Chapter 13—Financial Futures Markets
1. A(n) ____ is a standardized agreement to deliver or receive a specified amount of a specified financial
instrument at a specified price and date.
a.
option contract
b.
brokerage contract
c.
financial futures contract
d.
margin call
2. Interest rate futures are not available on
a.
Treasury bonds.
b.
Treasury notes.
c.
Eurodollar CDs.
d.
the S&P 500 index.
3. ____ take positions in futures to reduce their exposure to future movements in interest rates or stock
prices.
a.
Hedgers
b.
Day traders
c.
Position traders
d.
None of the above
4. ____ trade futures contracts for their own account.
a.
Commission brokers
b.
Floor brokers
c.
Commission traders
d.
Floor traders
5. The initial margin of a futures contract is typically between ____ percent of a futures contract’s full
value.
a.
0 and 2
b.
5 and 18
c.
25 and 40
d.
45 and 60
6. Futures exchanges take buy or sell positions on futures contracts.
a. True
b. False
7. If the prices of Treasury bonds ____, the value of an existing Treasury bond futures contract should
____.
a.
increase; be unaffected
b.
decrease; be unaffected
c.
A and B
d.
decrease; decrease
e.
decrease; increase
8. Assume that a T-bill futures contract with a face value of $1 million is purchased at a price of $95.00
per $100 face value. At settlement, the price of T-bills is $95.50. What is the difference between the
selling and purchase price of the futures contract?
a.
$.50
b.
$50
c.
$500
d.
$5,000
e.
none of the above
9. If speculators believe interest rates will ____, they would consider ____ a T-bill futures contract today.
a.
increase; selling
b.
increase; buying
c.
decrease, selling
d.
decrease; purchasing a call option on
10. Financial futures contracts on U.S. securities are ____ by non-U.S. financial institutions.
a.
not allowed to be traded
b.
are rarely desired
c.
are commonly traded
d.
A and B
11. Assume that speculators had purchased a futures contract at the beginning of the year. If the price of a
security represented by a futures contract ____ over the year, then these speculators would likely have
purchased the futures contract for ____ than they can sell it for.
a.
increased; more
b.
decreased; less
c.
remains the same; more
d.
increased; less
12. Assume that a futures contract on Treasury bonds with a face value of $100,000 is purchased at 93-00.
If the same contract is later sold at 94-18, what is the gain, ignoring transactions costs?
a.
$1,180,000
b.
$118
c.
$11,800
d.
$15,625
e.
$1,562.50
13. The use of financial leverage
a.
magnifies the positive returns of futures contracts.
b.
magnifies losses of futures contracts.
c.
both A and B
d.
none of the above
14. According to the text, when a financial institution sells futures contracts on securities in order to hedge
against a change in interest rates, this is referred to as
a.
a long hedge.
b.
a short hedge.
c.
a closed out position.
d.
basis trading.
15. A financial institution that maintains some Treasury bond holdings sells Treasury bond futures
contracts. If interest rates increase, the market value of the bond holdings will ____ and the position in
futures contracts will result in a ____.
a.
increase; gain
b.
increase; loss
c.
decrease; gain
d.
decrease; loss
16. The basis is the
a.
difference between the price of a security and the price of a futures contract on the
security.
b.
gain or loss from hedging with futures contracts.
c.
difference between a futures contract price and the initial deposit required.
d.
price paid for a futures contract after accounting for transactions costs.
e.
price paid for an option contract.
17. The profits of a financial institution with interest-rate sensitive liabilities and interest rate-insensitive
assets are ____ with hedging than without hedging if interest rates decrease.
a.
higher
b.
the same
c.
lower
d.
higher or the same
18. Assume that a bank obtains most of its funds from large CDs with a one-year maturity. Its assets are in
the form of loans with rates that adjust every six months. The bank would be ____ affected if interest
rates increase. To partially hedge its position, it could ____ futures contracts.
a.
adversely; purchase
b.
favorably; sell
c.
favorably; purchase
d.
adversely; sell
19. According to the text, a futures contract on one financial instrument to protect a position in a different
financial instrument is known as
a.
cross-hedging.
b.
ratio hedging.
c.
basis hedging.
d.
liquid hedging.
20. The effectiveness of a cross-hedge depends on the degree of correlation between the market values of
the two financial instruments.
a. True
b. False
21. If a futures contract is more volatile than the portfolio value, the amount of principal represented by
the futures contracts to hedge the portfolio is ____ the market value of the securities to be hedged.
a.
smaller than
b.
greater than
c.
equal to
d.
