Practice Test 3 Flashcards
A businessman sells his product in Japan and receives payment in Japanese currency. If he fears a devaluation of the Japanese yen, he would sell yen in the futures market.
a. True
b. False
a. True
The exporter, anticipating a decline in the Japanese yen, would protect himself by selling yen contracts. If the yen does decline in price, he will be able to close out his purchase by buying yen at a lower dollar amount, thereby generating a profit to offset his loss on the actual yen he receives.
A pool has operated for seven years. The pool operator must include the entire performance history in the disclosure document.
a. True
b. False
b. False
The risk disclosure document must include performance history for five years. If the pool for which the CPO is soliciting has been trading for more than five years, the disclosure document must contain only the last five years.
A sell stop order is an order that becomes a market order when the contract sells or is offered at or below the stop price.
a. True
b. False
a. True
A sell stop order becomes a market order when a contract sells or is offered at or below the stop price. It is used to limit a loss or protect a profit.
In a normal market, the difference between near and deferred futures contracts is called:
a. Basis
b. Crush
c. Reverse crush
d. Carrying charge
d. Carrying charge
A normal market is when the price for the nearest month is selling at the lowest price, while the prices for deferred months are selling at higher prices. This type of market is also referred to as a carrying charge market or a premium market.
A bottom head and shoulders and a descending triangle are bearish configurations on a chart.
a. True
b. False
b. False
This is false. A bottom head and shoulders is technically bullish.
A CPO’s account statements must be distributed at least quarterly.
a. True
b. False
a. True
This is true. A CPO must distribute statements of account at least quarterly. Pools with Net Asset Value greater than $500,000 must send statements monthly.
A client shorts a Eurodollar futures contracts on the CME at 94.70. Original margin is $810 per contract and maintenance margin is $600. Later the contracts settlement price is 94.88, the client would be required to deposit an additional:
a. 0
b. $110
c. $270
d. $450
d. $450
The client deposited original margin of $810. Since the Eurodollar futures values settled at a higher price and the client is short the contract, the equity in the contract will decline. The contract increased by 18 basis points and the value of each basis point is equal to $25. The equity is reduced by $450 (18 x $25). The equity is now $360 ($810 - $450). Since the equity in the account is below the maintenance requirement, the client must deposit $450 to bring the equity to the original margin requirement level.
Arbitration is used as a means of dispute settlement. Decisions of the arbitrator(s) are non-appealable.
a. True
b. False
a. True
Decisions of the arbitrator(s) are nonappealable and can be enforced in any court of competent jurisdiction.
Open interest decreasing while prices are going down is referred to as a:
a. Weak market
b. Liquidating market
c. Overbought market
d. Inverted market
b. Liquidating market
In this situation, existing positions are being liquidated more aggressively than new positions are being established. Therefore, since prices are going down, it is evident that longs are liquidating their positions more aggressively than shorts, i.e., selling their positions in order to leave the market and offering the contracts at progressively lower prices in order to offset their positions. This type of market is considered to be technically strong and is called a liquidating market.
A hedger establishes a futures position that is opposite to his cash position. He would be most concerned with:
a. The cash price
b. The futures price
c. Changes in the basis
d. Whether the cash and futures market will move up or down
c. Changes in the basis
The hedger does not care about the price of the cash or the futures. Instead, he cares about the basis, which is the relationship between the price of cash and the price of futures.
For example, if a hedger is long cash at $3.50 and short futures at $3.60, he does not care if the price of cash rises by $1.00 and the price of futures rises by $1.00 as his basis will not change. However, he would care if the price of cash rises by 99 cents and the price of futures rises by $1.00 as this would represent a basis change of 1 cent and would represent in this case a loss of 1 cent.
