You are on page 1of 34

DerivativeInvestments:ForwardsandFutures TestID:7441790

Question#1of85 QuestionID:464024

Considera9monthforwardcontractona10year7%Treasurynotejustissuedatpar.Theeffectiveannualriskfreerateis
5%overtheneartermandthefirstcouponistobepaidin182days.Thepriceoftheforwardisclosestto:

A) 1,037.27.

B) 1,001.84.
C) 965.84.

Explanation

Theforwardpriceiscalculatedasthebondpriceminusthepresentvalueofthecoupon,timesoneplustheriskfreeratefor
thetermoftheforward.

(1,00035/1.05182/365)1.059/12=$1,001.84

Question#2of85 QuestionID:464070

Howismarketbackwardationrelatedtoanasset'sconvenienceyield?Iftheconvenienceyieldis:

A) positive,causingthefuturespricetobebelowthespotpriceandthemarketis
inbackwardation.
B) negative,causingthefuturespricetobebelowthespotpriceandthemarketisin
backwardation.

C) largerthantheborrowingrate,causingthefuturespricetobebelowthespotprice
andthemarketisinbackwardation.

Explanation

Whentheconvenienceyieldismorethantheborrowingrate,thenoarbitragecostofcarrymodelwillnotapply.Itmeansthat
thevalueoftheconvenienceofholdingtheassetitisworthmorethanthecostoffundstopurchaseit.Thisusuallyappliesto
nonfinancialfuturescontracts.

Question#3of85 QuestionID:464012

Aportfoliomanagerholds100,000sharesofIPRDCompany(whichistradingtodayfor$9pershare)foraclient.Theclient
informsthemanagerthathewouldliketoliquidatethepositiononthelastdayofthequarter,whichis2monthsfromtoday.
Tohedgeagainstapossibledeclineinpriceduringthenexttwomonths,themanagerentersintoaforwardcontracttosellthe
IPRDsharesin2months.Theriskfreerateis2.5%,andnodividendsareexpectedtobereceivedduringthistime.However,
IPRDhasahistoricaldividendyieldof3.5%.Theforwardpriceonthiscontractisclosestto:

A) $905,175.
B) $903,712.

C) $901,494.

Explanation

Thehistoricaldividendyieldisirrelevantforcalculatingthenoarbitrageforwardpricebecausenodividendsareexpectedto

bepaidduringthelifeoftheforwardcontract.Intheabsenceofanarbitrageopportunity,thevalueof should

be0.

Therefore,FP=S0(1+Rf)T

903,712=900,000(1.025)2/12

Question#4of85 QuestionID:464009

Atcontractinitiation,thevalueofaforwardcontract:

A) issetto100byconvention.

B) dependsonthemarketpriceoftheunderlyingasset.
C) istypicallyzeroregardlessofthepriceoftheunderlyingasset.

Explanation

Duetothenoarbitrageprinciple,thepriceofaforwardcontractiscalculatedtomakethevalueofthecontractzeroatcontract
initiation.Neitherthelongnortheshorttypicallymakesanypaymenttoenterintotheforwardagreement.Aspecialcaseisan
offmarketforwardwhere,forwhateverreason,thecontractpriceisnotsetequaltothenoarbitrageprice,andthelongor
shortpositionmakesapaymenttotheoppositecounterpartytooffsetthedifference.

Question#5of85 QuestionID:464056

Thevalueofafuturescontractis:

A) zerowhentheaccountismarkedtomarketforanaccountthathassufficient
margin.

B) calculatedinthesamemannerasthevalueofaforwardcontract.
C) equaltothevariationmarginpaidonanygivenday.

Explanation

Thevalueofafuturescontractiszerowhentheaccountismarkedtomarketandthereisnomargincall.Thepriceofthe
contractisadjustedtothenew'noarbitrage'value,whichistheoreticallythesameasthesettlepriceattheendoftrading,as
longaspricechangelimitshavenotbeenreached.Notethatthisisdifferentfromaforwardcontract.Withaforwardcontract,
theforwardpriceisfixedforthelifeofthecontractsothecontractmayaccumulateeitherapositiveornegativevalueasthe
forwardpricefornewcontractschangesoverthelifeofthecontract.

Question#6of85
QuestionID:464017

JimTrent,CFAhasbeenaskedtopriceathreemonthforwardcontracton10,000sharesofGlobalIndustriesstock.The
stockiscurrentlytradingat$58andwillpayadividendof$2today.Iftheeffectiveannualriskfreerateis6%,whatprice
shouldtheforwardcontracthave?Assumethestockpricewillchangevalueafterthedividendispaid.

A) $56.85.

B) $58.85.
C) $56.82.

Explanation

Onemethodistosubtractthefuturevalueofthedividendfromthefuturevalueoftheassetcalculatedattheriskfreerate(i.e.
thenoarbitrageforwardpricewithnodividend).

FP=58(1.06)1/42(1.06)1/4=$56.82

Thisisequivalenttosubtractingthepresentvalueofthedividendfromthecurrentpriceoftheassetandthencalculatingthe
noarbitrageforwardpricebasedonthatvalue.

Question#7of85 QuestionID:464047

Creditrisktothelong(position)inaforwardcontractwillincreaseoverthelifeofthecontractduetoallofthefollowing
EXCEPTthe:

A) shortpartyhasdeterioratingfinances.
B) settlementdateisgettingcloser.

C) contractvaluetotheshortisnegativeanddecreasing.

Explanation

Deterioratingfinancesofthecounterpartyincreasetheprobabilityofdefault.Theamountowedtothelongincreasesasthe
valueoftheunderlyingassetincreases,whichisthesameasanincreaseinthevalueofthecontract.Anincreaseinthe
amount'owed'andanincreaseintheprobabilityofdefaultcanbothbeviewedasincreasingcreditrisk.Byitself,thepassage
oftimedoesnotnecessarilyincreasecreditrisk.

Question#8of85 QuestionID:464029

Thepriceofa35forwardrateagreement(FRA)isthe:

A) 2monthimpliedforwardrate5monthsfromtoday.
B) 3monthimpliedforwardrate5monthsfromtoday.

C) 2monthimpliedforwardrate3monthsfromtoday.

Explanation

ThenotationforFRAsisunique.TherearetwonumbersassociatedwithanFRA:thenumberofmonthsuntilthecontract
expiresandthenumberofmonthsuntiltheunderlyingloanissettled.Thedifferencebetweenthesetwoisthematurityofthe
underlyingloan.Forexample,a35FRAisacontractthatexpiresinthreemonths(90days),andtheunderlyingloanis
settledinfivemonths(150days).Thepriceofthe35FRAiscalculatedbyannualizingtheimpliedforwardrate.Theimplied
forwardrateiscalculatedfromthe3monthrateandthe5monthrate.

Question#9of85 QuestionID:464025

TheU.S.riskfreerateis2.96%,theJapaneseyenriskfreerateis1.00%,andthespotexchangeratebetweentheUnited
StatesandJapanis$0.00757peryen.Bothratesarecontinuouslycompounded.Thepriceofa180dayforwardcontracton
theyenandthevalueoftheforwardposition90daysintothecontractwhenthespotrateis$0.00797areclosestto:

ValueAfter90
ForwardPrice
Days

A) $0.00764 $0.00212

B) $0.00764 $0.00037

C) $0.00750 $0.00212

Explanation

Thenoarbitragepriceofthe180dayforwardcontractis:

F T=$0.00757e(0.02960.0100)(180/365)=$0.00764

Thevalueofthecontractin90dayswith18090=90daysremainingis:

Question#10of85 QuestionID:464069

Asituationwherethefuturespriceisabovethespotpriceoftheunderlyingassetiscalled:

A) positivecarry.

B) contango.

C) normalbackwardation.

Explanation

Asituationwherethefuturespriceisabovethespotpriceoftheassetiscalledcontango.

Question#11of85 QuestionID:464046

Overthelifeofaforwardcontract,theamountofcreditriskisleastlikelyto:

A) changesigns.

B) increase.

C) staythesame.
Explanation

Theamountofcreditriskisleastlikelytostaythesame.Theamountofcreditriskisbasedonthecontractvalue,whichiszero
atcontractinitiation.Forthevaluetostaythesame(atzero),theexpectedfuturepriceoftheassetmustnotchangeoverthe
lifeofthecontract,anunlikelycircumstance.Asthevalueofthecontracttothelonggoesfrompositivetonegative,the
amountofcreditriskchangesinsign.

Question#12of85 QuestionID:464027

30daysago,J.Kleintookashortpositionina$10million(3X6)forwardrateagreement(FRA)basedontheLondon
InterbankOfferedRate(LIBOR)andpricedat5%.ThecurrentLIBORcurveis:
30day=4.8%
60day=5.0%
90day=5.1%
120day=5.2%
150day=5.4%

ThecurrentvalueoftheFRA,totheshort,isclosestto:

A) $15,280.

B) $15,495.
C) $15,154.

