FINS1612 Study Guide - Final Guide: Futures Exchange, Futures Contract, United States Treasury Security

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bluebee342

5 Nov 2018

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F derivatives products cannot be used to hedge risks associated with interest rate movements. T a forward contract is a derivative product that is traded over-the-counter with a financial institution. T a financial futures contract allows a hedger to create a situation where any change in the physical market price of a financial instrument is mostly offset by a profit, or loss, derived from the futures market transactions. T a limit order is one in which a client instructs the broker to buy a specific contract only up to a specified price or to sell a specified contract down to a specified price. F an opening position in the futures market does not require an initial margin to be lodged with the futures exchange clearing-house. F margin calls are only made in the last few days before a contract is due to expire.

Related Questions

1. Which of the followings reduce(s) credit risk in futures contracts?

(1) Standardization of futures contracts

(2) Trading in exchanges

(3) Marking to market

A. Only (1)

B. Only (2)

C. Only (3)

D. Only (1) and (3)

E. All of (1), (2) and (3)

2. Letâs distinguish the meanings of transaction types of Buy, Sell, Short and Cover. If you want to speculate on price movement and expect the price of a certain option is expected to fall, then which transaction do you have to do?

A. buy

B. sell

C. short

D. cover

3. What does âcontract sizeâ mean in derivatives trades?

A. Number of contracts

B. Dollar value of one contract

C. Dollar value of the total contracts

D. Number of unit that denominates the asset per one contract

4. Suppose you are a speculator and expecting the price of soybeans to fall in three months. (You donât have soybeans) Which transaction do you have to make in the futures market?

A. Buy

B. Sell

C. Short

D. Cover

5. Suppose you are a fund manager and worrying about risk arising from the uncertain performance of the market as a whole. In order to reduce risk, which position of index futures do you have to take?

A. Buy

B. Sell

C. Short

D. Cover

6. Which of the following conditions does NOT cause the basis risk in hedge using futures?

a. Length of time to hedge is shorter than the length of time for futures to expire.

b. Length of time to hedge is longer than the length of time for futures to expire.

c. The underlying asset of futures is not the same as the asset to be hedged

d. The amount to be hedged is different from the amount of futures contracts

T. J. Patrick is a young, successful industrial designer in Portland, Oregon, who enjoys the excitement of commodities speculation. T. J. has been dabbling in commodities since he was a teen-ager-he was introduced to this market by his dad, who is a grain buyer for one of the leading food processors. T. J. recognizes the enormous risks involved in commodities speculating but feels that because he's young, he can afford to take a few chances. As a principal in a thriving industrial design firm, T. J. earns more than $150,000 a year. He follows a well-disciplined investment program and annually adds $15,000 to $20,000 to his portfolio.
Recently, T. J. has started playing with financial futures-interest-rate futures, to be exact. He admits he is no expert in interest rates, but he likes the price action these investments offer. This all started several months ago, when T. J. met Vinnie Banano, a broker who specializes in financial futures, at a party. T. J. liked what Vinnie had to say (mostly how you couldn't go wrong with interest-rate futures) and soon set up a trading account with Vinnie's firm, Banano's of Portland.
The other day, Vinnie called T. J. and suggested he get into 5-year Treasury note futures. He reasoned that with the Fed pushing up interest rates so aggressively, the short to intermediate sectors of the term structure would probably respond the most-with the biggest jump in yields.
Accordingly, Vinnie recommended that T. J. short sell some 5-year T-note contracts. In particular, Vinnie thinks that rates on these T-notes should go up by a full point (moving from about 5.5% to around 6.5%) and that T. J. should short 4 contracts. This would be a $5,400 investment because each contract requires an initial margin deposit of $1,350.
Questions
a. Assume T-note futures ($100,000/contract; 32's of 1%) are now being quoted at 103-16.
1. Determine the current underlying value of this T-note futures contract.
2. What would this futures contract be quoted at if Vinnie is right and the yield does go up by 1 percentage point, to 6.5%, on the date of expiration? (Hint: It'll be quoted at the same price as its underlying security, which in this case is assumed to be a 5-year, 6% semiannual-pay U.S. Treasury note. If necessary, refer to Chapter 11 and review the material on pricing semiannual-pay bonds.)
b. How much profit will T. J. make if he shorts 4 contracts at 103-16 and then covers when 5-year T-note contracts are quoted at 98-00? Also, calculate the return on invested capital from this transaction.
c. What happens if rates go down? For example, how much will T. J. make if the yield on T-note futures goes down by just 3/4 of 1%, in which case these contracts would be trading at 105-8?

d. What risks do you see in the reccommended short sale transaction? What is your assessment of TJ's new interest in financial futures? How do you think it compares to hsi established commodities investment program?

tantiger591

Agnes Chin is the chief financial officer of Grains Corp., an established agricultural commodities firm. The headquarters of Grains Corp. is located in Chicago.
It is now January and Agnes is working on two large deals that are coming up in the current year:
-Grains Corp. is going to purchase 100,000 bushels of wheat in 10 monthsâ time so as to meet its orders upstream.

-Grains Corp. is finally going to sell ofits 50,000 bushels of soybeans that has been in storage for the past 6 months. The transaction is to take place in 3
monthsâ time.
Prices in these transactions have not been fixed and hence they are risks that Agnes has to consider hedging. She checks the market data as presented below:

Agnes needs to analyse the nature of commodity price risk and the need for hedging this risk in the transactions. Help Agnes in her analysis by answering the following multiple choice questions:
(a) The 3-month forward price for the soybeans that is implied by the data is best approximated by
(i) 400,000
(ii) 500,000
(iii) 600,000

(b) Agnes notices that the 3-month futures price for soybeans that is traded in the market is significantly higher than the implied 3-month forward price. She may
take advantage of the arbitrage opportunity by
(i) selling 3-month soybeans futures to exactly hedge the price for the current storage of soybeans
(ii) buying more soybeans at spot, storing it for 3 months and buying 3-month soybeans futures
(iii) buying more soybeans at spot, storing it for 3 months and selling 3-month soybeans futures

(c) The futures contracts traded at the exchange expire in the months listed here:
March (H), May (K), July (N), September (U) & December (Z)
Is it possible to build a perfect hedge for the purchase of wheat with wheat futures contracts?
(i) Yes
(ii) No and she should enter into the September contract
(iii) No and she should enter into the December contract

(d) Judging from the data, the current state of the commodity market is likely to be
(i) backwardation
(ii) normal backwardation
(iii) contango

(e) If Agnes were to go long on the wheat futures, she will most likely notice that the market price on her futures contracts will
(i) gradually go down if the market remains generally calm
(ii) stay unchanged if the market remains generally calm
(iii) fluctuate significantly even while the market remain generally clam

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FINS1612 Study Guide - Final Guide: Futures Exchange, Futures Contract, United States Treasury Security

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