Variation margin is the amount of funds deposited by a customer in addition to the original margin when:
a. The market price moves against his position
b. The futures position is closed out
c. The customer holding the opposite side of the futures contract makes a demand for the deposit of additional funds
d. The market price declines by 50% or more if the customer is long or advances by 50% or more if the customer is short
a. The market price moves against his position
Variation margin is the margin that a member firm calls for when the market goes against a customer’s position. The call for additional margin will be sent when the equity drops to a predetermined level. For example, the initial margin requirement, which is deposited when the position is assumed, might be $1,000 and the variation margin level might be $750. If the equity drops to $750 or less, the member firm will call for additional margin necessary to bring the account to the initial level of $1,000.
An elevator operator has inventory of 5,000,000 bushels of corn. He wishes to hedge, but is reluctant to use the futures market. He decides to use options and wants to have minimum risk. Cash corn is 1.80 1/2 and December corn is 1.91 3/4. A December 190 call is 14 1/2 and a December 190 put is 11. The corn contract is 5,000 bushels. He decides to buy 1,000 options. In November, the cash price of corn is 1.76 3/4. The December option prices are 3 1/4 and 17 3/4. As a result of the hedge, what is the market price of the corn to the hedger?
a. 180
b. 180 1/4
c. 180 1/2
d. 183 1/2
d. 183 1/2
The market price of the corn to the hedger is 183 1/2, calculated as follows: ##
A trader buys a contract at a price of $4.55. The price advances to $4.65. The trader anticipates that the price will rise, but he wants to protect his profit if he is wrong. He would most likely place a stop order to sell at:
a. $4.70
b. $4.66
c. $4.63
d. $4.55
c. $4.63
The stop order to sell is placed below the current market price. As the market price is $4.65, choices (a) and (b) are not possible choices. Choices (c) and (d) are both below the current market price, but choice (d) is not a logical choice because the question states that the trader wants to protect most of his unrealized profit. If he were to enter a stop at $4.55 (his purchase price), he would lose all of his profit.
An individual has a profit of 88 points on each of three T-bill futures contracts. What is the total profit?
a. $2,200
b. $6,600
c. $8,800
d. $26,400
b. $6,600
One point on a T-bill contract equals $25. A profit of 88 points would, therefore, total $2,200. Based on three contracts, the total profit is $6,600.
A customer takes on a bear call spread position. The prices of the options are 2-20 and 5-24. The strike prices of the options are 84 and 88. The maximum potential loss is:
a. $875.00
b. $937.50
c. $3,062.50
d. $3,125.00
b. $937.50
Bear call spreads are credit spreads. Therefore, the investor sold (is short) the call at 5-24, and bought (is long) the call at 2-20 for a net credit of 3-04 (3 4/64 or $3,062.50). The maximum loss potential on a credit spread is the difference in the strike prices (88 - 84, or 4 points, or $4,000) minus the net credit ($3,062.50). The maximum loss is $937.50.
An IB does not maintain the signed and dated acknowledgment from the customer that he has reviewed the Risk Disclosure Document. It is given to the FCM.
a. True
b. False
b. False
The IB must maintain this record.
A trader buys a contract of corn at $1.25 and deposits margin of 12 cents a bushel. Commission is $30. He sells the corn at $1.41. The contract size of corn is 5,000 bushels. His net profit on the trade would be:
a. 15%
b. 25%
c. 45%
d. None of the above
d. None of the above
On a margin deposit of 12 cents a bushel, the trader is investing $600. The contract now advances 16 cents. His profit is therefore 16 cents a bushel times 5,000 bushels, which equals $800. From this profit, we deduct the commission of $30. This yields a net profit of $770. As his original margin investment was $600, a profit of $770 would represent slightly more than 128% ($770 divided by $600). Therefore, none of the figures in choices (a), (b), or (c) is correct.
In a thin market, with relatively few speculators, futures prices will:
a. Be about the same as in an actively traded market
b. Be more volatile than in an actively traded market
c. Be less volatile than in an actively traded market
d. Be much closer to the price of the cash commodity than would be the case in an actively traded market
b. Be more volatile than in an actively traded market
A thin market, which is one in which there are relatively few participants, is generally more volatile than a market in which there is a relatively large amount of participants. A volatile market is one in which there are wide spreads between bids and offers and large differences between subsequent trades.