Explanation

FRAsareenteredintohedgeagainstinterestraterisk.ApersonwouldbuyaFRAanticipatinganincreaseininterestrates.If
interestratesincreasemorethantherateagreeduponintheFRA(5%inthiscase)thenthelongpositionisowedapayment
fromtheshortposition.

Step1:Findtheforward90dayLIBOR60daysfromnow.

[(1+0.054(150/360))/(1+0.05(60/360))1](360/90)=0.056198.SinceprojectedinterestratesattheendoftheFRA
haveincreasedtoapproximately5.6%,whichisabovethecontractedrateof5%,theshortpositioncurrentlyowesthelong
position.

Step2:Findtheinterestdifferentialbetweenaloanattheprojectedforwardrateandaloanattheforwardcontractrate.

(0.0561980.05)(90/360)=0.001549510,000,000=$15,495

Step3:Findthepresentvalueofthisamount'payable'90daysaftercontractexpiration(or60+90=150daysfromnow)and
noteonceagainthattheshort(whomust'deliver'theloanattheforwardcontractrate)losesbecausetheforward90day
LIBORof5.6198%isgreaterthanthecontractrateof5%.

[15,495/(1+0.054(150/360))]=$15,154.03

Thisisthenegativevaluetotheshort.

Question#13of85 QuestionID:464076
Whatisthesituationcalledwhenafuturespricecontinuouslyincreasesoveritslifebecausemosthedgingstrategiesareshort
hedges?

A) Contango.

B) Normalbackwardation.

C) Anormalmarket.

Explanation

Normalbackwardationmeansthatexpectedfuturesspotpricesaregreaterthanfuturesprices.Itsuggeststhatwhenhedgers
arenetshortfuturescontracts,theymustsellthematadiscounttotheexpectedfuturespotpricestogetinvestorstobuy
them.Thefuturespricerisesasthecontractmaturestoconvergewithspotprices.

Question#14of85 QuestionID:464063

AllofthefollowingareexamplesofthemonetarybenefitsorcostsofholdinganassetunderlyingafuturescontractEXCEPT:

A) havingareadysupplyoftheassetforbusinesspurposes.
B) dividendpaymentsfromaportfolioofstocks.

C) storageandinsurancecostsforstoringgold.

Explanation

Havingareadysupplyofanassetforbusinesspurposesisanonmonetarybenefitofholdingtheasset.Thisconvenience
yieldcanresultinbackwardation.

Question#15of85 QuestionID:464060

Comparedtofuturespricesonasixmonthcontract,forwardpricesonanidenticalcontractare:

A) alwayshigher.
B) equal.
C) higher,lower,orequal.

Explanation

Futurespricesmaybehigherorlowerthanforwardpricesonacontractwithidenticalterms,dependingonthecorrelation
betweeninterestratechangesandthepricechangesoftheunderlyingasset.Wheninterestratesandassetvaluesare
positivelycorrelated,thefuturespricetendstobehigher,andwheninterestratesandassetvaluesarenegativelycorrelated,
thefuturespricetendstobelower.

Question#16of85 QuestionID:464030

Consideraforwardcontracton1millionMexicanPesosat$0.08254/MXN.60dayspriortoexpirationtheU.S.riskfreerateis
5%,theMexicanriskfreerateis6%,andthespotrateis$0.08211/MXN.Thevalueofthecontracttothelongisclosestto:
A) $297.
B) $553.

C) $553.

Explanation

Theformulais:

Vt=St/(1+Rfor)(Tt)F T/(1+Rdom)(Tt) .

Thevalueis0.08211/1.0660/3650.08254/1.0560/365=0.081327630.08188065=0.00055302.

TheanswerisinUSD/Peso,becausewhenmultiplyingbyPesos,theanswerisinUSD.

0.000553021millionPesos=$553.02.

Question#17of85 QuestionID:464055

Thevalueofafuturescontractbetweenthetimeswhentheaccountismarkedtomarketis:

A) neverlessthanthevalueofaforwardcontractenteredintoonthesamedate.

B) equaltothedifferencebetweenthepriceofanewlyissuedcontractandthesettle
priceatthemostrecentmarktomarketperiod.

C) thesameasthecontractprice.

Explanation

Betweenthemarktomarketaccountadjustments,thecontractvalueiscalculatedjustlikethatofaforwardcontractitisthe
differencebetweenthepriceatthelastmarktomarketandthecurrentfuturesprice,(i.e.thefuturespriceonanewlyissued
contract).Themarktomarketofafuturescontractisthepaymentorreceiptoffundsnecessarytoadjustforthegainsor
lossesontheposition.Thisadjuststhecontractpricetothe'noarbitrage'pricecurrentlyprevailinginthemarket.

Question#18of85 QuestionID:464008

Thetheoreticalpriceofaforwardcontract:

A) isthenoarbitrageprice.
B) equalsthelong'sexpectationofthefuturepriceoftheunderlyingasset.
C) isalwaysgreaterthanthecurrentpriceoftheunderlyingasset.

Explanation

Thetheoreticalpriceofaforwardcontractisthefuturepriceoftheunderlyingassetimposedbythenoarbitrageconditions.It
canbelessthanthecurrentpriceoftheassetifthecostofcarryisnegative.Accruedinterestispaidbythelongatdelivery
underabondforward,butisnotincludedinthepricequote,whichisusuallyintermsofyieldtomaturityatthesettlement
date.
Question#19of85 QuestionID:464061

Toinitiateanarbitragetradeifthefuturescontractisunderpriced,thetradershould:

A) borrowattheriskfreerate,shorttheasset,andsellthefutures.
B) shorttheasset,investattheriskfreerate,andbuythefutures.

C) borrowattheriskfreerate,buytheasset,andsellthefutures.

Explanation

Ifthefuturespriceistoolowrelativetothenoarbitrageprice,buyfutures,shorttheasset,andinvesttheproceedsattherisk
freerateuntilcontractexpiration.Takedeliveryoftheassetatthefuturesprice,payforitwiththeloanproceedsandkeepthe
profit.ForTreasurybill(Tbills),shortingtheassetisequivalenttoborrowingattheTbillrate.

Question#20of85 QuestionID:464007

Whichofthefollowingbestdescribesthepriceofaforwardcontract?Theforwardpriceis:

A) alwaysequaltothemarketpriceatcontracttermination.
B) alwaysexpressedindollars.

C) thepricethatmakesthevaluesofthelongandshortpositionszeroatcontract
initiation.

Explanation

Theforwardpriceisthecontractpriceoftheunderlyingassetunderthetermsoftheforwardcontract,andisthepricethat
makesthevaluesofthelongandshortpositionszeroatcontractinitiation.Itisnottheamountitcoststopurchasetheforward
contract.Theforwardpriceisexpressedintermsoftheunderlyingasset,andmaybeadollarvalue,exchangerate,or
interestrate.Thevalueofaforwardcontractcomesfromthedifferencebetweentheforwardcontractpriceandthemarket
pricefortheunderlyingasset.Thesevaluesarelikelytobedifferentatcontracttermination,whichwillresultinaprofitfor
eitherthelongortheshortposition.

Question#21of85 QuestionID:464058

Thenoarbitragepriceofafuturescontractwithaspotrateof990,atimetomaturityof2years,andariskfreerateof5%is
closestto:

A) 792.
B) 1040.

C) 1091.

Explanation

Thenoarbitragepriceofafuturescontractisbasedonthespotrate,thetimetomaturity,andtheriskfreerate.

FP =S0(1+Rf)T
=990(1.05)2

=1091
Question#22of85 QuestionID:464077

Thetheoreticalquestionofwhetherfuturespricesareunbiasedpredictorsoffuturespotratesfocuseson:

A) whetherfuturesmarketsareefficient.
B) thecorrelationbetweeninterestratechangesandassetpricechanges.

C) whetherfuturesbuyersaretakingonassetowners'pricerisk.

Explanation

Thetheoreticalanalysisofwhetherfuturespricesareunbiasedpredictorsofspotratesatfuturesexpirationdatesdependson
whetherfuturesbuyersarebeingcompensatedfortakingontheassetpriceriskthatfuturessellersareavoiding.Underthe
assumptionthatfuturestransactionsaredrivenbythosewithnaturalshortpricerisktransactingwiththosewhohavenatural
longpositions,expectedfuturespotpricesareequaltofuturesprices.

Question#23of85 QuestionID:464016

Thepriceofaforwardcontract:

A) dependsonforwardinterestrates.
B) changesoverthetermofthecontract.
C) isdeterminedatcontractinitiation.

Explanation

Thepriceofaforwardcontractisestablishedattheinitiationofthecontractandisexpressedindifferentterms,dependingon
theunderlyingassets.Itisthepricethatmakesthecontractvaluezero,anddependsoncurrentinterestratesthroughthe
costofcarrycalculation.

Question#24of85 QuestionID:464051

Thedifferencebetweenthespotandthefuturespricemustconvergetozeroatfuturesexpirationbecause:

A) thefuturescontractbecomesequivalenttotheunderlyingassetatexpiration.

