CHAPTER 19
COMMODITY AND FINANCIAL FUTURES
Teaching Guides for the Questions and Problems in the Text
QUESTIONS
19-1. A futures contract is an agreement for the purchase or sale of a commodity, financial
asset, or currency at a specified time in the future. The contract is created (often referred to
as “bought” and “sold”) through a commodity exchange. The price specified in the contract
is the futures price. The futures price may differ from the spot price, which is the price for
19-2. A long position is an agreement to buy the commodity in the future at the specified
price. Such a contract earns a profit if the price of the commodity rises, which increases the
value of the contract. A short position is an agreement to deliver the commodity in the
19-3. Margin is the amount the investor must put down (i.e., the good faith deposit) to buy
or sell a commodity contract. The amount of margin is small when compared to the value
of the contract. Hence, a small chnage in the price of the commodity produces a large
swing in the value of the speculator’s position. These large fluctuations in the value of the
If the price chnages sufficiently that the investor’s margin is reduced to the maintenance
The margin requirement associated with buying stock is essentially a downpayment. The
investor pays for a portion of the purchase and borrows the balance. The margin
requirement for securities establishes the minimum amount the investor must put down. An
investor, who enters into a futures contract, has not purchased or sold anything. There is no
19-4. Users and suppliers of commodities such as fabricators or farmers do not wish to
speculate on price fluctuations. They hedge their positions to reduce the risk of loss from
price fluctuations. For example, a farmer will enter a contract to sell in the future, that is to
19-5. If an individual expects a commodity’s price to fall, that speculator should establish
a short position (i.e., enter into a contract to make future delivery). If the price of the
19-6. Governments affect commodity prices by altering the demand or supply of the
commodity. For example, if a foreign government seeks to buy wheat, that increases the
The federal government regulates commodity markets through the Commodity Exchange
Authority, which is part of the Division of Agriculture. The purpose of the regulation is to
Exchange Authority does not seek to protect investors from their own folly and greed.
19-7. A financial futures contract is an agreement for the future purchase or delivery of a
financial asset such as a Treasury bond. If an individual expects interest rates to rise, he or
she is expecting the value of debt instruments to fall. This individual should enter a
19-8. If you anticipate that the price of the British pound will rise, you should take a long
19-9. This is a rework of question #3. The difference in the long and short positions is that
the long position is a contract to purchase in expectation of higher prices while the short
19-10. When speculators anticipate changes in stock prices, they may establish positions
in stock index futures. This alters the futures prices relative to the current market prices of
the stocks in the index. Arbitrageurs then can buy or short the stock (or baskets of
The prices of the individual stocks included in the stock indices may be more responsive to
changes in the futures markets than those stocks not included in the indices. The prices of
19-11. A swap agreement is a contract between two parties in which they agree to swap
payments. An American firm with operations in Canada may enter a swap agreement with
a Canadian firm with operations in the U.S. By swapping payments, the two firms avoid
having to convert currencies and the risk associated with changes in exchange rates.
Domestic firms may also swap payments. Obviously both parties must some potential for
19-12. Parts a and b ask the student to locate the futures market for wheat and to follow
PROBLEMS
19-1. This problem is designed to illustrate the profits and losses and the flows of funds
associated with futures contracts.
a. The investor must remit the margin requirement: $2,000.
b. The contract is currently worth $2.13 x 10,000 = $21,300.
The speculator has lost $1,300 and has $700 margin remaining. This amount is less than the
c. If the price continues to increase to $2.14, the speculator losses an additional $100
b. If the price of gold rises to $1,255, the contract
is worth:
The percentage gain is the profit divided by the amount committed (the margin):
c. If the price of gold decline to $1,248, the contract is worth:
d. At $1,238, the loss is $1,200 ($125,000 – 123,800) ,and the margin is reduced from
e. At $1,210, the value of the contract is $121,000, and the loss is $4,000. The margin in the
f. You close the long position by entering into an offsetting contract, that is, you enter into
19-3. This problem repeats problem 1 but applies the material to British pounds instead of
a. The speculator must remit the margin requirement: $2,000
b. The contract is currently worth $2.13 x 10,000 = $21,300.
