Hedging - Index Risk

Question 1

Elements of a forward contract

Answer 1

• Binding agreement
• Exchange a set amount of goods
• At a set future date
• At a price agreed today

Question 2

Element of a futures contract

Answer 2

• Standardised contract
• to buy or sell a specific amount
• at a particular price
• on a stipulated future date
• Futures contract represents a commitment to an additional transaction in the future

Question 3

Process in a futures question

Answer 3

1. What is needed
2. How many contracts
3. Gain/loss on futures
4. Actual transaction
5. Net

Question 4

Advantages and Disadvantages of futures

Answer 4

+ downward risk eliminated
- upside risk is also eliminated
- ‘margin call’ to top up losses may pose cash flow issue
- change in spot rate are not perfectly correlated with change in futures price

Question 5

Option - call option definition

Answer 5

An investor is entitled to buy the shares at the exercise price within the specified period

Question 6

Option - Put option

Answer 6

An investor has the right to sell the shares at the exercise price within the specified period

Question 7

Steps for an option working

Answer 7

1. What is needed
2. How many contracts
3. Cost of premium
4. Outcome on option(s)
5. Actual transaction
6. Net position