A customer buys a T-bill put and pays 1.75. The premium he pays for the put is:
a. $175.00
b. $2,734.38
c. $4,375.00
d. $5,468.75
c. $4,375.00
T-bill options are quoted in basis points. A premium of 1.75 represents 175 basis points at $25 each for a total of $4,375 (175 x $25).
In order for a trader to exceed speculative position limits, he must register with the CFTC.
a. True
b. False
b. False
The CFTC has established trading limits and position limits for certain commodities. These limits apply to speculators only. The limits do not apply to bona fide hedgers. There is no way that a trader could exceed these limits by applying to the CFTC for an exemption, as there are no exemptions of any kind granted to a trader by the CFTC.
On January 26, Jack Stevens agrees to purchase from XYZ Copper Industries 200,000 pounds of copper at 65.00 on May 1. Mr. Stevens also agreed to sell the 200,000 pounds of copper to DEF Heating Supply Co., on May 1, at the cash market price. On January 26, the cash market price is 65.00 and the May Futures is at 66.00. On February 2, copper prices begin to weaken and the cash market is now 64.50. The copper contract size is 25,000 lbs. To protect himself against an adverse price change, Mr. Stevens should:
a. Buy May copper futures
b. Sell May copper futures
c. Buy February and sell May futures
d. Sell February and buy May futures
b. Sell May copper futures
On May 1, Mr. Stevens has a commitment to purchase 200,000 pounds of copper at 65.00. He will then sell the copper at the cash market price to DEF Heating Co. His concern is declining copper prices, therefore, he should sell the May futures.
A futures contract:
Is for the purchase or sale of an established uniform quantity of an actual commodity as set forth in the exchange rules and regulations
Permits the seller to elect the deliverable grade as specified in the exchange rules and regulations
Permits the buyer to select the exact lot for purchase
Permits the seller to specify the exact lot for delivery
a. I and II
b. I and III
c. II and III
d. III and IV
a. I and II
A futures contract is a standardized contract entered into by a buyer and seller that always specifies a specific quantity (5,000 bushels of wheat, 36,000 pounds of imported boneless beef, 100 tons of soybean meal, etc.) of a specific grade (the basis grade with allowances for delivery of premium and discount grades) at the contract price. The rules of the exchange allow the seller to elect the day of delivery within the delivery month, and allows the seller to deliver either the basis grade at the contract price, or a premium or discount grade at appropriate differentials. The buyer must accept whatever grade the seller elects to deliver.
The buyer does not have the option of specifying the exact lot of the actuals that he wants, and the seller does not specify the exact lot that he will deliver when both enter into the contract.
The Commodity Pool Operator must distribute the Account Statement to the pool participants at least monthly in the case of pools with net assets of more than $500,000 at the beginning of the pool’s fiscal year.
a. True
b. False
a. True
The Account Statement must be distributed at least monthly to the pool participants in the case of pools with net assets of more than $500,000. If $500,000 or less, then it must be sent at least quarterly.
A customer is long five stock index futures contracts at 65.05. He liquidates when the price is 67.35. Commissions are $50 round-turn. The contract has an index of 250. His profit is:
a. $525
b. $575
c. $2,625
d. $2,875
c. $2,625
The customer’s profit is $2,625, calculated as follows:
A spread trader anticipates a bull market over the next three months and puts on a bull spread in the stock index futures market. The trader has:
a. Sold the deferred and bought the nearby
b. Bought the deferred and bought the nearby
c. Bought the deferred and sold the nearby
d. Sold the deferred and sold the nearby
c. Bought the deferred and sold the nearby
In a bull market for stock index futures where prices are rising, the deferred months should rise faster than the nearby months and thus the spread should widen.
A broker may transfer funds from a client’s regulated commodity account into a stock account of the client if the client has signed the Supplemental Commodity Customer’s Agreement Form.
a. True
b. False
a. True
A member firm is required to segregate the funds of customers that relate to commodity futures. It may not mix the funds with those pertaining to securities or anything else. The customer must give the member firm specific instructions, in writing, if he wants funds transferred from his commodity futures account to his securities account. If the customer wants the broker to be able to transfer funds automatically, he must give the broker a signed supplemental agreement also called a transfer authorization form.
The ratio by which the price of an option moves relative to the underlying futures contract is known as the:
a. Spread
b. Beta
c. Basis
d. Delta
d. Delta
The delta factor compares the price movement of an option contract with price movements of the underlying future.
A meat packer establishes a long hedge in hogs. He buys futures at $18.80. per cwt. His commission costs are $.11 per cwt and interest is $.05 per cwt. His total cost for futures is therefore $18.96 per cwt. When the hedge is removed, futures are $19.46 and cash is $19.35. Taking into consideration the hedge, what is the packer’s net cost for his hogs:
a. $18.45
b. $18.55
c. $18.65
d. $18.85
d. $18.85
In this question, the meat packer buys futures in order to fix his cost for the actuals that he intends to buy at a later date. When the hedge is placed, the price of futures is $18.80. The hedger has additional costs of 11 cents for commission and 5 cents for interest on the money he borrowed to buy futures. Therefore, his total cost for the futures is $18.96.
When the hedge is lifted, the cash price for the hogs is $19.35 and the futures price is $19.46. The hedge is lifted by the meat packer reversing his cash and futures positions. As he was short cash hogs, he will buy them at $19.46. The packer’s profit on the futures was 50 cents (selling price of $19.46 minus cost of $18.96). His net cost for the cash hogs was the cash price minus the profit on the futures, and is therefore $18.85 ($19.35 minus $.50). The following table shows the net result of the hedge.
Short cash hogs Buy cash hogs at $19.35 Buys futures at $18.96 Sells futures at $19.46 Profit .50 Cash price of hogs: $19.35 Profit on futures: .50 Net price received: $18.85
A customer is long December Gold at $480.50. He places a stop limit order at $465.00. When the stop is elected and the order is executed, the fill can be at all of the following prices EXCEPT:
a. $464.50
b. $465.00
c. $465.50
d. $480.50
a. $464.50
Since the customer is long the contract, the order placed is to sell at $465.00 stop limit. A stop limit will be activated (triggered) when the price drops to $465.00. If this should occur, the order becomes a limit order to sell at $465.00. In a limit order the client will accept no less than $465.00 when the order is executed.
Exchange rules state that authorization for discretion must be in writing and revoked in writing or is revoked upon the death of the customer (the death of the AP).
a. True
b. False
a. True
This is true. Discretion may be revoked by either the customer or firm. Discretion can be terminated only by written revocation signed by the person in whose name the account is carried; or by the written notification of the AP or firm that they will no longer act pursuant to such discretion. The death of the person in whose name the account is carried or the death of the AP who has been given discretion also terminates discretion.
An individual initiates a short position in a contract on which the initial margin is 12 cents per bushel and the maintenance margin is 10 cents per bushel. The selling price is 2.53 1/4. The customer would be called for additional margin if the price of the contract:
a. Advances above 2.55 1/4
b. Declines below 2.51 1/4
c. Changes by 2% or more
d. Changes by 5% or more
a. Advances above 2.55 1/4
If an individual initiates a short position and the price increases, he will experience a loss and be called for additional margin if the price advances above $2.55 1/4. Selling Price $2.53 1/4 Initial minus Maintenance Margin + .02 Total: $2.55 1/4
A client buys a June Value Line futures contract which settles at 123.65. The next day it closes at 124.80. The contract size is 500 times the dollar value of the index. The dollar value of the change is:
a. $5
b. $25
c. $575
d. $625
c. $575
To find the dollar value, take 124.80 and subtract 123.65 = 1.15. Then multiply 1.15 by 500 and the dollar change is $575.
