Chapter 15 – Forward, Futures, and Swap Contracts
1. Forward contracts are individually designed agreements and can be tailored to the specific needs of the ultimate end-
user.
a.
True
b.
False
2. Like future contracts, all forward contracts are processed by the exchange clearinghouse.
a.
True
b.
False
3. Because futures contracts are “marked–to-market” daily, the gains and losses are settled daily.
a.
True
b.
False
4. Some forward contracts, particularly in the foreign exchange market, are quite standard and liquid.
a.
True
Chapter 15 – Forward, Futures, and Swap Contracts
b.
False
5. Forward rate agreements usually require substantial collateral.
a.
True
b.
False
6. The futures exchange requires each customer to post an initial margin account.
a.
True
b.
False
7. Margin accounts are adjusted, or marked to market, at the end of each trading day.
a.
True
b.
False
8. The settlement price is set by the futures exchange after trading ends to reflect the midpoint of the closing price range.
a.
True
b.
False
9. The goal of a hedge transaction is to increase expected returns of a fundamental holding.
a.
True
b.
False
10. The basis is the spot price minus the future price.
a.
True
b.
False
11. An investor in a hedge position is no longer exposed to the absolute price movement of the underlying asset, but the
investor is still exposed to basis risk.
a.
True
b.
False
12. The number of future contracts needed to hedge a unit of the spot assets is solely a function of the variance of the spot
prices.
a.
True
b.
False
13. The basis (Bt,T) at time t between the spot price (St) and a futures contract expiring at time T (Ft,T) is St − Ft,T.
a.
True
b.
False
14. In the absence of arbitrage opportunities, the forward price should be equal to the spot price plus the cost of carry.
a.
True
b.
False
15. The cost-of-carry model is useful for pricing future contracts.
a.
True
b.
False
16. According to the cost of carry model, the futures price is the present value of the spot price discounted at the risk-free
rate.
a.
True
b.
False
17. In the cost of carry model, the inclusion of storage costs will increase the futures price.
a.
True
b.
False
18. In the absence of arbitrage opportunities, the forward contract price should be equal to the current spot price plus
interest.
a.
True
b.
False
19. The pure expectations hypothesis suggests futures prices serve as unbiased forecasts of future spot prices.
a.
True
b.
False
20. Interest rate parity is a key concept in managing risk in the commodities market.
Chapter 15 – Forward, Futures, and Swap Contracts
a.
True
b.
False
21. If you have entered into a currency futures hedge for the Japanese yen in connection with buying Japanese equipment
and if the yen goes from 110 yen/$1 to 100 yen/$1, you will lose in the spot market but have an offsetting gain in the
futures market.
a.
True
b.
False
22. Like hedging, arbitrage results in increased returns with a disproportional increase in risk.
a.
True
b.
False
23. The inclusion of dividends in the cost of carry model will increase the futures price.
a.
True
Chapter 15 – Forward, Futures, and Swap Contracts
b.
False
24. A riskless stock index arbitrage profit is possible if the following condition holds: F0,T = S0(1 + rf − d)T, where spot
price now is S0, value now of a futures contract expiring at time T is (F0,T), rf is the risk free rate, and d is the dividend.
a.
True
b.
False
25. Stock index futures are useful in providing a hedge against movements in an underlying financial asset.
a.
True
b.
False
26. If you were bearish on the near-term outlook for the stock market but did not want to sell your portfolio, you could
hedge against the decline by selling stock index futures.
a.
True
b.
False
Chapter 15 – Forward, Futures, and Swap Contracts
27. The Chicago Board of Trade (CBT) uses conversion factors to correct for differences in deliverable bonds.
a.
True
b.
False
28. The Eurodollar futures contract is a popular hedging vehicle because it is based on the three-month LIBOR.
a.
True
b.
False
29. The forward rate agreement is the most complicated of the OTC interest rate contracts.
a.
True
b.
False
30. In an interest rate swap, the fixed rate payer profits if interest rates fall.
a.
True
b.
False
31. While LIBOR is usually used with forward rate agreements, it is rarely used with other interest rate agreements.
a.
