Chap 15

Question 1

Cash market

Answer 1

a market where a product or commodity changes hands in exchange for a cash price paid when the transaction is completed.

Question 2

Futures market

Answer 2

the organized market for the trading of futures contracts.

Question 3

Futures contract

Answer 3

a commitment to deliver a certain amount of a specified item at a specified date at an agreed-upon price.

Question 4

Delivery month

Answer 4

much like the expiration date on put and call options; specifies when the commodity or item must be delivered and thus defines the life of the contract.

Question 5

Differences Futures and Options

Answer 5

Options

• Right to buy
• Strike price specified in option contract
• Up-front cost (premium)
• Loss limited to price paid for option

Futures

• Obligation to buy
• Delivery price set by supply and demand
• No up-front cost
• No limit on potential loss

Question 6

Open-outcry auction

Answer 6

method once used to conduct floor trading, which required traders to shout their orders while using elaborate hand signals.

Question 7

Hedgers

Answer 7

businesses that either produce a commodity or use it as an input to their production process.

Producers and processors (futures); Financial institutions and other large corporations (financial futures).

Protect their interests in the underlying commodity or financial instrument.

Make their revenues more predictable by locking in prices, interest rates or exchange rates.
Reason for existence of futures market.

Question 8

Speculators

Answer 8

trade futures contracts simply to earn a profit on expected price swings.

• Investors
• Provide liquidity

Question 9

Open interest

Answer 9

Total number of contracts that are open and have not been settled by delivery or offsetting transaction.

Question 10

Round-trip commissions:

Answer 10

includes the commission costs on both ends of the transaction (to buy and sell contract).

Question 11

Margin deposit:

Answer 11

Amount deposited with broker at time of commodity transaction to cover any loss in market value of futures contract due to price movements.

-Margin requirements range from 2% to 10%

Question 12

Maintenance margin:

Answer 12

• Minimum amount of deposit required at all times

- Margin call occurs if value drops below allowed amount

Question 13

Mark-to-the-market:

Answer 13

an investor’s margin position is checked daily.

Question 14

Characteristic of Margin trade

Answer 14

• All futures contracts are traded on margin
• No borrowing is required
• Margin deposit
• Maintenance margin
• Mark-to-the-market

Question 15

Commodities

Answer 15

Physical commodities like grains, wood, and meat make up a major portion of the futures market.

They have been actively traded in this country for well over a century.

Question 16

Characteristics of Commodities

Answer 16

Commodities are fungible goods that are qualitatively the same regardless of the supplier.

-As long as the underlying commodity meets the contractual standard, it can be traded with futures.

Investors can choose from dozens of commodities in the market for commodity contracts.

Question 17

Characteristics in a Commodities Contract

Answer 17

• Type of product
• Size of contract (in bushels, pounds, tons)
• Exchange where contract is traded
• Method of valuing contract (e.g., cents per pound, dollars per ton)
• Delivery month
• Settlement price
• Volume

Question 18

Settlement price:

Answer 18

the last price of the day, or the closing price.

Important since it is used to determine the daily market value of the contract and, therefore, an investor’s profit or loss for the day, as well as margin requirements.

Prior settle: previous day’s settlement price.

Question 19

Volume

Answer 19

the number of contracts traded for the day.

Question 20

Price Behavior of commodities

Answer 20

• Commodity prices react to a unique set of economic, political and international pressures, as well as to weather.
• Because we are dealing with such large trading units, even a modest price change can have enormous impact on the market value of a contract and thus investor returns or losses.
• Such price behavior is part of what draws investors to commodities.

Question 21

Daily price limit (commodities)

Answer 21

restriction on the day-to-day change in price.

Question 22

Maximum daily price range:

Answer 22

the amount a commodity price can change during the day; usually equal to twice the daily price limit.

Question 23

Return on invested capital (commodity)

Answer 23

measures the return on a commodities contract.

Return on investment capital = (selling price of commodity contract - purchase price of commodity) / Amount of margin deposit

Question 24

Forms of investing in commodities:

Answer 24

Speculating

Spreading

Hedging

Question 25

Speculating (in commodities)

Answer 25

involves using commodities as a way to generate capital gains.

• Try to capitalize on the wide price swings that are characteristic of so many commodities.
• Speculating and spreading are most used by individual investors.

Question 26

Spreading

Answer 26

futures investors use this trading technique as a way to capture some of the benefits of volatile commodities prices but without all the exposure to loss.

Question 27

Hedging

Answer 27

in the commodities market is more of a technical strategy that is used almost exclusively by producers and processers to protect a position in a product or commodity.

Question 28

Financial futures

Answer 28

a segment of the futures market in which futures contracts are traded on financial instruments.

Question 29

Currency futures

Answer 29

foreign currency contracts.

-Major market currencies such as British pound, Swiss franc, Canadian dollar, Japanese yen, and euro.

Question 30

Interest rate futures

Answer 30

futures contract on debt securities

U.S. Treasury securities, Federal funds, Interest rate swaps, Euromarket deposits, Foreign government bonds.

Question 31

Stock index futures

Answer 31

contracts pegged to broad-based measures of stock market performance.

• Dow Jones industrial average
• S&P 500
• Nasdaq 100
• Russell 2000

Question 32

what contracts use the “Quote system”?

Answer 32

It used by futures is set up to reflect the market value of the contract itself.

Question 33

Futures options

Answer 33

options that give the holders the right to buy (with calls) or sell (with puts) a single standardized futures contract for a specified period of time at a specified strike price.

On commodities and financial futures

A significant advantage that a futures option has over a futures contract is that the option limits the buyer’s loss exposure to the price of the option.