The CPO is not required to maintain confirmation statements received from the FCM.
a. True
b. False
b. False
This is false. A CPO must maintain records of trades performed by the FCM on behalf of the pool. Such records are used in computing performance results for disclosure purposes.
A Treasury bond trader who thinks interest rates will rise should:
a. Buy calls
b. Buy puts
c. Sell puts
d. Write covered puts
b. Buy puts
Bond prices have an inverse relationship to interest rates. In this situation, if interest rates are going up, bond prices will decline. The trader should therefore buy puts.
An account carried by one FCM for another FCM in which the transactions of two or more customers are combined and carried in the name of the originating broker rather than designated separately is called:
a. A house account
b. A segregated account
c. A customer’s regulated account
d. An omnibus account
d. An omnibus account
An omnibus account is an account that a non-clearing firm maintains with a clearing firm. The non-clearing firm will maintain all of the required records and will enter orders with the clearing firm in a single omnibus account rather than in an account where the name of each customer is designated.
In June, Central City Corporation (CC) plans to offer $30 million of 20-year bonds in November. Presently, CBT long-term U.S. T-bond futures are as follows:
September:89-28
December: 90-08
March: 90-16
June: 90-23
To hedge, he would go:
a. Long 300 March bond futures
b. Short 300 December bond futures
c. Short 30 March bond futures
d. Long 20 December bond futures
b. Short 300 December bond futures
He will short 300 December Bond futures contracts.
Total Dollar Volume of Bonds / T-Bond Contract Size = Number of contracts
30,000,000/100,000 = 300
In June, Central City Corporation (CC) plans to offer $30 million of 20-year bonds in November. Presently, CBT long-term U.S. T-bond futures are as follows:
September: 89-28
December: 90-08
March: 90-16
June: 90-23
Comparable bonds of North City Corporation (NC) are at 87-29. The CC treasurer is worried that interest rates may increase and he decides to hedge using T-bond futures. The T-bond futures contract size is $100,000.
The issue is fully sold by November 15 at an average price of 83-12 and on that date the futures position is offset at 84-31. Due to the hedge and the change in basis, CC has:
a. Provided protection against an increase in interest cost amounting to $22,500
b. Provided protection against an increase in interest cost amounting to $225,000
c. Been affected by an increase in interest cost amounting to $22,500
d. Been affected by an increase in interest cost amounting to $225,000
**b. Provided protection against an increase in interest cost amounting to $225,000** ##
In June, Central City Corporation (CC) plans to offer $30 million of 20-year bonds in November. Presently, CBT long-term U.S. T-bond futures are as follows:
September: 89-28
December: 90-08
March: 90-16
June: 90-23
Comparable bonds of North City Corporation (NC) are at 87-29. The CC treasurer is worried that interest rates may increase and he decides to hedge using T-bond futures. The T-bond futures contract size is $100,000.
The issue is fully sold by November 15 at an average price of 83-12 and on that date the futures position is offset at 84-31. As a result of the hedge, the final rate at which the issue was priced was:
a. 78-03
b. 82-00
c. 83-12
d. 88-21
d. 88-21
The final rate at which the issue was priced was 88 21/32.
Nov Cash: 83 12/32
+ Futures Profit: 5 9/32 = 88 21/32
According to NFA rules and CFTC regulations, an NFA member or an associated person of an NFA member has an obligation to verify a customer’s income and net worth.
a. True
b. False
b. False
This is false. There is no requirement that information supplied by the customer must be verified. Good business practice would be to verify such information.