B) thefuturescontracthastobeworththesameasallotherdeliverymonths.

C) anarbitragetradecanbeimplementedusingonlyotherfuturescontracts.

Explanation

Ifthefuturesandspotpricesarenotequal,arbitrageactivitywilloccur.

Question#25of85 QuestionID:464018

Anindexiscurrently965andthecontinuouslycompoundeddividendyieldontheindexis2.3%.Whatisthenoarbitrageprice
onaoneyearindexforwardcontractifthecontinuouslycompoundedriskfreerateis5%.

A) 991.1.

B) 991.4.
C) 987.2.

Explanation

ThefuturespriceFP=S0eT(eRT)
=S0e(R)T
=965e(.05.023)
=991.4

Question#26of85 QuestionID:464049

Attheexpirationofafuturescontract,thedifferencebetweenthespotandthefuturespriceis:

A) atitspointofhighestvolatility.
B) equaltozero.

C) alwayspositive.

Explanation

Thedifferencemustbezeroatexpirationbecauseboththespotpriceandthefuturespriceare,atthatpointintime,theprice
oftheunderlyingassetforimmediatedelivery.

Question#27of85 QuestionID:464079

WhichofthefollowingstatementsregardingEurodollarfuturesismostaccurate?

A) Eurodollarsfuturesarebasedon60dayLIBOR,whichisanaddonyield.
B) Everybasispoint(0.01%)moveinannualized60dayLIBORrepresentsa$25gainor
lossonthecontract.
C) EurodollarfuturesarepricedasadiscountyieldandLIBORissubtractedfrom100to
getthequote.

Explanation

Eurodollarfuturesarepricedasadiscountyieldandarequotedas100minus90dayLIBOR.

Question#28of85 QuestionID:464048

Thecreditriskinaforwardcontractis:

A) onlyanissueforthelong.
B) directlyrelatedtothecontractvalue.
C) positivelyrelatedtothetermofthecontract.

Explanation

Thecreditrisktothepartywiththepositionwiththepositivevalue(longorshort)isgreater,thegreaterthevalueofthe
forwardcontractatapointintime.Acontractwithalongertermmayhavealowercontractvalue.

Question#29of85 QuestionID:464062

Comparedtothepriceonanotherwiseidenticalforwardcontract,thepriceofafuturescontractis:

A) alwaysthesameatcontractinitiation.

B) higherwhenassetpricechangesarepositivelycorrelatedwithinterestratechanges.
C) lowerwhenassetpricechangesarepositivelycorrelatedwithinterestratechanges.

Explanation

Apositivecorrelationbetweenassetpricechangesandinterestratechangesmakesthemarktomarketfeatureattractivetoa
futuresbuyer.Thisleadstoahigherfuturespricecomparedtotheforwardpriceonanotherwiseidenticalcontract.

Question#30of85 QuestionID:464065

Thereturnfromthenonmonetarybenefitsofholdingtheassetunderlyingafuturescontractis(are)called:

A) thenonmonetaryreturn.

B) negativestoragecosts.

C) theconvenienceyield.

Explanation

Thereturnfromthenonmonetarybenefitsofholdingtheassetunderlyingafuturescontractiscalledtheconvenienceyield.

Question#31of85 QuestionID:464052

Regardingfuturescontracts,thespotpricereferstothe:

A) priceoftheunderlyingassetinaparticularlocation,or'spot',inthefuture.

B) presentvalueoftheexpectedfutureprice.
C) currentmarketpriceoftheassetunderlyingthefuturescontract.

Explanation

Thespotpricereferstothecurrentmarketpriceoftheassetunderlyingthecontract.Itisthepriceforimmediatedeliveryof
theasset.
Question#32of85 QuestionID:464066

Backwardationreferstoasituationwhere:

A) thefuturespriceisabovethespotprice.

B) thefuturespriceisbelowthespotprice.
C) longhedgersoutnumbershorthedgers.

Explanation

Backwardationreferstoasituationwherethefuturespriceisbelowthespotprice.Forbackwardationtooccur,theremustbe
asignificantbenefittoholdingtheasset,eithermonetaryornonmonetary.

Questions#3336of85

CraigChampion,CFA,managesportfoliosofU.S.securitiesforEuropeaninvestors.Hisclientshaveeachholddifferentkinds
ofsecurities,andeachhasdifferingviewswithrespecttohedgingexchangeraterisk.FrancoisLevisqueisaBelgianinvestor
whoholdsalargediversifiedportfolioofU.S.equities.LevisquehasareputationforsomesuccessintimingtheU.S.equity
market.Forexample,hehasoftenlockedingainsonhisportfoliowithderivativesshortlybeforeamarketcorrection.
Sometimeshealsohedgeshisportfolio'scurrencyrisk.LevisquehasjustinstructedChampiontotakealargeshortpositionin
S&P500index,eitherwithfuturesorwithaforwardcontract.Championnoticesthatthefuturespriceislessthanthecurrent
spotpriceandconsultswithhiscolleagueDanielleSilvers,CFA.Championsayshethinksthatthefuturespriceislessthanthe
spotpricebecausethedividendyieldoftheS&P500isgreaterthantheTreasuryBillrate.Silverssaysthatitcouldjustbe
backwardation.Silversalsonotesthattheuseofaforwardcontractmightbeagoodideabecausethecontractwillnotattract
theattentionofothermarketparticipantswhomightreacttoLevisque'smove.ChampiontellsSilversthatthereasonLevisque
wantstohedgehisequitypositionisthathethinksallU.S.interestrateswillincreasesoon.This,hebelieves,isbearishfor
equities,andhealsothinksthenegativerelationshipbetweenequitypricesandinterestratesmakesashortforwardcontract
moreattractivethanashortfuturescontract.

RagnarHvammenisaNorwegianinvestorwithalargeinvestmentinoilrelatedassetsthatheoftenhedgeswithfutures
contracts.Championnoticesthatthepriceofanoilfuturescontractisusuallyhigherthanthespotprice.Hvammenusesshort
termborrowingsindollars,frombothEuropeanandU.S.banks,tomeettheliquidityneedsofhisoilinvestments,andhehas
ChampionhedgetheseloanpositionswithEurodollarfutures.SilverssuggeststhatChampionshouldconsiderusingTbill
futurestohedgetheloansfromU.S.banks,anduseEurodollarfuturesonlyfortheEurodollarloans.Championsayshewill
lookintothat,aswellasforwardrateagreements,asalternativehedgingtoolsforHvammen.

ChampionisalsoevaluatingpricingofTbondfutures.Specifically,heislookingforpricingona1.2yearcontract.TheCTDis
a6.5%30yearbondissued10yearsagocurrentlyyielding5%.Theconversionfactorforthebondis1.08.Assumethatthe
riskfreerateoverthecontractperiodis3%.

Question#33of85 QuestionID:464092

ChampionandSilverseachgaveareasonforwhythefuturespriceoftheS&P500indexmightbelessthanthespotprice.
Withrespecttotheirstatements,itismostaccuratetoconcludethat:

A) Champion'sstatementisinvalidwhileSilver'sstatmentisvalid.
B) neitherstatementisvalid.

C) bothstatementsarevalid.
Explanation

TheequationforthepriceofafuturescontractonanequityindexisFP=S0e(R)T,whereisthedividendyieldandRis
theriskfreerate.IfR<,thenFP<S0andChampioniscorrect.Silverscouldbecorrectinthatbackwardationisdefinedas
FP<S0,withtherelationshipbeingcausedbytheriskaversionofhedgersoflongassetpositions.Theirriskaversionmakes
themwillingtotakeshortcontractsatlowerpricesthanotherwisemightbethecase.

Question#34of85 QuestionID:464093

IfChampionthinksthattheS&P500indexisnegativelycorrelatedwithinterestrates,thenchoosingtheshortforwardcontract
overtheshortfuturescontractis:

A) appropriatebecausetheforwardcontractwouldbenefitmorefromahigher
reinvestmentrate.

B) counterproductivebecauseashortfuturescontractwouldbenefitmorefromahigher
reinvestmentrate.

C) counterproductivebecauseashortfuturescontractwouldbenefitmorefromahigher
borrowingrate.

Explanation

Whenhedgingaposition,futurescontractsarebetterifthehedgeproducesapositivecashflow,viamarkingtomarket,when
interestratesriseandishurtwheninterestratesfall.Inthiscase,wheninterestratesriseandcauseequityvaluestofall,a
shortfuturespositionwillreceiveapositivecashflowthatcanbereinvestedatthehigherrate.Ifinterestratesfall,andthe
shortfuturespositionmustbemarkedtomarketwithanegativecashflow,theopportunitycostofthenegativecashflowis
lower.Forwardcontractsthatdonotrequiremarkingtomarketdonot"benefit"fromchangesininterestrates.

Question#35of85 QuestionID:464094

Oilfuturespricesmightbehigherthanthespotpricebecause:

A) therearemorecoststhanbenefitstoholdingtheasset.

B) ofreversecontango.

