1-24/32 per contract or $1,750 per contract x 200 contracts ($20,000,000 / 100,000 par value per contract) = $350,000 gain.
S&P 500 index futures are best suited for hedging which of the following stock portfolios? A) Portfolio of stocks of many utility companies B) Portfolio of stocks of many technology corporations C) Stock of one large industrial corporation D) Broadly diversified portfolio
D) Broadly diversified portfolio S&P 500 index futures contracts reflect overall market performance based on a large number of common stocks of companies in many diverse industries.
A corporation will receive $2,500,000 in maturing T-bills in two months, and plans to reinvest the proceeds in new T-bills. However, its financial officers worry that interest rates may decline. What should you recommend? (T-bill futures have a $1,000,000 par) A) Sell 3 T-bill futures B) Buy 2-½ T-bill futures C) Sell 2 T-bill futures D) Buy 3 T-bill calls
D) Buy 3 T-bill calls The corporation should place an anticipatory hedge by buying three T-bill futures or calls on T-bill futures today. The corporation's risk is that interest rates will decline (making T-bill prices rise). The buy hedge will profit if rates indeed decline. To fully hedge its $2,500,000 investment, the corporation needs to buy three T-bill futures or futures option contracts, each representing $1,000,000 par value.
Lex owns 1,000 shares of Swell Computer (SWL) common stock priced at $60 per share. Lex, however, worries that consumer demand for personal computers is declining and that it will depress the price of Swell Computer common stock. On January 1, Lex sells 10 SWL futures contracts at $61.25 to hedge his long position. On June 21, when the futures contract expires, Swell Computer common stock trades at $50 per share and Lex buys back his hedge at $50. What is the result of Lex's strategy? A) Gain of $21,250 B) Loss of $1,250 C) Gain of $125 D) Gain of $1,250
D) Gain of $1,250 Loss on stock $10 / share × 1,000 shares = ($10,000) Gain on futures $11.25 × 1,000 = $11,250 Result = $1,250
Erica has a long position consisting of 1,000 shares of Royal Entertainment (RNT) common stock which pays a dividend of $0.20 in November. Erica is concerned that the price of Royal Entertainment may fall. On October 1, when the stock is trading at $42.71, Erica sells 10 single stock futures contracts on RNT at $43.05. On December 20, expiration day, Erica buys back the futures RNT and sells her stock at $49.96. What is Erica's profit of loss as a result of these transactions? A) Loss of $3,400 B) Gain of $3,400 C) Loss of $540 D) Gain of $540
D) Gain of $540 Gain on stock = $49.96 − $42.71 × 1,000 = $7,250 Dividend from stock = $200 Loss from futures = $43.05 − $49.96 × 1,000 = ($6,910) Results = $540 The dividend becomes part of this investor's return because she owned the stock at the time of the dividend distribution.
If trading in shares of MNO is halted, which of the following would also be subject to the halt? MNO single stock futures A narrow-based index where MNO constitutes 50% or more of its market capitalization A narrow-based index futures contract in which MNO is a component issue of any size A) I only B) II and III C) I and III D) I and II
D) I and II If the component equals 50% or more of the index's market capitalization, a halt in a component of a security futures index contract only halts trading of the index. The halt applies to options on MNO stock.
T-bill futures trade on the A) NYSE Liffe U.S. B) KCBT C) COMEX D) IMM
D) IMM T-bill futures trade on the IMM (International Monetary Market), a division of the Chicago Mercantile Exchange (CME).
An investor holding a diversified portfolio of preferred stocks effectively hedges those securities by taking a short position in which of the following futures contracts? A) CFE VIX B) NYSE Composite C) S&P 500 D) T-bonds
D) T-bonds Preferred stocks are fixed-income assets, similar to bonds. Because preferred stock prices respond to interest rate changes as bonds do, preferred stocks are most effectively hedged by shorting interest rate futures.
Which is the most likely reason why a single stock futures contract would reflect a price that is lower than that of the underlying stock? A) Demand for the stock has fallen sharply. B) The stock has split. C) The stock has lowered or discontinued its dividend. D) The stock pays a relatively high dividend.
D) The stock pays a relatively high dividend. Generally, single stock futures trade at a premium to the underlying stock's price. Nevertheless, in rare instances when a stock offers a relatively high dividend, the market will price the single stock future at a discount. In essence, the buyer is compensated through the lower price to reflect that they are not receiving the dividend.
Why would a single stock futures contract reflect a price that is lower than that of the underlying stock? A) The stock has split. B) The stock has lowered or discontinued its dividend. C) Demand for the stock has fallen sharply. D) The stock pays a relatively high dividend.
D) The stock pays a relatively high dividend. Generally, single stock futures trade at a premium to the underlying stock's price. Nevertheless, in rare instances when a stock offers a relatively high dividend, the market will price the single stock future at a discount. In essence, the buyer is compensated through the lower price to reflect that they are not receiving the dividend.