True
b.
False
32. In a forward rate agreement (FRA), two parties agree today to a future exchange of cash flows based on two different
interest rates.
a.
True
b.
False
33. On the settlement date for a forward rate agreement (FRA) contract, the difference between the two interest rates is
multiplied by the FRA’s par value and prorated by the length of the holding period.
a.
True
b.
False
34. A plain vanilla swap agreement is used in similar situations as a forward rate agreement.
a.
True
b.
False
35. Equity swaps are traded in the OTC markets.
a.
True
b.
False
36. Equity swaps are equivalent to portfolios of forward contracts calling for the exchange of cash flows based on two
different investment rates: (1) a variable debt rate and (2) the return to an equity index.
a.
True
b.
False
37. An investor who wants a long position in a ____ must first place the order with a broker, who then passes it on to the
trading pit or electronic network. Details of the order are then passed on to the exchange clearinghouse.
a.
call option
b.
put option
c.
forward contract
d.
futures contract
e.
All of these are correct.
38. The process by which invest on margin accounts are credited or debited to reflect daily trading gains or losses is
referred to as the ____ process.
a.
hedge rationing
b.
daily settlement
c.
marked-to-market
d.
book–to-market
e.
account realization
39. The major difference between valuing futures versus forward contracts stems from the fact that future contracts are
a.
traded on exchange.
b.
backed by a clearinghouse.
c.
marked-to-market daily.
d.
less risky.
e.
relatively inflexible.
40. As a contract approaches maturity, the spot price and forward price
a.
increase.
b.
diverge.
c.
maintain a fixed price differential.
d.
have a random relationship.
e.
converge.
41. The basis (Bt,T) at time t between the spot price (St) and a futures contract expiring at time T (Ft,T) is
Chapter 15 – Forward, Futures, and Swap Contracts
a.
Bt,T = St + Ft,T.
b.
Bt,T = St − Ft,T.
c.
Bt,T = St Ft,T.
d.
Bt,T = St/Ft,T.
e.
Bt,T = Ft,T/St.
42. According to the cost of carry model, the relationship between the spot (S0) and futures price (F0,T) is
a.
S0 = F0,T/(1 + rf)T.
b.
S0 = F0,T(1 + rf)T.
c.
S0 + F0,T = (1 + rf)T.
d.
S0 = F0,T + (1 + rf)T.
e.
S0 − F0,T = (1 + rf)T.
43. A backwardated futures market occurs when
a.
F0,T < S0.
b.
F0,T = S0.
c.
F0,T > S0.
d.
F0,T > E( ST).
e.
F0,T > ST.
44. Which of the following is true when F0,T < E(ST)?
a.
occurs when long hedgers outnumber short hedgers
b.
occurs when short hedgers outnumber long hedgers
c.
The market is said to be in contango.
d.
The market is said to be in normal contango.
e.
The pure expectations hypothesis holds.
45. When F0,T > E(ST), it is known as
a.
backwardation.
b.
normal backwardation.
c.
normal contango.
d.
inverted spread.
e.
pure expectations equilibrium.
46. The inclusion of the following in the cost of carry model will increase the futures price.
Chapter 15 – Forward, Futures, and Swap Contracts
a.
dividends
b.
storage costs
c.
interest rate
d.
taxes
e.
transaction costs
47. The cost of carry includes all of the following EXCEPT
a.
storage costs.
b.
insurance.
c.
current price.
d.
financing costs.
e.
risk-free rate.
48. In the absence of arbitrage opportunities, the forward contract price should be equal to the current price plus
a.
contract price.
b.
the cost of carry.
c.
margin requirement.
d.
the price discovery rate.
e.
the convenience return.
49. Which of the following is NOT considered a “cost of carry”?
a.
commissions for physical storage
b.
an opportunity cost for the net amount of invested capital
c.
a premium for the convenience of consuming the asset now
d.
a risk premium for uncertainty
e.
the intrinsic price of the underlying
50. Financial futures include all of the following underlying securities EXCEPT
a.
stock indexes.
b.
treasury bonds.
c.
bank deposits.
d.
foreign currencies.
e.
