Practice Test 2 Flashcards
A business firm that has sold a commodity which is not owned and has hedged with a purchase of futures is said to be:
a. Short the basis
b. Long the basis
c. A short hedger
d. Both b and c
a. Short the basis
An individual is “short the basis” when he is short the cash commodity. Examples would be the grain exporter who has entered into a contract to supply grain at a fixed price for delivery at a later date, and who does not currently own the grain. Another example would be a plywood dealer who has sold plywood to a home builder for delivery at today’s price. Delivery will not be made for six months, and the dealer does not currently own the cash plywood. A third example would be a flour miller who has contracted to supply flour to a bakery over the next 12 months, and who has not yet purchased the wheat.
In all of the above examples, the business firm has committed itself to deliver a commodity at a fixed price sometime in the future. The firm does not own the cash commodity and is concerned with a price rise. It will therefore hedge buying futures (long hedge).
The terms “long the basis” and “short hedger” both apply to the hedger who is long the cash commodity. As he would be concerned with a price decline, he will sell futures. An example of a business that is long the basis (long cash) and who would sell futures (short hedge) is the grain elevator operator who has grain in inventory. He will sell futures to protect against falling prices.
Which of the following is NOT considered to be part of carrying charges:
a. Storage costs
b. Interest
c. Transportation
d. Insurance
c. Transportation
Transportation is not considered part of carrying charges.
Firms are required to keep a record of all option complaints.
a. True
b. False
a. True
This is true. NFA Rule 2-18 requires that the firm keep a copy of all option complaints they receive and make a notation concerning the action taken to resolve the situation.
The term “reversal chart” would apply to a:
a. Bar chart
b. Line chart
c. Point and figure chart
d. Moving average chart
c. Point and figure chart
Point and figure charts are handled differently than bar charts. In a bar chart, the high and low range for the day, plus the closing price, are plotted on the chart. In a point and figure chart, this is not done. In this type of chart, the analyst first determines the scale he will use. The scale might be 1/2 cent, or 1 cent, or any other variation that he chooses. Whatever scale is decided upon then determines what will be plotted on the chart.
Let’s assume that the analyst determines that he will use a 1 cent scale. He will make entries on his chart only if the price of the commodity advances or declines by one cent. It does not matter over how long a period this change takes place. As soon as the change upward or downward is 1 cent, an entry will be made. Let’s assume that the initial price of the commodity is $4.10. The commodity trades the following day up to a high of $.10 3/4. No entry will be made on the chart at all because the price has not varied by the scale amount of 1 cent. The next day, the commodity advances to $4.11 1/4. Since the advance was over 1 cent from the initial starting price, an entry would be made on the chart. The commodity does not fluctuate over the next three days more than 1/4 point, so no entries will be made. On the following day, however, the commodity advances to $4.13. Since the change in price was over 1 cent, another entry would be made on the chart.
On the following day, the commodity drops in price to $4.12 1/2. As this is a change of less than 1 cent, no entry is made. The next day, the price drops again, to $4.11 3/4. As the change was now over one cent, another entry would be made.
Note that prices are plotted when they either advance or decline by the amount that the analyst has determined as his variation. If the price has advanced, and then reverses itself and declines by the amount of the variation (in this case 1 cent), an entry is made on the chart. This is the reason why the point and figure chart is also referred to as a “reversal chart.”
A trader buys a corn contract at $1.25. Margin is 12 cents a bushel and the commission is $30. The contract size is 5,000 bushels. If he sells the contract at $1.31, his profit is:
a. 50%
b. 45%
c. 15%
d. 5%
b. 45%
The question states that margin is 12 cents a bushel. Therefore, multiply the margin of 12 cents by the number of bushels (5,000) to indicate a margin deposit of $600. The question further states that the price advances by 6 cents a bushel. Therefore, multiply 6 cents by the number of bushels in the contract, to indicate an advance of $300. The customer’s gross profit is therefore $300. From this profit of $300, we must deduct the commission of $30, to indicate a net profit of $270. In order to determine his margin of profit on his investment, we would divide the net profit of $270 by the total amount of his investment ($600), which indicates a profit of 45%.
There is a maximum discount at which a distant futures month can sell under a near futures month.
a. True
b. False
b. False
In an inverted market (also called a discount market), cash is selling above futures, and nearby futures are selling above distant futures. There is no maximum amount of discount between nearby futures and distant futures. In a premium market, where cash is selling for less than futures, and the nearby futures are less than distant futures, there is a maximum premium that distant futures may sell above near futures. This maximum premium is the amount of the carrying charges. However, although there is a maximum premium in a carrying charge market, there is no maximum discount in an inverted market.
