Question 1

Briefly discuss the concept of margin in futures trading.

Accepted Answer

The item being traded is not transferred at the time of the futures contract, so the margin is not a down payment. Instead, it is a performance bond. It is common for the margin to be in the range of two to ten percent of the value of the contract.

Question 2

Assume a portfolio manager holds $2 million (par value) of 9 percent T-bonds that mature in 5 to 10 years. The current market price is 77, for a yield of 12 percent. Fearing a rise in interest rates over the next three months, the manager seeks to protect this position by hedging in futures.
(a) If T-bond futures are available at 67, what is the gain or loss from a simple hedge of 20 contracts if the price three months later is 60?
(b) What is the gain or loss on the cash position if the bonds are priced at 68 three months hence?
(c) What is the net effect of this hedge?

Accepted Answer

Solution: (a) Since the manager is long in the cash market, the correct hedge is a short futures position.
This problem ignores weighted hedges. The $ \$ 2 $ million face value represents $ \$ 2,000,000 / \$ 1000=2000 $ bonds, which at a current price of 77 is worth $ \$ 1,540,000 $.
The manager sells 20 contracts at a current price of 67 , for a total transaction value of $ 20(\$ 67,000)=\$ 1,340,000 $. Repurchasing the futures three months later at a price of 60 results in a total cost of $ 20(\$ 60,000)=\$ 1,200,000 $.

$\begin{array}{llll}
\text { Beginning sale } \quad \$ 67,000 \times 20 & = & \$ 1,340,000 \
\text { Ending purchase } \quad \$ 60,000 \times 20 & = & \underline{1,200,000} \
\text { Gain from short futures } & = & \$ 140,000
\end{array}$

(b) As noted in (a), there are 2000 bonds. If the bonds are priced at 68 three months later, the cash market position is:

$\begin{array}{llll}
\text { Beginning: } & \$ 770 \times 2000 & = & \$ 1,540,000 \
\text { Ending: } & \$ 680 \times 2000 & = & \underline{\$ 1,360,000} \
\text { Loss from long bonds }& & = & \$ 180,000
\end{array}$

$\text { (c) The net effect of this hedge is a loss of } \$ 40,000 \text {. }$

$\begin{array}{lll}
\text { Gain from short futures } & = & \$ 140,000 \text { from part (a) } \
\text { Loss from long bonds } & = &  \underline{180,000 \text { from part (b) }}\
\text { Net loss }&&{\$ 40,000}
\end{array}$

Question 3

As an economic function of futures markets, what does "price discovery" mean?

Accepted Answer

A)   The futures price and spot price converge over time.
B)   The spot price is a discounted value of the futures price.
C)   The futures price provides information about the expected future spot price.
D)   In equilibrium, the spot price and futures price are equal. C

Question 4

Who assumes the other side of every futures transaction?

Accepted Answer

A)   The dealer
B)   The futures exchange
C)   The commodity producer
D)   The clearinghouse

Question 5

Which of the following variables is not established on a futures contract?

Accepted Answer

A)   Contract size
B)   Contract premium
C)   Delivery date
D)   Specified grade

Question 6

The National Futures Association is the federal agency which regulates the futures markets.

Accepted Answer

A) True 
 B)False

Question 7

Which of the following represents the most popular stock-index futures position that is used to benefit from a stock market decline?

Accepted Answer

A)   A short position in the S&P 500 contract
B)   A long position in the S&P 500 contract
C)   A short position in the DJIA contract
D)   A long position in the DJIA contract

Question 8

The intermarket spread is also known as a quality spread, involving two different markets, such as buying an NYSE contract and selling an S&P contract for the same month.

Accepted Answer

A) True 
 B)False

Question 9

A pension fund holds $10 million in T-bonds. In order to protect against a rise in interest rate, the pension fund should use a short hedge in T-bond futures.

Accepted Answer

A) True 
 B)False

Question 10

Japan, which banned financial futures in 1985, is now very active in developing futures exchanges.

Accepted Answer

A) True 
 B)False

Question 11

Assume an investor buys one June NYSE Composite Index futures contract on May 1 at a price of 72. The position is closed out after four days. The prices on the three days after purchase were 72.5, 72.1 and 72.2. The initial margin is $3500.
(a) Calculate the current equity on each of the next three days.
(b) Calculate the excess equity for those three days.
(c) Calculate the final gain or loss on this position.

Accepted Answer

The answer of Assume an investor buys one June NYSE...

Question 12

Approximately what percentage of futures contracts are offset prior to delivery?

Accepted Answer

A)   25
B)   50
C)   75
D)   95

Question 13

What are the methods of settling a futures contract?

Accepted Answer

The answer of What are the methods of settling a...

Question 14

What economic functions are fulfilled by futures?

Accepted Answer

The answer of What economic functions are fulfilled by futures?...

Question 15

Futures exchange members:

Accepted Answer

A)   trade strictly for their own accounts.
B)   trade strictly for others.
C)   can trade for their own accounts or for others.
D)   are not allowed to trade on the exchange where they are members.

Question 16

Futures exchanges standardize nonstandard forward contracts, establishing such features as contract size, delivery dates, and grades that can be delivered. Only the price and number of contracts are left for futures traders to negotiate.

Accepted Answer

A) True 
 B)False

Question 17

Program trading generally involves positions in both stocks and stock-index futures.

Accepted Answer

A) True 
 B)False

Question 18

The forward price is:

Accepted Answer

A)   the price agreed upon today for deferred delivery of an asset.
B)   the spot price of an asset at the time it is delivered in the future.
C)   the future value of the spot price of an asset.
D)   a multiple of the current spot market price.

Question 19

What is meant by the term "marked to market"?

Accepted Answer

The answer of What is meant by the term "marked...

Question 20

The difference between the cash price and the futures price on the same asset or commodity is known as the:

Accepted Answer

A)   basis.
B)   spread.
C)   yield spread.
D)   premium.

Exam 20: Futures Contracts

Briefly discuss the concept of margin in futures trading.

As an economic function of futures markets, what does "price discovery" mean?

Who assumes the other side of every futures transaction?

Which of the following variables is not established on a futures contract?

The National Futures Association is the federal agency which regulates the futures markets.

Which of the following represents the most popular stock-index futures position that is used to benefit from a stock market decline?

The intermarket spread is also known as a quality spread, involving two different markets, such as buying an NYSE contract and selling an S&P contract for the same month.

A pension fund holds $10 million in T-bonds. In order to protect against a rise in interest rate, the pension fund should use a short hedge in T-bond futures.

Japan, which banned financial futures in 1985, is now very active in developing futures exchanges.

Approximately what percentage of futures contracts are offset prior to delivery?

What are the methods of settling a futures contract?

What economic functions are fulfilled by futures?

Futures exchange members:

Futures exchanges standardize nonstandard forward contracts, establishing such features as contract size, delivery dates, and grades that can be delivered. Only the price and number of contracts are left for futures traders to negotiate.

Program trading generally involves positions in both stocks and stock-index futures.

The forward price is:

What is meant by the term "marked to market"?

The difference between the cash price and the futures price on the same asset or commodity is known as the: