Practice Test 1

Question 1

Discretionary accounts must be renewed by the customer:

a. Every six months
b. Every 12 months
c. At the discretion of the member firm
d. Never

Answer 1

d. Never
Discretionary accounts need not be renewed by the customer.

Question 2

Unless a time limit is specified, an order automatically expires at the end of the day.

a. True
b. False

Answer 2

a. True
Unless otherwise specified, all orders are assumed to be day orders and are canceled at the end of the trading session if they have not been executed. If a customer does not want the order to be canceled, he will instruct the broker to keep it in effect. The broker will then enter a good until canceled (GTC) notation on the order before it is sent to the floor broker. This type of order remains in effect until it is executed, or the customer cancels the order, or the contract month expires.

Question 3

When futures prices are higher than the cash price, the market would be:

a. Inverted
b. Reverse
c. Discount
d. Premium

Answer 3

d. Premium
If the price of futures is higher than the price of the cash commodity, and the price of distant futures is higher than the price of near futures, the market is called a premium market or a carrying charge market. The terms inverted market and discount market both refer to a market where the price of cash is higher than the price of futures, and the price of near futures is higher than the price of distant futures.

Question 4

Each day the clearing house determines the margin requirements of the speculator and hedge customers of all brokerage firms.

a. True
b. False

Answer 4

b. False
The clearing house determines the amount of margin that is owed to the clearing house by the clearing member firm at the end of each day. The clearing member firm is required to deposit any additional margin that is required before the opening of trading the next day. If there is excess equity in the member firm’s account at the clearing house, the member firm could withdraw the excess.

This question is not stating that the clearing house determines the margin due from member firms. Instead, it is saying that the clearing house determines the amount of margin due from customers of member firms. The member firm is responsible for determining and collecting the amount of margin that customers must deposit, not the clearing house.

Question 5

An individual who buys a futures contract against a cash forward sale is a:

a. Spreader
b. Scalper
c. Hedger
d. Speculator

Answer 5

c. Hedger
An individual who buys a futures contract against a cash forward sale is known as a hedger. The term cash forward sale refers to a cash market transaction in which the buyer and the seller negotiate for the sale of a specified amount of a commodity to be delivered on a specified date in the future. The price might be agreed upon at the time of the sale, or the buyer and seller might agree that the price is to be determined at the time of delivery. If the seller of the commodity does not own it at the time of the sale, and the price is determined as of the time the transaction is negotiated, he will be concerned about a price rise. He would therefore hedge by buying futures.

Question 6

A GNMA futures contract is least similar to which of the following contracts?

a. T-notes
b. T-bonds
c. Municipal Bonds
d. T-bills

Answer 6

d. T-bills
GNMA, T-notes, T-bonds and municipal bonds all have long-term maturities. T-bills have short-term maturity.

Question 7

If a customer dies, an associated person should cancel all open orders.

a. True
b. False

Answer 7

b. False
If a customer dies, the member firm should cancel all open orders.

Question 8

An elevator, warehouse or depository is designated as regular for delivery by:

a. The CFTC
b. The Exchange
c. The U.S. Department of Agriculture
d. The U.S. Department of Commerce

Answer 8

b. The Exchange
The exchange determines which grain elevators, warehouses or other depositories are regular for delivery, which means those from which the commodity may be delivered by a futures seller to a futures buyer.

Question 9

The minimum margin that a member firm must collect from its customers is determined by:

a. The CFTC
b. The floor committee of the exchange
c. The board of directors of the exchange
d. The member firm

Answer 9

c. The board of directors of the exchange
An individual who buys a futures contract against a cash forward sale is known as a hedger. The term cash forward sale refers to a cash market transaction in which the buyer and the seller negotiate for the sale of a specified amount of a commodity.

Question 10

A stop order to sell would be used to liquidate a long in a falling market?

a. True
b. False

Answer 10

a. True
A stop order to sell is placed below the market to liquidate a long position in a falling market. It is used to attempt to limit the loss on a long position.

Question 11

An elevator operator who purchases grain and hedges generally plans to deliver the grain on each futures contract that the hedger sells.

a. True
b. False

Answer 11

b. False
A grain elevator operator who has purchased grain will hedge by selling futures. His intention in selling futures is to protect himself against a price decline on his inventory. Although he has the option of delivering on his futures contract, his intention at the time he placed the hedge was only to protect his cash position, not to use the futures market as a means of selling his cash grain.

Question 12

The FCM’s APs, partners or officers are required to learn the essential facts about the firm’s customers and must supervise the amount of trading and the nature of trading in each account that the member firm maintains.

a. True
b. False

Answer 12

a. True
The APs, the manager of the office and the principals of the firm are required to use due diligence to know the customer and insure that transactions for the customer are suitable based on the customer’s financial means and investment objectives.

Question 13

When there appears to be adequate nearby cash stocks of a commodity with available storage, the futures market would be:

a. Inverted
b. Normal
c. Flat
d. Characterized by low open interest

Answer 13

b. Normal
A normal market is one in which the cash price is lower than the price of futures, and the price of near futures is lower than the price of distant futures. This type of market will occur when there are adequate supplies of the cash commodity and adequate storage facilities. In this case, buyers will not be particularly anxious to acquire the cash commodity, tending to reduce demand. However, farmers who have brought their crop to market will be under pressure to sell it in order to raise money to repay loans and to prepare for the next planting season. There will therefore be pressure on supply that is not matched by a corresponding demand, and the price of cash will tend to drop.

As the crop year proceeds, the initial large supply will be consumed. The price of the commodity will tend to increase as users who did not acquire the commodity before will enter orders to buy it. These purchases will be made from individuals who bought the commodity and stored it. The higher price that will be paid for the commodity will reflect the carrying charges, which are the costs that were incurred by those individuals who stored the commodity.

Question 14

An exporter of soybean oil, confident that the price of soybeans, the demand for soybean oil, and currency exchange rates will remain stable, would be most concerned with:

a. Increases in the cost of soybeans
b. Decreases in the demand for soybean oil leading to falling prices
c. Fluctuations in the foreign exchange rates in the countries where the product is sold
d. Increases in shipping rates

Answer 14

d. Increases in shipping rates
Given that the exporter is confident that the price of soybeans, the demand for soybean oil, and currency exchange rates will remain stable, he would still be concerned that the cost of shipping could increase and thus diminish his profit. In order to protect himself from an increase in shipping costs, he could purchase freight futures.

Question 15

If the exchange changes the margin requirement, all traders whose equity is below the new maintenance margin level will always be required to deposit additional margin to immediately raise the equity to the new initial margin level.

a. True
b. False

Answer 15

a. True
When the exchange changes the margin requirement, accounts that are below the new maintenance level must deposit additional margin to immediately raise the equity to the new initial margin level.

Question 16

The rules of the Chicago Board of Trade allow any RCR to exercise discretion over a customer’s account.

a. True
b. False

Answer 16

b. False
The Chicago Board of Trade does not allow an RCR to exercise discretion over a customer’s account unless he has had at least two years of experience and has been continuously registered during that period.

Question 17

The size of the open interest of commodity futures contracts is NOT limited to the available supply of the cash commodity.

a. True
b. False

Answer 17

a. True
Open interest is the total number of contracts that have been established in a commodity that have not yet been closed out. There is no direct relationship between the open interest and the available supply of the commodity.

Question 18

A stop order to buy would be used to offset a short position in a rising market.

a. True
b. False

Answer 18

a. True
A stop order to buy is placed above the market price to offset a short position in a rising market. It is used to attempt to limit the loss on a short position.