If an investor is long a put option on a financial futures contract and he decides to exercise, he will assume a:
a. Long futures position
b. Short futures position
c. Long actuals position
d. Short actuals position
b. Short futures position
Anyone who buys or is long a put option on a financial future will assume a short futures position if the option is exercised.
Margin due from a clearing house member based upon the settlement price is payable to the clearing house:
a. 24 hours after the call
b. 1 hour after the call
c. Before the market opens the next business day
d. None of the above
c. Before the market opens the next business day
A member firm is required to deposit both original and variation margin with the clearing house before the opening of trading on the following day. In the event that the market for a commodity is particularly volatile, the clearing house has the right to demand immediate margin. This emergency margin would have to be deposited by the member firm within one hour.
The sale of corn futures by a hog feeder is a bona fide hedge.
a. True
b. False
b. False
Since the hog feeder is short the basis (does not own corn), he will establish a long hedge.
When nearby futures are below the deferred futures, the market is called:
a. A discount market
b. An inverted market
c. A regular market
d. A normal market
d. A normal market
A “normal market,” which is also called a “premium market” and a “carrying charge market,” is one in which the cash price is lower than the futures prices, and the price of near futures is lower than the price of deferred futures.
If the cash price is higher than the price of futures, and the price of near futures is higher than the price of deferred futures, the market is called an “inverted market” or a “discount market.”
To liquidate a long position when the futures price reaches a certain level above the existing price, one would enter:
a. A sell stop order
b. A buy stop order
c. A sell limit order
d. A fill or kill order
c. A sell limit order
A trader liquidates a long position by selling. If he wants to liquidate a long position at a price that is above the current market, he will enter a sell limit order. This is an order that may be executed only at or above the price specified in the order. For example, an individual might have bought a contract of plywood at 115. He anticipates that the price will advance to 120, at which price he wants to sell in order to take his profit. He will enter a limit order to sell at 120. If the contract trades up to this price, the broker will sell, but under no circumstances will he accept less than 120.
The sell stop order is placed below the market. This type of order will be entered by a trader who has a long position and who wants to limit his loss on the downside. In the above example, the trader who bought the contract at 115 and anticipated an advance to 120 realizes that the price could drop, in which case he will suffer a loss. Therefore, he might enter a sell stop order at 110, which instructs the broker to sell at the market if the contract sells down to or below 110.
The buy stop order is placed above the market. It is used to limit a loss on a short position. The trader might have sold short at 120, anticipating a drop in price. However, as he realizes the price could also advance, causing a loss, he will enter an order to buy at 125. If the contract rises to 125 or higher, the broker will buy it at the market.
A fill or kill order is an order to be executed immediately when the broker enters the trading pit. He may do all or part of the order. If any part of the order cannot be completed immediately, it will be canceled.
The agency responsible for floor brokers and floor traders is the:
a. NFA
b. CFTC
c. Exchange
d. NASD
b. CFTC
The CFTC is the agency responsible for the commodity industry including floor brokers and floor traders. An exchange is a membership organization. The NFA is an industry association. Both the exchange and the NFA are DSROs (Designated Self-Regulatory Organizations). The CFTC is the independent federal agency that has overall responsibility to regulate the futures industry.
The primary significance of volume and open interest lies in:
a. Their respective changes in connection with price changes
b. Their changes in connection with each other
c. Whether their size is large or small
d. Their relationship to the size of the crop
a. Their respective changes in connection with price changes
Volume and open interest figures are used by technical analysts to estimate the course of the market. Volume figures measure the total number of contracts that are traded. Open interest is the total number of contracts that have been established and that have not yet been liquidated.
Some technical analysts think that changes in volume and the direction of the market can be reliable indicators of the trend of the market. For example, if the market is increasing in price and the volume is also increasing at the same time, this could indicate a continuing uptrend. If the market declines in price and the volume increases as the price declines, this could indicate a continuing downtrend in the market.
Technical analysts also use the trend of prices and open interest to make judgements about the future course of the market. For example, if the open interest is increasing, this means that new buyers and new sellers are entering the market. If the price increases at the same time the open interest increases, the market is considered to be technically strong. The reasoning behind this analysis is that the new longs are increasing their buying power as the price advances and will be able to assume new positions. The shorts, on the other hand, are suffering losses as the market advances and can be expected to start closing out their positions to cut their losses. Shorts close out their positions by buying the commodity, and this will add more buying pressure to the market, thus causing further price advances.
At the top of the market, some longs will attempt to sell to realize their profit, but will find that new buyers are not interested in entering the market at prices that they consider to be too high. The longs will therefore have to offer their contracts at progressively lower prices and the market will drop. Since new buyers are not entering the market, the longs will be selling to the existing shorts and the open interest will be declining. This type of market is technically weak and is called a “liquidating market.”