A client has a common stock portfolio valued at $90,000. Fearing a declining market, she hedges by selling 1 Major Market Index contract at 222.25 (one point equals $500). Now, the cash value of the stock portfolio declines by $15,000 and the MMI trades at 189. What is the effect of the hedge on the portfolio? A) $1,625 gain B) $1,200 loss C) $1,200 gain D) $1,625 loss
A) $1,625 gain With the hedge, the portfolio gains $1,625. The answer factors how much the gain on the short futures position offsets the decline in the portfolio value (222.25 − 189.00 = 33.25 × 500 = $16,625 gain on futures) or (16,625 gain on futures and a 15,000 loss on stock portfolio equals a $1,625 net gain).
Which of the following is least likely to use the S&P 500 futures contract for trading or hedging? A) Bond portfolio manager B) Speculator C) Stock underwriting syndicate D) Stock portfolio manager
A) Bond portfolio manager A bond portfolio manager hedges (protects) with a futures contract on a debt instrument. A speculator might use the S&P 500 futures contract to speculate on which way the overall stock market may move. A stock portfolio manager might use a stock futures contract (S&P 500) to hedge a diversified stock position. A syndicate of broker/dealers involved in underwriting a stock issue might use an S&P 500 futures contract to hedge their risk.
Which of the following reasons would explain why the prices of single stock futures do not precisely match the prices of the underlying stocks? While owners of stock receive dividends, owners of long single stock futures positions do not. Owning a single stock future is a highly leveraged position when compared to being long the stock, so the long stock position carries more opportunity cost. This accounts for some of the pricing differential between the single stock futures contract relative to the current market value of the stock. A) Both I and II B) II only C) Neither I nor II D) I only
A) Both I and II Although the prices of SFP and the underlying stock move in the same direction, they are not identically priced instruments. For instance, the pricing of stocks typically reflects the expectation of dividend payments; because single stock futures do not entail dividends, there is price differential between the stock futures contract and the stock itself. Furthermore, the extreme leverage available with single stock futures means that the investor has less money in the investment than an investor who owns the stock outright. This also accounts for price differences between the two contracts.
Why are the prices of single stock futures different from those of the underlying stocks? Owners of stock receive dividends, but owners of long single stock futures positions do not. Owning the stock outright entails greater opportunity cost to the investor because ownership of a single stock futures contract is far more leveraged than outright ownership of a corresponding number of shares. A) Both I and II B) I only C) Neither I nor II D) II only
A) Both I and II While the prices of single stock futures and the underlying stock move in the same direction, they are not identically priced instruments. The pricing of stocks typically reflects the expectation of dividend payments and because single stock futures do not entail dividends, there is price differential between the stock futures contract and the stock itself. Furthermore, the extreme leverage available with single stock futures means that the investor has less money tied up in the investment than an investor who owns the stock outright.
XYZ Incorporated (XYZ) with common stock currently trading at $40 per share and MNO (MNO) with common stock currently trading at $60 per share both operate retail electronics stores nationwide. Company Z (a retailer) will soon introduce a new online music service that is expected to generate strong sales. Lars believes that XYZ will outperform MNO and gain market share. Nevertheless, Lars is unsure about volatility within the industry which makes him uncomfortable to own XYZ outright. With 90 days remaining before the expiration of the single-stock futures contract, Lars buys XYZ futures at $40.30 and sells MNO futures at $60.45. How much of each stock should he trade to create an equal spread? A) Buy 30 contracts of XYZ and sell 20 contracts of MNO B) Buy 30 contracts of MNO and sell 20 contracts of XYZ C) Buy 20 contracts of MNO and sell 30 contracts of XYZ D) Buy 20 contracts of XYZ and sell 20 contracts of MNO
A) Buy 30 contracts of XYZ and sell 20 contracts of MNO An effective way to calculate the equal exposure between the two stocks is to use the spread ratio. The spread ratio is one stock price divided by the other or 60 / 40 = 3:2. To correctly weight the spread, Lars should buy 30 single stock futures contracts on XYZ and sell 20 contracts on MNO. Given this 3:2 ratio, a 10% move in XYZ equals a 10% move in MNO. A 1-for-1 spread skews the spread toward the more expensive stock.
A pension fund manager operates an equity portfolio of select stocks worth $2.1 million. The portfolio has a beta of 1.10. The S&P 500 (1 pt = $250) is at 280. Which of the following would be the best hedging strategy to hedge against a down market? A) Buy 33 S&P 500 puts B) Write 33 S&P 500 calls C) Sell 33 S&P 500 futures D) Sell 30 S&P 500 futures and write 30 S&P 500 puts
A) Buy 33 S&P 500 puts $2,100,000 divided by $70,000 (280 × $250) = 30 × beta 1.1 = 33 put contracts. The manager is long the portfolio and should buy 33 puts. Selling futures would cancel out any gain on market appreciation.