Question 19

Your client is long 3 March live cattle contracts at 45.30 cents. He later offsets at 48.40 cents. The contract size is 40,000 lbs. Ignoring commission, his realized gain is:

a. $3,720
b. $3,550
c. $1,240
d. $1,050

Answer 19

a. $3,720
Your client has a gain of $3,720 determined as follows:

Question 20

If you hear that a market for a grain is “5 cents under”, you would assume:

a. That the nearest futures month is trading 5 cents less than the next futures month
b. That the price of cash grain is 5 cents less than its normal price at this time of the year
c. That the price of cash grain is 5 cents less than the price of the nearest futures month
d. That the price of the nearest futures month is 5 cents less than the price of the cash grain

Answer 20

c. That the price of cash grain is 5 cents less than the price of the nearest futures month
The price for grain is frequently quoted under a basis method rather than a flat price method. The basis method quotes the cash price as it relates to the futures price. The flat price method quotes the price as a dollar amount. For example, let’s assume the cash price is $4.50 and the price of the nearest futures month is $4.55. Under the basis method, the price would be stated as “5 cents under”. This is because the price of cash is 5 cents under the price of futures. Under the flat price method, the price of cash would be quoted as $4.50.

Question 21

The price of a futures contract bought or sold is determined by:

a. The exchange
b. Prearranged agreements between floor brokers
c. The floor broker on the exchange trading floor
d. Open bids and offers on the exchange floor

Answer 21

d. Open bids and offers on the exchange floor
All orders in futures contracts are transacted on the floor of the exchange in the trading pits. The floor brokers must announce their bids and offers by open outcry. The price of the contract is determined by the highest bid and the lowest offer at any particular time. There are no prearranged agreements on the exchange floor between brokers or between anyone else, with the single exception of the ex-pit trades, which is a special type of trade in which hedgers exchange their cash and futures positions by private negotiation.

Question 22

Records of IBs, FCMs, CTAs and CPOs must be kept seven years.

a. True
b. False

Answer 22

b. False
This is false. CFTC rules require records to be kept for five years.

Question 23

The sale of September wheat in Chicago and the purchase of September wheat in Kansas City would be an:

a. Intermarket spread
b. Interdelivery spread
c. Intramarket spread
d. None of the above

Answer 23

a. Intermarket spread
An intermarket spread is the purchase of a commodity in one market (in this case, Kansas City) and the sale of the same commodity in another market (in this case, Chicago). The terms “intramarket spread” and “interdelivery spread” both refer to the same thing. This is the purchase and sale of the same commodity on the same exchange in different delivery months. For example, the purchase of September wheat on the Chicago Board of Trade and the sale of December wheat on the Chicago Board of Trade would be an example of an intramarket or interdelivery spread.

Question 24

If the price of a commodity becomes extremely volatile, margin is increased and leverage is decreased.

a. True
b. False

Answer 24

a. True
This is true. Margin requirements are increased if the market price of the commodity becomes volatile.

Question 25

An individual has described himself as a fundamental analyst. This means that he is primarily concerned with:

a. Point and figure charts
b. The direction of price changes, changes in volume and changes in open interest as indicated on charts
c. Supply and demand factors relating to the commodity plus basic economic and governmental factors
d. All of the above

Answer 25

c. Supply and demand factors relating to the commodity plus basic economic and governmental factors
A fundamental analyst is interested in such factors as supply and demand for the commodity, basic economic data, governmental actions, weather conditions and the like. Technical analysts are interested in such factors as charts and trading volume.

Question 26

A hedger is computing the basis on which he will sell his cash commodity. The hedger will compute the basis that he will offer:

a. By noting the current price of the commodity and adding 50% to allow him a profit
b. By computing the difference between the price of the cash commodity and the price of the futures contract that was purchased or sold
c. By assuming that prices will not change and therefore disregarding all factors other than transportation
d. By charging the price of futures at the nearest contract market

Answer 26

b. By computing the difference between the price of the cash commodity and the price of the futures contract that was purchased or sold
The basis is the difference between the price of the cash commodity and the price of the futures contract that was purchased or sold. The cash market, in relation to the futures market for the same commodity, varies from time to time because of transportation costs, interest rates, available storage space, and supply and demand. In a normal (premium) market, the price of the cash commodity is under the futures price. For example: ##ADD IMAGE

Question 27

A trader assumes two long contracts in sugar at a price of 8.45 cents. The commission on each contract is $62. The trader liquidates his position when the price of sugar has advanced to 9.45 cents. The contract size is 112,000 lbs. The trader would have a net profit of:

a. $2,240
b. $2,116
c. $2,206
d. $1,986

Answer 27

b. $2,116
The trader would make a profit of $.01 per lb. The size of the contract is 112,000 lbs. The profit per contract is $1,120. The customer has two contracts. $1,120 x two contracts = $2,240. The commission is $62 per contract, for a total of $124. The net profit is $2,240 - $124 = $2,116. Remember to take into consideration the number of contracts involved when determining your answer.

Question 28

The maximum number of contracts, either long or short, in any one futures month or in all futures months combined which may be held open or be controlled by any one person, as prescribed by the CFTC, is:

a. The speculative position limit
b. The trading limit
c. A limit placed on speculators and hedgers
d. A limit placed on hedgers only

Answer 28

a. The speculative position limit
The CFTC has established position limits and trading limits for certain regulated commodities. These limits apply to long positions, short positions and spread positions established on one or more exchanges. The trading limit is the maximum number of contracts that a trader may enter into in any single trading session, while the position limit is the maximum number of contracts that he may hold at any one time. Trading limits and position limits apply to speculators only. They do not apply to bona fide hedgers.

Question 29

An order to sell at “market on opening” would require that it be executed on the first price of the day only.

a. True
b. False

Answer 29

b. False
An order marked to sell (or buy) “market on opening” need not be done at the first price of the day only. It would be acceptable if the order were done within the opening range of prices for the commodity.

Question 30

A futures contract is a legally binding contract, but does not always require the original buyer or seller to make or take delivery.

a. True
b. False

Answer 30

a. True
When one enters into a futures contract, he is legally bound to perform on the terms of the contract. If one is long, he is legally bound to accept delivery of the commodity if he is long after the first delivery day. If one is short the contract, he is legally bound to make delivery of the commodity during the delivery month. However, one may easily eliminate this liability by offsetting the contract before the delivery month. A long will sell an equivalent amount of contracts and thus shift his liability to another long. A short will buy an equivalent amount of contracts and shift his liability to another seller. Therefore, the original long and short do not have to perform on the contract if they offset their positions.

Question 31

The term “supply elasticity” refers to a situation in which producers of a commodity will increase the amount produced as the price advances.

a. True
b. False

Answer 31

a. True
A commodity is said to be “supply elastic” when changes in price cause changes in the amount produced. As price rises, more is produced; as prices fall, less is produced. A commodity is said to be “demand elastic” when changes in price cause changes in the amount purchased. As price rises, less is purchased; as prices fall, more is purchased.

Question 32

A businessman who produces chocolate candy would protect himself against a rise in the price of the products he will purchase through:

a. A short hedge in cocoa futures
b. A short hedge in sugar futures
c. A long hedge in cocoa futures
d. None of the above

Answer 32

c. A long hedge in cocoa futures
A user of the cash commodity who is concerned about a price increase would establish a long hedge (buy futures).

Question 33

If a commodity pool operator has traded commodity interests for two years, he must disclose:

a. The actual performance for the past year
b. The actual performance for the entire operating history plus other pools operated by the CPO
c. Projection figures for the next 12 months
d. Testimonials from previous clients

Answer 33

b. The actual performance for the entire operating history plus other pools operated by the CPO
A commodity pool being solicited that has been in existence for less than three years must disclose its entire operating history. In addition, the CPO must disclose the performance history of any other pools operated by the CPO or trading manager for the preceding five years, or for the life of the pool, whichever is less.