C) therearemorebenefitsthancoststoholdingtheasset.

Explanation

Incalculatingthefuturesprice,wewouldsubtractthebenefitsofholdingtheasset,e.g.,thepresentvalueofdividendsand
coupons,andaddthecostsofholdingtheasset.Oildoesnotpayadividend,andtherewouldbecostsforholdingoil.
Contangodescribesthesituationwherethefuturespriceexceedsthespotprice,andthereisnotsuchthingasreverse
contango.

Question#36of85 QuestionID:464095

WithrespecttousingEurodollarfutures,insteadofTbillfutures,tohedgeshorttermloansfromU.S.banks,Championis:

A) justifiedbecausetheEurodollarfuturesmarketisveryliquid,andLIBORisless
correlatedwithshorttermloanratesthanistheTbillrate.

B) justifiedbecausetheEurodollarfuturesmarketisveryliquid,andLIBORismore
correlatedwithshorttermloanratesthanistheTbillrate.
C) notjustifiedbecausetheEurodollarfuturesmarketisnotveryliquid,andLIBORis
morecorrelatedwithshorttermloanratesthatTbills.

Explanation

EurodollarfuturesarefuturesondollarLIBOR,andLIBORistheprevailingrateonverylargebankloanscalledEurocurrency
loans.TheratesonTbillscanbedrivenbyinfluences(e.g.,aflighttoquality)thataredifferentthanthosethatdrivedollar
LIBORrates.Asaresult,Eurodollarfuturesaremorehighlycorrelatedwith(dollar)bankloanratesshouldprovideabetter
hedgefortheclient'sbankloanexposure.Moreover,theEurodollarfuturesmarketislargeandveryliquid.

Question#37of85 QuestionID:464081

UnlikeU.S.Tbillsandtheirfuturescontracts,norisklessarbitragerelationexistsbetweenLIBORandtheEurodollarfutures
contract:

A) butEurodollarfuturescontractsarestillauseful,widelyusedhedgingvehicle
forexposuretoLIBOR.

B) thereforeinvestorsmustutilizesyntheticinstrumentstohedgetheirexposureto
LIBOR.

C) resultinginmostinvestorshedgingtheirLIBORexposurewith90dayTbillcontracts.

Explanation

Althoughanimperfecthedge,EurodollarfuturesarestillwidelyusedtohedgeexposuretoLIBOR.

Question#38of85 QuestionID:464045

Thebestmeasureoftheamountofcreditriskexposureforaforwardcontract,atapointintime,isthe:

A) notionalamountofthecontract.

B) liabilitiesofthecounterparty.

C) valueofthecontract.

Explanation

Theamountofcreditriskisbestmeasuredbythecontractvalueatapointintime.Thisisthepresentvalueofthesettlement
payment,basedoncurrentmarketprices,interestrates,orexchangerates.Thepartytowhomthepaymentwouldbemade
hasthecreditrisk,theriskthatthepaymentwillnotbemadeorthattheassetwillnotbedelivered/purchasedatcontract
expiration.

Question#39of85 QuestionID:464015

Atexpiration,thevalueofaforwardcontractis:

A) equaltothemarketpriceoftheunderlyingasset.
B) thedifferencebetweenthecontractpriceandthemarketvalueoftheunderlying
asset.
C) alwaysgreaterthanorequaltozero.

Explanation

Inaforwardcontract,thelongisobligatedtobuy,andtheshortisobligatedtosell,theunderlyingassetatthecontractprice.
Thedifferencebetweenthecontractpriceandthemarketpriceoftheassetiswhatgivesthecontractvalue.Thecontracthas
apositivevalueatexpirationtothelong/shortonlyifthecontractpriceisbelow/abovethemarketprice.

Question#40of85 QuestionID:464011

Theforwardpriceina90dayforwardcontractonanondividendpayingstockcurrently(atcontractinitiation)sellingfor$55
whenthe90dayriskfreerateis5%isclosestto:

A) $54.32.

B) $52.38.

C) $55.67.

Explanation

Question#41of85 QuestionID:464028

Whatisthevalueofa6.00%1x4(30daysx120days)forwardrateagreement(FRA)withaprincipalamountof$2,000,000,
10daysafterinitiationifL10(110)is6.15%andL10(20)is6.05%?

A) $700.00.
B) $767.40.

C) $745.76.

Explanation

Thecurrent90dayforwardrateatthesettlementdate,20daysfromnowis:
([1+(0.0615x110/360)]/[1+(0.0605x20/360)]1)x360/90=0.061517

Theinterestdifferenceona$2million,90dayloanmade20daysfromnowattheaboveratecomparedtotheFRArateof
6.0%is:
[(0.061517x90/360)(0.060x90/360)]x2,000,000=$758.50

Discountthisamountatthecurrent110dayrate:
758.50/[1+(0.0615x110/360)]=$745.76

Question#42of85 QuestionID:464022

Acompanyhaschosentousea6x9FRAexpiringin6monthstomitigatetheriskofpayingafloatingcoupononthebond
issue.ThecurrenttermstructureforLIBORisasfollows:

Term InterestRate
180days 5.65%
270days 5.95%
Whatisthepriceofthisforwardrateagreement(FRA)?

A) 3.19%
B) 6.37%

C) $6.37

Explanation

ThepriceofanFRAisthefixedrate.TodeterminetheFRA'sfixedrate,thefollowingformulashouldbeused:

TheFRA"sfixedratewouldbequotedas6.37%.

ThepriceofanFRAisgivenasaratepercentage,neverasadollaramount.

Question#43of85 QuestionID:464053

Attheexpirationofafuturescontract,thefuturespriceis:

A) thesameasthepriceattheinitiationofthecontract.

B) equaltothemarketpriceforimmediatedeliveryoftheasset.
C) aboveorbelowthemarketprice,dependingonsupplyanddemand.

Explanation

Atexpiration,thefuturespriceisequaltothepriceoftheassetforimmediatedeliverybecausethecontractcallsfordeliveryof
theassetonthatdate.Notethatatexpiration,thespotpriceandthefuturespriceareequal.

Question#44of85 QuestionID:464073

Supposethesoybeanmarketisinbackwardationwithacashpriceof$6.50/bushelandafuturespriceof$6.00/bushel.Also
assumethatatraderowns5,000bushelsofsoybeansanddoesnotneedthesoybeansuntilafterfuturesexpiration.Whichof
thefollowingisthebeststrategyforthetrader?
A) Sellthesoybeansinthespotmarket,buyanappropriatefutures,andprofit
$1,250.

B) Sellthesoybeansinthespotmarket,buyanappropriatefutures,andprofit$2,500.

C) Donothingsincetheconvenienceyieldissohigh.

Explanation

Sincethetraderdoesnotneedthesoybeansnowheshouldmonetizetheconvenienceyieldbysellinginthespotmarketand
simultaneouslybuysoybeanfuturesforhislaterneeds.Thetotalprofitiscomputedasfollows:

Totalprofit=(CashPriceFuturesPrice)Amount=($6.50$6.00)5,000=$2,500.

Questions#4550of85

ChantalDuPontistheCFOofVetementsVerdun,amanufacturerofspecialtyclothinganduniforms,locatedinnorthern
France.ThefirmiscurrentlyundergoinganexpansionwhichwillrequireDuPonttodrawdown25milliononVetements
Verdun'screditlineasa90daybridgeloanbeforethemortgagecloses.Themoneywillnotbeneededfor60days,atwhich
pointtheinterestratewillbedetermined.Theinterestrateontheloanwillbebasedoff90dayLIBOR.

DuPontisbecomingconcernedbecauseofsignsthatinterestratesmaybegintorise.Thefirmcannotaffordtohaveits
borrowingcostsincreasesignificantlyovercurrentrates.InresponsetoDuPont'sconcerns,thecompany'sCEO,Viviane
Lamarre,hasaskedDuPonttohedgethefirm'sborrowingcosts,evenifthatentailssomeneartermoutlays.

DuPontandLamarrediscussenteringintoaforwardrateagreement(FRA)tohedgeVetementsVerdun'sinterestrate
exposureonthecreditline.CurrentLIBORratesare:

Liborrate

30day 2.6%

60day 2.8%

90day 3.0%

120day 3.2%

150day 3.3%

180day 3.4%

TheydecidetogoforwardwiththehedgeandDuPontentersintotheappropriateFRAforthefullamountof25million.
Inthefirst30daysoftheFRA,thefixedincomemarketsrallysharply.ThenewsetofLIBORrates,onthethirtiethdayofthe
FRA,is:

Liborrate

30day 2.2%

60day 2.4%

90day 3.6%

120day 3.8%
150day 3.8%

180day 3.8%

Atthesettlementdate,theinterestsavingsontheloantermis23,750.DuPonttellsLamarre,"Iamlookingforwardtocashing
oursettlementcheckfor23,750."Lamarreadds,"Yes,andontopofthatwegettoborrowfor90daysatabelowmarket
rate."BothDuPontandLamarrearepleasedwiththeirdecisiontohedge.