It is now February. In May, your customer will receive $92,000 from the sale of his home. He plans to invest this money in Treasury bills and likes the current yield on three-month Treasury bills. Which of the following should he do to achieve today's yield? A) Buy three-month T-bill futures B) Sell three-month T-bill futures and take delivery C) Sell three-month T-bill futures D) Buy three-month T-bill futures and take delivery
A) Buy three-month T-bill futures This is an anticipatory hedge because your customer seeks protection against declining T-bill rates; this is accomplished by buying T-bill futures. There is no need to take delivery.
A U.S. importer of Japanese electronics placed a $2 million order with a Japanese manufacturing company. The importer is offered a 4% discount if he pays in yen. What should he do to protect his currency risk? A) Buy yen futures B) Sell yen futures C) Sell yen forward and buy yen futures D) Buy dollar futures
A) Buy yen futures To enjoy the discount and minimize currency risk, the importer pays in yen and hedges the cost of yen with a long position in futures. The importer buys yen futures to avoid loss if the yen rises in value prior to his purchase.
Which of the following typically has the greatest influence on Treasury bill rates? A) Federal Open Market operations B) Changing the prime rate C) Changing reserve requirements D) Changing discount rate
A) Federal Open Market operations Although the other answers influence bill rates, FOMC activities have the greatest influence. Open market operations by the Federal Open Market Committee of the Federal Reserve Board are the most commonly used tool for influencing interest rates.
In which of the following circumstances may a customer's short sell order be executed on a tick or bid higher than the previous bid? The stock is listed on the New York Stock Exchange (NYSE). The stock trades on the Nasdaq Exchange. The transaction establishes a securities futures position. A) I and II B) I and III C) II and III D) I only
A) I and II A customer's short sell order may be only be executed on a tick or bid higher than the previous bid if the order establishes a short position on a stock trading on the NYSE or on the Nasdaq. No such rule applies to the establishment of short sale positions in security futures. This is an advantage of using a security futures contract to establish a short position.
Which of the following instruments may compose a security futures contract? Common stock Preferred stock American depository receipts Broad-based stock indexes A) I and III B) II and III C) III and IV D) I and IV
A) I and III Common stock and ADRs qualify as underlying instruments for a security futures contract.
Which of the following statements best describes the regulation of margin in conjunction with single stock futures? A) Minimum margin requirements to establish customer positions in single stock futures are set by the exchanges and typically represent approximately 20% of the value of the stock underlying the futures contract. B) Margin regulation for single stock futures falls under Federal Reserve Board (FRB) Regulation T, so the initial margin that must be deposited to establish a single stock futures position is 50% of the current market value of the stock. C) Margin regulation for single stock futures falls under the regulation of the SEC, so the investor must pay interest on amounts borrowed from the firm in which the account is carried. D) All deposits of margin to initiate or carry positions on single stock futures must be made in cash.
A) Minimum margin requirements to establish customer positions in single stock futures are set by the exchanges and typically represent approximately 20% of the value of the stock underlying the futures contract. Minimum margin requirements to establish customer positions in single stock futures are set by the exchanges at 20% of the value of the stock underlying the futures contract. The margin for shares of stock is currently set at 50% for retail investors by the Fed. Unlike a stock investor buying on margin, futures margins, which are set by the exchanges, do not represent a down payment on an asset, but instead represent a kind of performance bond from the investor to the exchange clearinghouse.
Because current SEC and CFTC regulations set initial and maintenance margins for security futures at 20%, which of the following is TRUE? A) Required maintenance margin calls are not equal to mark-to-market losses. B) Exchanges and brokerage firms cannot set initial or maintenance margins levels for security futures different from 20%. C) Excess equity resulting from a favorable price move equals the gain on a security futures position. D) Marking to market is not necessary.
A) Required maintenance margin calls are not equal to mark-to-market losses. Required maintenance margin calls are not equal to marked-to-market losses. Such margin calls for long security futures positions are only 80% of the mark-to-market loss on the contract, while margin calls for short security futures positions are 120% of the loss because the maintenance margin requirement is 20% of the new market value of the contract. When there is a gain on a long security futures position, the excess equity in the account increases by only 80% of the mark-to-market gain; when there is a gain on a short security futures position, the excess equity in the account increases by 120% of the mark-to-market gain. Security futures contracts must be marked to market each business day. The regulatory initial and maintenance margin requirements are minimum levels, so exchanges and broker/dealers may set higher (but not lower) levels of margin.
Which of the following would be the most responsive to changes in the federal funds rate? A) T-bill futures B) T-bond futures C) VIX futures D) T-note futures
A) T-bill futures The federal funds rate is a short-term rate; therefore, short-term instruments would respond more immediately to changes in this rate than would long-term debt instruments.
Futures on the Dow Jones Industrial Average trade (Big Dow DJIA ($25) (D)) on which exchange? A) The Chicago Board of Trade B) The American Stock Exchange C) The Index and Option (IOM) division of the Chicago Mercantile Exchange D) The New York Stock Exchange
A) The Chicago Board of Trade Futures on the Dow Jones Industrial Average trade on the Chicago Board of Trade.
