CFA Level 1 - Derivative Investments Session 17 - Reading 62 (Notes, Practice Questions, Sample Questions) 1. For a futures trade: A) a single price is determined by supply and demand . (Explanation — There is no bid/ask spread in futures trades; the price for the trade isdetermined on the ﬂoor of the exchange and is the single price thelong will pay the short for the asset at the termination of the contract) B)the buyer pays the bid price; the seller receives the ask price.C)the seller receives the bid price; the buyer pays the ask price 2. Which of the following statements about futures and the clearinghouse is least accurate? The clearinghouse: A) has defaulted on one half of one percent of futures trades. (Explanation — In the history of U.S. futures trading, theclearinghouse has never defaulted.Other information on the clearinghouse:The clearinghouse guarantees that traders in the futures market willhonor their obligations. The clearinghouse does this by splitting eachtrade once it is made and acting as the opposite side of each position.The clearinghouse acts as the buyer to every seller and the seller toevery buyer. By doing this, the clearinghouse allows either side of thetrade to reverse positions later without having to contact the other
side of the initial trade. This allows traders to enter the marketknowing that they will be able to reverse their position any time thatthey want. Traders are also freed from having to worry about theother side of the trade defaulting, since the other side of their trade isnow the clearinghouse.To safeguard the clearinghouse, the exchange requires traders to postmargin and settle their accounts on a daily basis) B)requires the daily settlement of all margin accounts.C)guarantees that traders in the futures market will honor theirobligations 3. Which of the following statements about futures markets is least accurate? A)Hedging is the prime social rationale for futures trading. B) Initial margin can only be posted in cash. (Explanation — Margin can be posted in cash, bank letters of credit, or T-bills) C)Futures markets allow market participants to discover the market'sexpectation of future cash market prices 4. Standardization features of futures contracts do not include the: A)delivery time.B)quality of the good that can be delivered. C) delivery price of the commodity. (Explanation — The delivery, or spot price at contract expiration, of a commodity is a variable andcannot be included in a futures contract. Quality and delivery time areboth part of the standardized terms of a futures contract.)
5. All of the following are characteristics of futures contracts EXCEPT: A)they are liquid.B)the contract size is standardized. C) they trade in a dealer (over the counter) market. (Explanation — Futures contracts trade on organized exchanges; forward contractsare created by dealers.) 6. Which of the following statements regarding futures contracts is least accurate? A)The exchange sets the times of trading for futures contracts. B) Price ﬂuctuations can be any amount. (Explanation — The minimum price ﬂuctuation, called a ‘tick’, is set by the exchange. The otherstatements are true) C)The long will have gains when the futures price rises above the initialcontract price. 7. An investor bought a futures contract covering 100,000 Mexican Pesos at 0.08196 and deposited margin of $320. The following day thecontract settlement price was 0.08201. The new margin balance in theaccount is: A)$320.B)$314. C) $325 (Explanation — 320 + 100,000(0.08201 − 0.08196) = $325)
8. An investor sold ten March stock index futures contracts. The multiplier on the contract is 250. At yesterday’s settlement price of998.40 the margin balance in the account was computed as $86,450.Today the index future had a settlement price of 1000.20. The newmargin amount is: A) $81,950. (Explanation — 86,450 − 10 × 250 × (1000.2 − 998.4) = $81,950) B)$90,950.C)$86,900. 9. A trader is long four July gold futures contracts, each with a contract size of 300 oz. If the price of July gold increases from $380.20 to $381.00per ounce the change in the margin balance will be: A)$240. B) $960. (Explanation — 4 × 300 × (381 – 380.20) = $960) C)-$960. 10. Most deliverable futures contracts are settled by: A)delivery of the asset at contract expiration. B) an o setting trade. (Explanation — Most futures positions are closed out by an o setting trade at some point during life of the contract.) C)a cash payment at expiration.
11. An o setting trade is used to: A) close out a futures position prior to expiration. (Explanation — An o setting/reversing trade is used to close out a futures position priorto expiration.) B)fully hedge a risk arising in the normal course of business activity.C)partially hedge the interest rate risk of a bond position. 12. Closing out a futures position prior to expiration: A) can be done by entering into an o setting trade at the current futures price. (Explanation — Taking the opposite position in an equal number of contracts on the same asset with the same expiration dateends any further exposure under the original contract) B)can only be done by the long.C)removes price risk but not necessarily counterparty risk. 13. Prior to contract expiration the short in a futures contract can avoid futures exposure by: A)using an exchange-for-physicals.B)paying a cash settlement amount. C) entering into a reversing trade. (Explanation — Prior to expiration, a futures position (long or short) is closed out by an o setting/reversingtrade. The other methods are used to settle positions at contractexpiration)
14. Which of the following statements about closing a futures contract through o set is most accurate? A)A low percentage of o sets take place ex-pit. B) e clearinghouse nets the position to zero. (Explanation — An o set trade must be conducted on the ﬂoor of the exchange through theclearinghouse. Exchange for physicals (EFP) involves private partiesand takes place ex pit, or o the exchange ﬂoor.) C)In an o set, or reversing trade, a trader makes an exact oppositetrade (maturity, quantity, and good) to her current position, eitherthrough the clearinghouse or a private party. 15. Which method is NOT an appropriate way to close out a futures contract? A)Reverse trade.B)Delivery. C) Default. (Explanation — Default is failure to perform as required under the contract.) 16. All of the following are methods to close out a futures position EXCEPT: A)delivery of the underlying commodity. B) allowing the contract to expire without taking action. (Explanation — A futures contract cannot expire without any action being taken. If thecontract has not been closed out through an o setting trade, then oneparty must deliver the underlying commodity and the other partymust purchase the commodity.) C)through an exchange for physicals with another trader.