The speculator has lost $1,300 and has $700 margin remaining. This amount is less than the
c. If the price continues to increase to $2.14, the speculator losses an addition $200 ($0.01
19-4. a. Payment in terms of the spot price:
b. Payment in terms of the futures price:
c. If the price of the pound declines to $1.35, the recipient receives pounds worth
d. To hedge, the investor sells (shorts) a contract for the future delivery of pounds. The
value of that contract is $1,560,000 based on the future price of $1.56. When the investor
receives the pounds after six months, that individual can deliver the pounds at the price
e. Since the investor has a contract to sell pounds at $1.56, the price decline is irrelevant.
f. Since the investor has a contract to sell pounds at $1.56, the price increase is irrelevant.
g. If the investor had not hedged, 1,000,000 pounds would be worth $1,800,000. The
investor earns a $200,000 profit on the increase in the value of the pound from $1.60 to
19-5. a. Expected payment based on the current exchange rate:
b. Expected payment based on the futures exchange rate:
c. If the pound is worth $1.53, the loss is
d. If the pound is worth $1.72, the gain is
e. If the portfolio manager hedges, that assures a price of $1.61, so the total value is $1.61
f. If the price of the pound is $1.53, the $240,000 loss on the bond portfolio is partially
g. If the price of the pound is $1.72, the portfolio manager does not experience a gain. The
19-6. This problem essentially repeats the first two problems but applies the concept to a
a. You must remit the margin requirement: $2,000.
b. The value of the contract based on the index:
c. The value of the contract is 601 x $250 = $150,250. Since you entered into a short
d. If the index rises to 607, the value of the contract is $151,750. Your margin has been
e. If the index is 594, the value of the contract is 594 X $250 = $148,500. You have made a
f. The margin requirement is the same for long and short positions: $2,000.
g. If you entered the futures contract to buy and the value of the index rose to 607, the
value of the contract rises to $151,750. No additional margin is required, and you may
h. In (d) you lost funds, which means additional margin is required. In (g) you made a
i. Unlike commodity contracts, securities are not delivered or received at the expiration of
19-7. If you expect the price of gold to rise from $950 to $1,000, you would want a long
position in the futures contract. If the futures price were $990, you would enter a contract
If the futures price were $1,018, you would reverse the process and sell (short) the futures.
If your expectation is fulfilled, you could buy the gold for $1,000 and deliver it through the
contract for $1,018 and make $18. (Of course, if the expectation is not fulfilled and the
price exceeds $1,018, you sustain a loss since you must buy the gold for more than $1,018
and sell it for $1,000.)
19-8. If the current price of wheat is $3.70 and carrying costs of wheat are $0.74 (3.70 x
0.2), then the futures price has to be $4.44.
19-9. Party A receives payments based on S&P 500 index and makes payments based on
the EAFE. The flow of payments is
Payment received – Payment made = Net cash flow
$500,000 $1,200,000 ($700,000)
The counterparty (Party B) receives payments based on the EAFE Index and makes
payments based on the S&P 500 index. The flow of payments is
Payment received – Payment made = Net cash flow
$1,200,000 $500,000 $700,000
In a swap agreement, the net difference in the payments is that one party makes and
payments and the other receives the payments. In the first period, Party A remits $700,000
because the return on the EAFE exceeded the return on the S&P 500. In the second period,
the S&P generated a negative return, so the first party (A) paid the counter-party (B) the
return on the EAFE plus the negative return on the S&P. During the third period, the only
Teaching Guides for the Financial Advisor’s Investment Case: Futures to Defer Taxes
This case is designed to illustrate how a futures contract may be used in addition to
1. The value of the contract in terms of the index:
2. a. Number of contracts that must be sold:
b. Since DeLuca owns $1,000,000 worth of stock, he must take a short position in the
futures contract in order to hedge. If the value of the stock declines, the value of the short
3. The margin requirement is $2,000 per contract, so DeLuca will have to remit $40,000.
4. If the market declines by 5 percent, the value of each contract declines by 5 percent (if
the contracts move exactly with the market) to $47,500. DeLuca earns $2,500 per contract
5. If the portfolio’s beta is 1.0 and the market declines by 5 percent, the value of a
6. If the portfolio’s beta is less than 1.0, that implies the value of the portfolio will
7. If the market rises by 10 percent to 110, the value of a contract becomes 110 x 500 =
8. When stock index futures contracts expire, settlement occurs in cash, so DeLuca will
9. Since losses on the portfolio are offset by gains on the futures contracts (and vice versa