Which of the following statements regarding the holding of single stock futures positions in customer accounts is TRUE? A) Under NFA rules, single stock futures positions may be held in a commodities account. Under FINRA rules, single stock futures positions may be held in a securities account. B) Under NFA rules, single stock futures positions may not be held in customer securities accounts. C) Due to the interchangeable (fungible) nature of stock shares, single stock futures positions acquired through one established exchange may be offset on another. D) Under FINRA rules, single stock futures positions may not be held in a commodities account unless a securities account is simultaneously established.
A) Under NFA rules, single stock futures positions may be held in a commodities account. Under FINRA rules, single stock futures positions may be held in a securities account. Single stock futures represent excellent cooperation between investment regulators. Under NFA rules, single stock futures may be held in a commodities account, while under FINRA rules, single stock futures may be held in a securities account. There is no requirement that a customer holding a position in single stock futures maintain both a commodities and a securities account.
Which of the following statements regarding holding single stock futures positions in customer accounts is TRUE? A) Under NFA rules, single stock futures positions may be held in commodities accounts and under FINRA rules, single stock futures positions may be held in securities accounts. B) Under FINRA rules, single stock futures positions may not be held in commodities accounts unless a securities account is simultaneously established. C) Due to the interchangeable (fungible) nature of shares of stock, single stock futures positions acquired through one established exchange may be offset on another. D) Under NFA rules, single stock futures positions may not be held in customer securities accounts.
A) Under NFA rules, single stock futures positions may be held in commodities accounts and under FINRA rules, single stock futures positions may be held in securities accounts. Single stock futures are a cooperative effort between investment regulators. Under NFA rules, single stock futures may be held in futures accounts while under FINRA rules, and single stock futures may be held in securities accounts. There is no requirement that a customer holding a position in single stock futures maintain both a commodities and a securities account. Although shares of stock are indeed fungible (interchangeable), there is no current mechanism in place through which a customer may offset a single stock futures position acquired on one exchange on a different exchange.
All of the following are true statements of the nature and characteristics of applying short single stock futures positions EXCEPT A) a seller may only lose if the value of the security falls to $0 B) an investor may place a preset sell order underneath a stock he owns to protect against further downside movement C) if the investor is locked-out from selling a stock in a retirement plan such as a 401(k) account, he can sell the future instead D) the seller of a futures contract receives the interest rate cost of carry, less the expected dividend payment
A) a seller may only lose if the value of the security falls to $0 An investor may place a preset sell order underneath a stock he owns to protect himself against further downside movement. If locked-out from selling a stock in a retirement plan such as a 401(k) account, he can sell the future instead; the investor faces unlimited risk.
Trading single stock futures on a specific company relative to the stock market is also known as A) alpha capture B) beta squeeze C) equity swap D) single strangle
A) alpha capture Trading based on the independent risks of a specific stock is also known as alpha capture.
A U.S. exporter will be paid 2,000,000 euros in two months upon delivery of its goods. It hedges its risk (125,000 euros contract size). The exporter should A) buy EUR puts B) sell EUR calls C) buy EUR calls D) buy EUR futures
A) buy EUR puts Upon payment, the exporter will own (long) euros. Its risk is that euros will lose value relative to the USD. The exporter hedges this risk by buying euro puts which will profit if the euro falls relative to the USD.
A U.S. importer has sold forward German machine parts and has completed a contract with the manufacturer for payment in euros in 3 months. She wishes to hedge her risk. You recommend A) buy euros futures B) sell euros calls C) buy euros puts D) short euros futures
A) buy euros futures The U.S. importer, having sold forward the parts, must pay the manufacturer. Since the importer must buy euros in the futures, she should buy futures today as a hedge against the risk of a rise in the euro.
Settlement of a stock index futures contract at maturity requires the delivery of A) cash B) securities in the particular index C) a due bill D) a portfolio of securities
A) cash
A long hedger on S&P SmallCap 600 contracts (1 = $500) enters his two-contract hedge when the index is at 421.56 and the futures are 422.65. He closes and buys stock when the index is 430.21 and the futures are 431.50. The result of the hedge was a A) gain of $200 B) gain of $2000 C) loss of $200 D) loss of $2000
A) gain of $200 There is a change of -.20 (1.09 − 1.29). Long hedgers profit if the basis becomes more negative. .20 × 2 × $500 = $200 gain
A U.S. importer has sold forward Japanese cameras based on a price of 25 million yen, agreeing to deliver in 3 months. He wishes to hedge his exchange rate risk. Contract size is 12,500,000 yen. At the time of sale the yen is .004075 and Sep yen futures are .004225. At the time of delivery the yen is .004250 and the Sep futures are .004395. What is the importer's effective cost? A) $102,000 B) $105,750 C) $106,125 D) $51,000
A) $102,000 There is a change of -.000005Effective purchase price is $.004075 plus a loss of .000005 or .004080 × 25 million = $102,000. The effective cost is the final cash price (.004250) minus gains on his futures position (.004395 − .004225 = .00017).[.004250 − .00017 = .004080]
A firm that wishes to carry customer accounts trading or holding positions in single stock futures must be registered as a futures commission merchant (FCM) with the Commodity Futures Trading Commission (CFTC) broker/dealer with the Securities Exchange Commission (SEC) A) II only B) Both I and II C) I only D) Neither I nor II
B) Both I and II A firm wishing to sell single stock futures (SSFs) must be registered simultaneously as a broker/dealer with the SEC and as a futures commission merchant (FCM) with the CFTC.
