Cours 2

Question 1

What is a forward contract?

Answer 1

It is an agreement to buy or sell a real or financial commodity at a pre-determined date and price.

Question 2

What are the best main characteristics of a forward contract?

Answer 2

• It is OTC
• There is no $ exchanged before maturity

Question 3

How do we describe the forward price when the contract is issued?

Answer 3

• The forward price is fixed such that the value of the contract = 0
• The forward price is different for different maturity

Question 4

What are the disadvantages of forward contracts (3)?

Answer 4

• Getting out of a forward position is difficult because you can’t terminate the contract.
• There is a credit risk of default.
• There are delivery risks.

Question 5

What is a solution for the inconveniences of a forward contract?

Answer 5

Use a futures contract; it is more flexible.

Question 6

What are the main specifications of a futures contract? (5)

Answer 6

• There are underlying assets with an exact type and quality.
• There are specified contract sizes.
• There are specificities on the delivery of the contract.
• There are clear contract expiry dates
• Standardization facilitates price comparison and increases the liquidity of contracts.

Question 7

What are the credit and delivery risk management offered by the exchange for future contracts?

Answer 7

• There is payment of collateral and daily settlement of gains and losses by a clearing house.
• There is a possibility to exit positions at any time.

Question 8

Describe the process of opening a future position.

Answer 8

1) The investor takes a long or short position.
2) The value of the future at initialization is 0.
3) The investor must place a money collateral in a margin account.

Question 9

How do you close a futures contract position?

Answer 9

By taking a position opposite to the one taken at the opening.

Question 10

What is a “front month” future contract?

Answer 10

It is a future contract that has a maturity date near the current date. They are the most liquid contract.

Question 11

What is the comportement of the delivery price of a forward and a future contract?

Answer 11

• Forward contract: delivery price is fixed during the contract’s life.
• Futures contract: delivery price changes every day.

Question 12

What is the relation between spot and future price at maturity? What happens if it is not respected?

Answer 12

1) At maturity: spot price = futures price
2) There is an arbitrage opportunity if the spot price < future price at maturity.

Question 13

What is the arbitrage strategy if the spot price < future price at maturity

Answer 13

An arbitrageur has to buy the asset, short a futures contract, and make delivery for an immediate profit.

Question 14

What is the settlement price?

Answer 14

• It is the futures price just before the market closes.
• This is the price used in the marking-to-market process.

Question 15

What is the open interest?

Answer 15

It is the number of open contracts.

Question 16

Who can initiate delivery?

Answer 16

It is the investor with the short position that can initiate delivery by notifying the central exchange of his intention to deliver.

Question 17

What happens if the trader with the short position can deliver different qualities of underlying assets?

Answer 17

If the trader delivers different qualities of the underlying assets, the futures will be affected downwards. This is because the trader with the long position is uncertain of the quality provided and is unwilling to accept a high futures price as if there were no such uncertainty.