Question 34

A trader purchases one contract of soybean oil at 15.50 per hundred pounds (15.5 cents per pound). The contract size is 60,000 lbs. If he deposits margin of $750:

a. His margin deposit would be approximately 9% of the value of the soybean oil
b. His margin deposit would be approximately 8% of the value of the soybean oil
c. His margin deposit would be approximately 6% of the value of the soybean oil
d. His margin deposit would be approximately 5% of the value of the soybean oil

Answer 34

b. His margin deposit would be approximately 8% of the value of the soybean oil
The value of the margin deposit is determined as follows: ##ADD IMAGE

Question 35

A spread could be defined as:

a. The purchase of one futures contract and the sale of another futures contract for commodities that are different but that can be used interchangeably
b. The purchase of one futures contract and the sale of another futures contract on the same exchange, but in different delivery months
c. The purchase of one futures contract and the sale of another futures contract on two different exchanges
d. All of the above are examples of spreads

Answer 35

d. All of the above
All are definitions of spreads. Choice (a) indicates an intercommodity spread, which is the purchase and sale of different but economically related commodity futures. Choice (b) is an intramarket spread, which is the sale of the same commodity futures on the same exchange, with a difference in the delivery months for the purchase and sale. Choice (c) is an intermarket spread, which is the purchase of a commodity future on one exchange and the sale of the same commodity future on another exchange.

Question 36

The actual transfer of ownership of a commodity occurs at the time the order is executed.

a. True
b. False

Answer 36

b. False
The actual transfer of ownership of a commodity occurs at delivery.

Question 37

A person would be “long the basis” if he:

a. Has sold a commodity for delivery in the future and has placed a long hedge
b. Has a commodity in his inventory that is unhedged
c. Owns the cash commodity and has placed a short hedge
d. Owns the cash commodity and has placed a long hedge

Answer 37

c. Owns the cash commodity and has placed a short hedge
A person is “long the basis” if he has the cash commodity in inventory and he has sold futures.

Question 38

If a member firm wishes to open an account where an individual is exercising power of attorney over another individual’s account, the member firm must obtain a copy of the power of attorney and notification if the agent is sharing in the profits:

a. Because the exchanges require notification of any participation in the profits and require that monthly statements be sent to the customer
b. Because the CFTC must approve such accounts before they are opened
c. Because such accounts are prohibited by the rules of the exchanges and therefore may not be opened
d. Because the agent may not receive more than 50% of the profits

Answer 38

a. Because the exchanges require notification of any participation in the profits and require that monthly statements be sent to the customer
If an individual is sharing in an account with a customer and is exercising power of attorney over the account, the member firm must obtain a copy of the power of attorney and must send monthly statements to the participants in the account.

Question 39

A trader who is long July corn at $1.55 places a stop order to sell at $1.50. This insures that he will not lose more than 5 cents a bushel.

a. True
b. False

Answer 39

b. False
A stop order to sell is an order that is placed below the current market price. It is entered to protect a profit or to minimize a loss. Once the contract sells at or below the price designated in the order, it becomes a market order and will be executed at the best price available at that time.

In this question, the trader enters a sell stop order at $1.50. He is instructing his broker to sell the contract if the price drops to $1.50 or less. This is an example of the sell stop order entered to minimize a loss.

Once the commodity reaches (or is offered at) $1.50, the order becomes a market order to sell at the best price. This will help to minimize a loss but does not ensure a loss of no more than 5 cents.

Question 40

A chartist who notes an ascending triangle formation in a particular futures contract would probably surmise that the price would decline if there is a breakout.

a. True
b. False

Answer 40

b. False
An ascending triangle is a chart formation that indicates that the price of a commodity future is rising. If there is a breakout in an ascending triangle, this is an indication that the price will advance.

Question 41

Cash grain prices normally are at a premium to futures when:

a. The harvest is at its peak
b. There is a current shortage of the commodity
c. Supply and demand for the grain are in balance
d. There is a current oversupply of the commodity

Answer 41

b. There is a current shortage of the commodity
If the price of cash is at a premium to the price of futures, this type of market would be called an inverted market. An inverted market comes about when there is a shortage of the cash commodity. Users of the cash commodity will bid up the price on whatever is available because they need it now to keep their businesses in operation. They will also buy near futures with the intention of taking delivery in order to obtain the actuals. This combination of buying cash and near futures will cause the price to rise. Distant futures will not be subject to the same pressures and therefore will not receive the same buying support. Therefore, the price of cash and the price of near futures will rise above the price of more distant futures.

Question 42

A farmer who has a crop growing in the ground and who sells futures would be assuming the role of a hedger.

a. True
b. False

Answer 42

a. True
A farmer who has a crop growing in the ground might wish to establish his selling price even before the crop is harvested. He could do this by selling futures. Let’s look at an example to see how this could be accomplished.

A farmer is growing 50,000 bushels of wheat. He would like to realize $3.00 a bushel. The price of futures in Chicago is currently $3.10. The farmer hedges by selling 50,000 bushels in Chicago. When the crop is harvested, the price has dropped to $2.80 a bushel for cash wheat. However, the price of futures has also dropped, to $2.90 a bushel. The farmer will sell the futures contract at a price of $2.90 a bushel. The farmer will sell his cash wheat at the going price of $2.80, and lift his hedge by buying futures at $2.90. He will have achieved his price objective of $3.00 a bushel because the profit on futures, when added to the cash price he received, totals $3.00. The following diagram shows the net result of the hedge.

Question 43

The NFA designates exchanges as contract markets.

a. True
b. False

Answer 43

b. False
This is false. The CFTC designates exchanges as contract markets.

Question 44

A customer has a long position on which the margin requirement is $1,000. He decides to switch to a later delivery month and instructs his account executive to sell his existing position and at the same time establish a new position of equivalent size in the later delivery month. In this case, the existing margin on deposit will cover his requirement on the new position, and no additional cash need be deposited.

a. True
b. False

Answer 44

a. True
If a customer switches a contract from one month to another month, the margin on his existing contract may be used to meet the margin requirement on the new contract.

Question 45

A spreader who has purchased December corn and sold March corn on the same exchange has established:

a. An intermarket spread
b. An intercommodity spread
c. A commodity-products spread
d. An intramarket spread

Answer 45

d. An intramarket spread
The purchase of a commodity in one month and the sale of the same commodity in another month on the same exchange is called both an “intramarket spread” and an “interdelivery spread.” Both terms are used to describe the same type of spread.

An intermarket spread is the purchase of a commodity on one exchange and the sale of the same commodity in the same or different delivery months on a different exchange.

An intercommodity spread is the purchase of one commodity and the sale of a different commodity that is related (such as corn and oats, which are substitutes for each other as livestock feed) on the same or on different exchanges.

A commodity-products spread is the purchase of a commodity and the sale of products derived from the commodity, such as the purchase of soybeans and the sale of soybean oil and meal. The spread could also be established by selling the commodity and buying the products.

Question 46

A customer shorts 6 Nasdaq 100 index futures contracts at 1250. The index multiplier is 100 and the initial margin requirement is $11,000 per contract. If the index closes at 1240.50, what is the customer’s total equity?

a. $60,030
b. $65,050
c. $66,950
d. $71,700

Answer 46

d. $71,700
The client deposited $66,000 ($11,000 x 6 contracts) in initial margin. Since the customer shorted the futures contracts and the index value decreased, the equity in the account will increase. ##IMAGE

Question 47

An FCM may consider an account to be in a “hedge account” only if:

a. The account is one that handles the actual cash commodity in the conduct of its business
b. The account owns a membership on the exchange
c. The account places orders of a specified minimum size that varies with the different exchanges
d. All of the above

Answer 47

a. The account is one that handles the actual cash commodity in the conduct of its business
In order to be considered a hedger, the account must be a producer or user of the cash commodity, such as a farmer, miller or importer.