An RCR may enter an order for a customer who is currently undermargined if the customer assures him that a remittance is under way.
a. True
b. False
a. True
The margin rules of the Chicago Board of Trade require that a member may not accept orders for new transactions from a customer unless the minimum initial margin on the new transaction is deposited and the margin on established positions is at least equal to maintenance requirements of the exchange. However, if a customer states that funds required to fully margin his account are being transmitted at once, the member firm may accept this as adequate for a reasonable period of time and may allow the customer to establish a new position.
A hedged position does not guarantee full price protection against adverse price movements because:
a. The basis may change
b. The actual position held in inventory may not be an exact multiple of the futures contract
c. The basis grade may differ from the hedger’s cash position
d. All of the above
d. All of the above
All of the factors listed in the answer are correct statements. The purpose of a hedge is to protect the hedger against losses on his cash position. If the hedge is perfect, which means that there is no change in the basis between the hedger’s cash price and his futures price when the hedge is placed and when it is lifted, the hedge would be the purchase of cash wheat at $2.50 and the sale of futures at $2.60, with the hedge lifted when cash wheat is $2.30 and futures are $2.40. The basis was 10 cents under (cash was 10 cents less than futures) when the hedge was placed and when the hedge was lifted.
Few hedges are perfect, and therefore the hedger could still suffer a loss if the basis changes in an adverse direction. The hedge will still afford him protection against most of the loss due to adverse price change, but will not afford him full protection. Let’s examine the reasons why the hedge might not be completely effective.
An adverse change in the basis could result in a loss. Let’s assume that a hedger is long 1,000 tons of sugar. He buys the sugar for 38.70 and hedges when the price of futures is 39.90. His basis is therefore 1.20 cents under. His cash price of 38.70 is 1.2 cents under his futures price of 39.90. Since he is long 1,000 tons of sugar, he will establish a selling hedge by selling 20 sugar contracts (a contract in sugar is 50 tons). If the price of cash and futures rises or falls by exactly the same amount when the hedge is lifted, he will have neither profit nor loss. However, if the price of cash should drop more than the price of futures, he would suffer a loss. Let’s assume that the price drops for both cash and futures. The cash price drops to 38.20 and the futures price drops to 39.50. His basis is now 1.30 under. Since the basis widened, he will suffer a loss. The following shows his initial and closeout positions.
## Cash Futures Basis Buy 1,000 tons at 38.70 Sell 20 contracts at 39.90 1.20 under Sell 1,000 tons at 38.20 Buy 20 contracts at 39.50 1.30 under Loss .50 Profit .40 The hedger has a loss of 50 points (1/2 cent per pound) on his cash position. This was only partially offset by his profit of 40 points on his futures. His net loss was therefore 10 points, which is 1/10th of a cent per pound. As he was long 2,400,000 pounds (1,000 long tons at 2,400 pounds each), his net loss on the hedge was $2,400 (2,400,000 times .001). Had he not hedged his position, however, his loss would have been the full 1/2 cent per pound, or $11,200.
Another reason why a hedge might not be fully effective is if the hedger’s cash position is not a multiple of the futures contract. For example, if the sugar hedger was long 1,030 tons, he would have to hedge either 20 contracts and remain vulnerable for 30 tons on his cash position, or 21 contracts, which would leave him vulnerable for 20 tons on his futures position. If he hedged 20 contracts and the price dropped, he would bear the full extent of the loss on 30 tons. If he hedged 21 contracts and the price advanced, he would bear the full extent of the loss on 20 tons.
A third reason why a hedge might not be fully effective is because the basis grade of the commodity that is traded might differ from the hedger’s cash position. The factors that affect the basis grade might not be the same as the factors that affect the cash grade. For example, an individual might be long No. 1 wheat and he hedges on the Chicago board of Trade, where the basis grade is No. 2 wheat. No. 1 wheat might drop by 1 cent a bushel, while No. 2 wheat drops by only 3/4 cent a bushel, because of different supply and demand factors between the two grades of wheat. His loss of 1 cent on his cash wheat will only be partially offset by his gain of 3/4 cent on his selling hedge of No. 2 wheat.
A customer is long five contracts of sugar at 7.55. He offsets the position when sugar is 8.55. Round-turn commissions are $30. The size of the contract is 112,000 lbs. The net profit is:
a. $1,090
b. $1,120
c. $5,450
d. $5,600
c. $5,450
The net profit is $5,450, calculated as follows:
##
All of the following are advantages of futures trading EXCEPT:
a. Provides an alternative market for the commodity which increases liquidity of inventory
b. Buyers and sellers are able to deal directly with each other
c. The cost of financing is lowered through hedging
d. The value or price of a commodity is constantly being established
b. Buyers and sellers are able to deal directly with each other
All are advantages of futures trading except that buyers and sellers can deal directly with each other. When a futures contract is entered into by a buyer and a seller, it is done through a brokerage firm that is a member of the exchange. The buyer and the seller are not aware of each other’s identity, and there is no direct dealing between them.