When an individual purchases a futures contract, actual ownership of the cash commodity is accomplished:
a. When he deposits the initial margin
b. When he offsets his position
c. When he deposits an amount equal to 50% of the value of the cash commodity over and above the initial margin requirement
d. When the actual commodity is delivered and he pays for it
d. When the actual commodity is delivered and he pays for it
A purchase of a futures contract is not a purchase of the cash commodity. It is a contingent liability to purchase the cash commodity only when and if it is delivered by a seller. Actual ownership occurs only when the cash commodity is delivered by the seller and the buyer pays for the commodity.
Your client has gold bars and coins and wants to protect the value of his investment against declining gold prices. You would recommend that he buy an:
a. In-the-money call
b. In-the-money put
c. At-the-money call
d. At-the-money put
d. At-the-money put
In this situation, it is expected that gold prices will be declining. Your recommendation should be to buy a short-term, at-the-money put or, if available, an out-of-the-money put. The put will be inexpensive and, hence, highly leveraged. The client’s risk is limited to the option premium.
Commodity Pool Operators may receive funds in their own name.
a. True
b. False
b. False
A commodity pool operator must receive customer funds in the name of the pool in which the customer is participating.
The following information concerns COMEX gold spreads.
July 465.50
August 465.60
September 466.10
November 468.20
December 468.80
February 469.20
Which of the following will probably be the most profitable spread if it is expected that the spread will narrow?
a. Sell July and buy August
b. Buy September and sell November
c. Buy July and sell August
d. Buy February and sell December
b. Buy September and sell November
When a spread narrows, the difference between the near and the deferred month price will decrease. In a normal market, the deferred month will be more expensive so the investor should buy the near month and sell the deferred month (choices b and c).
To maximize his gain the investor should select the spread which is widest. The July-August spread is .10 (465.60 - 465.50), while the September-November spread is 2.10 (468.20 - 466.10).
Which of the following is least important in determining interest rates?
a. Fiscal policy
b. Unemployment rates
c. Monetary policy
d. Supply of money
b. Unemployment rates
Fiscal policy, monetary policy and money supply are fundamentally important in determining interest rates.
A miller buys a futures contract of wheat at $3.04 and takes delivery. The contract size is 5,000 bushels. On the day of delivery, the settlement price for wheat is $3.42. The miller would have a total cost for the wheat of:
a. $17,100
b. $15,800
c. $15,200
d. None of the above
c. $15,200
The miller’s cost for the 5,000 bushels is the price at which he bought the futures. 5,000 bushels at $3.04 per bushel totals $15,200.
If a CTA handles a managed account, it is the CTA’s responsibility to insure that his clients receive monthly account statements.
a. True
b. False
b. False
Any “managed account” handled by a CTA will be carried on a fully disclosed basis by an FCM. It is the responsibility of the FCM (not the CTA) to send statements of account to the client.
A hedger is said to be “short the basis” when:
a. He recognizes that prices are low and establishes a long futures hedge to protect against a subsequent expected price rise
b. He has sold the cash commodity but has no inventory, and so he establishes a protective long futures hedge
c. He converts a futures position into a cash position through an exchange for physicals transaction
d. He has the cash commodity in inventory and wishes to protect himself against a price advance
b. He has sold the cash commodity but has no inventory, and so he establishes a protective long futures hedge
The term “short the basis” means short the cash commodity. An individual who has entered into a firm commitment to deliver the cash commodity at the current price, but who does not own the cash commodity, will establish a buying hedge. He will then be short the cash and long the futures.
Choice (a) appears to be correct. However, it says that the hedger recognizes that prices are low, and this is the reason that he hedges by buying futures. This is not correct. Someone who is short the basis will hedge to protect himself whether he thinks the price is low or he thinks the price is high. If the long hedger only hedged when he thought the cash price was low, he would be subjecting himself to large risks and would be assuming the role of a speculator.
When an option is exercised, it is done by the:
a. Option buyer
b. Option seller
c. Commission house
d. Clearing house
**a. Option buyer** The holder (or buyer) of the option has the right to exercise the contract.
