Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
Chapter 11: Forward, Futures, and Swaps
Multiple Choice Questions
1. Section: 11.1 Forward Contracts
Learning Objective: 11.1
Level of difficulty: Intermediate
2. Section: 11.1 Forward Contracts
Learning Objective: 11.1
Level of difficulty: Intermediate
3. Section: 11.1 Forward Contracts
Learning Objective: 11.1
Level of difficulty: Intermediate
4. Section: 11.1 Forward Contracts
Learning Objective: 11.1
Level of difficulty: Intermediate
5. Section: 11.1 Forward Contracts
Learning Objective: 11.1
Level of difficulty: Intermediate
6. Section: 11.1 Forward Contracts
Learning Objective: 11.1
Level of difficulty: Intermediate
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
7. Section: 11.1 Forward Contracts
Learning Objective: 11.1
Level of difficulty: Intermediate
8. Section: 11.2 Futures Contracts
Learning Objective: 11.2
Level of difficulty: Intermediate
9. Section: 11.2 Futures Contracts
Learning Objective: 11.2
Level of difficulty: Intermediate
10. Section: 11.2 Futures Contracts
Learning Objective: 11.2
Level of difficulty: Intermediate
11. Section: 11.2 Futures Contracts
Learning Objective: 11.2
Level of difficulty: Intermediate
12. Section: 11.2 Futures Contracts
Learning Objective: 11.2
Level of difficulty: Intermediate
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
13. Section: 11.2 Futures Contracts
Learning Objective: 11.2
Level of difficulty: Intermediate
14. Section: 11.2 Futures Contracts
Learning Objective: 11.2
Level of difficulty: Intermediate
15. Section: 11.2 Futures Contracts
Learning Objective: 11.2
Level of difficulty: Intermediate
16. Section: 11.2 Futures Contracts
Learning Objective: 11.2
Level of difficulty: Intermediate
17. Section 11.3 Swaps
Learning Objective: 11.3
Level of difficulty: Intermediate
18. Section 11.3 Swaps
Learning Objective: 11.3
Level of difficulty: Challenging
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
19. Section 11.3 Swaps
Learning Objective: 11.3
Level of difficulty: Intermediate
20. Section 11.3 Swaps
Learning Objective: 11.3
Level of difficulty: Intermediate
21. Section 11.3 Swaps
Learning Objective: 11.3
Level of difficulty: Intermediate
22. Section 11.4 The Financial Crisis and The Credit Default Swap Market
Learning Objective 11.4
Level of difficulty: Intermediate
23. Section 11.5 Forward Interest Rates and Forward Rate Agreements (FRAs) 11.5
Learning Objective 11.5
Level of difficulty: Intermediate
Practice Problems
Basic
24. Section 11.2 Futures Contracts
Learning Objective: 11.2
Level of difficulty: Basic
Solution:
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
Each day, any profits and losses will be credited to an investor’s account to calculate the equity
25. Section 11.2 Futures Contracts
Learning Objective: 11.2
Level of difficulty: Basic
Solution:
The number of futures contracts outstanding represents open interest, which reflects the true
26. Section 11.3 Swaps
Learning Objective: 11.3
Level of difficulty: Basic
Solution
One counterparty has a comparative advantage in the fixed rate market. In contrast, the other
27. Section 11.4 The Financial Crisis and the Credit Default Swap Market
Learning Objective: 11.4
Level of difficulty: Basic
Solution:
In the total return swap, one party receives a fixed or floating rate on a notional amount, while
28. Section 11.2 Future Contracts
Learning Objective: 11.2
Level of difficulty: Basic
Solution:
Intermediate
29. Section 11.1 Forward Contracts
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
Learning Objective: 11.1
Level of difficulty: Intermediate
Solution:
a. To hedge the bond portfolio against changes in interest rates, Simon can use the bond futures
contract. This will be a good hedge because of the very high correlation between the returns on
30. Section 11.1 Forward Contracts
Learning Objective: 11.1
Level of difficulty: Intermediate
Solution:
Today
In one year
Position
Number
of
Contracts
Cost
today
(C$)
Forward
(C$/US)
Spot
(C$/US$)
in one year
Payoff
(C$)
Profit (Loss)
(C$)
A
Long
$200
B
Short
($200)
C
Long
$100
$100
D
Long
($300)
($300)
E
Long
$800
$800
F
Short
($2,500)
($2,500)
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
b. The profit (loss) on the contract is determined by:
c. The forward rate today is determined by:
e. The spot rate in one year is determined by:
f. If the future spot rate is greater than the forward rate, long positions make money and short
31. Section 11.1 Forward Contracts
Learning Objective: 11.1
Level of difficulty: Intermediate
Solution:
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
Spot
Cost of carry
1-year forward
price
1-year
interest rate
Annual storage
cost
A
$200
B
$235
$285
2% of spot
D
$350
$400
4%
F
$300
3%
$5 per ounce
G
$250
$285
$15 per ounce
( )
.08*200 .04*200
200
+


(1 )
1.12*200
F c S=+
=
8%
4% of spot
(F) To determine the spot price:
(G) To determine interest rate:
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
32. Section 11.1 Forward Contracts
Learning Objective: 11.1
Level of difficulty: Intermediate
Solution:
Compare the costs and benefits of using the spot and forward markets:
33. Section 11.1 Forward Contracts
Learning Objective: 11.1
Level of difficulty: Intermediate
Solution:
34. Section 11.1 Forward Contracts
Learning Objective: 11.1
Level of difficulty: Intermediate
Solution:
35. Section 11.1 Forward Contracts
Learning Objective: 11.1
Level of difficulty: Intermediate
Solution:
a. Because the firm has a short position (i.e., short exposure) in the underlying asset (i.e., euros),
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
36. Section 11.1 Forward Contracts
Learning Objective: 11.1
Level of difficulty: Intermediate
Solution:
a. Because the firm has a long position (i.e., long exposure) in the underlying asset (i.e., euros), it
37. Section 11.1 Forward Contracts
Learning Objective: 11.1
Level of difficulty: Intermediate
Solution:
I will receive R3.5 million in one year, so:
38. Section 11.2 Futures Contracts
Learning Objective: 11.2
Level of difficulty: Intermediate
Solution:
Forwards
Futures
Contracts
Customized
Standardized
Trading
Dealer or OTC Markets
Exchanges
clearinghouse
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
Initial deposit
Not required
Initial margin and
maintenance margin required
Settlement
On maturity date
Marked to market daily
39. Section 11.2 Futures Contracts
Learning Objective: 11.2
Level of difficulty: Intermediate
Solution:
Basis risk is the risk associated with a hedged position that is attributable to the fact that the asset
40. Section 11.2 Futures Contracts
Learning Objective: 11.2
Level of difficulty: Intermediate
Solution:
Ethel
Egbert
Day
Spot
price
Daily
profit (loss)
Equity position
(margin balance)
Daily
profit (loss)
Equity position
(margin balance)
0
$100
$30,000
$30,000
1
$75
$(25,000)
$5,000
$25,000
$55,000
2
$50
$(25,000)
$(20,000)
$25,000
$80,000
3
$80
$30,000
$10,000
$(30,000)
$50,000
4
$130
$50,000
$60,000
$(50,000)
$0
5
$100
$(30,000)
$30,000
$30,000
$30,000
41. Section 11.2 Futures Contracts
Learning Objective: 11.2
Level of difficulty: Intermediate
Solution:
Day
Spot
price
Daily profit
Equity position
(margin balance)
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
2
20.75
3
21.00
4
19.75
5
19.25
42. Section 11.2 Futures Contracts
Learning Objective: 11.2
Level of difficulty: Intermediate
Solution:
Day
Spot
price
Daily profit
Equity position
(margin balance)
0
20.00
0
50,000
1
20.50
25,000
2
20.75
12,500
3
21.00
4
19.75
62,500
5
19.25
87,500
43. Section 11.2 Future Contracts
Learning Objective: 11.2
Level of difficulty: Intermediate
Solution:
Day
Spot
price
Daily profit
(loss)
Equity
position
before cash
deposit
Margin call?
Cash
deposit
Equity
position
(margin
balance)
0
$100
0
$0
No
$30,000
$30,000
2
No
$25,500
3
$103
No
$33,500
4
2,000
$22,500
5
$100
No
$32,500
44. Section 11.3 Swaps
Learning Objective: 11.3
Level of difficulty: Intermediate
Solution:
Introduction to Corporate Finance, Fourth Edition Booth, Cleary, Rakita
Start of
Period
LIBOR
%
Floating
pay %
Fixed pay
%
Net pay
%
Net pay
$
1
4%
3%
–3%
0%
$0
2
5%
3.5%
–3%
.5%
$5,000
3
3%
2.5%
–3%
–.5%
–$5,000
4
1%
1.5%
–3%
–1.5%
–$15,000
45. Section 11.4 The Financial Crisis and the Credit Default Swap Market
Learning Objective: 11.4
Level of difficulty: Intermediate
Solution: There are two big differences between a credit default swap (CDS) and insurance. First,
the risk attached to regular insurance, such as house or car insurance, is essentially random since
46. Appendix 11A
Learning Objective 11.5
Level of difficulty: Intermediate
Solution:
1 year forward
rate expected in
Implied 1-year forward
rate %