Options, Futures and Other Derivatives Ch5

Question 1

What is a forward contract?

Answer 1

A forward contract is an agreement between two parties to buy or sell an asset at a predetermined price on a future date.

Question 2

Differentiate between a forward contract and a futures contract.

Answer 2

Forward contracts are customized

Question 3

What is the role of the clearinghouse in futures markets?

Answer 3

Clearinghouses act as intermediaries

Question 4

Explain the concept of marking-to-market in futures trading.

Answer 4

Marking-to-market involves adjusting the margin account daily to reflect changes in the market value of the futures contract.

Question 5

Define the term marginaling in futures trading.

Answer 5

Marginaling is the process of adjusting margin accounts daily based on price changes in the underlying asset.

Question 6

What is the significance of initial margin in futures trading?

Answer 6

Initial margin is the minimum amount of cash or collateral required to open a futures position

Question 7

Explain the concept of variation margin in futures trading.

Answer 7

Variation margin is the amount of money transferred between the buyer and seller’s margin accounts daily to cover gains or losses on the futures contract.

Question 8

Define the term basis risk in futures contracts.

Answer 8

Basis risk refers to the risk that the relationship between the spot price and the futures price may change

Question 9

What are the primary reasons for using futures contracts?

Answer 9

Hedging against price fluctuations

Question 10

Explain how futures contracts aid in price discovery.

Answer 10

Futures markets provide information on future price expectations

Question 11

Define the concept of backwardation in futures markets.

Answer 11

Backwardation occurs when the futures price is lower than the spot price

Question 12

Explain the concept of contango in futures markets.

Answer 12

Contango occurs when the futures price is higher than the spot price

Question 13

What are the advantages of using futures contracts over forward contracts?

Answer 13

Standardization

Question 14

What role do speculators play in futures markets?

Answer 14

Speculators provide liquidity

Question 15

Define the term deliverable grade in futures contracts.

Answer 15

Deliverable grade refers to the quality standards that the underlying asset must meet for physical delivery in a futures contract.

Question 16

Explain the process of convergence in futures markets.

Answer 16

Convergence refers to the gradual approach of futures prices towards the spot price as the contract approaches its expiration.

Question 17

Calculate the forward price of an asset given: Spot Price = $100, Risk-free Interest Rate = 5%, Dividend Yield = 2%, Time to Expiration = 1 year.

Answer 17

Forward Price = Spot Price * e^((Risk-free Interest Rate - Dividend Yield) * Time to Expiration)

Question 18

Calculate the forward price when: Spot Price = $120, Risk-free Interest Rate = 4%, Dividend Yield = 1.5%, Time to Expiration = 0.5 years.,

Answer 18

Forward Price = Spot Price * e^((Risk-free Interest Rate - Dividend Yield) * Time to Expiration)

Question 19

Determine the basis when: Futures Price = $110, Spot Price = $105.,

Answer 19

Basis = Futures Price - Spot Price

Question 20

Calculate the implied interest rate when: Futures Price = $115, Spot Price = $110, Dividend Yield = 2%, Time to Expiration = 1 year.

Answer 20

,Implied Interest Rate = ((Futures Price / Spot Price) - 1 + Dividend Yield) / Time to Expiration

Question 21

Compute the cost-of-carry rate given: Spot Price = $90, Futures Price = $95, Time to Expiration = 6 months.,

Answer 21

Cost-of-Carry Rate = ((Futures Price / Spot Price) - 1) / Time to Expiration

Question 22

Determine the net advantage of carry when: Yield = 6%, Storage Income = $50, Interest Expense = $30.,

Answer 22

Net Advantage of Carry = (Yield + Storage Income) - Interest Expense

Question 23

Calculate the roll return for the transition from an old futures contract priced at $105 to a new futures contract priced at $110.,

Answer 23

Roll Return = New Futures Price - Old Futures Price

Question 24

Compute the convenience yield when: Spot Price = $100, Futures Price = $98, Risk-free Interest Rate = 3%, Time to Expiration = 6 months.,

Answer 24

Convenience Yield = Risk-free Interest Rate - ((Futures Price / Spot Price) - 1) / Time to Expiration

Question 25

Calculate the full carrying charge when: Storage Cost = $20, Interest Expense = $40, Time to Expiration = 1 year.,

Answer 25

Full Carrying Charge = Storage Cost + Interest Expense

Question 26

Determine the basis risk impact on futures pricing given: Futures Price = $120, Spot Price = $115, Basis = $8.,

Answer 26

Basis Risk Impact = (Futures Price - Spot Price) - Basis