B and C are both possible
22. In cross-hedging, if the futures contract value is ____ volatile than the portfolio value, hedging will
require a ____ amount of principal represented by the futures contracts.
a.
less; greater
b.
more; greater
c.
more; smaller
d.
none of the above
23. Municipal Bond Index (MBI) futures
a.
involve a physical exchange of bonds.
b.
are based on a Treasury bond index.
c.
are based on actively traded corporate bonds.
d.
are settled in cash.
24. Systemic risk reflects the risk that a particular event could
a.
cause losses at a firm due to inadequate management control.
b.
spread adverse effects among several firms or among financial markets.
c.
cause a loss in value due to market conditions.
d.
have a larger effect on the futures position than on the position being hedged.
25. A savings and loan association has long-term fixed-rate mortgages financed by short-term funds. It
hedges by selling Treasury bond futures. If interest rates decline, and many mortgages are prepaid
a.
the gain on the futures contracts offsets the loss on the mortgages.
b.
the gain on the mortgages offsets the loss on the futures contracts.
c.
the gain on the futures contracts more than offsets any unfavorable effects on mortgages.
d.
a loss on the futures contracts more than offsets the favorable effect on the mortgage
portfolio.
26. If a financial institution expects that the market value of its municipal bonds will decline because of
economic conditions, it could hedge its position by ____ futures contracts on ____.
a.
purchasing; Treasury bonds
b.
purchasing; the S&P 500 Index
c.
purchasing; a Municipal Bond Index
d.
selling; a Municipal Bond Index
27. The net gain or loss on a futures contract for a stock index that is not closed out is based on the
difference between the futures price when the initial position was created and the futures price at
a.
the settlement date.
b.
the date at which the futures price reaches its maximum.
c.
the date at which the futures price reaches its minimum.
d.
the date three months beyond the date when the initial position was taken.
28. The value of an S&P 500 futures contract is $500 times the index. Assume the futures price on the
S&P 500 index is 1612 at the time of purchase. If the index price is $1619 when the position is closed
out, the gain is
a.
$700.
b.
$7,000.
c.
$3,190.
d.
$3,120.
e.
$3,500.
29. Assume that a stock mutual fund uses stock index futures as it conducts dynamic asset allocation. This
means that the mutual fund
a.
liquidates its stocks whenever it expects a market downturn.
b.
maintains a constant buy position in stock index futures.
c.
maintains a constant sell position in stock index futures.
d.
none of the above
30. Companies with international trade can hedge ____ by ____ currency futures.
a.
payables; selling
b.
receivables; buying
c.
payables; buying
d.
A and B
e.
B and C
31. Assume that corporate bond portfolio managers are concerned about the possibility of many bond
defaults resulting from a future recession. A short position in Treasury bond futures ____ an effective
hedge against the default risk. A short position in Treasury bill futures ____ an effective hedge against
the default risk.
a.
would be; would be
b.
would be; would not be
c.
would not be; would not be
d.
would not be; would be
32. Which of the following statements is incorrect with respect to cross-hedging?
a.
Even when the futures contract is highly correlated with the portfolio being hedged, the
value of the futures contract may change by a higher or lower percentage than the
portfolio’s market value.
b.
If the futures contract value is more volatile than the portfolio value, hedging will require
a greater amount of principal represented by the futures contracts.
c.
The effectiveness of a cross-hedge depends on the degree of correlation between the
market values of the two financial instruments.
d.
If the price of the underlying security of the futures contract moves closely in tandem with
the security hedged, the futures contract can provide an effective hedge.
e.
All of the above are correct with respect to cross-hedging.
33. ____ risk is the risk that the position being hedged by a futures contract is not affected in the same
manner as the instrument underlying the futures contract.
a.
Market
b.
Liquidity
c.
Credit
d.
Basis
e.
None of the above
34. Trading restrictions imposed on specific stocks or stock indices are referred to as
a.
index busters.
b.
index options.
c.
circuit breakers.
d.
protective covenants.
35. Financial leverage, when used in association with a futures contract, ____ the positive returns and
____ losses.
a.
magnifies; reduces
b.
reduces; magnifies
c.
magnifies; magnifies
d.
reduces; reduces
36. Currency futures may be purchased to hedge ____ or to capitalize on the expected ____ of that
currency against the dollar.
a.
receivables; appreciation
b.
receivables; depreciation
c.
payables; depreciation
d.
payables; appreciation
37. The risk that the position being hedged by a futures position is not affected in the same manner as the
instrument underlying the financial futures contract, is referred to as
a.
market risk.
b.
liquidity risk.
c.
default risk.
d.
basis risk.
38. Dynamic asset allocation involves the switching between risky and low-risk investments by
institutional investors over time in response to changing expectations.
a. True
b. False
39. The prices of stock index futures
a.
are always the same as the prices of the stocks representing the index.
b.
are always a little above the prices of the stocks representing the index.
c.
are always a little below the prices of the stocks representing the index.
d.
none of the above
40. The actions of numerous institutional investors to sell stock index futures instead of selling stocks to
prepare for a market decline would likely cause the index futures price to be
a.
equal to the prevailing stock prices.
b.
below the prevailing stock prices.
c.
above the prevailing stock prices.
d.
negative.
41. Speculators in futures contracts that normally close out their futures positions on the same day that the
positions were initiated are referred to as
a.
day traders.
b.
hedgers.
c.
closed-end traders.
d.
position traders.
42. Speculators in futures contracts that normally maintain the futures position that they initiate for
extended periods of time (such as weeks or months) are referred to as
a.
day traders.
b.
hedgers.
c.
closed-end traders.
d.
position traders.
43. Which of the following is incorrect regarding organized exchanges trading financial futures contracts?
a.
Organized exchanges establish and enforce rules for the trading of financial futures
contracts.
b.
Organized exchanges ensure that the seller of the futures contract always delivers the
securities covered by the contract, whether the contract was settled prior to the settlement
date or not.
c.
Organized exchanges clear, settle, and guarantee all transactions that occur on their
exchanges.
d.
The operations of financial futures exchanges are regulated by the Commodity Futures
Trading Commission (CFTC).
e.
All of the above are correct.
44. Marcia buys an S&P 500 futures contract with a September settlement date when the index is 1,750.
By the settlement date, the S&P 500 index falls to 1,400. The return on Marcia’s position in the S&P
500 futures contract is ____ percent.
a.
−20
b.
−10
c.
25
d.
20
e.
0
45. Laura sells an S&P 500 futures contract with a September settlement date when the index is 1,750. By
the settlement date, the S&P 500 index falls to 1,400. The return on Laura’s position in the S&P 500
futures contract is ____ percent.
a.
−20
b.
−10
c.
25
d.
20
e.
0
46. Assume a corporation is receiving a large amount of funds in the near future. The company plans to
use the funds to purchase municipal bonds. Also assume that the company is concerned that interest
rates decrease before the purchase date, which would make the municipal bonds more expensive. In
order to hedge against this possibility, the company should ____ MBI futures contracts. If interest rates
decrease, the futures contract will generate a ____.
a.
sell; loss
b.
purchase; gain
c.
purchase; loss
d.
sell; gain
e.
none of the above
47. If there are ____ traders with buy offers than sell offers for a particular contract, the futures price will
____ until this imbalance is removed.
a.
more; decrease
b.
more; rise
c.
fewer; rise
d.
none of the above
48. Which of the following statements is incorrect?
a.
Circuit breakers are trading restrictions imposed on specific stocks or stock indexes.
b.
Circuit breakers guarantee that prices will turn upward.
c.
Circuit breakers may be able to prevent large declines in prices that would be attributed to
panic selling rather than to fundamental forces.
d.
Circuit breakers may allow investors to determine whether circulating rumors are true.
49. ____ risk is the risk of losses as a result of inadequate management or controls.
a.
Basis
b.
Systemic
c.
Operational
d.