Devaluation of the U.S. dollar typically has what effect on silver? A) No effect because the dollar is tied to silver B) Bullish C) None of these D) Bearish
B) Bullish A falling dollar (assuming no change in the intrinsic value of silver) should cause the price of silver (expressed in dollars and cents per ounce) to increase.
Which of the following factors is least likely to influence the price of a single stock futures contract? A) Competition in the industry in which the corporation that issued the underlying stock operates B) Changes in the rate of inflation C) Management changes in the corporation that issued the underlying stock D) Decrease in earnings in the underlying stock
B) Changes in the rate of inflation Factors that impact the underlying stock impact the single stock futures contract. These factors include management changes, changes to earnings, and the corporation's competitive position within its industry. Inflationary changes only impact stock prices indirectly.
Which of the following statements regarding customer margin for security futures is TRUE? A) Regulation T applies to both futures and securities accounts. B) Crossmargining between security futures positions in futures and securities accounts is not permitted. C) Portfolio margining systems can be used for customers' security futures positions. D) They apply to foreign customers trading security futures on foreign exchanges through U.S. brokers.
B) Crossmargining between security futures positions in futures and securities accounts is not permitted. Cross margining between securities and futures accounts is prohibited by SEC and CFTC regulations. Regulation T requirements apply to securities accounts but not to futures accounts that trade security futures. Customer margin regulations of the SEC and CFTC do not apply to foreign customers trading security futures on foreign exchanges through U.S. brokers, even though the underlying securities may be U.S. securities.
Which of the following is the type of stock least likely to be included in the Financial Index? A) Real estate investment trust B) Data processing company C) Insurance company D) Bank
B) Data processing company Only common stocks of financial businesses are included in the NYSE Financial Index.
What are federal funds? A) Funds held by the U.S. Treasury B) Excess reserves of commercial banks C) Types of mortgage-backed securities D) Tax liabilities to the federal government
B) Excess reserves of commercial banks Fed funds, or federal funds, are excess reserves at commercial banks and certain other financial institutions.
Which of the following federal acts governing investments had to be amended to permit joint regulation of single stock futures? The Commodities Exchange Act (CEA) The Securities Exchange Act The Internal Revenue Code (IRC) The Glass Steagall Act A) I and III B) I and II C) II and III D) III and IV
B) I and II The Commodity Futures Modernization Act of December 21, 2000 (CFMA) amended the Commodity Exchange Act (CEA) and the Securities Exchange Act to permit the trading of futures on single stocks and narrow-based indices futures (referred to as security futures), and to establish a framework for joint regulation by the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) of Security Futures Products (SFPs). Under the CFMA, security futures products will be subject to the joint regulation of the CFTC and the SEC.
Under NFA rules, in which of the following situations would a firm be in violation of the rules against trading ahead? The customer's order originates in a different branch office than the one from which the house order is entered. The firm's trading department has no access to information regarding customer orders. A) Both I and II B) Neither I nor II C) II only D) I only
B) Neither I nor II Neither situation reflects a deliberate action to trade ahead of customers. The NFA's Interpretive Notice regarding obligations to customers provides two examples of when a firm would reasonably not be aware of a customer's order. First, when a customer's order originates in a different branch office than the firm's proprietary order. Second, when the firm's trading department does not have access to information about customer orders.
Assuming the Federal Reserve Board tightens credit, the probable effect on the value of the dollar is A) bearish B) bullish C) none of these D) counteractive
B) bullish As the Federal Reserve tightens credit, interest rates rise; this is bullish for the dollar (versus other currencies).
The price of a security futures contract would generally be A) equal to the value of its tracking stock (if any) less the net carrying cost B) equal to the value of the underlying stock plus the net cost of carrying the stock position over the term of the futures contract C) the sum of the total dollar value of the outstanding number of shares underlying the futures contract divided by the number of shareholders D) equal to the value of the underlying stock, the total interest expense of owning the securities and the cash dividends expected to be received
B) equal to the value of the underlying stock plus the net cost of carrying the stock position over the term of the futures contract The price of a security futures contract equals the value of the underlying stock or index plus the net cost of carrying the stock or index position over the term of the futures contract.
All of the following describe original margin EXCEPT that it is A) the minimum amount of funds a customer must deposit with her broker B) established by the federal government C) established by the exchange on which the commodity trades D) the funds required by the broker when a futures contract is initiated
B) established by the federal government The federal government does not set margin requirements for futures contracts. This is done by the clearinghouses and exchanges. Specific firms may set higher (but never lower) margin requirements. The exchange requires the margin funds at the time the contract is initiated. Margin is the amount a customer must deposit when establishing a contract position, and the exchange sets customer margin requirements.