The futures market does provide an alternate channel for the marketing of the cash commodity when a futures contract is settled by delivery, the cost of financing can be reduced because banks will lend money on a more favorable basis when a position is hedged, and the price of a commodity is constantly being established through sales that take place on the exchange.
A buy stop order becomes a market order when there is an execution or bid at the stop price.
a. True
b. False
a. True
A buy stop order is an order that is placed above the market, to buy the commodity if the price rises to or above the stop price. The buy stop order in commodities differs from the buy stop order in securities in that the securities stop order is one that becomes a market order when the stock trades at or above the stop price. In the commodities stop order, the order becomes a market order when the commodity trades at or above, or is bid at or above, the stop price.
Let’s examine a buy stop order to see how it is handled. A customer has sold a contract of oats at 99. He thinks that the price will fall, and he will therefore profit by buying the contract at the lower price. However, he realizes that the price could advance as well, and he would like to minimize his loss to around 2 cents a bushel, so he enters an order to buy a contract at 101 stop. The floor broker gets the order and holds it until the price rises. After a few days, the price has risen. The highest bid is now 100 3/4 and the lowest offer is 101 1/4. A broker enters the crowd and buys the contract offered at 101 1/4. The stop is immediately put into effect and a contract will now be bought at the best price available.
Let’s see how the order would be effected on a bid at the stop price. The market is once again 100 3/4 bid, 101 1/4 offered. A broker enters the crowd and bids for the commodity at 101. Since this bid is at the stop price, the order will immediately become a market order. The broker with the stop order will now buy the contract offered at 101 1/4.
Since a call option is the right to go long the futures market and a put option is the right to go short the futures market, a put option offsets a call option.
a. True
b. False
b. False
This is false. An investor closes out (offsets) an option position by undoing the opening position. An investor long a call option closes out the position by selling the call (not with a put).
When a customer signs his margin agreement, he is allowing the member firm to automatically transfer funds from his regulated commodities account to his securities account if there is excess equity in the commodities account and a deficit in the securities account.
a. True
b. False
b. False
The margin agreement does not allow the member firm to transfer funds from a commodity futures account into a securities account. In order to transfer funds, the customer would either have to give his written permission each time a transfer is to be made, or would have to sign the transfer consent form (supplemental agreement) to have transfers made automatically.
A businessman has agreed to deliver the cash commodity in three months at the price in effect today. In order to hedge effectively, he would:
a. Sell futures
b. Buy futures
c. Buy the cash commodity
d. All of the above are possible ways to hedge his risk
b. Buy futures
The businessman has agreed to deliver the cash commodity in the future. He does not own the cash commodity and wishes to protect himself against a price rise. He would therefore buy futures.
Which of the following is not an important influence affecting futures prices for an agricultural commodity?
a. Changes in Government agricultural policy
b. Stated opinions of officials of the various exchanges
c. News regarding international developments and monetary devaluation
d. Weather, seasonal price patterns and general business conditions
b. Stated opinions of officials of the various exchanges
Choices (a), (c) and (d) are all important influences that will cause price changes in commodities. Government agricultural policy is a very important factor. To just cite two of many possibilities, if the Government announced the end of acreage allotments in a commodity that was subject to them, this could be expected to greatly increase the supply of the commodity. If the Government announced that it was increasing its purchases of commodities to make donations to needy nations, this would have a direct bearing on demand for the commodity.
News regarding international developments and money devaluations would have a direct impact on prices of commodities. For example, announcement of a much larger crop in certain foreign countries would lead to a greater supply and a concurrent drop in price, whereas news of a drought would lead to a smaller crop and a greater demand, indicating a price increase. A devaluation of money by a country lessens the ability of that country to import foreign goods, and therefore this would lessen demand in that country.
Weather conditions have a direct bearing on the size of the crop. Seasonal price patterns will give a trader an indication of comparative factors between the current year and past years. General business conditions will indicate the ability of consumers to purchase a particular commodity. If conditions are good, there will presumably be more purchases than if conditions are poor.
The stated opinions of the officials of the exchanges are not of particular importance in regard to supply and demand factors that determine prices for commodities.
