Mid-term test Topic 3 Flashcards
15. A company enters into a short futures contract to sell 50,000 units of a commodity for 70 cents per unit. The initial margin is $4,000 and the maintenance margin is $3,000. What is the futures price per unit above which there will be a margin call? A. 78 cents B. 76 cents C. 74 cents D. 72 cents
- D
There will be a margin call when more than $1000 has been lost from the margin account so that the balance in the account is below the maintenance margin level. Because the company is short, each one cent rise in the price leads to a loss or 0.01×50,000 or $500. A greater than 2 cent rise in the futures price will therefore lead to a margin call. The future price is currently 70 cents. When the price rises above 72 cents there will be a margin call
16. A company enters into a long futures contract to buy 1,000 units of a commodity for $60 per unit. The initial margin is $6,000 and the maintenance margin is $4,000. What futures price will allow $2,000 to be withdrawn from the margin account? A. $58 B. $62 C. $64 D. $66
- B
Amounts in the margin account in excess of the initial margin can be withdrawn. Each $1 increase in the futures price leads to a gain of $1000. When the futures price increases by $2 the gain will be $2000 and this can be withdrawn. The futures price is currently $60. The answer is therefore $62.
17. You sell one December futures contracts when the futures price is $1,010 per unit. Each contract is on 100 units and the initial margin per contract that you provide is $2,000. The maintenance margin per contract is $1,500. During the next day the futures price rises to $1,012 per unit. What is the balance of your margin account at the end of the day? A. $1,800 B. $3,300 C. $2,200 D. $3,700
- A
The price has increased by $2. Because you have a short position you lose 2×100 or $200. The balance in the margin account therefore goes down from $2,000 to $1,800.
18. The frequency with which futures margin accounts are adjusted for gains and losses is A. Daily B. Weekly C. Monthly D. Quarterly
- A
In futures contracts margin accounts are adjusted for gains or losses daily.
- Margin accounts have the effect of
A. Reducing the risk of one party regretting the deal and backing out
B. Ensuring funds are available to pay traders when they make a profit
C. Reducing systemic risk due to collapse of futures markets
D. All of the above
- D
Initial margin requirements dramatically reduce the risk that a party will walk away from a futures contract. As a result they reduce the risk that the exchange clearing house will not have enough funds to pays profits to traders. Furthermore, if traders are less likely to suffer losses because of counterparty defaults, there is less systemic risk.
20. On Sept. 6, 2008, a copper mining company sold December 2008 futures contracts to hedge the sale price of its expected production of copper in November 2008. On this date the spot price of copper was US 180 cents per pound and the Dec. 2008 futures price was US 174 cents per pound. Subsequently, on Nov. 19, 2008, the company sold its copper production for US 188 cents per pound and at the same time closed out its December futures position for US186 cents per pound. What was the total price per pound of copper received by the company? A. 174 cents B. 186 cents C. 188 cents D. 176 cents
- D
- The basis is defined as spot minus futures. A trader is hedging the sale of an asset with a short futures position. The basis increases unexpectedly. Which of the following is true?
A. The hedger’s position improves.
B. The hedger’s position worsens.
C. The hedger’s position sometimes worsens and sometimes improves.
D. The hedger’s position stays the same.
- A
The price received by the trader is the futures price plus the basis. It follows that the trader’s position improves when the basis increases.
22. Futures contracts trade with every month as a delivery month. A company is hedging the purchase of the underlying asset on June 15. Which futures contract should it use? A. The June contract B. The July contract C. The May contract D. The August contract
- B
As a general rule the futures maturity month should be as close as possible to but after the month when the asset will be purchased. In this case the asset will be purchased in June and so the best contract is the July contract.
23. On March 1 a commodity’s spot price is $60 and its August futures price is $59. On July 1 the spot price is $64 and the August futures price is $63.50. A company entered into futures contracts on March 1 to hedge its purchase of the commodity on July 1. It closed out its position on July 1. What is the effective price (after taking account of hedging) paid by the company? A. $59.50 B. $60.50 C. $61.50 D. $63.50
- A
The user of the commodity takes a long futures position. The gain on the futures is 63.50−59 or $4.50. The effective paid realized is therefore 64−4.50 or $59.50. This can also be calculated as the March 1 futures price (=59) plus the basis on July 1 (=0.50).
24. On March 1 the price of a commodity is $1,000 and the December futures price is $1,015. On November 1 the price is $980 and the December futures price is $981. A producer of the commodity entered into a December futures contracts on March 1 to hedge the sale of the commodity on November 1. It closed out its position on November 1. What is the effective price (after taking account of hedging) received by the company for the commodity? A. $1,016 B. $1,001 C. $981 D. $1,014
- D
The producer of the commodity takes a short futures position. The gain on the futures is 1015−981 or $34. The effective price realized is therefore 980+34 or $1014. This can also be calculated as the March 1 futures price (=1015) plus the November 1 basis (= − 1).
25. A six month long forward contract on an asset is entered into when the spot price is $110 and the risk free rate of interest is 7 per cent per year. Two months later the spot price of the stock is $125 and the risk free rate of interest is still 7 per cent. Assuming continuous compounding, the forward prices at (i) the initiation of this forward contract and (ii) two months later are, respectively: A. $113.92 and $127.95 B. $117.98 and $129.45 C. $113.92 and $122.12 D. $106.22 and $122.12
- A
26. A six month, long forward contract that was negotiated four months ago has a delivery price of $500. The current spot price for the underlying asset is $550. The two month risk-free interest rate is 4.8% per annum. The value of this long forward contract at this time should be (assume continuous compounding): A. - $54.42 B. - $53.98 C. + $53.98 D. + $54.42
- C
- A company due to pay a certain amount of a foreign currency in the future decides to hedge with futures contracts. Which of the following best describes the advantage of hedging?
A. It leads to a better exchange rate being paid
B. It leads to a more predictable exchange rate being paid
C. It caps the exchange rate that will be paid
D. It provides a floor for the exchange rate that will be paid
- B
Hedging is designed to reduce risk not increase expected profit. Options can be used to create a cap or floor on the price. Futures attempt to lock in the price
- Which of the following increases basis risk?
A. A large difference between the futures prices when the hedge is put in place and when it is closed out
B. Dissimilarity between the underlying asset of the futures contract and the hedger’s exposure
C. A reduction in the time between the date when the futures contract is closed and its delivery month
D. None of the above
- B
Basis is the difference between futures and spot at the time the hedge is closed out. This increases as the time between the date when the futures contract is put in place and the delivery month increases. (C is not therefore correct). It also increases as the asset underlying the futures contract becomes more different from the asset being hedged. (B is therefore correct.)
- Which of the following is a reason for hedging a portfolio with an index futures?
A. The investor believes the stocks in the portfolio will perform better than the market but is uncertain about the future performance of the market
B. The investor believes the stocks in the portfolio will perform better than the market and the market is expected to do well
C. The portfolio is not well diversified and so its return is uncertain
D. All of the above
- A
Index futures can be used to remove the impact of the performance of the overall market on the portfolio. If the market is expected to do well hedging against the performance of the market is not appropriate. Hedging cannot correct for a poorly diversified portfolio.
