MaxMarkCh18QuestionsOnly.docx
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MaxMarkCh18QuestionsOnly.docx
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MaxMarkCh18QuestionsOnly
MaxMark—Viney
MenuItem18:
(Topic18)Futurescontractsandforwardrateagreements
Question1:
Futurescontractsaretradedonseveralexchangeslocatedinvariouscountries.Whichofthefollowingiscorrect?
A:
futurescontractsarenotstandardisedbyeachexchange
B:
mostofthecontractstradedontheSydneyFuturesExchangearealsotradedononeormoreotherfuturesexchangessuchastheChicagoBoardofTrade
C:
futurescontractsarehighlystandardisedbutthecontractstradeddifferbetweenthevariousexchanges
D:
theconventionsadoptedforquotingthepricesoffuturescontractsarethesameforallfuturesexchanges
Feedback:
Oneessentialfeatureoffuturescontractsisstandardisationbuttheconventionsforquotingpricesdifferbetweenexchanges,soAandDarenotcorrect.Ingeneral,thecontractstradeddifferbetweenexchangesbecauseeachexchangetradesfuturescontractsthatarebasedonsecuritiesthatareissuedandtradedwithinthesamecountrysoBisalsoincorrectbutCiscorrect.
MORE:
FinancialInstitutions,InstrumentsandMarkets5/e,p.699.
Whilefuturescontractsarehighlystandardised,thetypesofcontractsvarybetweenexchangesindifferentcountries.Eachfuturesexchangetendstooffercontractsbasedonunderlyingsecuritiestradedinthatcountry.Forexample,withgovernmentbondfuturescontracts,theCBOToffersUSTreasurybondfuturescontracts,theSydneyFuturesExchangeoffersCommonwealthTreasurybondfuturescontractsandEurexoffersEuro-Bundcontracts.Theconventionadoptedforthequotationofthepriceofafuturescontractonaparticularexchangemayalsovary.Forexample,intheUSandEuropeanmarketsbondsaretypicallyquotedonthebasisoftheircleanprice,beingthepresentvalueofabondlessaccruedinterest,whereasintheAustralianmarketbondsarequotedonthebasisoftheiryieldtomaturity.
Question2:
Agroupofstudentswasaskedtoidentifythegeneralprinciplesthatapplytotheuseoffuturescontracts.Whichofthefollowingprinciplesidentifiedbythestudentsisnotcorrect?
A:
futurescontractsarederivativeproductsthatarederivedfromanunderlyingphysicalcommodityorfinancialinstrument
B:
pricingoffuturescontractsisbasedonthepriceoftheunderlyingitem
C:
futurephysicalmarketpricechangesareoffsetbyaprofitorlossinthefuturesmarket
D:
futurescontractsareusuallyclosedoutbydeliveryofthephysicalmarketcommodityorinstrument
Feedback:
Manyfuturescontractsarenotdeliverableandevenwhencontractsaredeliverable,deliveryofthephysicalmarketcommodityorinstrumentisrare.Mosttraderscloseouttheirpositionbyareversingtradepriortothedeliverydate,sothestatementinDisfalse,makingitthecorrectanswer.
MORE:
FinancialInstitutions,InstrumentsandMarkets5/e,p.698.
Ahedgercanuseafuturescontracttocreateasituationinwhichanychangeinthephysicalmarketpriceofacommodityorfinancialassetisoffsetbyaprofitorlossderivedfromacorrespondingchangeinthevalueofthefuturescontract.Thefollowingexampleillustratesthegeneralprinciplesandproceduresinvolvedinhedgingthroughthefuturesmarket.
Considerafarmerwhogrowswheat.Thefarmerisconcernedthatthepriceofwheatmayfallbeforethewheatisreadyforharvestandsale.Thefarmerwouldbehappytoobtainthecurrentpriceofwheat,butthewheatwillnotbereadytoharvestforsomemonths.Thepotentialadverseeffectofafallinwheatpricescanbehedgedbysellingfuturescontractstodayequalinvaluetothecurrentvalueoftheexpectedwheatharvest.Thefuturescontractisanobligationforthefarmertosupplyaspecifiedquantityofwheatonaspecifiedfuturedateandatapricespecifiedtoday.
Whenthespecifiedfuturedatearrives,thefarmerhastwooptions.Thefirstistodeliverthewheataccordingtothetermsofthefuturescontractsandreceivetheoriginallyagreed-uponprice.However,thiscourseofaction(thatis,thephysicaldeliveryofthecommodity)isnotnormallytaken.Thesecondoptionisforthefarmertosellthewheatthroughtheusualgrainmarketand,atthesametime,repurchasethefuturescontractsthatwereoriginallysoldatthecommencementofthehedgingstrategy.Ifthepriceforwheatinthegrainmarkethasfallenonthedaythatthefarmerrepurchasesthefuturescontracts,thepriceoftherelatedwheatfuturescontractswillalsohavefalleninlinewiththepricechangesinthephysicalmarket.(Remember,thepriceofaderivativecontractisderivedfromtheunderlyingphysicalmarketproduct.)
Question3:
WhichofthefollowingarecharacteristicsoffuturestradingontheSydneyFuturesExchange(SFE)?