Cash and futures prices will converge:
a. At the country elevator
b. At the market location during the month of delivery
c. At the terminal elevator
d. At the clearing house
b. At the market location during the month of delivery
The price of cash and the price of futures must converge during the delivery month. If the prices did not converge, traders would buy the less expensive and sell the more expensive, thereby causing the prices to come together. For example, let’s assume that the price of the cash commodity is $3.00 and the price of futures is $3.10 during the delivery month. Traders would sell futures at $3.10 and immediately buy cash at $3.00. They would then deliver the cash commodity against the futures they just sold (as this is the delivery month, there would be no carrying charges) and would thereby insure themselves of a profit of 10 cents. The act of selling futures would drive the price down, while the purchase of cash would drive the price up. Eventually, the prices would converge.
A trader takes a position in a corn contract and deposits the necessary margin of $1,500. Maintenance is $1,100. The exchange subsequently raises the initial margin requirement to $2,000 and the maintenance requirement to $1,500. In this case the trader:
a. Must immediately deposit an additional $500
b. Need not deposit any additional margin on his existing position
c. Would have to deposit an additional $2,000
d. Would be required to liquidate his position
b. Need not deposit any additional margin on his existing position
If the exchange raises the initial margin requirement, the FCM would not be required to obtain additional margin unless the equity in the account dropped below the new maintenance margin level.
An individual buys a contract of wheat at $4.10 a bushel and wants to guarantee himself against a loss of more than 5 cents. You would advise him:
a. To place a stop order to sell at $4.05
b. To place a stop limit order to sell at $4.05
c. To place a market if touched order to sell at $4.05
d. That there is no way he can guarantee himself against losing no more than 5 cents a bushel
d. That there is no way he can guarantee himself against losing no more than 5 cents a bushel
There is no order that can guarantee a customer against losing more than a specified amount. In this question, the customer is long a contract at $4.10 and wants to protect himself against a price drop. He would like to limit his potential loss to approximately 5 cents. Therefore, he will place an order to sell below the market at $4.05. Choice (c) may be disregarded because it says that he will place a market if touched order to sell at $4.05. MIT orders to sell are similar to limit orders to sell and are placed above the market.
Choices (a) and (b) both describe possible orders that he could place below the market. The stop order is one that will become a market order once the contract trades down to that price. Let’s assume that it trades at $4.05 and the best bid is now $4.04 1/2. The broker would sell on this bid and the loss would be 5 1/2 cents.
If the broker had a stop limit order, he would be required to obtain the limit price or better once the contract sold at or below the stop price. In the above example, the order became a market order once a trade occurred at $4.05. Since the best bid is now $4.04 1/2, the broker will not execute the order at all. If the price never rises to the limit of $4.05, the customer may end up selling for substantially less at a later date.
Spread positions, compared to net long and net short positions:
a. Generally require lower margin and have lower risk
b. Generally require higher margin and have higher risk
c. Generally require lower margin and have higher risk
d. Generally require higher margin and have lower risk
a. Generally require lower margin and have lower risk
Spreads require a lower margin than net long or net short positions because there is usually lower risk associated with a spread than with a net position.
A moving average chart:
a. Will indicate the trend of the market without any time lag
b. Is the same as a point and figure chart
c. Is the same as a bar chart
d. Will indicate the trend of the market, but may lag behind the current market
d. Will indicate the trend of the market, but may lag behind the current market
A moving average chart is a simple chart to construct that indicates the trend of the market. Let’s construct a moving average chart first, and then see what the pitfalls are in its use.
The moving average chart takes the closing prices of a commodity for a number of successive days and averages the prices. On the following day, the oldest price is dropped and replaced by the price of the current day. The chart might be constructed on any number of days or even weeks that the chartist chooses to use. For example, he might make a three day chart, a 10-day chart, a 20-day chart, etc. In each case, the prices would be averaged for the number of days, with the oldest price dropped on each day. Let’s examine a simple three day chart. Let’s assume that the chartist is starting the chart right now and the commodity closed on the last 3 days at $2.00, $2.10 and $2.20. The three prices would be added together ($6.30) and divided by the number of days in the average (3) to indicate a price of $2.10. This would be charted and would be point A on the chart. The next day, the commodity jumps substantially in price to $2.40. The first day’s price would be dropped and the close of $2.40 substituted. Adding the three prices ($2.10, $2.20 and $2.40) and dividing by 3 indicates an average of slightly more than 2.23. This is charted at point B. On the following day, the commodity closes at $2.60, another substantial increase. We would drop the oldest price of $2.10 and substitute $2.60. The average of $2.20, $2.40 and $2.60 is $2.40. This is charted at point C.
