Chapter 11 part 2 forwards

Question 1

what are future contracts

Answer 1

a standardized exchange-traded contract in which the seller agrees to deliver a commodity to the buyer at some point in time

Question 2

What is a clearing corporation

Answer 2

a company that is responsible for reducing the credit risk of futures contracts and option contracts and for making sure that delivery takes place

Question 3

what is margin

Answer 3

a good faith deposit with a clearing house that is made by both the buyer and the seller to ensure they complete the transaction

Question 4

what is initial margin

Answer 4

a relatively small deposit made with the clearinghouse, usually between 2 and 10% of the value of the contract

Question 5

what is maintenance or variation margin

Answer 5

a minimum amount that must be maintained in a margin account

Question 6

what is margin call

Answer 6

a requirement to add money and increase an equity postion to a minimum level

Question 7

what is daily resettlement

Answer 7

marking to market and adjusting inveotrs’ equity position

Question 8

what is settlement price

Answer 8

the price used to settle futures contracts

- usually the daily closing price

Question 9

what is notional amount

Answer 9

the dollar amount upon which a contact is valued

Question 10

what is offsetting

Answer 10

cancelling a futures position by making an equivalent but opposite transaction

Question 11

futures contracts are like what

Answer 11

like are forwards (buy from banks only)

Question 12

forwards involve what

Answer 12

credit risk which is why investors need a line of credit with their bank before they can purchase

Question 13

futures are what

Answer 13

standardized Forwards , something needs to be standardized in order to be tradable so that people know exactly what they are getting

Question 14

the dramatic growth in the development of futures markets occurred because of what problems

Answer 14

1. credit risk (borrower won’t pay) if he suffers a loss

problem solved: all futures are made with futures exchange, not with an individual

Question 15

what is the clearinghouse in canada

Answer 15

Canadian derivatives clearing corporation (CDCC) of the Montreal exchange

Question 16

what two types of margins does CDCC enforce

Answer 16

1. initial margins and

2. a maintenance or variation margin

Question 17

how is the margin set and by who

Answer 17

it is set by CDCC and it is based on the risk involved in the underlying asset: the riskier the asset the higher the margin

Question 18

new or smaller clients have a higher margin?

Answer 18

yes

Question 19

does the underlying asset and the contract need to both be standardized

Answer 19

yes

Question 20

what are the most commonly delivered months

Answer 20

March, June, Sept, December

Question 21

in practice does physical delivery take place?

Answer 21

no , most positions are closed o9ut with an offsetting transaction before the final day of trading which is generally a couple of days before delivery

Question 22

what is the general term for most futures and what does this mean for investors

Answer 22

a rolling 18 month term

investors can normally buy and sell futures on the same commodity with 6 different maturity dates

Question 23

is there a lot of trading that takes place on Canadian exchanges

Answer 23

no

Question 24

What is open interest

Answer 24

the number of contracts that are outstanding

- the true amount of futures market activity

Question 25

what is basis risk

Answer 25

the risk associated with a hedged position that is attributable to the fact that the asset to be hedged is not identical to the asset used as the hedge

Question 26

when do individuals have to report to the MX (montreal exchange)

Answer 26

when they have 250 or more contracts

Question 27

why is there a maximum of contracts someone can have

Answer 27

the maximum is 37,575

this is to make sure that no single institution dominates trading

Question 28

with more futures contracts, the underlying asset is clearly specified, and the party responsible for delivering the asset has no choice. however, bond futures generally provide what

Answer 28

a choice

Question 29

if interst rates increase then the market value of the bond will

Answer 29

fall , causing a loss in their value

Question 30

whther the gain on futures contact exactly equals the loss on the long Canada bond portfolio depends on what

Answer 30

how sensitive both are to interst rate changes

Question 31

if the bond portfolio’s value changes exactly minimc those of the asset underlying the CGB contract, the portfolio will be what

Answer 31

completely hedged

Question 32

when a portfolio is not completely hedged the investor is

Answer 32

exposed to basis risk

Question 33

what is an advantage of forward contracts

Answer 33

is that they can be structured to minimize (or even eliminate) basis risk
this is because, unlike futures, forwards are not standardized and can therefore be tailored made with respect to underlying assets and maturity dates

Question 34

for bonds, how can basis risk be reduced

Answer 34

by adjusting the number of bond futures sold to create a weighted average hedge