A:
transactionsinthe‘tradingpits’areconductedby‘openoutcry’
B:
tradingoccursviaanelectronicsystemthatmatchesbuyingandsellingorders
C:
themainroleoftheclearing-house(SydneyFuturesExchangeClearing-House[SFECH])istorecordalltransactions
D:
thepricesforbondfuturescontractsarequotedintermsofthedollarvalueoftheunderlyingbond
Feedback:
Transactionsinthetradingpitswereconductedbyopenoutcrybutthetradingfloorwasclosedin1999andalltradingontheSFEnowoccursviaanelectronicsystem.Theclearing-househasotherimportantrolesincludingenforcingpaymentofdepositsandmargins,andthepricesofbondfuturescontractsarequotedintermsoftheyieldoftheunderlyingbond,notitsprice.Insummary,Bistheonlyaccuratestatement.
MORE:
FinancialInstitutions,InstrumentsandMarkets5/e,pp.700–701.
ThebrokerswillpasstheorderstoSFEdealerswhowillentertheirrespectiveordersintotheSFE’selectronictradingsystem.Thesystemautomaticallymatchescorrespondingbuyandsellorders.Wheremorethanonebuyorsellorderislodgedonthesystematthesameprice,thefirstorderreceivedisgivenpriorityinthematchingprocess.
Untilmid-1999thesetransactionswouldhavebeenhandledonthetradingflooroftheSFE.Theorderswouldhavegonetotheten-yearTreasurybondtradingpit—oneofaseriesofrecessedpitsontheflooroftheexchangewheretradeinspecificcommoditiesorcontractstookplace,byasystemknownasopenoutcry.Thebidstobuyorsellwerecalledoutaloudsothatalldealerstradinginthatpitcouldhear.Theverbaloutcrywassupportedbyhandsignals.Forexample,atraderholdinguphisorherhandwiththehandfacingawayfromthetraderandwiththreefingersshowingwasindicatinganoffertosellthreecontracts.Thiswasintendedtogiveeachdealeranequalchancetoacceptthebuyorsellpricesbeingquoted.Iftherewerenoresponsestothecalledquotes,thepricecouldbeadjustedandquotedaloudagainuntilitattractedapartytocompletethetransaction.OpenoutcrytradingnolongeroccursinAustralia,andisrapidlydisappearingfromotherexchangesaroundtheworld.However,thelargestexchangesinChicagostillretainopenoutcry.
Returningtotheexample:
theelectronictradingsystemhasmatchedthebid(buy)ofcompanyBwiththeask(sell)ofcompanyS,andthetransactionisinplace.Thepriceofthetransactionisbasedontheyieldofthecontract;however,afuturescontractontheSFEisquotedasanindexfigure(100minustheyield).Thethree-yearCommonwealthTreasurybondcontractisquotedtotwodecimalplaces,whiletheten-yearcontractisquotedtothreedecimalplaces.Therefore,ifcompanyBandcompanySenterintocontractsatayieldof7.25percentperannum,thecontractwillbequotedas92.750(100minus7.25).
Futurescontractsarequotedatanindexfigureof100minustheyieldsothatadealercanfollowthebasicprincipleofbuylowandsellhigh.Thepriceofthecontractintheexampleisbasedona7.25percentyield.Ifthiscontractweretobesoldatalaterdateatayieldof6percent,thenitatfirstseemsthatalosswouldbemadebecausethecontractwasboughtat7.25percentandsoldat6percent.If,however,wecalculatetheactualpricesofthetwocontractswefindthataprofitwouldbemade.Therefore,byadoptingtheindexquoteconvention,ifthedealerbuysat92.750andsellsat94.000itisapparentthataprofithasbeenmade.
Question4:
WhichofthefollowingstatementsaboutmarginrequirementsontheSydneyFuturesExchange(SFE)isnotcorrect?
A:
eachpartyenteringintoafuturescontractisrequiredtopayaninitialmargin
B:
initialmarginschangefromtimetotimeandtendtobeincreasedwhenpricevolatilityishigh
C:
ifthepriceofacontractchanges,eachpartymayberequiredtotopuptheinitialmargin
D:
marginsaredesignedtocoverthemaximumlossthatcanbeexpectedinasingleday
Feedback:
Allthestatementsareaccurateexceptthatwhenthepriceofacontractchanges,onlyoneparty—thatistheonethathasincurredalossmayberequiredtotopuptheinitialmargin—soCisinaccurate,makingitthecorrectanswer.
MORE:
FinancialInstitutions,InstrumentsandMarkets5/e,p.702.
Anagreementtobuyiscalledalongpositionandanagreementtosellisknownasashortposition.WhencompanyBandcompanySenterintotheirpositions(contracts)theydonotneedtopaythefullpriceofthecontract;insteadtheyareonlyrequiredtopayadepositorinitialmargin.Theinitialmarginisheldbytheclearing-house.Initialmarginschangefromtimetotime,dependingonthepricevolatilityoftheunderlyingcommodityorfinancialassetofthefuturescontract.Duringperiodsofhighpricevolatility,themargintendstobeincreased.Theinitialmarginsaresimilartoaperformancebondorcollateralthatsupportsthevalueofthefuturescontract.Theyareimposedtoensurethatdealersandtheirclientsare
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