Question 48

IBs and FCMs are required to keep records of only those option complaints in excess of $1,000 because these must be reported to the NFA.

a. True
b. False

Answer 48

b. False
All option complaints must be kept. If they are verbal complaints, a written record of the complaint must be made.

Question 49

A customer offsets a position in the current delivery month and simultaneously takes a new position in a deferred futures month. This type of order would be called:

a. A switch order
b. A spread order
c. A give-up order
d. A hedge order

Answer 49

a. A switch order
A switch order is an order to liquidate a futures contract and assume a new position in the same commodity in a later delivery month.

Question 50

When a person buys or sells a futures contract, the person is liable for:

a. Only the original margin
b. Not more than 70% of the cash value of the futures contract
c. The full value of the contract
d. None of the above

Answer 50

c. The full value of the contract
When an individual enters into a futures contract, he is liable for the full value of the contract for as long as his position is open. The only way he may eliminate his liability is to make an offsetting transaction. However, until such time as he offsets his position, he will be liable to make or take delivery on the actuals. The margin deposit that the trader gives to the brokerage firm is simply a “good faith” deposit indicating his ability and willingness to perform on the contract. If the market goes against him, the firm will insist on more margin to protect itself and make certain that it will not suffer a loss because the customer is unable to perform on his obligation.

Question 51

Margin requirements are generally higher for short positions than for long positions.

a. True
b. False

Answer 51

b. False
Margin requirements are the same for both long and short positions.

Question 52

Funds in an account in excess of the amount required to fully margin existing positions may be withdrawn or used to margin new positions.

a. True
b. False

Answer 52

a. True
Funds in an account in excess of the amount required to fully margin existing positions may be withdrawn or used to margin new positions.

Question 53

A discretionary account may be handled by:

a. Any associated person who has passed the required examination
b. An associated person with a minimum of one year’s experience
c. An associated person with a minimum of two years’ experience who has been continuously registered during that period
d. All of the above

Answer 53

c. An associated person with a minimum of two years’ experience who has been continuously registered during that period
An RCR must have two consecutive years of commodity experience to handle a discretionary account.

Question 54

Which of the following statements is true regarding a selling hedge?

a. It can be the same as a buying hedge.
b. It protects the hedger against a price rise.
c. It enables the dealer with unsold inventory to remain competitive no matter where prices subsequently move.
d. It is used by individuals who are short the basis.

Answer 54

c. It enables the dealer with unsold inventory to remain competitive no matter where prices subsequently move.
A selling hedge involves the sale of futures. Futures are sold by hedgers who are long the basis (long the cash commodity). An individual who is long cash is concerned about a price decline. If the price of the cash commodity should drop, he would have a loss on his cash position. However, if he has hedged by selling futures, his loss on cash would be essentially offset by his gain on futures when the price of futures drops by roughly the same amount. Therefore, if an individual is long cash and the price drops, he could sell his cash commodity at the current price and remain competitive. His loss on cash will be made up by his profit on futures.

Choices (a) and (d) are incorrect because a buying hedge is the opposite of a selling hedge. A buying hedge is the purchase of futures, and is made when the hedger is short the basis (short the cash commodity) as in the case of a grain exporter who has sold grain at today’s price for delivery in three months. His concern is with a price rise, and therefore he buys futures. Choice (b) is incorrect because the selling hedge is made to protect against a price decline, not a price rise.

Question 55

A customer buys three gold contracts on the Commodity Exchange (Comex) and sells them at a profit of $3.40 an ounce. The total commission on the three contracts is $120. The contract size is 100 troy ounces. The net profit on the trade is:

a. $1,440
b. $1,200
c. $900
d. $880

Answer 55

c. $900
Three contracts would total 300 ounces. As the profit per ounce is $3.40, the total profit is $1,020. Subtracting the total commission of $120 yields a net profit of $900.

Question 56

Organized futures exchanges developed mainly:

a. Because the government prohibited speculation in commodities that were not traded on organized exchanges
b. Because there was a need to provide an active market for speculators who wished to trade in futures
c. Because users of the cash commodity needed the futures markets as a way to obtain price protection on their cash commodity
d. Because banks refuse to extend credit to producers unless they have hedged their cash positions

Answer 56

c. Because users of the cash commodity needed the futures markets as a way to obtain price protection on their cash commodity
The primary reason that the futures exchanges evolved was to provide a medium for producers and users of the cash commodity to hedge their risk.

Question 57

In figuring the equity in a commodity account, the closed-out positions and monies deposited or withdrawn are considered, not the open contracts.

a. True
b. False

Answer 57

b. False
When a member firm computes the equity in a customer’s account, it takes into consideration the open positions and the amount of cash in the account. If there are unrealized profits on open positions, the customer’s equity will be credited with the increase in value. If there are unrealized losses on the open positions, the customer’s equity will be reduced by the amount of the loss. The customer may withdraw any excess in cash or use the excess to establish new positions. If there is a decline in the equity, the member firm will call for more margin once the equity drops below the maintenance margin level.

Question 58

A stop order to buy is entered:

a. Above the current market price
b. Below the current market price
c. Either above or below the current market price
d. None of the above

Answer 58

a. Above the current market price
A stop order to buy is entered above the current market. A stop order to sell is entered below the current market. A buy stop order would be entered to limit a loss if the price of a commodity should advance. This would occur if a customer was short a contract. He anticipates that the price will go down, but he recognizes the fact that he could be wrong and the price could also advance. Therefore, he would enter a buy stop order above the market to cut his loss if the price should advance.

Question 59

If a speculator maintains accounts for the same CFTC regulated commodity at several different commission firms, he can thereby avoid reporting his position to the CFTC.

a. True
b. False

Answer 59

b. False
CFTC rules require that a trader report to the CFTC once he reaches the position limit in certain commodities. The reporting level is 25 contracts in all regulated commodities except cotton (50 contracts) and grains (200,000 bushels). The trader must report once his position reaches this level, and it is immaterial whether his trading was done on a single exchange or on more than one exchange, or if his position was amassed at a single brokerage firm or at more than one brokerage firm.

Question 60

Which of the following hedgers would most likely effect a selling hedge?

a. A grain elevator operator who wants to protect his cash position
b. An exporter who has entered into a contract to deliver the cash commodity at a later date and who does not own the commodity
c. An individual who is short the cash commodity and who is committed to make delivery at a later date
d. All of the above

Answer 60

a. A grain elevator operator who wants to protect his cash position
A selling hedge (sale of futures) would be established by an individual who is long the basis (long the cash commodity). A grain elevator operator would be long the cash commodity and would protect himself against falling prices by selling futures.

Question 61

Clearing members are not permitted to pay to customers interest on minimum margin deposited.

a. True
b. False

Answer 61

a. True
Interest may not be paid on a customer’s minimum margin deposit.

Question 62

All futures trading in the pits or in the trading rings of an exchange must be done by open outcry.

a. True
b. False

Answer 62

a. True
All futures trading on the exchange must be done in the ring by open outcry.

Question 63

Mr. Jones has a maintenance margin call for $8,000 and an MIT order to buy wheat. He is killed in an accident. The RCR should:

a. Liquidate his position and cancel the open order
b. Await instructions from Mr. Jones’ wife
c. Await instructions from the executor of the estate
d. None of the above are correct

Answer 63

a. Liquidate his position and cancel the open order
If a customer dies, the member firm will cancel all open orders and will liquidate all open positions. The member firm will not send out any proceeds until it has received the proper documents appointing an executor for the estate.

