final exam - chapter 17

Question 1

Forward Contract

 Definition 

Answer 1

Forward Contract
 Definition 
Arrangement calling for future delivery of an asset at agreed-upon price today

Question 2

Who will deliver at contract expiration?

Answer 2

Trader who commits to delivering asset

Short position holder

Question 3

Who will pay for the delivery?

Answer 3

Trader who commits to purchasing asset

Long position holder

Question 4

Both traders have the _____.

Answer 4

obligations

Question 5

When to pay?

Answer 5

when delivered

Question 6

future contract definition:

Exchange traded Forward contracts =>

Answer 6

futures contracts

Contracts are standardized

Question 7

future contract definition:

OTC traded Forward contracts =>

Answer 7

forward contracts

Contracts are customized.

Question 8

Why forwards or futures?

Answer 8

Essentially a method to lock in the price of the
underlying asset to be traded in the future.
Trade the contracts from a hedging perspective.

Question 9

 Trade the contracts from a speculative perspective

Answer 9

 Expecting the underlying asset price to go up or down.
 Why not speculate by trading the underlying asset directly?
 Futures buyer pays anything when enters into the
contract?

Question 10

Clearinghouse

Answer 10

Clearinghouse
• Facilitates trading just like option clearing corporation
• Both parties must open performance bond accounts.

Question 11

• Closing out positions

3

Answer 11

• Closing out positions
 • Reversing trade
 • Take or make delivery
 • Most trades reversed and do not involve actual
    delivery

Question 12

• Open interest –

Answer 12

• Open interest – number of outstanding contracts

Question 13

Marking to Market

Answer 13

Marking to Market
 Daily settlement of obligations on
futures positions

Question 14

 Performance Bond Account Maintenance.

Answer 14

Performance Bond Account Maintenance.
 Value below which trader’s margin may
not fall; triggers margin call

Question 15

Futures buyer pays anything when enters into the

contract?

Answer 15

you pay nothing doesn’t matter about the price

this is called long features

Question 16

Speculation 

Answer 16

Speculation
 Short if you believe price will fall
 Long if you believe price will rise

Question 17

Hedging 

Answer 17

Hedging

Long: Endowment fund will purchase stock in 3
months; manager buys futures now to protect
against rise in price
 Short: Hedge fund invests in long-term bonds;
manager worries interest rates may increase and
sells futures

Question 18

Spot-Futures Parity Theorem
 Purchase commodity now, store to T  Simultaneously take short position in futures  “All-in cost” of purchasing commodity and storing it
(including cost of funds) must equal futures price to
prevent arbitrage

Answer 18

Spot-Futures Parity Theorem
 Purchase commodity now, store to T

 Simultaneously take short position in futures

 “All-in cost” of purchasing commodity and storing it
(including cost of funds) must equal futures price to
prevent arbitrage

Question 19

Futures price is not equal to the market

expected future spot price

Answer 19

Futures price is not equal to the market

expected future spot price

Question 20

How should future contracts be set?

Answer 20

 Futures price must be set in such a way the

value of the contract to both parties is zero.

Question 21

`Large component of derivatives market

Answer 21

• swaps

- foward contract is a swap with a single exchange of cash flow at it expiration

Question 22

What are swaps

Answer 22

One party agrees to pay the other a fixed
price in exchange for the market price, or
vice versa over the specified multiple times
in the future.

Question 23

Swap Tenor:

Answer 23

1. # of Cash flow exchanges

2. Cash flow frequency