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Sample Q 3

The document presents a series of questions and answers related to futures trading and hedging strategies. Key topics include the impact of basis on hedging positions, selecting appropriate futures contracts for asset purchases, calculating effective prices after hedging, determining optimal hedge ratios, and the advantages of using futures for currency hedging. Additionally, it discusses reasons for hedging a portfolio with index futures.

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Minh Nguyễn Mai Bảo
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12 views3 pages

Sample Q 3

The document presents a series of questions and answers related to futures trading and hedging strategies. Key topics include the impact of basis on hedging positions, selecting appropriate futures contracts for asset purchases, calculating effective prices after hedging, determining optimal hedge ratios, and the advantages of using futures for currency hedging. Additionally, it discusses reasons for hedging a portfolio with index futures.

Uploaded by

Minh Nguyễn Mai Bảo
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Sample Q 3

1. The basis is defined as spot minus futures. A trader is hedging the sale of an asset with a short
futures position. The basis increases unexpectedly. Which of the following is true?

A. The hedger’s position improves.


B. The hedger’s position worsens.
C. The hedger’s position sometimes worsens and sometimes improves.
D. The hedger’s position stays the same.

Answer: A

The price received by the trader is the futures price plus the basis. It follows that the trader’s
position improves when the basis increases.

2. Futures contracts trade with every month as a delivery month. A company is hedging the
purchase of the underlying asset on June 15. Which futures contract should it use?
A. The June contract
B. The July contract
C. The May contract
D. The August contract

Answer: B

As a general rule the futures maturity month should be as close as possible to but after the
month when the asset will be purchased. In this case the asset will be purchased in June
and so the best contract is the July contract.

3. On March 1 a commodity’s spot price is $60 and its August futures price is $59. On July 1 the
spot price is $64 and the August futures price is $63.50. A company entered into futures
contracts on March 1 to hedge its purchase of the commodity on July 1. It closed out its
position on July 1. What is the effective price (after taking account of hedging) paid by the
company?
A. $59.50
B. $60.50
C. $61.50
D. $63.50

Answer: A
The user of the commodity takes a long futures position. The gain on the futures is 63.50−59
or $4.50. The effective paid realized is therefore 64−4.50 or $59.50. This can also be
calculated as the March 1 futures price (=59) plus the basis on July 1 (=0.50).

5. Suppose that the standard deviation of monthly changes in the price of commodity A is $2.
The standard deviation of monthly changes in a futures price for a contract on commodity B
(which is similar to commodity A) is $3. The correlation between the futures price and the
commodity price is 0.9. What hedge ratio should be used when hedging a one month
exposure to the price of commodity A?
A. 0.60
B. 0.67
C. 1.45
D. 0.90

Answer: A

The optimal hedge ratio is 0.9×(2/3) or 0.6.

7. A company has a $36 million portfolio with a beta of 1.2. The futures price for a contract on
an index is 900. Futures contracts on $250 times the index can be traded. What trade is
necessary to increase beta to 1.8?
A. Long 192 contracts
B. Short 192 contracts
C. Long 96 contracts
D. Short 96 contracts

Answer: C

To increase beta by 0.6 we need to go long 0.6×36,000,000/(900×250) or 96 contracts

10. A company due to pay a certain amount of a foreign currency in the future decides to hedge
with futures contracts. Which of the following best describes the advantage of hedging?
A. It leads to a better exchange rate being paid
B. It leads to a more predictable exchange rate being paid
C. It caps the exchange rate that will be paid
D. It provides a floor for the exchange rate that will be paid

Answer: B
Hedging is designed to reduce risk not increase expected profit. Options can be used to
create a cap or floor on the price. Futures attempt to lock in the price

14. Which of the following is a reason for hedging a portfolio with an index futures?
A. The investor believes the stocks in the portfolio will perform better than the market
but is uncertain about the future performance of the market
B. The investor believes the stocks in the portfolio will perform better than the market
and the market is expected to do well
C. The portfolio is not well diversified and so its return is uncertain
D. All of the above

Answer: A

Index futures can be used to remove the impact of the performance of the overall market
on the portfolio. If the market is expected to do well hedging against the performance of
the market is not appropriate. Hedging cannot correct for a poorly diversified portfolio.

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