So far, we have charted the average prices and the chart indicates that the prices are advancing, as they are indeed advancing. However, on the following day, the price drops to $2.50. Dropping the last price in our previous average and substituting $2.50, we have an average of $2.50 ($2.40, $2.60 and $2.50 divided by 3). This is charted at point D. Note that the chart indicates an advancing market even though the market has turned downward. On the following day, the price again drops to $2.40. Our average is still $2.50 (we drop the price of $2.40 of three days ago and substitute the closing price today: 2.60, 2.50 and 2.40 divided by 3 equals 2.50). This is charted at point E.
$2.60________________________________________
$2.50____________________D______E____________
$2.40_______________C________________________
$2.30________________________________________
$2.20____________B___________________________
$2.10______A_________________________________
Using the information concerning the closing prices, it is apparent that the price dropped substantially on the fourth day, from $2.60 to $2.50, but the average continued to indicate a rising market. On the following day, the price again dropped substantially, from $2.50 to $2.40, but the chart did not reflect this drop. If a trader based his buying and selling decisions on the chart, he might buy at point D or E, which indicates a rising market, even though the market is actually falling at these points. He could very well buy in a declining market and sell in a rising market because of the delay inherent in this type of chart in its indication of the trend of the market.
A customer’s securities account has a debit of $2,000 and his regulated commodity account has a surplus of $2,500. The member firm may:
a. Automatically transfer funds from the regulated commodity account to the securities account
b. Automatically transfer funds from the regulated commodity account to the securities account if the customer has given the firm prior written instructions
c. Not transfer funds under any circumstances
d. None of the above
b. Automatically transfer funds from the regulated commodity account to the securities account if the customer has given the firm prior written instructions
The CFTC has established regulations which prohibit a member firm from using customers’ funds that relate to commodity futures. The member firm is required to segregate these funds and may not use the funds for its own purposes nor may the firm combine these funds with funds relating to securities or anything else.
If the customer wants to transfer funds relating to commodity futures to any other account, the customer would have to give the member firm specific instructions each time the transfer is to be made. If the customer wanted the broker to be able to transfer funds relating to commodity futures automatically, without requiring specific consent for each transfer, he would sign the transfer consent form.
January 2:
Cash: 424 1/2
Futures: 443 3/4
February 9:
Cash: 428
Futures: 449
Using the information given above, assume that a farmer initiates a short hedge on January 2. What would be the contribution of the hedge to the carrying charges if the hedge were closed out on February 9:
a. +1 3/4
b. - 1 3/4
c. +8 3/4
d. - 8 3/4
b. - 1 3/4
The farmer initiates his positions on January 2 when cash is selling for 424 1/2 and futures are selling for 443 3/4. He lifts the hedge on February 9, when cash is 428 and futures 449.
The net result of the hedge, taking into consideration the profit on cash of 3 1/2 and the loss on futures of 5 1/4, is a net loss of 1 3/4.
The fundamental study of a commodity entails knowledge of:
a. Basic economic forces of supply and demand
b. Seasonal price patterns
c. Demand factors
d. Past futures prices
a. Basic economic forces of supply and demand
All of the items listed in the answer are significant factors and will be considered by a trader. However, the fundamental study of commodities entails knowledge of the basic supply and demand factors regarding that particular commodity and therefore answer (a) is the best answer.
A customer is long 10 December 500 gold puts. He wishes to liquidate the position. He would:
a. Buy 10 December gold calls
b. Buy 10 December futures contracts
c. Sell 10 December 500 gold calls
d. Sell 10 December 500 gold puts
d. Sell 10 December 500 gold puts
In order to close-out (liquidate) an option position, the customer must undo his opening transaction. In this case he would sell the puts he originally purchased.
A sell stop limit order becomes a market order when the contract trades at or below the limit price.
a. True
b. False
b. False
A stop limit order is an order that becomes a limit order to sell once the contract sells at or below the stop price. On a straight stop order, the order would become a market order to sell once the commodity trades at or below the stop price. Let’s look at both the stop order and the stop limit order to see how they are handled by a floor broker.
A broker receives a stop order to sell at 98 and a stop limit order to sell at 98. In both cases, nothing will be done until the contract trades (or is offered) at 98 or less. The broker enters the pit and the market is currently 97 3/4 bid, 98 1/4 offered. Nothing will be done by the floor broker. Another broker now enters the pit and sells a contract at 97 3/4. Since the contract has now traded below the stop price, both orders will be elected. The best bid in the pit after the above transaction is now 97 1/2. The broker will immediately sell one contract (the one that was a straight stop order) because this order became a market order, to be executed at the best price available, once the stop price was reached. Nothing will be done with the stop limit order until a bid arrives in the pit at 98 or higher as the customer has specified that, once the stop price was reached, his order was to become a limit order to be executed only at 98 or higher.