17. Which of the following statements about closing a futures position is least accurate? A)Few futures positions are settled by delivery of cash or assets. B) Closing a position through delivery refers exclusively to the physical delivery of goods. (Explanation — Delivery can also occur through cash settlement of gains and losses. The other statements are true.Approximately one percent of futures transactions are closed throughactual delivery or cash settlement.) C)Except for exchange for physicals (EFP) transactions, futurescontracts must be closed on the exchange ﬂoor. 18. Which of the following statements about closing a futures position through delivery is most accurate? A) Depending on the wording of the contract, a trader may close a contract by either delivering the goods to a designated location or bymaking a cash settlement of any gains or losses. (Explanation — The other statements are false.Physical deliveries and cash settlements combined represent less thanone percent of all settlements.An exchange for physicals di ers from a delivery in that:The traders actually exchange the goods.The contract is not closed on the ﬂoor of the exchange.The two traders privately negotiate the terms of the transaction.) B)Although the popularity of physical delivery has decreased over time,delivery by cash settlement remains the most popular method ofclosing a futures position.C)Delivery is also known as exchange for physicals (EFP).
19. An exchange-for-physicals, as it pertains to futures contracts: A)is another term for delivering an asset to satisfy a futures contract.B)is another term for accepting delivery of an asset to satisfy a futurescontract. C) involves an agreement o the ﬂoor of the exchange. (Explanation — An exchange-for-physicals involves an agreement between long andshort contract holders to settle their respective obligations by deliveryand purchase of an asset. It is executed o the ﬂoor of the exchangeand reported to exchange o cials who then cancel both positions.) 20. Which of the following statements regarding Treasury bond futures is least accurate? A) Upon delivery, the long pays the short the futures price divided by the conversion factor for the bond the short chooses to deliver. (Explanation — The delivery price for Treasury bonds under thecontract is multiplied by the conversion factor for the bond the shortchooses to deliver. The other statements are true.) B)They are a deliverable contract.C)The contract size is $100,000. 21. At the Chicago Board of Trade, futures on foreign currencies have a contract size ﬁxed in: A) foreign currency units and are priced in dollars per foreign currency unit. (Explanation — In the U.S., futures contracts for foreign currencies have a contract size ﬁxed in foreign currency units (e.g.
125,000 Euros) and are priced in dollars per foreign currency unit(e.g. $0.08341 per Peso).) B)dollars and are priced in dollars per foreign currency unit.C)dollars and are priced in foreign currency units per dollar. 22. Which of the following statements about futures contracts on U.S. exchanges is least likely accurate? A)Prices of currency futures contracts are quoted as U.S. dollars perunit of the foreign currency.B)A $100,000 Treasury bond futures contract that settles at 102-16represents Treasury bonds worth $102,500. C) If annualized 90-day LIBOR decreases from 3.64% to 3.58%, a long position in a $1 million Eurodollar futures contract loses $150. (Explanation — The long position in a Eurodollar contract gains valuewhen LIBOR decreases. Price quotes on Eurodollar futures arecalculated as 100 minus annualized 90-day LIBOR in percent. Achange in 90-day LIBOR of 0.01% represents a $25 change in value ona $1 million Eurodollar futures contract. If LIBOR decreases from3.64% to 3.58%, the contract price increases six ticks from 96.36 to96.42, so the long position gains 6 × $25 = $150.Treasury bond futures that have a face value of $100,000 are quotedas a percent of face value with fractions measured in 1/32nds. A bondfutures quote of 102-16 represents 102 16/32, or 102.5% of $100,000,which is $102,500.Currency futures contracts are set in units of the foreign currency andstated as USD/unit.)
23. Which is the only type of commodity where trading in forward contracts is larger than trading with future contracts? A) Foreign currency. (Explanation — Trading in foreign currency forwards is far larger than the trading in futures. For example, withinternational trade, businesses can hedge against adverse currencyﬂuctuations. But each business arrangement is unique, and mostrequire the ﬂexibility of a forward, whose terms are not standardized,that meets their special needs) B)Agricultural.C)Interest rate.