The federal funds rate is the rate of A) interest on long-term municipal bonds B) interest at which certain banks lend excess reserves to other banks C) interest collected on T-bond futures contracts D) growth of the federal funds debt
B) interest at which certain banks lend excess reserves to other banks The federal funds rate is the rate at which banks lend excess reserves to other depositories, typically overnight.
In February, a customer sells 1,500 shares short at 53-½ and hedges her position with 2 Mar S&P 500 stock index futures (1 equals $250). The contract is trading at 1104.90. In March, the customer covers her short position at 55-3/8 and offsets her futures at 1103.80. The result of the hedge is a A) net gain of $2,262.50 B) loss of $3,362.50 C) net loss of $2,262.50 D) profit of $3,362.50
B) loss of $3,362.50 The total loss is $3,362.50 (- $2,812.50 + - $550 = - $3,362.50). On the stock: Sells at: 53-½ Buys at: - 55-3/8 Loss - 1-7/8 = $1.875[- 1-7/8 × 1,500 shares = - $2,812.50] On the futures: Sells at: 1,103.80 Buys at: - 1,104.90 Loss - 1.10 [- 1.10 × 250 × 2 = -$550] Loss on the futures is $550.00, loss on the stock is $2,812.50; the total loss is $3,362.50.
Long-term U.S. Treasury bonds generally A) are discounted, and yield is the difference between the purchase price and the maturity price B) pay interest semiannually C) pay interest monthly D) pay interest annually
B) pay interest semiannually T-notes, like T-bonds, make semiannual interest payments. T-bills are discounted and yield the difference between the purchase price and the maturity price.
A 5 contract short hedge in eurodollars, entered with futures prices of 108.00, is closed when futures are 107.20. The cash transaction takes place at 107.20. What is the profit on the futures position A) $100,000 B) $100 C) $10,000 D) $1,000
C) $10,000 A basis point (.01%) is $25. 80 x 25 = 2,000 x 5 = $10,000
A U.S. importer has sold forward Japanese cameras based on a price of 25 million yen, agreeing to deliver in 3 months. He wishes to hedge his exchange rate risk. Japanese futures are 12,500,000 yen. At the time of sale the yen is .004075 and the Sep yen futures are .004225. At the time of delivery the yen is .004250 and the Sep futures are .004395. What is the importer's effective cost? A) $105,750 B) $106,125 C) $102,000 D) $51,000
C) $102,000 There is a difference of +.000005. Method One: Effective purchase price is .004075 plus a loss of .000005 or .004080 × 25 million = $102,000. Method Two: .004250 − .000170 = .004080
A speculator sells 2 index contracts at $750.10 and later buys them back at $751.45 (contract size = $500 multiplied by the index). The round-turn commissions are $60 per contract. What is the gain or loss? A) Gain of $1,470 B) Loss of $725 C) Loss of $1,470 D) Gain of $725
C) Loss of $1,470 The trader sold 2 futures contracts at 750.10 and offset them at 751.35, for a loss of 1.35 points per contract. The trading loss is 1.35 points × $500 × 2 contracts = $1,350, to which is added $120 in commission costs for 2 contracts, giving an overall loss of $1,470. Futures commissions are often quoted as a "round turn" (i.e., there is a single charge per contract to both buy and sell).
Delivery months for CBOT Treasury bond futures are A) February, May, August, November B) January, April, July, October C) March, June, September, December D) January, March, April, June, July, September, October, December
C) March, June, September, December T-bond futures use standard calendar quarters as delivery months.
How much money may be withdrawn from an investor's account when he sells a single stock future? A) 100% of the sale price B) 80% of the sale price C) None D) 50% of the sale price
C) None The seller of a SSF receives no funds. The buyer of a future does not have to pay any portion of the stock price in advance, either. Those with long and/or short positions must maintain the margin in their accounts.
Lex owns 1,000 shares of Swell Computer (SWL) common stock priced at $60 per share. Lex, however, worries that consumer demand for personal computers is declining and that it will depress the price of Swell Computer common stock. On January 1, Lex sells short 10 SWL futures contracts at $61.25 to hedge his long position. On June 21, when the futures contract expires, Swell Computer common stock trades at $70 per share and Lex buys back his hedge at $70. What is the result of Lex's strategy? A) Loss of $1,250 B) Loss of $125 C) Profit of $1,250 D) Profit of $12,500
C) Profit of $1,250 The result of the hedge is shown as follows: Gain on the long stock: $10 / share × 1,000 shares = $10,000 Loss on the short futures: $8.75 × 1,000 shares = ($8,750) Result = $1,250
An active management team maintains a portfolio of equities valued at $12.8 million with a computed beta of .8 using the S&P 500 index as its benchmark. The S&P 500 index is at 2048 with a multiplier of $250. To simulate a total hedge of the portfolio, the managers would A) Sell 25 S&P index contracts B) Buy 25 S&P index contracts C) Sell 20 S&P index contracts D) Buy 30 S&P index contracts
C) Sell 20 S&P index contracts The management team would need to sell 20 S&P index contracts to fully hedge their $12.8 million equity portfolio. $12,800,000 divided by (2048 × $250) × .8 = 20
Britain finds additional oil deposits in the North Sea and Japan has labor problems. To take advantage of the expected currency fluctuations A) sell pounds and buy yen B) buy pounds C) buy pounds and sell yen D) sell yen
C) buy pounds and sell yen Buy pounds and sell yen. Discovery of oil in the North Sea would be bullish for the pound; labor problems are bearish for yen (at least in the short term).
