Chat with AIExam 11: Derivatives Markets
Explain how forward and futures markets differ.
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VerifiedA forward contract is arranged between two parties for the specific amount needed. It is an off-the-exchange, negotiated contract tailored to the needs of the counterparties. A futures contract, traded on an exchange, is a standardized contract on a quantity of a commodity or financial security. The exchange is the counterparty for all buyers and sellers of futures contracts, requiring an initial margin payment and daily settlement. The forward contract has a chance of default, whereas the futures contract does not. With only a few standardized futures contracts traded, one can seldom get a perfect hedge with futures, whereas a forward contract can hedge a transaction to the penny. Finally futures contracts provide investors with liquidity that allows them to change their positions if desired and forwards do not. Many futures do not result in delivery of the underlying asset, but forwards do.
What determines whether a buyer or a seller of a derivative security is a hedger or a speculator?
(74) VerifiedA hedger has a position in an underlying asset or an intention to trade the asset in the future. The hedger will thus trade derivatives to offset the price risk in the "spot" market. That is, the hedger buys/sells so as to gain in the derivative securities if adverse price movements occur in the spot market.A speculator in a derivative transaction has no spot position in the underlying asset and trades derivatives contracts to increase his/her risk exposure instead of decreasing it.
Options premiums vary directly with the maturity of the option.
(85) VerifiedTrue
The writer of a call option on stock benefits if the underlying stock price decrease or if the volatility of the stock's price decreases.
(85) A hedger with a long spot position should buy futures to reduce their risk.
(73) The price sensitivity rule assists the hedger by estimating the number of futures contracts to trade.
(73) Margin requirements relate to the amount of cash down payment or equity one must havedeposited before participating in a futures trade.
(77) A bank has longer duration assets than liabilities and is considering using an interest rate swap to reduce its interest rate risk. Describe how a change in interest rates would impact the bank's equity. Should the bank pay a variable rate of interest and receive a fixed interest rate in the swap or vice versa? Explain why.
(77) A bank has made fixed rate loans funded with shorter term certificates of deposit. To reduce its interest rate risk the bank could sell short term interest rate futures.
(80) A call option writer will profit if the underlying stock's volatility decreases in value, all else equal.
(69) If the option exercise price is greater than the current stock price, a call option is out-of-the-money but the put option is in-the-money.
(92) A manager of a large stock portfolio has earned a respectable return by October, and would like to protect that return for the rest of the year using options. Describe the least risky way she could guarantee a certain portfolio return with trades in derivative securities.
(65) Basis risk is the risk that the price of futures contracts will not vary in exactly the same way as the price of the item being hedged.
(89) A swap entails buying and selling a futures contract at the same time.
(72) Speculators are gamblers that provide no social value to the economy.
(81) A depository institution can reduce the variability of its cost of funds by selling Eurodollar futures.
(75) If you forecast that interest rates are likely to decrease over the next several years, you might sell a T-bond futures contract or buy an interest rate cap to take advantage of your expectations.
(81) A savings and loan with interest rate-sensitive liabilities and interest rate insensitive assets (i.e., a negative GAP) might swap future fixed rate interest payments to receive variable rate interest payments to reduce its risk.
(78) Margin risk involves the chance that initial margin requirements will be increased once an investor buys the futures contract.
(64) The long financial futures hedger net loses when futures contracts are marked to market after an increase in the price of the underlying asset.
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