Lecture 17

Question 1

Forward =

Answer 1

Deferred-delivery sale of asset with the sales price agreed now

Question 2

Futures =

Answer 2

Similar to forward but the feature is formalised and standardised by contracts

Question 3

Key differences between forward and future (3)

Answer 3

• Standardised contracts create liquidity
• Marked to market
• Exchange mitigates credit risk

Question 4

Futures contract =

Answer 4

Obligation to make/ take delivery of an underlying asset at a predetermined price

Question 5

Futures price =

Answer 5

Price for underlying asset is determined today, but settlement is at a future date

Question 6

Futures contract specifies

Answer 6

Quantity and quality of underlying asset and how it is delivered

Question 7

Long =

Answer 7

Commitment to purchase commodity on a delivery date

Question 8

Short =

Answer 8

Commitment to sell commodity on delivery date

Question 9

Futures are traded

Answer 9

On a margin

Question 10

At the time the contract is entered into

Answer 10

No money changes hands

Question 11

Profit to long =

Answer 11

Spot price at maturity - original futures price

Question 12

Profit to short =

Answer 12

Original futures price - sport price at maturity

Question 13

Futures contract = zero sum game

Answer 13

Gains and losses net out to zero

Question 14

Unlike call option, payoff to long position can be negative because

Answer 14

Futures trader cannot walk away from the contract if it is not profitable

Question 15

Exchange acts as

Answer 15

Clearing house and counter-party to both sides of the trade

Question 16

Net position of a trading house =

Answer 16

0

Question 17

Open interest =

Answer 17

Number of outstanding contracts

Question 18

If currently in a long position, will instruct trader to

Answer 18

Enter short side of contract to close out position

Question 19

Most futures contracts are closed out by

Answer 19

Reversing trades

Question 20

Marking to market =

Answer 20

Profits/ losses from the new futures price are paid over or subtracted from the account

Question 21

Convergence of price =

Answer 21

Movement of the price of a futures contract towards the spot price of the underlying cash commodity as the delivery date approaches. The two prices must converge, or else traders would exploit any price difference to make a risk-free profit

Question 22

Initial margin =

Answer 22

Funds/ interest earning securities deposited to provide capital to absorb losses

Question 23

Maintenance margin =

Answer 23

Established value below which trader’s margin may not fall

Question 24

Margin call =

Answer 24

When the maintenance margin is reached, the broker will ask for additional margin funds

Question 25

Speculators

Answer 25

Seek profit from price movements

Question 26

Short

Answer 26

Believe the price will fall

Question 27

Long

Answer 27

Believe the price will rise

Question 28

Hedgers

Answer 28

Seek protection from price movements

Question 29

Long hedge

Answer 29

Protecting against a rise in the purchase price

Question 30

Short hedge

Answer 30

Protecting against a fall in the selling price

Question 31

Why buy futures contract instead of just underlying asset? (2)

Answer 31

• Lower transaction costs

- Provides leverage

Question 32

Basis =

Answer 32

Difference between the futures price and the spot price Ft- Pt

Question 33

Convergence property states that at maturity

Answer 33

Ft - Pt = 0

Question 34

Basis risk =

Answer 34

Variability in basis means that gains and losses on contract and asset may not perfectly offset if they are liquidated before maturity

Question 35

Spot-Futures parity theorum states there are two ways to acquire asset for a date in the future

Answer 35

• Purchase now and store it

- Take long position in futures

Question 36

With a perfect hedge

Answer 36

Futures pay-off = certain therefore no risk, therefore should earn riskless rates of return