A customer buys a futures contract. The price drops below the original margin level but is above the maintenance level. The customer may buy additional contracts based upon the excess equity above the maintenance level.
a. True
b. False
b. False
A customer may not withdraw equity from his account, nor may he use equity to take additional positions (pyramiding), unless the equity is above the original margin level. If the account is below the original margin level but is above the maintenance level, the customer is not required to deposit additional margin on his existing positions, but he will not be able to withdraw any equity. If the equity drops below the maintenance margin level, the customer will be required to deposit additional margin to bring the equity back to the original level. Let’s look at an example.
The original margin level is $1,000 and the maintenance level is $750. The customer buys five contracts and deposits $5,000. The contracts advance in price and the equity increases to $7,000. In this case, the customer could either withdraw $2,000 in cash or he could initiate two new positions.
Let’s assume that the contracts decline in price and the equity is reduced to $4,000 ($800 per contract). No call would be sent for additional margin as the equity is still above the $750 maintenance level, but no money may be withdrawn nor may new positions be assumed based upon the current equity in the account.
The contracts continue to decline in price and the equity is now $3,500 ($700 per contract). Since the equity is below the maintenance level, a call for additional margin of $1,500 will be sent in order to bring the account back to the original margin level of $5,000 ($1,000 per contact).
An inverted head and shoulders pattern usually indicates to technical analysts:
a. A continuing price decline in a declining market
b. The reversal of a declining market
c. The reversal of an advancing market
d. A stagnating market
b. The reversal of a declining market
An inverted head and shoulders pattern is considered to be a bullish chart formation that usually leads to advancing prices.
A grain exporter has sold grain for delivery in three months. The long range weather report indicates turbulent conditions in the shipping lanes. To protect against potential higher shipping costs, the exporter may go long freight futures.
a. True
b. False
a. True
Freight futures can be purchased to protect against the potential rise in shipping costs.
A trader takes a long position of two contracts of silver. He sells the contracts after the price advances by 35 1/2 cents. The size of the contract is 5,000 ounces. The total commission on the two contracts is $100. The trader’s profit is:
a. $3,450
b. $3,550
c. $17,450
d. $34,500
a. $3,450
If the price advances 35 1/2 cents, the total profit would be $3,550 (10,000 ounces times .355). As the commission on the two contracts is $100, the net profit after deducting commission is $3,450.
When ex-pit transactions are made, the cash purchase is made at a specified basis and the futures transaction is made outside the trading pit.
a. True
b. False
a. True
An ex-pit transaction (also called an “against actuals” or an “exchange for physicals” transaction) is one in which a hedger enters into a cash market transaction with another hedger. The rules of the exchange allow the futures transaction to be made outside of the trading pit, at a prearranged basis, and open outcry is not required.
In an ex-pit transaction, a person who is long the basis (long the cash commodity) will have a selling hedge (sale of futures). He will sell his cash commodity to someone who is short the basis (short cash) who would have established a buying hedge (purchase of futures). The hedgers will determine the basis on which the transaction is to occur and will exchange their futures position on the basis they have negotiated. The person who is long the basis (long cash) will exchange his cash commodity for the long futures of the other person. The person who is short the basis will exchange his long futures position for the cash commodity.
If a customer has granted power of attorney to another individual to handle his account:
a. The member firm must obtain written permission for the customer prior to the exercise of discretion
b. The customer must get written confirmations on each trade
c. The customer must receive a monthly statement of account
d. All of the above
d. All of the above
Before a member firm will allow anyone to exercise discretion in a customer’s account, the member firm will require that the customer sign the proper documents authorizing the other person to exercise discretion. The customer will receive duplicate confirmations on each trade that is made in the account and will also receive duplicate monthly statements.
A customer’s sell stop limit order at 140 1/2 may be executed at all of the following prices EXCEPT:
a. 140
b. 140 1/2
c. 140 3/4
d. 150 1/2
a. 140
A sell stop limit order is an order that becomes a limit order once the commodity trades at or through the stop price. A straight stop order is one that becomes a market order once the commodity trades at or through the stop price. In the stop limit order, the trader will not accept an execution at a price that is lower than the limit price, while in a straight stop order, he will accept whatever the price happens to be once the stop is elected.
For example, a broker receives a sell stop order to sell at 140 1/2 and a sell stop limit order to sell at 140 1/2. In the straight stop order, he is being instructed by the trader to sell at the best available price once the commodity trades at 140 1/2 or less. In the sell stop limit order, he is being instructed by the trader to accept no less than 140 1/2 if the commodity trades at this price or less.
The broker goes to the floor with both orders. The market is currently 140 1/4 bid and 140 3/4 offered. This means that neither order will be elected at present. A trader enters the pit and sells a contract at 140 1/4. This elects both the stop order and the stop limit order. The best bid now available is 140. The broker will sell the stock on his straight stop order at this price. However, he will not take any action on the stop limit order until a bid arrives at 140 1/2 or higher because the customer has given him a limit and will not accept an execution below this price.