All of these are correct.
51. Financial futures have become an increasingly attractive investment alternative because the Chicago Board of Trade
(CBOT) began trading them in 1977, and their hedging function partly accounts for the growth in trading. Which of the
following statements concerning financial futures is true?
a.
Financial futures protect the investment portfolio against inflation in the economy.
b.
Investors seek protection against the increasing volatility of interest rates.
Chapter 15 – Forward, Futures, and Swap Contracts
c.
Unlike commodity futures, factors that influence price shifts are not supply and demand of the commodity but
buyer psychology.
d.
A reason for their popularity is that trading is restricted to government obligations, which reduces risks.
e.
A reason for their popularity is that trading is tax-free.
52. The most popular financial futures in terms of average daily volume are the
a.
OEX contracts.
b.
S&P 500 contracts.
c.
LIBOR contracts.
d.
t-bill contracts.
e.
t-bond contracts.
53. In your portfolio you have $1 million of 20-year, 8 5/8 percent bonds that are selling at 83.15 (or 83 15/32) against
this position. Because you feel interest rates will rise, you sell 10 bond futures at 81.15 (or 81 15/32) against this position.
Two months later, you decide to close your position. The bonds have fallen to 78, and the futures contracts are at 75.16
(75 16/32). Disregarding margin and transaction costs, what is your gain or loss?
a.
$5,000 loss
b.
$500 loss
c.
breakeven
d.
$500 gain
e.
$5,000 gain
Chapter 15 – Forward, Futures, and Swap Contracts
Exhibit 15.1
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
In late January 2004, The Union Cosmos Company is considering the sale of $100 million in 10-year bonds that will
probably be rated AAA like the firm’s other bond issues. The firm is anxious to proceed at today’s rate of 10.5 percent. As
treasurer, you know that it will take until sometime in April to get the issue registered and sold. Therefore, you suggest
that the firm hedge the pending issue using Treasury bond futures contracts each representing $100,000.
Case 1
Case 2
Current Value − January 2004
Bond Rate
10.5%
10.5%
June 2004 Treasury Bonds
78.875
78.875
Estimated Values − April 2004
Bond Rate
11.0%
10.0%
June 2004 Treasury Bonds
75.93
81.84
54. Refer to Exhibit 15.1. Explain how you would go about hedging the bond issue?
a.
sell 1,000 contracts
b.
buy 1,000 contracts
c.
sell 100 contracts
d.
sell 10,000 contracts
e.
buy 10,000 contracts
55. Refer to Exhibit 15.1. What is the dollar gain or loss assuming that future conditions described in Case 1 actually
occur? (Ignore commissions and margin costs.)
a.
$2,945,000.00 gain
b.
$65,500.00 gain
c.
$2,945,000.00 loss
d.
$65,500.00 loss
e.
$10,500.00 loss
56. Refer to Exhibit 15.1. What is the dollar gain or loss assuming that future conditions described in Case 2 actually
occur? (Ignore commissions and margin costs).
a.
$2,965,000.00 gain
b.
$45,500.00 gain
c.
$2,965,000.00 loss
d.
$45,500.00 loss
e.
$0
Exhibit 15.2
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Assume you are the Treasurer for the Johnson Pharmaceutical Company and in late July 2004, the company is considering
the sale of $500 million in 20-year bonds that will most likely be rated the same as the firm’s other debt issues. The firm
would like to proceed at the current rate of 8.5%, but you know that it will probably take until November to bring the
issue to market. Therefore, you suggest that the firm hedge the pending issue using Treasury bond futures contracts, which
each represent $100,000.
Case 1
Case 2
Current Value − July 2004
Bond Rate
8.5%
8.5%
Dec. 2004 Treasury Bonds
87.75
87.75
Estimated Values − Nov. 2004
Bond Rate
9.5%
7.5%
Dec. 2004 Treasury Bonds
85.60
91.65
57. Refer to Exhibit 15.2. How you would go about hedging the bond issue?
a.
buy 5,000 contracts