Fundamentals of Derivatives Markets (McDonald)
Chapter 5 Financial Forwards and Futures
5.1 Multiple Choice Questions
1) KMW, Inc. plans to pay a dividend of $0.50 per share both 3 and 6 months from today.
KMW’s share price today is $36.00 and the continuously compounded quarterly interest rate
is 1.5%. What is the price of a 6–month prepaid forward contract, which expires immediately
after the second dividend?
A) $35.00
B) $35.02
C) $36.98
D) $37.00
2) The S&P 500 Index is priced at $950.46. The annualized dividend yield on the index is 1.40%.
What is the price of a 6–month prepaid forward contract on the S&P 500 Index?
A) $943.83
B) $950.00
C) $964.26
D) $984.21
3) HAW, Inc. plans to pay a $1.10 dividend per share in 3 months and a $1.15 dividend in 6
months. HAW’s share price today is $45.60 and the continuously compounded quarterly
interest rate is 2.1%. What is the price of a forward contract, which expires immediately after
the second dividend?
A) $45.28
B) $45.96
C) $45.60
D) $46.24
4) The S&P 500 Index is priced at $950.46. The annualized dividend yield on the index is 1.40%.
The continuously compounded annual interest rate is 8.40%. What is the price of a forward
contract that expires 9 months from today?
A) $937.48
B) $942.66
C) $984.36
D) $1001.69
5) Which of the following statements does NOT accurately reflect the relationship between
securities and synthetic forward contracts?
A) Forward = stock – zero coupon bond
B) Zero coupon bond = stock – forward
C) Prepaid forward = forward – zero coupon bond
D) Stock = forward + zero coupon bond
6) The annualized dividend yield on the S&P 500 Index is 1.40%. The continuously
compounded interest rate is 6.4%. If the 9–month forward price is $925.28 and the index is
priced at $950.46, what is the profit/loss from a cash–and–carry strategy?
A) $25.18 loss
B) $25.18 gain
C) $61.50 loss
D) $61.50 gain
7) The price of an S&P 500 Index futures contract is $988.26 when you decide to enter a long
position. When the position is closed the futures price is $930.32. If there are no settlement
requirements, what is your dollar gain or loss? (Ignore opportunity costs.)
A) $14,485 loss
B) $14,485 gain
C) $57.94 loss
D) $57.94 gain
8) The price of an S&P 500 Index futures contract is $988.26 when you decide to enter a long
position. When the position is closed the futures price is $930.32. If there are no settlement
requirements, what is your percentage gain or loss under a 15.0% margin requirement?
(Ignore opportunity costs.)
A) 39% gain
B) 39% loss
C) 43% gain
D) 43% loss
9) Consider an investment in five S&P 500 Index futures contracts at a price of $924.80. The
initial margin requirement is 15.0% and the maintenance margin is 10.0%. If the
continuously compounded interest rate is 5.0% what will the futures price need to be for a
margin call to occur 10 days from now? Assume no settlement within the 10 days.
A) $852.64
B) $872.79
C) $898.63
D) $905.25
10) The S&P 500 Index price is $925.28 and its annualized dividend yield is 1.40%. LIBOR is
4.2%. How many futures contracts will you need to hedge a $25 million portfolio with a beta
of 0.9 for one year?
A) 105
B) 120
C) 80
D) 95
11) The manager of a blue chip growth stock mutual fund is trying to fully hedge the $650
million portfolio position during the last two months of the calendar year. The current price
of the S&P 500 Index futures contract is 1200. If the mutual fund has a beta of 1.24, how
many contracts will be needed to hedge the fund?
A) 1,083
B) 3,033
C) 242,963
D) 541,666
12) When purchasing a stock, which arrangement allows for the simultaneous payment of the
stock price in cash and receipt of the actual stock certificate?
A) Forward contract
B) Fully leveraged purchase
C) Outright purchase
D) Prepaid forward contract
13) When purchasing a stock, which arrangement allows for the buyer to borrow the entire
purchase price of the security?
A) Forward contract
B) Fully leveraged purchase
C) Outright purchase
D) Prepaid forward contract
14) When purchasing a stock, which arrangement allows for payment of the stock today and
receipt of the stock at an agreed–upon future date?
A) Forward contract
B) Fully leveraged purchase
C) Outright purchase
D) Prepaid forward contract
15) When purchasing a stock, which arrangement allows for both the payment of the stock and
receipt of the stock at some specified date in the future?
A) Forward contract
B) Fully leveraged purchase
C) Outright purchase
D) Prepaid forward contract
16) If the prepaid forward contract on a non–dividend paying stock sells for $85.25 and the
annual required rate of return on the stock is 6.5%, which of the following 1 year forward
contract prices does NOT represent an arbitrage opportunity?
A) $ 85.25
B) $ 89.56
C) $ 90.98
D) $ 91.32
17) If the price on a 1 year forward contract is $65.92, which of the following prepaid forward
contracts on a non–dividend paying stock does NOT represent an arbitrage opportunity if
the annual required rate of return on the stock is 8.4%?
A) $ 62.56
B) $ 60.61
C) $ 64.52
D) $ 71.70
18) A strategy in which you buy the underlying asset and short the offsetting forward contract is
called a ________.
A) Cash–and–carry
B) Cash–and–carry arbitrage
C) Quasi–arbitrage–carry
D) Quasi–arbitrage
19) An arbitrage related strategy in which you substitute a low yield position for one with a
higher return is called a ________.
A) Cash–and–carry
B) Cash–and–carry arbitrage
C) Quasi–arbitrage–carry
D) Quasi–arbitrage
20) What phrase is used to describe the payment made by an investor who holds a short index
position?
A) Cash–and–carry
B) Lease rate
C) Rate of return
D) Rent
5.2 Short Answer Essay Questions
1) Explain the impact transaction costs have on the ability to make arbitrage profits in forward
and futures markets.
2) Name some advantages that futures contracts have over forward contracts.
3) What is the process involved in creating a cash–and–carry strategy?
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4) What are some uses for index futures contracts?
5) Explain the relationship between beta and cross hedging in the case of a portfolio of equity
securities is being hedged by a S&P500 Index contract.
5.3 Class Discussion Question
1) Throughout the chapter the topic of arbitrage is mentioned. Ask the class to explain
arbitrage. Follow–up the answers by asking what role arbitrage plays in futures and forward
markets. Finish up the Q & A with a group discussion of why arbitrage exists, given the
limited opportunity for arbitrage profits. Guide students towards an understanding of the
necessity of the arbitrage function, despite the limited opportunity for profit.