Question 64

The area on a chart where one might expect increased demand for a futures contract would be called:

a. A support area
b. A resistance area
c. A congestion area
d. None of the above

Answer 64

a. A support area
A congestion area is a chart formation with a relatively narrow range of prices in which the futures contract has traded for some time. The top of the congestion area is called a resistance area and the bottom of the congestion areas is called a support area. When the price reaches the resistance area on the top side, increased selling prevents further price advance. When the price reaches the support area on the down side, increased buying retards a further price decline.

Question 65

A trader buys two contracts of pork bellies at 33.20 cents. He sells them at 36.40 cents. The contract size is 40,000 lbs. His profit on this transaction, disregarding commission, is:

a. $1,920
b. $2,432
c. $2,560
d. $2,624

Answer 65

c. $2,560
The contract advanced by 3.20 cents. We would therefore multiply 40,000 (contract size) by .032 (.032 is the decimal equivalent of 3.2 cents). This indicates a profit of $1,280 on one contract. Since two contracts are involved, simply multiply this by two, which indicates a total profit of $2,560.

Question 66

A buying hedge would be used by:

a. A farmer to protect the price for his crop
b. A grain elevator operator to protect his inventory from price decline
c. An exporter to protect his later purchase from price advance
d. None of the above

Answer 66

c. An exporter to protect his later purchase from price advance
A buying hedge (purchase of futures) is established by an individual who is short the basis (short the cash commodity) such as an exporter who has agreed to deliver the cash commodity at a fixed price in the futures and does not currently own the cash commodity.

Question 67

In connection with trading in commodity futures, the CFTC is NOT responsible for:

a. Limiting maximum speculative positions
b. Prohibiting price manipulation
c. Licensing delivery facilities
d. Designating a futures exchange as a contract market

Answer 67

c. Licensing delivery facilities
The CFTC is responsible for all of the items listed in the answer except the licensing of warehouses, grain elevators and other depositories. The exchange designates these facilities as “regular for delivery”.

The CFTC is responsible for establishing maximum trading limits and maximum position limits in regulated commodities. The trading limits refer to the maximum number of contracts that may be traded in any single day, while the position limits refer to the maximum position that a speculator may hold at any one time. The CFTC will investigate any instances of price manipulation of commodity futures that comes to its attention and will refer any violations to the appropriate law enforcement agency. In addition, the CFTC is responsible for designating exchanges as “contract markets”, which means markets that are eligible to trade in commodity futures.

Question 68

A trader initiates a long position in live cattle at a price of 41 cents per pound. The contract size is 40,000 lbs. His initial margin deposit is $500. This means that:

a. Margin represents approximately 4% of the value of the contract
b. Margin represents approximately 3% of the value of the contract
c. He will be called for additional margin if the price of the contract advances
d. He will have additional buying power if the contract declines in price

Answer 68

b. Margin represents approximately 3% of the value of the contract
Correct. The futures price is 41 cents per pound. Therefore, the total value of the contract is $16,400 (40,000 pounds times .41). Dividing the margin of $500 by the contract value of $16,400 indicates that margin is approximately 3% of the value of the contract.

Question 69

A trader has a long futures position that he wants to offset. This means that:

a. He will sell futures to match a purchase of the cash commodity
b. He will buy futures because he is short the cash commodity and he anticipates that he will buy cash at a later date
c. He will sell futures on the same exchange in the same delivery month
d. He will buy futures because he anticipates a price decline

Answer 69

c. He will sell futures on the same exchange in the same delivery month
A long position is offset through a sale of the same futures contract on the same exchange in the same delivery month.

Question 70

A customer has indicated that he might be interested in taking a position if the price of a commodity reaches a certain level. Two weeks later, the commodity reaches the level indicated. The AP tries to contact the customer but is unable to do so. Even though the account executive does not have discretionary authorization, he may enter the order if he thinks he will be able to contact the customer within a short time after the order is executed.

a. True
b. False

Answer 70

b. False
The customer has indicated an interest but has not given the account executive a definite order. In the absence of a specific order or discretionary authorization, the account executive may not take any action.

Question 71

The most advantageous time to place a selling hedge is in:

a. An inverted market at less than full carrying charges
b. An inverted market at more than full carrying charges
c. A normal market at less than full carrying charges
d. A normal market at full carrying charges

Answer 71

d. A normal market at full carrying charges
The most profitable selling hedge will be one that is placed in a carrying charge market at full carrying charges. This is because, as the delivery month nears, the price of cash and the price of futures must converge. In order for the price of cash and the price of futures to converge, one of three things must happen. Either the price of cash must go up to meet the price of the futures, or the price of futures must go down to meet the price of cash, or the price of cash must go up while the price of futures goes down. In any of these cases, the hedger will have a profit. Let’s look at an example of a selling hedge placed in a carrying charge market versus a selling hedge placed in an inverted market.

First, let’s define a selling hedge. A selling hedge is the sale of futures. Futures are sold by hedgers who are long the basis (long the cash commodity). Now let’s define a carrying charge market and an inverted market. A carrying charge market is one in which the price of cash is less than the price of futures, and the price of near futures is less than the price of distant futures. The following table could indicate a carrying charge market:

Cash Price $2.45
Price of July futures $2.55
Price of September futures $2.65
Price of December futures $2.75
An inverted market is one in which the price of cash is higher than the price of distant futures. An inverted market could appear as follows:

Cash Price $2.75
Price of July futures $2.65
Price of September futures $2.55
Price of December futures $2.45
Now let’s look at a selling hedge placed in a carrying charge market. Remember that the price of cash and the price of futures must converge at the delivery location during the delivery month. Let’s assume that a hedge is placed when cash is $2.45 and September futures are $2.65.

The hedge is held until September. The initial position will appear as follows:

Cash: Buy @ $2.45
Futures: Sell @ $2.65

The hedger holds his position until September. The price of cash rises to $2.55 and the price of futures drops to $2.55. The prices have converged, as they must. The hedger sells cash and buys futures, with the following results:

Cash:
Buy @ $2.45
Sell @ $2.55
—————–
Profit: $.10

Futures:
Sell @ $2.65
Buy @ $2.55
—————–
Profit: $.10

The hedger has a profit of 20 cents because he hedged in a carrying charge market. What would have happened if he hedged in the inverted market? He would buy cash at $2.75 and sell futures at $2.55. When he closes out his position, cash might be $2.60 and futures also $2.60 (remember that the prices must converge). The result would be a loss of 20 cents, as is seen by the following:

Cash:
Buy @ $2.75
Sell @ $2.60
—————–
Loss: $.15

Futures:
Sell @ $2.55
Buy @ $2.60
—————–
Loss: $.05

Question 72

The term “selling pressure” describes a market in which the amount of the commodity that is available for sale exceeds the amount of the commodity that is demanded by buyers.

a. True
b. False

Answer 72

a. True
The term “selling pressure” describes a market in which the amount of the commodity that is available for sale exceeds the amount that is currently in demand by buyers. A market in which selling pressure exists is characterized by lower prices.

Question 73

A violation of an exchange speculative position limit is a violation of CFTC regulations.

a. True
b. False

Answer 73

a. True
A violation of an exchange rule is a violation of a CFTC regulation.

Question 74

In the event of a violation of any law relating to commodity futures, the Commodity Futures Trading Commission may take the offender to court without referring the matter to the Attorney General.

a. True
b. False

Answer 74

a. True
The CFTC may take legal action if there is a violation of any law relating to commodity futures.

Question 75

In a discount market:

a. The cash commodity offered exceeds demand
b. Futures prices are the same as the cash price
c. Futures prices are lower than the cash price
d. Futures prices are higher than the cash price

Answer 75

c. Futures prices are lower than the cash price
A discount market is one in which the price of the cash commodity is higher than the price of futures, and the price of near futures is higher than the price of distant futures. A discount market is also called an inverted market.