On many commodity exchanges, hedgers have a lower original margin than speculators.
a. True
b. False
a. True
The rules of some exchanges allow member firms to charge their hedge customers a lower original margin than the amount that they charge speculators. The hedge customer has a cash position to offset his futures position. Therefore, his risk is lower if the price of the futures should move against him. Any loss on the futures position will be offset by a gain on the cash position. In addition, the hedge customer is more likely to have the facilities to make or take delivery on the actuals than would a speculator. A third reason for lower hedge margin is because it is generally easier to determine the financial condition of the hedge customer than it is to determine the financial condition of the speculator.
Changes in the basis might occur because of:
a. Change in the current demand factors for a commodity
b. Change in demand for a commodity at a particular destination at a particular time
c. Change in the demand for future delivery
d. All of the above
d. All of the above
The term “basis” describes the relationship between the cash price today and the price of the particular futures month in which the hedge is established.
One factor that can cause a change in the relationship between the cash and futures price is a change in demand for the commodity which will, in turn, cause a change in its price. This might be a temporary situation, such as a current shortage of the commodity causing an increase in purchases as users try to assure supply by buying it today. This will cause a rise in the price of cash and near futures, but not necessarily distant futures. Conversely, there might be adequate supplies currently, but it is anticipated that there will be a shortage in the future. Therefore, distant futures will receive more buying support than near futures and its price will increase more.
Another factor is that there might be a shortage of the commodity at a particular location due to local factors, which will cause its price to rise. This will not be reflected in prices elsewhere. Therefore, all of the choices listed are correct statements.
A member firm requires a customer to sign the Customer’s Agreement in order to:
a. Assure itself that the customer has sufficient funds to speculate in futures
b. Allow the broker to liquidate the customer’s position if the customer fails to meet the broker’s margin call
c. Free the broker from any liability for failing to execute the orders of the customer properly
d. Allow the broker to use the funds of the customer in any way he sees fit
b. Allow the broker to liquidate the customer’s position if the customer fails to meet the broker’s margin call
The customer agreement has a provision that allows the member firm to liquidate a futures position if the customer fails to meet a margin call.
When prices of futures fluctuate over a relatively narrow range, chartists believe that a congestion area has been formed.
a. True
b. False
a. True
A congestion area is a chart formation in which the price of the commodity has traded in a relatively narrow range for a period of time. A small upward movement in the price is met by increased selling and the price does not advance any further, while a small downward movement in price is met by increased buying and the price does not decline any further.
A major economic role filled by a futures market is:
a. Determination of prices
b. Price restraint
c. Providing a market for surplus commodities
d. Solving commodity shortages
a. Determination of prices
One of the most important functions met by commodity exchanges is the determination of the price for commodities. This price is determined by the interaction of the forces of supply and demand which are manifested on the floor of the exchange.
An IB may be guaranteed by more than one FCM.
a. True
b. False
b. False
Introducing brokers can only be guaranteed by one Futures Commission Merchant at a time.
A customer is long five contracts of orange juice (OJ) at 1.3915. He liquidates the position at 1.4560. Round-turn commissions are $30. The size of the contract is 15,000 lbs. What is the net profit or net loss?
a. $937.50 profit
b. $937.50 loss
c. $4,687.50 profit
d. $4,687.50 loss
**c. $4,687.50 profit** ##
A pension fund manager can use a short hedge in stock index futures to protect the value of his portfolio.
a. True
b. False
a. True
A pension fund manager with (long) a portfolio of stocks could hedge the position by selling stock index futures.
An order to buy December corn at 1.45 MIT should be entered:
a. Below the market price
b. Above the market price
c. May not be entered for corn
d. At the market
a. Below the market price
A market-if-touched order is similar to a limit order. Both are entered below the market in the case of a buy order and above the market in the case of a sell order. In the case of the buy MIT and the buy limit order, the trader is instructing his broker to buy the contract only if it goes down to a price that he considers to be attractive. He is unwilling to buy at the current price because he thinks it is too high. In the case of the sell MIT and the sell limit order, the trader is long the commodity and he instructs the broker to sell only if the price rises to the limit specified in the order. His reasoning is that it will go to this price and he does not wish to give up his long position below this price and therefore take a lower profit.
The MIT order differs from the limit order in that the limit order must be executed at the limit price or better. In the case of the buy limit, the purchase must be made at the limit or less; in the case of the sell order, at the limit price or higher. In the case of the MIT order, the order becomes a market order once the contract trades at the limit price and could be executed at, above or below the limit price once a trade occurs at this price.