If the seller remits his delivery notice on a stock index futures contract, the buyer will take delivery in A) index certificates B) escrow receipts C) cash D) stock certificates
C) cash Index futures settle in cash.
If a customer establishes a short Dec futures contract in soybean oil, and then a week later goes long a May soybean oil futures contract, his margin requirement is A) doubled B) increased to the spread rate C) decreased to the spread rate D) unaffected
C) decreased to the spread rate Spreads qualify for lower margin requirements and both sides of the spread do not have to be either established or liquidated at the same time.
The price of a single stock futures contract is the ________ value of the underlying stock minus the ________ value of the dividends. A) future; present B) present; present C) future; future D) present; future
C) future; future The price of a single stock futures contract is best described as the future value of the underlying stock minus the future value of the dividends on that stock.
A pension fund manager is long $10,000,000 worth of equity stocks. The beta of his portfolio relative to the S&P 500 (Floor) futures contract (SP) is 1.2. The SP is currently priced at 1300. The SP has a $250 multiplier. The manager wishes to hedge the systematic risk of his portfolio. Of the choices given his best strategy would be to A) long 250 S&P 500 futures B) short 37 S&P 500 puts C) short 37 S&P 500 futures D) long 100 S&P 500 futures
C) short 37 S&P 500 futures Systematic (or market) risk of a long position is hedged by selling futures. $10,000,000 ÷ (1300 × $250) = 325,000 × 1.2 = 37
All of the following participate in the regulation of security futures trading EXCEPT the A) FINRA B) CFTC C) FRB D) CME
D) CME The CME is not a regulatory agency; the FRB regulates the extension of credit in the securities industry and has jurisdiction over SFP. The SEC and CFTC were jointly appointed as the primary regulators over trading in SFPs. The FINRA is one of the SEC's regulatory enforcers.
Settlement on a T-bond or T-note futures contract may occur by delivering the financial instrument to any A) bank within 50 miles of the exchange B) bank or brokerage firm C) national bank D) Federal Reserve System Bank
D) Federal Reserve System Bank CBOT regulations specify that settlement on a financial futures contract delivery occur when the financial instrument is delivered to any Federal Reserve System Bank.
Which of the following topics is NOT covered in web-based training required for securities representatives who intend to engage in the business of securities futures trading? A) Stocks and stock options B) The nature of futures contracts C) Regulatory requirements for security futures D) Hedge and spread relationships between agricultural and financial futures
D) Hedge and spread relationships between agricultural and financial futures The futures markets are rooted in agricultural commodities while securities futures have nothing to do with agricultural futures. To enable firms to sufficiently train their registered representatives, FINRA and NFA have developed a web-based training program.
A U.S. importer has sold forward German machine parts and has contracted with the German manufacturer for payment in euros in three months. If he wants to hedge his risk, you recommend A) short euro futures B) buy euro puts C) sell euro calls D) buy euro futures
D) buy euro futures The only choice listed that effectively protects the importer is buying euro futures. The U.S. importer, having sold forward the parts, must pay the manufacturer. The importer's risk is that the value of the euro will rise relative to the value of the dollar, and must place a hedge that will benefit if a rise occurs.
Settlement on an open index futures position after the last trading day is accomplished by A) delivering one share from each company B) delivering shares of selected companies of the seller's choice C) None of these D) cash
D) cash Stock index contracts use cash settlement only.
Selling stock index futures contracts can A) exchange company (business) risk for market risk B) protect against rising stock prices C) hedge a portfolio of bonds D) hedge a portfolio of common stocks
D) hedge a portfolio of common stocks By shorting a stock index futures contract to hedge a portfolio of common stocks, one virtually removes systematic risk (i.e., market risk) from the portfolio and retains only nonsystematic risk (i.e., company-specific risk). Indexes based on common stocks cannot be used to hedge holdings of bonds or preferred stock. Hedging long stock positions means protecting against falling, not rising, stock prices. Future contracts based upon T-bonds would be used to hedge a bond portfolio, not stock index contracts.
Basis risk of S&P 500 futures, when hedging a specific stock or portfolio, depends on the relationship of the A) price of the individual stock to the individual stock average B) price of the individual stock to the stock index C) futures price to the stock index D) price of the individual stock to the stock index, and the futures price to the stock index
D) price of the individual stock to the stock index, and the futures price to the stock index For an effective hedge, futures and cash price movements should correspond or correlate. Thus, the individual stock and the index futures should move in correlation. As the cash position declines, the futures position should profit.