Prepayment
50. Financial futures contracts on stock indexes are referred to as interest rate futures.
a. True
b. False
51. Financial futures contracts are rarely sold over the counter.
a. True
b. False
52. Brokers commonly require margin deposits from their customers above those required by the
exchanges.
a. True
b. False
53. Purchasers of financial futures contracts usually know who the sellers are, and vice versa.
a. True
b. False
54. The futures price is mainly a function of the prevailing price of the underlying security plus an
expected adjustment in that price by the settlement date.
a. True
b. False
55. A financial institution that hedges with interest rate futures is less sensitive to economic events than an
institution that does not hedge.
a. True
b. False
56. A bond index futures contract allows for the buying, but not the selling, of a bond index for a specified
price at a specified date.
a. True
b. False
57. Market participants who expect the stock market to perform poorly before the settlement date may
consider selling S&P 500 index futures.
a. True
b. False
58. Stock index futures cannot be closed out before the settlement date.
a. True
b. False
59. The value of a stock index futures contract has little correlation with the value of the underlying stock
index.
a. True
b. False
60. Since stock index futures prices are primarily driven by movements in the corresponding stock
indexes, participants in stock index futures monitor indicators that may signal changes in the stock
indexes.
a. True
b. False
61. The price of stock index futures may reflect investor expectations about the market more rapidly than
stock prices.
a. True
b. False
62. Financial futures contracts on U.S. securities are commonly traded by non-U.S. financial institutions
that maintain holdings of U.S. securities.
a. True
b. False
63. Purchasers of currency futures contracts are required to hold the contract until the settlement date and
accept delivery of the foreign currency at that time.
a. True
b. False
64. Which of the following statements is incorrect regarding organized futures exchanges?
a.
Organized exchanges establish and enforce rules for the trading of financial futures
contracts.
b.
Organized exchanges serve as market makers for futures contracts by taking positions in
futures.
c.
Organized exchanges clear, settle, and guarantee all transactions that occur on their
exchanges.
d.
The operations of financial futures exchanges are regulated by the Commodity Futures
Trading Commission (CFTC).
e.
All of the above are correct.
65. Stock index futures are priced ____ than the stock index itself.
a.
higher
b.
lower
c.
either higher or lower
d.
none of the above
66. An unexpected ____ in the consumer price index tends to create expectations of ____ interest rates and
places ____ pressure on Treasury bond futures prices.
a.
increase; higher; downward
b.
increase; lower; downward
c.
increase; higher; upward
d.
decrease; higher; downward
e.
none of the above
67. Bill Baher, a private investor, purchased a futures contract on Treasury bonds at a price of 102-12.
Two months later, Baher sells the same futures contract in order to close out the position. At that time,
the futures contract specifies 103-15. What is Baher’s nominal profit? The par value of the futures
contract is $100,000.
a.
$1,030.00; profit
b.
$1,030.00; loss
c.
$1,093.75; profit
d.
$1,093.75; loss
e.
none of the above
68. Clarke plans to satisfy cash needs in nine months by selling its Treasury bond holdings for $4 million.
However, Clarke is concerned that interest rates might increase over the next three months. To hedge
against this possibility, Clarke plans to sell Treasury bond futures. Thus, Clarke sells ____ futures
contract for a price of 99-12. Assuming that the actual price of the futures contract declined to 97-20,
Clarke would make a ____ of $____ from closing out the futures position.
a.
40; profit; $76,800
b.
40; loss; $76,800
c.
50; profit; $70,000
d.
40; profit; $70,000
e.
none of the above
69. _________ take positions in financial futures to reduce their exposure to future movements in interest
rates or stock prices; ________ commonly take the opposite position and thus serve as counterparties
on many transactions.
a.
Speculators; hedgers
b.
Hedgers; speculators
c.
Arbitrageurs; speculators
d.
Hedgers; arbitrageurs
70. Some specialized futures contracts are sold over the counter, whereas standardized financial futures
contracts are traded on exchanges.
a. True
b. False
71. A financial institution that wishes to reduce its exposure to the possibility of declining interest rates
might use:
a.
a long hedge.
b.
a short hedge.
c.
a day hedge.
d.
index arbitrage.
72. Settlement of stock index futures contracts occurs through delivery of the underlying securities.
a. True
b. False
73. ___________ involves the buying or selling of stock index futures with a simultaneous opposite
position in the stocks that the index comprises.
a.
Dynamic asset allocation
b.
Cross-hedging
c.
Index arbitrage
d.
Net hedging
74. Which of the following is not a type of risk associated with futures contracts?
a.
basis risk
b.
liquidity risk
c.
market risk
d.
postpayment risk
75. Credit risk exists for futures contracts traded on exchanges, but it is normally not a concern for
over-the-counter futures transactions.
a. True
b. False
76. __________ occurs when a firm does not have adequate controls to monitor the employees responsible
for its futures positions and those employees take more speculative positions than the firm desires.
a.
Credit risk
b.
Control risk
c.
Operational risk
d.
Management risk