Question#45of85 QuestionID:464039

Whichstatementmostaccuratelydescribesa2x3forwardrateagreement?

A) Contractexpiresintwomonthsonanunderlyingloansettledinthreemonths.

B) Underlyingloanoftwomonthmaturityunderacontractthatexpiresinthreemonths.
C) Twomonthunderlyinginterestrateonacontractsettledinthreemonths.

Explanation

A2x3forwardrateagreementisacontractthatexpiresintwomonthsandtheunderlyingloanissettledinthreemonths.The
underlyingrateisa30day(1month)rateona30day(1month)loanin60days(2months).(StudySession16,LOS48.a)

Question#46of85 QuestionID:464040

WhichforwardrateagreementwouldmosteffectivelyhedgeVetementsVerdun'sexposuretoLIBOR?

A) 2x3.
B) 2x5.

C) 3x2.

Explanation

VetementsVerdunneedstobehedgedagainst90dayLIBORratesthatwillprevail60daysfromnow.Suchahedgewould
requireatwomonthcontractonthreemonthrates,tobesettledinfivemonths:a2x5.(StudySession16,LOS48.c)

Question#47of85 QuestionID:464041

WhichvalueisclosesttothepriceofthemosteffectivehedgeforVetementsVerdun?

A) 3.3%.

B) 3.6%.

C) 3.0%.

Explanation

Theactual,unannualizedrateonthe60dayloanis:

R60=0.02860/360=0.00467

Theactual,unannualizedrateonthe150dayloanis:

R150=0.033150/360=0.01375

Sotherateona90dayloantobemade60daysfromnowis:
FR(60,90)=((1+R150)/(1+R60))1
FR(60,90)=(1.01375/1.00467)1
FR(60,90)=1.009041
FR(60,90)=0.904%

Weannualizethisrateusingtheformula:

0.904%(360/90)=3.62%

(StudySession16,LOS48.c)

Question#48of85 QuestionID:464042

Whatmustthe90dayLIBORratehavebeenattheexpirationofthecontract?

A) 4.0%.

B) 3.6%.
C) 3.4%.

Explanation

SinceVetementsVerdunislongtheFRA,themarketrateofinterestatsettlementmustbehigherthanthepriceofthe
contractandthe23,750hasapositivevalue.Theinterestsavingsattheendoftheloantermwillbe:

Interestsavings=((marketrate(90/360))(0.0362(90/360)))25,000,000
23,750=((marketrate90/360)0.00905)25,000,000
0.000950=marketrate90/3600.00905
0.0100=marketrate0.25
0.0400=marketrate

Themarketratemusthavebeen4.0%.

(StudySession16,LOS48.c)

Question#49of85 QuestionID:464043

RegardingthestatementsmadebyLamarreandDuPontabouttheultimatevalueoftheirhedge:

A) Lamarre'sstatementiscorrectDuPont'sstatementisincorrect.

B) Lamarre'sstatementisincorrectDuPont'sstatementisincorrect.

C) Lamarre'sstatementisincorrectDuPont'sstatementiscorrect.

Explanation

TheinterestsavingsattheendoftheloantermmustbediscountedbacktothepresentvalueontheFRAsettlementdate:

Settlementpayment=Presentvalueofinterestsavings
Settlementpayment=23,750/(1+(0.04090/360))
Settlementpayment=23,750/(1+0.010)
Settlementpayment=23,750/1.010
Settlementpayment=23,515

Thesettlementcheckwouldbefor23,515.DuPont'sstatementisincorrect.Lamarre'sstatementisalsoincorrectbecausethe
settlementcheckrepresentsthevalueofthebelowmarketloan.Theactualloanwillbeattheprevailingrate,andthe
settlementontheFRAwilloffsettheinterestcostontheloan.

(StudySession16,LOS48.c)

Question#50of85 QuestionID:464044

ThirtydaysintotheFRA,whatisthevalueofthecontractfromVetementsVerdun'sperspective?

A) Due43,943.

B) Due45,000.
C) Owes43,943.

Explanation

Sincewehavemoved30daysintotheFRA,thenewratefortheendofthecontractisthe30dayrate(60daysoriginally
minus30dayspassed)andthenewrateforthesettlementoftheloanisthe120dayrate(150daysoriginallyminus30days
passed).

Withthatinformation,thepricingisstraightforward:

Theactual,unannualizedrateonthe30dayloanis:

R30=0.02230/360=0.00183

Theactual,unannualizedrateonthe120dayloanis:

R120=0.038120/360=0.01267

Therateona90dayloantobemade30daysfromnowis:

FR(30,90)=((1+R120)/(1+R30))1
FR(30,90)=((1+0.01267)/(1+0.00183))1
FR(30,90)=(1.01267/1.00183)1
FR(30,90)=1.0108201
FR(30,90)=1.0820%

Weannualizethisrateusingtheformula:

1.082%(360/90)=4.33%

Theinterestsavingis:

Interestsaving=((0.043390/360)(0.036290/360))25,000,000
Interestsaving=(0.010830.00905)25,000,000
Interestsaving=0.0017825,000,000
Interestsaving=44,500

Theinterest"saving"isapositive44,500.Discountingthatbackatthecurrent120dayratewehave:

FRAvalue=44,500/(1+(0.038120/360))
FRAvalue=44,500/(1+(0.012667))
FRAvalue=44,500/1.012667
FRAvalue=43,943

ThevalueoftheFRAtoVetementsVerdun30daysintothecontractis43,943.Inotherwords,theyaredue43,943.

(StudySession16,LOS48.c)
Question#51of85 QuestionID:464054

Theprimarydifferenceincreditriskbetweenforwardsandfuturescontractsismostlikelybecause:

A) futuresaremarkedtomarketdaily.

B) futuresmarketshavehigherqualityparticipants.
C) forwardsmarketshavehigherqualityparticipants.

Explanation

Futuresaremarkedtomarketdailythisreducescreditrisktoasingleday'slosses.

Question#52of85 QuestionID:464020

Calculatethenoarbitrageforwardpricefora90dayforwardonastockthatiscurrentlypricedat$50.00andisexpectedtopayadividend
of$0.50in30daysanda$0.60in75days.Theannualriskfreerateis5%andtheyieldcurveisflat.

A) $48.51.

B) $50.31.

C) $49.49.

Explanation

Thepresentvalueofexpecteddividendsis:$0.50/(1.0530/365)+$0.60/(1.0575/365)=$1.092

Futureprice=($50.001.092)1.0590/365=$49.49

Question#53of85 QuestionID:464071

Whichofthefollowingstatementsisleastaccurate?

A) Backwardationmeansthefuturespriceisbelowtheasset'spriceandoccursif
rfisgreaterthanthedividendyield.

B) Normalbackwardationmeansthatthefuturespriceislessthantheexpectedasset
priceatcontractexpiration.Itcouldoccurbecausethefuturespriceonlyreflectsthe
riskfreerateinanarbitragetransaction.
C) Normalcontangomeansthefuturespriceisgreaterthantheexpectedassetpriceis
atcontractexpiration.Thismightoccurifthereishighdemandtobuycontracts.

Explanation

Recognizethatthequestionislookingforafalsestatement.Backwardationmeansthatf0<S0.However,rfincreasesthe
valueoff0anddividendyielddecreasesthevalueoff0.Backwardationwouldoccurifrfislessthanthedividendyield.

Normalbackwardationoccurswhenthefuturespriceislessthantheexpectedassetpriceatcontractexpirationandcorrectly
explainswhyf0isgenerallylessthantheexpectedfuturespotprice.Notethecontrastwithbackwardationwhichmeansf0<
S0.

Normalcontangooccurswhenthefuturespriceisgreaterthantheexpectedassetpriceatcontractexpiration.Thestatement
thathighdemandtobuythecontractcouldincreasethecontractpriceisalsocorrect.Notethecontrastwithcontango,which
meansthefuturespriceisabovetheasset'sspotprice.(LOS49.f)

Question#54of85 QuestionID:464014

Duringthelifeofaforwardcontract,thevalueofthecontractisbestdescribedas:

A) thedifferencebetweenthefuturevalueofthespotpriceandtheexpected
futurepriceoftheunderlyingasset.

B) thedifferencebetweenthespotpriceandthepresentvalueoftheforwardpriceofthe
underlyingasset.

C) thepresentvalueoftheexpectedfuturepriceoftheunderlyingasset.

Explanation

Thevalueofaforwardcontractonanassetwithnocashflowsduringitstermisequaltospot(forwardprice)/(1+Rf)t ),the
differencebetweenthespotpriceandthepresentvalueoftheforwardpriceoftheunderlyingasset.

Questions#5560of85

MonicaLewis,CFA,hasbeenhiredtoreviewdataonaseriesofforwardcontractsforamajorclient.Theclienthasaskedfor
ananalysisofacontractwitheachofthefollowingcharacteristics:

1. AforwardcontractonaU.S.Treasurybond
2. Aforwardrateagreement(FRA)
3. Aforwardcontractonacurrency

InformationrelatedtoaforwardcontractonaU.S.Treasurybond:TheTreasurybondcarriesa6%couponandhasa
currentspotpriceof$1,071.77(includingaccruedinterest).Acouponhasjustbeenpaidandthenextcouponisexpectedin
183days.Theannualriskfreerateis5%.Theforwardcontractwillmaturein195days.