If a corporation intends to issue $10,000,000 of debentures in April that will mature in 20 years, and wants to hedge its anticipated offering. The corporation is concerned with A) rising interest rates and therefore establishes a buying hedge B) falling interest rates and therefore establishes a selling hedge C) falling interest rates and therefore establishes a buying hedge D) rising interest rates and therefore establishes a selling hedge
D) rising interest rates and therefore establishes a selling hedge The corporation establishes a selling hedge to protect itself against higher borrowing costs due to rising interest rates and lower prices.
A U.S. exporter negotiating a contract in Mexican pesos protects his or her currency risk by A) selling T-bill futures B) buying peso futures C) buying T-bill futures D) selling peso futures
D) selling peso futures If the exporter accepts payment in pesos, he or she will ultimately have a long cash peso position. To protect this long cash position, the exporter sells (short) pesos futures.
For the S&P 500 futures contract, the final settlement price on the last day is determined A) by the index value at noon rounded to the nearest .01 B) by the index value at noon rounded to the nearest .05 C) the same way as any other day D) using the opening prices of the stocks in the index on the third Friday of the contract month
D) using the opening prices of the stocks in the index on the third Friday of the contract month The last trading day is the third Thursday of the contract month.
True or False A normal yield curve has a downward (negative) slope.
False A normal yield curve reflects lower yields on short-term bonds than (higher) yields on longer term bonds. A normal yield curve slopes upward, or has a positive slope. An inverted yield curve has a downward, or negative, slope.
True or False All security futures contracts must be fungible.
False A requirement of listing security futures is clearinghouses must have arrangements for identical security futures contracts that can be originated and offset on different markets. However, there is currently no requirement that the various markets develop identical contracts, and the contracts are not fungible.
True or False A British manufacturer contemplating the purchase of a U.S. company hedges exchange rate risk by buying British pound futures.
False Buying pound futures will not reduce the manufacturer's currency risk. The British company's risk is the pound will fall relative to the dollar; it shorts (sells) pound futures.
True or False Commodity futures exchanges are not responsible for attempting to prevent price manipulation.
False False. The ability to enforce laws against price manipulation is one of the requirements an exchange must meet to be approved by the CFTC.
True or False Credit-tightening moves by the Federal Reserve Board and an increasing balance of trade surplus for the United States is historically bullish for the U.S. dollar.
False Higher U.S. interest rates and a trade surplus typically make the dollar rise relative to other currencies.
True or False Facing the prospect of rising U.S. interest rates, an investor seeks a futures position that could protect against the falling value of the dollar.
False Rising U.S. interest rates are bullish for the dollar; one would not expect its value to fall.
True or False Swift Water Mines, a U.S. based palladium mining and export company, is looking to sell palladium to a German company with payment being made in euros. Swift Water's risk management team perceives a strengthening dollar against the euro. To hedge, the mining company would buy euro futures.
False The U.S. mining company is expecting payment in euros. When the euros are deposited in the account, it will sell the euros for dollars. If the dollar strengthens against the euro, the euro would weaken resulting in a loss for the exporter. To hedge against this eventuality, the mining company would likely make a substitute sale by selling euro futures.
True or False Your customer holds a short S&P 500 futures position through the close of the last trading day. Because the customer holds a short futures position, he must pay cash to a party holding a long position in S&P 500 futures.
False Without knowing the settlement price of the futures contract (derived from the price of the actual index) versus the previous day's settlement price, it is impossible to determine who gains and who loses.
True or False Broad-based stock indices such as the DJIA, the Nasdaq-100, and the S&P 500 that trade on futures exchanges, are not considered security futures products.
True Broad-based indexes are considered futures products, not security futures products, and are regulated exclusively by the CFTC.
True or False Actively registered securities or futures representatives who intend to engage in security futures business must complete a proficiency-training program and are not required to pass a qualifying examination.
True Currently registered securities or futures professionals who intend to engage in security futures business must complete a proficiency training program and are not required to pass qualifying examination.
True or False A speculator who believes interest rates will decline will go long financial instrument futures.
True For the speculator to benefit from falling rates, she will go long (buy) futures. As rates decrease, prices on outstanding financial instruments increase. Futures contracts trade based on prices.
True or False Hedging with stock index futures, such as the NYSE Composite and the S&P, is most effective if an individual stock correlates closely with the stock index.
True The closer the correlation, the more effective the hedge. For the futures to effectively offset risk from change in the cash position, the futures and the cash prices must change in a related manner.
True or False Hedging with stock index futures, such as the NYSE Composite and the S&P 500, is most effective if an individual stock correlates closely with the stock index.
True The closer the correlation, the more effective the hedge. For the futures to effectively offset risk from change in the cash position, the futures and the cash prices must change in a related manner. A close correlation means the two positions tend to move together. A hedge should involve a futures position that most closely matches the stock position.