Question 76

Hedging techniques only work effectively for the short term.

a. True
b. False

Answer 76

b. False
There is no reason why a hedge will not be as effective for a long-term period of time as for a short-term period of time. In the event that the time of the hedge extends over a very long period, it might be necessary for the hedger to switch his futures position from a month that is expiring to a more distant month. However, the fact that he has to switch his position (and therefore pay another commission) does not make the hedge any less effective.

Question 77

A customer’s equity drops below the maintenance level. The FCM is unable to contact the customer. The firm may not liquidate any part of his account because it was unable to contact the customer.

a. True
b. False

Answer 77

b. False
An FCM will always attempt to contact a customer if there is a margin call. This is sound business practice. However, if the FCM is unable to contact the customer, it still has the right to liquidate his position if the margin is not deposited.

Question 78

An order to sell a futures contract at 10.35 is a:

a. Contingent order
b. Limit order
c. Stop order
d. MIT order

Answer 78

b. Limit order
This type of order would be a limit order. The customer is instructing the broker to sell the contract at a price of $10.35 or higher. The customer will not accept an execution at a price lower than $10.35.

If the customer wished to place a sell stop order or a sell MIT order at $10.35, this would have to be noted on the order, as “Sell at $10.35 Stop” or “Sell at $10.35 MIT”.

Question 79

A customer has a spread position. He is long August gold at $460 and short December gold at $470. He liquidates his position when August gold is at $455 and December is at $468. The size of the contract is 100 troy ounces. His net profit or loss is:

a. $270 profit
b. $300 loss
c. $330 profit
d. $330 loss

Answer 79

**b. $300 loss** 
 ##

Question 80

The purchase of October futures versus the sale of August futures in the same commodity on the same exchange is an:
Intramarket spread
Intermarket spread
Intradelivery spread
Interdelivery spread
a. I and III
b. I and IV
c. II and III
d. II and IV

Answer 80

b. I and IV
The purchase of October futures of a commodity versus the sale of August futures of the same commodity is called an intramarket spread. Another term that is used to describe this type of spread is an interdelivery spread.

The sale of a commodity on one exchange and the purchase of the same commodity in the same or a different month on another exchange is an intermarket spread. For example, the purchase of July wheat on the Kansas City Board of Trade and the sale of September wheat on the Chicago Board of Trade would be an example of an intermarket spread.

Question 81

The CFTC is responsible for determining the daily price limits for regulated commodities.

a. True
b. False

Answer 81

b. False
The price limits, which refer to the maximum a contract will be allowed to trade above or below the previous day’s settlement price, is determined by the exchange, not the CFTC.

Question 82

If a seller delivers against his short futures position with a better than contract grade, the buyer will be required to pay a designated premium for the delivery.

a. True
b. False

Answer 82

a. True
The seller determines the grade that he will deliver on his short futures sale and the buyer must accept the grade that is delivered, provided that it is an acceptable grade under the standards of the exchange. If the grade delivered is above the contract grade, the buyer must pay a designated premium. If the grade is lower than the contract grade, the buyer will obtain it at a discount.

Question 83

A hedged commodity position:

a. Eliminates the chance for profit
b. Increases a company’s need for working capital
c. Shifts the risk of loss due to price movement to others
d. All of the above

Answer 83

c. Shifts the risk of loss due to price movement to others
The basic purpose of a hedge is to protect the hedger against the risk of loss due to adverse price change. If the individual is long the basis (long cash), he will establish a selling hedge (sale of futures) to protect himself against a price decline. If the individual is short the basis, he will establish a buying hedge to protect against a price advance. In both cases, the hedger is shifting the risk to speculators who are willing to assume the risk in return for the opportunity to make a profit due to price changes

Choice (a) is incorrect because it says that there is no opportunity for profit when a position is hedged. Even if a position is hedged, there would still be an opportunity for a small profit (or a small loss) due to changes in the basis. The basis is the price difference between the hedger’s cash position and his futures position.

Choice (b) is incorrect because it states that a company with a hedged position will require more working capital to operate. Actually, the company would require less working capital. A buying hedge (purchase of futures) is made by a firm that is short the cash commodity, such as an exporter who must deliver the commodity in six months. The grain exporter could protect himself against a price rise by buying the cash commodity and storing it for six months. This would require substantial working capital. His other alternative would be to buy futures instead. In this case, he could operate with less working capital.

Question 84

A technical analyst who observes a double bottom formation on a chart would be likely to conclude that a major break in price is likely to occur.

a. True
b. False

Answer 84

a. True
A double bottom is a chart pattern that indicates the next move is likely to be bullish.

Question 85

A written demand left at the office of the customer for an additional margin deposit because of adverse fluctuations in the marketplace shall be deemed sufficient notification if the FCM is unable to effect personal contact with the customer.

a. True
b. False

Answer 85

a. True
A member firm will normally attempt to contact a customer if there is a margin call. However, failure to contact the customer does not affect the member firm’s right to liquidate the customer’s position if market conditions so dictate.

Question 86

A trader has $1,250 invested in soybeans and soybean margin is 25 cents per bushel. Soybeans closed today at $4.50 per bushel. The soybean contract size is 5,000 bushels. What percentage of his position in soybeans does his margin money represent?

a. 3.3%
b. 5.6%
c. 7.0%
d. 7.6%

Answer 86

b. 5.6%
The percentage of his position is determined as follows: Margin (.25) / Market Price of Commodity (4.50) = 5.6%

Question 87

A long futures position in a commodity established on a certain exchange may be offset by selling the same futures:

a. On any other exchange that is trading the commodity
b. On any commodity exchange
c. On the same exchange
d. On any CFTC regulated commodity exchange

Answer 87

c. On the same exchange
When an individual initiates a position on an exchange, and later wishes to make an offsetting transaction in order to liquidate his position, he must do so on the same exchange where he took the original position. For example, if an individual purchases 5,000 bushels of May wheat on the Chicago Board of Trade and he decides to leave the market by selling 5,000 bushels of May wheat, he may do this only on the Chicago Board of Trade.

Question 88

When a broker enters a GTC order, he will note as part of the order the time when it is to be canceled.

a. True
b. False

Answer 88

b. False
A GTC order is good until the order is executed, canceled, or the contract expires. Therefore, no time will be indicated in the order.

Question 89

A short hedge protects against:

a. Rising prices
b. Falling prices
c. Both of the above
d. None of the above

Answer 89

b. Falling prices
A short hedge (selling hedge) is the sale of futures. Futures are sold by hedgers who are long the basis (long cash) and are used to protect against falling prices for the cash commodity. If the price of cash should decline, the loss on cash will be approximately offset by the gain on futures, which will also decline in price.

Question 90

The Chicago Board of Trade Clearing House requires clearing member firms to deposit margin on net long or net short positions in a particular commodity position, while the Chicago Mercantile Exchange requires clearing member firms to deposit margin on both long and short positions.
True
False

Answer 90

a. True
The CBOT requires margin on a net basis while the CME requires margin on a gross basis.

Question 91

A speculator may avoid exceeding the CFTC speculative position limits by establishing his position on two different exchanges.

a. True
b. False

Answer 91

b. False
The CFTC establishes the maximum trading limits and position limits in certain commodities. The trading limit applies to the maximum amount of contracts that a speculator may trade in any particular trading session. The position limit applies to the maximum position that a speculator may hold in a commodity. The limits apply to all contracts, both long and short, on all exchanges. However, the limits do not apply to bona fide hedgers.