Informationrelatedtoaforwardrateagreement:Therelevantcontractisa39FRA.Thecurrentannualized90day
moneymarketrateis3.5%andthe270dayrateis4.5%.Basedonthebestavailableforecast,the180dayrateatthe
expirationofthecontractisexpectedtobe4.2%.

Informationrelatedtoaforwardcontractonacurrency:TheriskfreerateintheU.S.is5%and4%inSwitzerland.The
currentspotexchangerateis$0.8611perSwissFrance(SFr).Theforwardcontractwillmaturein200days.

Question#55of85 QuestionID:464032

Basedontheinformationgiven,whatinitialpriceshouldLewisrecommendforaforwardcontractontheTreasurybond?

A) $1,073.54.

B) $1,035.12.

C) $1,070.02.
Explanation

Theforwardprice(FP)ofafixedincomesecurityisthefuturevalueofthespotpricenetofthepresentvalueofexpected
couponpaymentsduringthelifeofthecontract.Inaformula:

FP=(S0PVC)(1+Rf)T

A6%coupontranslatesintosemiannualpaymentsof$30.Withariskfreerateof5%and183daysuntilthenextcouponwe
canfindthepresentvalueofthecouponpaymentsfrom:

PVC=$30/(1.05)183/365=$29.28.

With195daystomaturitytheforwardpriceis:

FP=($1,071.77$29.28)(1.05)195/365=$1,070.02.

(StudySession16,LOS51.c)

Question#56of85 QuestionID:464033

SupposethatthepriceoftheforwardcontractfortheTreasurybondwasnegotiatedoffmarketandtheinitialvalueofthe
contractwaspositiveasaresult.Whichpartymakesapaymentandwhenisthepaymentmade?

A) Theshortpaysthelongatthematurityofthecontract.

B) Thelongpaystheshortattheinitiationofthecontract.

C) Thelongpaystheshortatthematurityofthecontract.

Explanation

Ifthevalueofaforwardcontractispositiveatinitiationthenthelongpaystheshortthevalueofthecontractatthetimeitis
enteredinto.Ifthevalueofthecontractisnegativeinitiallythentheshortpaysthelongtheabsolutevalueofthecontractat
thetimethecontractisenteredinto.(StudySession16,LOS51.a)

Question#57of85 QuestionID:464034

SupposethatinsteadofaforwardcontractontheTreasurybond,asimilarfuturescontractwasbeingconsidered.Whichone
ofthefollowingalternativescorrectlygivesthepreferencethataninvestorwouldhavebetweenaforwardandafutures
contractontheTreasurybond?

A) Itisimpossibletosayforcertainbecauseitdependsonthecorrelation
betweentheunderlyingassetandinterestrates.

B) Theforwardcontractwillbepreferredtothefuturescontract.

C) Thefuturescontractwillbepreferredtotheforwardcontract.

Explanation

Theforwardcontractwillbepreferredtoasimilarfuturescontractpreciselybecausethereisanegativecorrelationbetween
bondpricesandinterestrates.Fixedincomevaluesfallwheninterestratesrise.Borrowingcostsarehigherwhenfundsare
neededtomeetmarginrequirements.Similarlyreinvestmentratesarelowerwhenfundsaregeneratedbythemarktomarket
ofthefuturescontract.Consequentlythemarktomarketfeatureofthefuturescontractwillnotbepreferredbyatypical
investor.(StudySession16,LOS51.a)

Question#58of85 QuestionID:464035
Basedontheinformationgiven,whatinitialpriceshouldLewisrecommendforthe39FRA?

A) 4.96%.

B) 4.66%.

C) 5.66%.

Explanation

ThepriceofanFRAisexpressedasaforwardinterestrate.A39FRAisa180dayloan,90daysfromnow.Thecurrent
annualized90daymoneymarketrateis3.5%andthe270dayrateis4.5%.Theactual(unannualized)ratesonthe90day
loan(R90)andthe270dayloan(R270)are:

R90=0.035(90/360)=0.00875

R270=0.045(270/360)=0.03375

Theactualforwardrateonaloanwithatermof180daystobemade90daysfromnow(writtenasFR(90,180))is:

Annualized=0.02478(360/180)=0.04957or4.96%.

(StudySession16,LOS51.c)

Question#59of85 QuestionID:464036

Basedontheinformationgivenandassuminganotionalprincipalof$10million,whatvalueshouldLewisplaceonthe39
FRAattimeofsettlement?

A) $38,000paidfromshorttolong.

B) $37,218paidfromlongtoshort.

C) $19,000paidfromlongtoshort.

Explanation

ThevalueoftheFRAatmaturityispaidincash.Ifinterestratesincreasethenthepartywiththelongpositionwillreceivea
paymentfromthepartywithashortposition.Ifinterestratesdeclinethereversewillbetrue.Theannualized180dayloanrate
is4.96%.Giventhatannualizedinterestratesfora180dayloan90dayslaterareexpectedtodropto4.2%,acashpayment
willbemadefromthepartywiththelongpositiontothepartywiththeshortposition.Thepaymentisgivenby:

ThepresentvalueoftheFRAatsettlementis:

38,000/{1+[0.042(180/360)]}=38,000/1.021=$37,218

(StudySession16,LOS51.c)

Question#60of85 QuestionID:464037

Basedontheinformationgiven,whatinitialpriceshouldLewisrecommendforaforwardcontractonSwissFrancsbasedona
discretetimecalculation?

A) $1.1552.
B) $0.8656.

C) $1.0053.

Explanation

Thevalueofaforwardcurrencycontractisgivenby:

WhereFandSarequotedindomesticcurrencyperunitofforeigncurrency.Substituting:

(StudySession16,LOS51.c)

Questions#6166of85

WandaBrockworksasaninvestmentstrategistforGlobos,aninternationalinvestmentbank.Brockhasbeentaskedwith
designingastrategyforinvestinginderivativesinMazakhastan,anEasternEuropeancountrywithimpressiveeconomic
growth.

OneofthefirsttasksBrocktacklesinvolveshedging.GloboswantstohedgesomeofitsinvestmentsinMazakhastanagainst
interestrateandcurrencyvolatility.Afterabitofresearch,Brockhasgatheredthefollowingdata:

TheU.S.riskfreerateis5.5%,andmostinvestorscanborrowat2%abovethatrate.
TheFederalReserveBoardisexpectedtoraisethefedfundsrateby0.25%inoneweek.
ThecurrentspotratefortheMazakhastaniancurrency,thegluck,is9.4073G/$.
Annualized90dayLIBORis7.6%.
Globos'economistsexpectannualized90dayLIBORtoriseto7.9%overthenext60days.
TheMazakhastanriskfreerateis3.75%,andmostinvestorscanborrowat1.5%abovethatrate.

Usingtheabovedata,Brockdevelopssomehedgingstrategies,andthendeliversthemtoGlobos'futuresdesk.

BrockthenturnsherattentiontoMazakhastaniancommodities.Globoshasacquiredtherightstolargedepositsofcopper,
silver,andmolybdenuminMazakhastanandsuspectsthefuturesmarketsmaybemispriced.Brockhasassembledthe
followingdatatoaidherinmakingrecommendationstoGlobos'futuresdesk:

Copper
Spotprice:G3.15/pound.
1yearfuturesprice:G3.54/pound.
Silver
Spotprice:G12.75/pound.
1yearfuturesprice:G12.82/pound.
Molybdenum
Spotprice:G34.45/pound.
1yearfuturesprice:G35.23/pound.
Aftermakingsomecalculations,BrockassessesthearbitrageopportunitiesinMazakhastanandpassestheinformationonto
thefuturesdesk.Shortlyafterward,sheisinformedthatGlobos'Mazakhastansubsidiaryusesitssilverholdingsascollateral
forbusinessloans,whichallowstheunittoobtainafavorableinterestrate.

JonahMason,oneofGlobos'traders,asksBrockforafewdetailsabouttheMazakhastanfinancialmarkets.Brocksends
Masonashortemailcontainingthefollowingobservations:

Mazakhastan'sinvestorsdon'tlikerelyingonoldvaluationdatabecauseassetvalueshavechangedrapidlyinthepast,so
theygenerallyuseamarktomarketvaluationsystem.
Standard&Poor'sjustraisedMazakhastan'ssovereigndebttoinvestmentgrade.
Interestratestendtomoveinthesamedirectionasassetvalues.
Newtechnologicalinnovationsandcommercialexpansionhassubstantiallyboostedtheincomeoftheaverage
Mazakhastanian.

BeforeMasonreceivestheemail,heturnshisattentiontoamemoaboutafuturescontractasubordinateisconsidering.
Unfortunately,thememoarriveswithoutthesummarypagetothenotes.Masonmustdeducethenatureofthehedgebased
onitscharacteristics:Theriskfreerateusedincalculatingthefuturesprice,andthatpriceadjustedtoaccountforindividual
futurecashflows.

Question#61of85 QuestionID:464085

Thepriceofa75daygluckfutureshouldbeclosestto:

A) 9.3750G/$.

B) 9.4429G/$.
C) 0.1081$/G.

Explanation

Tocalculatethepriceofacurrencyfuture,usethefollowingequation:
Spotexchangerate(1+domesticriskfreerate)t /(1+foreignriskfreerate)t .
Inthiscase,sincetheexchangerateisexpressedinglucksperdollar,theMazakhastaninterestrateisconsidereddomestic.
Sincewearepricinga75dayfuture,thetimevariable"t"is75/365.
9.4073G/$(1.0375)(75/365)/(1.055)(75/365)=9.3750G/$.

(StudySession16,LOS52.h)

Question#62of85 QuestionID:464086

BasedontheinformationhereceivedfromBrock,Masoncanbestconcludethat:

A) futurespricesarehigherthanforwardpricesinMazakhastan.

B) inflationinMazakhastanislikelytorise.
C) pricesofcorporatebondsinMazakhastanarelikelytorise.

Explanation

SinceMazakhastanianinvestorsprefermarktomarketaccountingandinterestratesarepositivelycorrelatedtoassetvalues,
Masoncanconcludethatfuturespricesarehigherthanforwardprices.Theupgradeofsovereigndebtcouldspilloverintothe
privatesector,drivingupbondprices.Andanincreaseinconsumerincomecouldsparkspendingthatdrivesupinflation.But
neitherthedebtinformationnortheincomeinformationissufficienttodrawconclusions.(StudySession14,LOS46.c)
Question#63of85 QuestionID:464087

BasedonthetwocharacteristicsofthefuturescontractinMason'smemo,whichofthefollowingdoesthecontractreferto?

Treasurybondfutures? Stockindexfutures?

A) Yes No

B) Yes Yes

C) No Yes

Explanation

BothTreasurybondfuturesandstockindexfuturesrequiretheuseoftheriskfreeratetodetermineprice.Butwhilethe
pricingofbondfuturesrequiresthediscountingofindividualcoupons,thepricingofstockindexfuturesdoesnot,insteadusing
acontinuouslycompoundeddividendyield.(StudySession14,LOS46.f)

Question#64of85 QuestionID:464088

BasedonBrock'sinformation,howshouldtradersbesttakeadvantageofarbitrageopportunitiesinMazakhastan?Forthis
questiononly,assume3%transactioncostforfuturescontracts.

A) Buyspotcopper,donottradesilver,andsellspotmolybdenum.

B) Buyspotcopper,sellspotsilver,andsellspotmolybdenum.

C) Buyspotcopper,sellspotsilver,anddonottrademolybdenum.

Explanation

Firstwemustdeterminewhetherthefuturescontractsaremispriced,bymultiplyingthecommoditypriceby(1+theriskfree
rate),or1.0375.Thebasicequationusestheriskfreerate,butwehavetheactualborrowingrate,andforrealworld
purposestheactualborrowingrateprovidesamoreaccuratepriceestimate.Forpracticalpurposes,weshouldprobablyuse
theborrowingrate,butbothratesprovidethesameanswertothequestionabove.Forillustrationpurposes,weusetherisk
freerateinthediscussionbelow.

Itturnsoutthatallthreecontractsaremispriced.Copperfuturesareoverpriced,andsilverandmolybdenumfuturesare
underpriced.However,transactioncostsmuddythewater.Assuminga3%commissiononfuturestrades,thepricedifferential
onmolybdenumisnotsufficienttojustifyanarbitragetrade.Thus,thetradersshouldbuycopper,forwhichthefutures
contractisoverpriced,andsellsilver,forwhichthefuturescontractisunderpriced,andmakenotradesinmolybdenum
despitethefactthatthefuturescontractisunderpriced.

Copper Silver Molybdenum


(perpound) (perounce) (perpound)

Spotprice G3.15 G12.75 G34.45

Futuresprice G3.54 G12.82 G35.23

Noarbitragefuturesprice G3.27 G13.23 G35.74

Potentialarbitrageprofits G0.27 G0.41 G0.51

Transactioncosts G0.11 G0.38 G1.06


Arbitrageopportunity Yes Yes No

(StudySession16,LOS52.h)

Question#65of85 QuestionID:464089

AssumethatGloboshastakenapositionintheEurodollarfuturescontract,itisnow60dayslaterandthecontractisexpiring.
Globosinterestrateforecastfor90dayLIBORwascorrect.Thevalueofthefuturescontractatexpirationisclosestto:

A) $980,250.

B) $981,000.

C) $921,000.

Explanation

TheEurodollarfuturescontractisbasedon90dayLIBOR.
Theforecastfor90dayLIBORwas7.9%.Thus,thecontractpriceatexpirationis:

$1,000,000(1(0.07990/360))=$980,250.(StudySession14,LOS46.g)

Question#66of85 QuestionID:464090

WhichofthefollowingwouldbemostlikelytocauseacontangosituationwithsilverfuturesinMazakhastan?

A) Anincreaseintheavailabilityofassetbackedloans.

B) Ahugesilverdiscovery.
C) Ashortageofwarehousespacethatdrivesuprentalrates.

Explanation

Inacontangosituation,futurespricesarehigherthanthespotprice.Thisnormallyoccurswhentherearenobenefitsto
holdinganasset,orwhenthecostsofstoringanassetarehighenoughtooffsetthebenefitsofholdingtheasset.Anincrease
intheavailabilityofassetbackedloanswouldincreasetheconvenienceyieldofsilver,whichwouldnotcauseacontango
situation.Asilverdiscoverycouldhavesomeeffectonthepriceofsilver,butshouldnotaffectacontangosituationonewayor
another.Ontheotherhand,anincreaseinstoragecostswouldoffsetsomeoftheconvenienceyield.Wedon'tknowwhether
suchanincreaseincostswouldbeenoughtomakethenetcostofholdingsilverpositive,butanyincreaseincostscould
contributetoacontangosituation.(StudySession14,LOS46.e)

Question#67of85 QuestionID:464013

Thepriceofaforwardcontract:

A) mustbeequaltothemarketpriceatcontracttermination.

B) isequaltothevalueofthecontractinequilibrium.

C) isthesettlementpricefortheunderlyingasset.

Explanation

Thepriceofaforwardcontractisthepriceoftheunderlyingassetthatthelongwillpaytotheshortatsettlement(fora
deliverablecontract).Thevalueofaforwardcontractcomesfromthedifferencebetweentheforwardcontractpriceandthe
marketpricefortheunderlyingasset.Thisdifferencebetweenpriceandvalueisakeyconcepttounderstand.Aforward
contracthasonlyoneprice,whichappliestoboththelongandtotheshort.

Question#68of85 QuestionID:464078

Undertheviewthatfuturesmarketsareprimarilyamechanismforshorthedgersandlonghedgerstooffsettheirrespective
assetpricerisks:

A) expectedfutureassetpricesarelessthanthefuturesprices.
B) futurespriceswillbeunbiasedpredictorsoffuturespotrates.

C) forwardpriceswillbegreaterthanfuturesprices.

Explanation

Undertheviewthatfuturesmarketsareprimarilyamechanismforshorthedgersandlonghedgerstooffsettheirrespective
risks,futurespriceswillbeunbiasedpredictorsoffuturespotrates.

Question#69of85 QuestionID:464074

Whichofthefollowingbestdefinesnormalcontango?Normalcontangoiswhenthefuturespricelies:

A) belowtheexpectedfuturespotpriceandthefuturespricefallsoverthelifeof
thecontract.
B) abovetheexpectedfuturespotpriceandthefuturespricerisesoverthelifeofthe
contract.
C) abovetheexpectedfuturespotpriceandthefuturespricefallsoverthelifeofthe
contract.

Explanation

Apatternoffallingfuturespricesisknownasnormalcontango.Thissituationoccursifhedgersarenetlong.

Question#70of85 QuestionID:464082

Anindexiscurrently876,theriskfreerate(Rf)is7%,andthedividendyieldontheindexportfoliois1.8%.Assumingthat
thesearecontinuouslycompoundedyields,thepriceofan18monthindexfutureisclosestto:

A) 947.1.

B) 943.0.
C) 945.2.

Explanation

FP=876e(0.070.018)1.5=947.1.
Question#71of85 QuestionID:464067

Whichofthefollowingbestdefinesbackwardation?Themarketissaidtobeinbackwardationif:

A) thefuturespriceexceedsthecashpriceorthedistantfuturespriceexceeds
thenearbyfuturesprice.
B) thecashpriceexceedsthefuturesprice.

C) thefuturespriceexceedsthecashprice.