The trading and position limit for wheat is 2,000,000 bushels. A speculator buys 1,500,000 bushels of wheat on the Chicago Board of Trade. The maximum number of additional bushels of wheat that he could buy would be 500,000 bushels. He could buy the additional wheat on the Chicago Board of Trade or any other exchange that trades in wheat, but he could not buy more than 500,000 bushels regardless of the exchange on which he makes the purchase.

Question 92

In a normal corn market, when the deferred delivery is at a premium to the nearby and in anticipation of a widening in the spread difference, your customer should:

a. Buy the nearby and sell the deferred
b. Buy the deferred and buy the nearby
c. Sell the nearby and buy the deferred
d. Sell the deferred and buy the nearby

Answer 92

c. Sell the nearby and buy the deferred
If a spreader anticipates that a spread will widen, he will buy the higher-priced (deferred) contract and sell the lower-priced (nearby) contract. If he expects the spread to narrow, he will buy the lower-priced (nearby) contract and sell the higher-priced (deferred) contract.

Question 93

The determination of when delivery on a futures contract will be made within the established delivery period is by:

a. The buyer
b. The seller
c. The exchange
d. Both a and b

Answer 93

b. The seller
The seller determines the day within the delivery month when he will make delivery to the buyer, and the seller also determines the grade of commodity that he will deliver. The buyer does not have any option in regard to either the delivery date or the grade delivered. The seller will send a Notice of Intention to Deliver to the clearing house, which will pass it to an eligible buyer.

Question 94

A spread trader is speculating in the stock index futures market. Currently, the spreads are normal and the trader is anticipating a bull market. If the spread is expected to widen, the trader should:

a. Buy the nearby month and sell the deferred month
b. Sell the nearby month and buy the deferred month
c. Buy the nearby month and buy the deferred month
d. Sell the nearby month and sell the deferred month

Answer 94

b. Sell the nearby month and buy the deferred month
In a bull market, when prices are rising, the deferred months should rise faster than the nearby month and the spread should strengthen or widen. The trader should, therefore, sell the nearby month and buy the deferred.

Question 95

A commodity order to buy 10 December wheat at 2.18 1/8 GTC is:

a. A time order
b. A time of day order
c. An open order
d. A contingent order

Answer 95

c. An open order
This is an open order, also called a good til canceled order. The trader is instructing the firm to maintain an order to buy 10,000 bushels of December wheat at 2.18 1/8 or less until the order is executed or the contract month expires. In the absence of the notation “GTC”, the floor broker will automatically cancel the order at the end of the trading session.

Question 96

The New York Cotton Exchange, the Chicago Board of Trade, and the Chicago Mercantile Exchange all have rules in regard to controlled (discretionary) accounts.

a. True
b. False

Answer 96

a. True
All exchanges have established rules regarding the handling of discretionary accounts.

Question 97

A person who has a crop growing in the soil cannot sell any part of his crop until the harvesting is in process or has been completed.

a. True
b. False

Answer 97

b. False
A farmer could sell his growing crop, even before it is harvested, by means of a “cash forward” sale, which is a cash market transaction whereby he agrees to deliver a specific amount of a specific grade of commodity at a future date. The price might be determined in advance, or the farmer and the buyer might agree to establish the price on the day delivery is made. Another alternative available to the farmer would be to fix his selling price by selling futures. By selling futures, the farmer is establishing the eventual price that he will receive when the crop is harvested.

Question 98

The major distinction between a cash commodity contract and a commodity futures contract is:

a. Liquidation of the contract by offset
b. “To arrive” provisions
c. Inspection procedures
d. Commodity grade

Answer 98

a. Liquidation of the contract by offset
The most significant difference between a futures contract and a cash contract is that the cash contract is directly negotiated between the buyer and the seller, and both parties are obligated to each other to perform on the terms of the contract. In a futures contract, the buyer and seller do not know the identity of each other, nor do they care. In the event that either party decides not to fulfill his obligation to make or take delivery of the actual commodity, he need simply offset his position. Since the clearing house of the exchange has become the buyer to each seller and the seller to each buyer once the initial trade is made, it does not matter how many parties replace the original parties to the trade. The long who decides to accept delivery on the futures contract is assured that the clearing house will obtain a short who will make delivery. The short who decides to make delivery is also assured that the clearing house will find a long to accept delivery.

Question 99

Open interest is the number of futures contracts which have been:

a. Bought or sold and which have not been liquidated
b. Bought minus the number sold which have not been liquidated
c. Bought plus the number sold which have not been liquidated
d. Bought or sold since the inception of trading in the contract

Answer 99

a. Bought or sold and which have not been liquidated
Open interest is the total number of contracts that have not been liquidated. Each contract consists of a long (buyer) and a short (seller), and therefore you would not add the longs to the shorts to derive the open interest. Choice (d) is incorrect because the open interest is the number contracts presently open, not the number of contracts that have been established since the inception of trading.

Question 100

A clearing member firm maintains an account for a non-clearing firm on an omnibus basis. The clearing member must know if the non-clearing member’s customers have deposited the necessary margin.

a. True
b. False

Answer 100

b. False
If a clearing member firm maintains an account for a non-clearing member firm, the clearing member need not concern itself with the margin requirements of the other firm’s customers. The non-clearing member firm would be responsible for collecting margin from its customers.

Question 101

A GTC order has as part of the order the time when it is to be canceled.

a. True
b. False

Answer 101

b. False
A GTC order (good until canceled) is one that remains in effect until the order is executed or canceled by the customer, or the contract month expires. If a customer wanted an order to remain in effect only until a certain time, and then wanted it to be canceled, he would enter a good until the end of the week, or good until the end of the month, or good until a certain specified time, when he enters the order with his account executive.

Question 102

If a farmer has sold futures contracts in an amount that equals the size of the cash commodity that he is growing, the farmer is:

a. Assuming the role of a hedger
b. Assuming the role of a spectator
c. Assuming the role of a spreader
d. Performing an illegal act

Answer 102

a. Assuming the role of a hedger
If a user of the cash commodity takes a position in the futures market that corresponds to his cash position, he would be assuming the role of a hedger.

Question 103

Membership in the National Futures Association is mandatory for all of the following EXCEPT:

a. Futures Commission Merchants
b. Commodity Pool Operators
c. Commodity Trading Advisors
d. Banks

Answer 103

d. Banks
The NFA membership is open to but not required for exchanges, banks and commodity-related business firms.

Question 104

The buyer of a futures contract, who has not liquidated his position before trading in the contract expires, must accept delivery and make full payment in a manner provided by the:

a. Clearing house
b. Board of directors of the exchange
c. CFTC
d. Floor Committee

Answer 104

b. Board of directors of the exchange
The exchange determines the method of delivery for all futures contracts traded on the exchange.

Question 105

Original margin is all of the following EXCEPT:

a. The amount of funds required by the broker when the futures contract is initiated
b. Established by the commodity exchange on which the commodity is traded
c. To insure performance under the terms of a futures contract
d. Established by the federal government

Answer 105

d. Established by the federal government
Original or initial margin is the amount of money prescribed by the exchange on which the commodity is traded. It is the amount that a customer is required to deposit when he takes a position in futures. The purpose of the margin deposit is to insure that the customer will perform under the terms of the contract, and to protect the broker against loss due to adverse price movements. There is no federal regulation of margin deposits in commodity futures, and the CFTC is not involved in establishing margin requirements.

Question 106

One of your clients has a margin account in stocks and a margin account in commodities. The member firm would be required to keep each account separately.

a. True
b. False

Answer 106

a. True
Cash relating to commodity futures must be kept separate from all other funds of the member firm.