Explanation

Backwardationoccurswhenthereisaconvenience,orsecurity,associatedwithholdingthespotasset,usuallywhenitis
uncertainwhethertheassetwillevenbeavailableinthefuture.Backwardationisrarewithfinancialfutures.

Question#72of85 QuestionID:464021

Astockiscurrentlypricedat$110andwillpaya$2dividendin85daysandisexpectedtopaya$2.20dividendin176days.
Thenoarbitragepriceofasixmonth(182day)forwardcontractwhentheeffectiveannualinterestrateis8%isclosestto:

A) $110.20.
B) $110.00.

C) $110.06.

Explanation

Intheformulationbelow,thepresentvalueofthedividendsissubtractedfromthespotprice,andthenthefuturevalueofthis
amountattheexpirationdateiscalculated.

(1102/1.0885/3652.20/1.08176/365)1.08182/365=$110.06

Alternatively,thefuturevalueofthedividendscouldbesubtractedfromthefuturevalueofthestockpricebasedontherisk
freerateoverthecontractterm.

Question#73of85 QuestionID:464068

Asituationwherethefuturespriceisbelowthespotpriceoftheassetiscalled:

A) contango.

B) backwardation.

C) negativecarry.

Explanation

Asituationwherethefuturespriceisbelowthespotpriceoftheunderlyingassetiscalledbackwardation.

Question#74of85 QuestionID:464050
Whatisthedifferencebetweenspotandfuturesprices?Spotpricesarealways:

A) lowerthanfuturesprices.

B) equaltothefuturespriceatfuturesexpiration.

C) deliveredtomeetthefuturesobligationatexpiration.

Explanation

Thedifferencebetweenthespotandthefuturespricemustbezeroatexpirationtoavoidarbitrage.

Question#75of85 QuestionID:464057

Thevalueofafuturescontract:

A) iszeroafterthemarktomarketperiod.

B) isequaltothemarginbalanceinthefuturesaccountafterthemarktomarketperiod.

C) isbasedonthedifferencebetweenthefuturespriceatcontractinitiationandthe
currentfuturesprice.

Explanation

Thevalueofafuturescontractmaybepositiveornegativeduringatradingday,howeverwhentheaccountismarkedto
marketthefuturespriceiseffectivelyresettothemostrecentsettlepricesothatthecontracthaszerovalueunlessthe
equilibriumpriceisoutsidedailypricechangelimits.

Question#76of85 QuestionID:464072

Undertheviewthatfuturestransferriskfromassetholderstofuturesbuyers,the:

A) convenienceyieldispositive.

B) expectedassetpriceinthefuturewillbelessthanthefuturesprice.

C) futurespricewillbelessthantheexpectedfuturespotprice.

Explanation

Undertheviewthatfuturestransferriskfromassetholderstofuturesbuyers,thefuturespricewillbelessthantheexpected
futurespotprice.Thelongs(speculators)mustbecompensatedforbearingassetpriceriskbyreceivingalowerfuture
purchasepricefortheasset.

Question#77of85 QuestionID:464064

Considertwoassetswithidenticalstoragecosts.Fortheassetwiththegreaterconvenienceyield,thepercentagedifference
betweenthenoarbitragepriceandthespotpricewillbe:

A) greateratcontractinitiationbutthesameatexpiration.
B) loweranytimepriortoexpiration.
C) greaterthroughoutthetermofthecontract.

Explanation

ThenetcostsofholdinganassetareNetCosts=StorageCostsConvenienceYield.Whentheconvenienceyieldishigher,
netcostsofcarrying(storing)theassetarelower,andthefuturespricewillbelower.Thedifferencebetweenthespotprice
andthefuturespriceiszeroatexpirationforanyasset.

Question#78of85 QuestionID:464010

Thecontractpriceofaforwardcontractis:

A) thepricethatmakesthecontractazerovalueinvestmentatinitiation.

B) alwaysthepresentvalueoftheexpectedfuturespotprice.
C) determinedatthesettlementdate.

Explanation

Thecontractpricecanbeaninterestrate,discount,yieldtomaturity,orexchangerate.Theforwardpriceisthefuturevalueof
thespotpriceadjustedforanyperiodicpaymentsexpectedfromtheasset.Anexampleofwhentheforwardpricemaybeless
thanthespotpriceisinthecaseofanequityindexcontractwherethedividendyieldisgreaterthantheriskfreerate.

Question#79of85 QuestionID:464026

Calculatethepriceofa200dayforwardcontractonan8%U.S.Treasurybondwithaspotpriceof$1,310.Thebondhasjustpaida
couponandwillmakeanothercouponpaymentin150days.Theannualriskfreerateis5%.

A) $1,305.22.

B) $1,333.50.

C) $1,270.79.

Explanation

Coupon=(1,0000.08)/2=$40.00

Presentvalueofcouponpayment=$40.00/1.05150/365=$39.21

Forwardpriceonthefixedincomesecurity=($1,310$39.21)(1.05)200/365=$1,305.22

Question#80of85 QuestionID:464080

TheprimaryreasonthatEurodollarfuturescontractsdonotallowapurearbitrageopportunityrelativetoLIBORisthat:

A) theEurodollarfutureisdenominatedinU.S.dollarsandLIBORisbasedupon
Eurodollartimedeposits.

B) Eurodollarfuturesdonothaveadeliveryoptionthatincreasespriceefficiency.
C) thevalueofthedepositdoesnotchange$25foreverybasispointchangeinexpected
90dayLIBOR.

Explanation

Eurodollarfuturesarepricedatadiscountyield.LIBORisanaddonyield,whichistheratethatisearnedonthefaceamount
ofadeposit.TheresultisthatthedepositvalueisnotperfectlyhedgedbytheEurodollarcontract.

Question#81of85 QuestionID:464059

Wheninterestratechangesarenegativelycorrelatedwiththepricechangesoftheassetunderlyingafutures/forward
contract:

A) futurespricesmaybehigherorlowerdependingontheriskfreerateandprice
volatility.

B) futurespricesarehigher.

C) forwardpricesarehigher.

Explanation

Anegativecorrelationbetweenassetpricechangesandinterestratechangesmakesthemarktomarketfeatureunattractive
toafuturesbuyer.Thisleadstoalowerfuturesprice,comparedtotheforwardpriceonanotherwiseidenticalcontract.

Question#82of85 QuestionID:464023

Calculatetheprice(expressedasanannualizedrate)ofa1x4forwardrateagreement(FRA)ifthecurrent30dayrateis5%
andthe120dayrateis7%.

A) 6.86%.

B) 7.47%.

C) 7.63%.

Explanation

A1x4FRAisa90dayloan,30daysfromtoday.
Theactualrateonthe30dayloanis:R30=0.05x30/360=0.004167
Theactualrateonthe120dayloanis:R120=0.07x120/360=0.02333
FR(30,90)=[(1+R120)/(1+R30)]1=(1.023333/1.004167)1=0.0190871
Theannualized90dayrate=0.0190871x360/90=.07634=7.63%

Question#83of85 QuestionID:464083

Thepriceofa9monthfutureonanewlyissuedTreasurybondiscalculatedasthebondprice:

A) increasedatthe9monthriskfreerate,minusonecouponpayment.

B) minusonecouponpayment,increasedatthe9monthriskfreerate.
C) increasedatthe9monthriskfreerate,minusonecouponpaymentincreasedatthe
3monthrateformoney6monthsfromnow.

Explanation

Thenoarbitrage9monthfuturespriceforanewlyissuedcouponbondiscalculatedas:

BondPrice(1+Rf)9/12Coupon(1+Rf)3/12

Analternative(equivalent)methodis:

[BondPrice(Coupon/(1+Rf)6/12)](1+Rf)9/12

Question#84of85 QuestionID:464019

ThevalueoftheS&P500Indexis1,260.Thecontinuouslycompoundedriskfreerateis5.4%andthecontinuousdividendyieldis
3.5%.Calculatethenoarbitragepriceofa160dayforwardcontractontheindex.

A) $562.91.

B) $1,310.13.

C) $1,270.54.

Explanation

FP=1,260e(0.0540.035)(160/365)=1,270.54

Question#85of85 QuestionID:464075

WhichofthefollowingstatementsregardingnormalbackwardationisCORRECT?Futurespricestendto:

A) riseoverthelifeofthecontractbecausehedgersarenetlongandhaveto
receivecompensationforbearingrisk.

B) falloverthelifeofthecontractbecausehedgersarenetshortandhavetoreceive
compensationforbearingrisk.

C) riseoverthelifeofthecontractbecausespeculatorsarenetlongandhavetoreceive
compensationforbearingrisk.

Explanation

Normalbackwardationmeansthatexpectedfuturespotpricesaregreaterthanfuturesprices.Itsuggeststhatwhenhedgers
arenetshortfuturescontracts,theymustsellthematadiscounttotheexpectedfuturespotpricestogetspeculatorsto
assumetheriskofholdinganetlongposition.Thefuturespricerisesoverthelifeofthecontract,whichcompensates
speculatorsfortheexposureoftheirlongpositions.

You might also like