Question 107

A customer enters a limit order without specifying any time limit. This would be:

a. A day order, and if not executed, the order would be canceled at the end of the trading session
b. A day order, and if not executed, the order would be entered automatically the next day
c. A good-until-canceled order
d. A good-until-the-end-of-the-week order

Answer 107

a. A day order, and if not executed, the order would be canceled at the end of the trading session
If a limit order is entered without any time specification (such as GTC), the order is a day order and will be canceled at the end of the trading session if it has not been executed.

Question 108

One of the major advantages of futures trading for a businessman who hedges his position is that he can be flexible in timing his cash market transactions.

a. True
b. False

Answer 108

a. True
Hedging allows a businessman flexibility that he might not otherwise have. If an individual who is long the cash commodity has not hedged his position and the price changes adversely, it may be impossible for him to sell his product at the current price because he would realize an unsustainable loss. Therefore, he would be forced to hold the commodity in the hope that the price will reverse itself in a favorable direction. Had he hedged his position, he could sell the product at the current price, accepting the loss, because his futures position would show a profit that would approximately equal his cash loss.

Question 109

Speculation in the futures market generally:

a. Increases fluctuations in futures prices
b. Alters supply and demand forces
c. Reduces the farmer’s risk in growing his crop
d. Reduces the range of price fluctuation

Answer 109

d. Reduces the range of price fluctuation
A large number of speculators in a market will reduce the range of fluctuation in the price of futures. This is because a large number of speculators will increase the continuity of the market. The term “market continuity” refers to a market in which there are frequent trades in the commodity, small spreads between the bids and the offers, and minimum price changes between successive transactions. The larger the number of participants in the market, the more continuous the market will be. Many bids and offers will compete with each other and therefore tend to narrow the spread. This will lead to trades that are made at narrow differences from preceding trades and therefore the range of price fluctuation will be reduced.

Choice (a) says that speculation increases futures price fluctuations, and is incorrect because it is the opposite of what speculation actually does. Choice (b) is incorrect because speculation does not alter supply and demand forces. Supply and demand is manifested through the bids and offers of participants in the market, and this is what establishes prices. Choice (c) is wrong because the risk to the farmer in growing his crop from such things as drought and disease is not in any way affected by speculation.

Question 110

If a speculator wishes to avoid having to report his position in regulated commodities, he may do so by opening accounts at different member firms and making certain that no single account reaches the reporting level.

a. True
b. False

Answer 110

b. False
Speculators must report once they reach the specified number of contracts as required by the CFTC and the exchanges. Contracts that are opened at different member firms or on different exchanges are added together and, once the reporting level is reached, must be reported.

Question 111

The purpose of charting is to identify:

a. A major trend
b. The reversal of a major trend
c. A possible price objective
d. All of the above

Answer 111

d. All of the above
Chartists are traders who use charts of past futures prices in order to estimate the future course of the market. The charts are used to indicate a major uptrend or downtrend, or the reversal of a major uptrend or downtrend. Some chartists also think that it is sometimes possible to estimate the extent of an uptrend or downtrend based upon the past prices of the commodity. Therefore, all of the answers are correct.

Question 112

If a speculator sells soybean futures and at the same time buys soybean meal and soybean oil futures, he would be establishing a:

a. Crack spread
b. Reverse crack spread
c. Crush spread
d. Reverse crush spread

Answer 112

d. Reverse crush spread
This is an example of a commodity-products spread and is called a “reverse crush spread”. A reverse crush spread is the sale of the primary commodity (soybeans) and the purchase of the products derived from the primary commodity (soybean oil and soybean meal).

A reverse crush spread is established when a trader thinks the price relationship between the primary commodity and the products is out of line, with the primary commodity (soybeans) too high and the prices of the products (soybean oil and soybean meal) too low. He anticipates that the spread will narrow, and will therefore sell the higher priced item (soybeans) and buy the lower priced items (meal and oil).

The crush spread is one in which the primary commodity (beans) is purchased and the products (meal and oil) are sold. A trader will establish a crush spread when he determines that the price of beans is relatively low and the price of oil and meal is relatively high.

Question 113

A futures market hedge is:

a. Established only when prices are expected to move in the direction of the hedge
b. A temporary substitute for a later cash market transaction
c. Always placed in the nearby futures contract
d. All of the above

Answer 113

b. A temporary substitute for a later cash market transaction
A futures market hedge is a substitute transaction that temporarily takes the place of a cash market transaction that will be made at a later time. An investor will create a selling hedge when he is long the basis (the cash commodity) and a buying hedge when short the basis.

Question 114

Responsibility for regulating U.S. Treasury bill futures is in the hands of the:

a. U.S. Treasury
b. Federal Reserve Board
c. Comptroller of the Currency
d. Commodity Futures Trading Commission

Answer 114

d. Commodity Futures Trading Commission
The CFTC regulates Treasury bill futures.

Question 115

In a normal market, the premium of a distant delivery month over the nearby delivery month reflects the:

a. Basis
b. Carrying charges
c. Inadequate availability of the cash commodity
d. Spread

Answer 115

b. Carrying charges
In a normal market (also called a carrying charge market or a premium market), the cash price is lower than the price of futures, and the price of near futures is lower than the price of distant futures. In a normal market, there is adequate supplies of the cash commodity and adequate storage facilities. The premium of the distant months over the nearer months reflects the cost of holding the commodity and are called carrying charges.

Question 116

A commodity order which has no provision as to time of execution is:

a. An open order
b. A day order
c. Either of the above
d. Neither of the above

Answer 116

b. A day order
If an order does not have any indication of the time duration, it is assumed to be a day order and will automatically be canceled at the end of the trading session if it is not executed. If the trader wants the order to remain in effect beyond the current trading session, he would indicate this by instructing the broker to mark “GTC” (good until canceled) on the order. In this case, the order would remain in effect beyond the current trading session.

Question 117

Open interest consists of open long plus open short positions.

a. True
b. False

Answer 117

b. False
Open interest is the total number of contracts that have not been liquidated. Since each contract consists of a buy and sell side, it would be incorrect to add the buys and sells together to determine the open interest. This would amount to double counting and would reflect an open interest that is exactly twice the number of open contracts.

Question 118

If an individual wished to place a hedge against a cash forward sale, he would:

a. Sell futures
b. Make a substitute sale
c. Buy futures
d. Arbitrage

Answer 118

c. Buy futures
The hedger is “short the basis”, which means that he is short the cash commodity. He has sold the commodity at today’s price. His concern is that the price of the commodity will rise in value. If it does, he will have to buy it at the higher price to fulfill his commitment. This could result in a loss. To protect himself, he will buy futures. If the price of the cash commodity rises, the price of futures should also rise by about the same amount, and his loss on cash will be offset by his profit on the futures.

Question 119

The margin that a customer deposits with a member firm is:

a. A down payment toward the full cost of the contract
b. A performance bond
c. Established by the CFTC
d. Lower on long accounts than on short accounts

Answer 119

b. A performance bond
Margin that is deposited on the purchase or sale of futures contracts is a good-faith deposit or performance bond. The purpose of the margin deposit is to protect the member firm against an adverse price movement and to demonstrate the customer’s ability and willingness to meet his obligations.

Question 120

A customer, dissatisfied with an execution, may file a complaint with:

a. The Floor Committee
b. The Arbitration Committee
d. The Business Conduct Committee
d. The CFTC

Answer 120

b. The Arbitration Committee
If a customer has a dispute with a member firm in regard to any of the member firm’s business dealing, the customer will seek satisfaction through the Arbitration Committee of the exchange. The Floor Committee is involved with the rules regarding trading on the floor, and will insure that all bids and offers are made by open outcry and are in full conformance with exchange requirements. The Business Conduct Committee has the responsibility of making sure that members adhere to just and equitable principles of trade. It would be involved in such things as manipulation of the market, misuse of customer funds and the like. The CFTC is not directly involved in the supervision of member firms’ conduct with customers.