Math Flashcards by Kris Bovee

What investment strategy would best exploit an increase in the Swiss franc in relation to the US dollar at the end of the second quarter of the year if it is currently January?

[A] The best strategy is to buy June futures in Swiss francs.
[B] The best strategy is to sell June futures in Swiss francs.
[C] The best strategy is to buy January futures in Swiss francs.
[D] The best strategy is to buy January futures in Swiss francs and sell June futures in Swiss francs.

[A] The best strategy is to buy June futures in Swiss francs.

EXPLANATION

If you expect an increase in the value of the Swiss franc, you should buy futures of the Swiss franc in order to lock in the current price. This way, you could sell the futures for a profit, or hold the futures until expiration and buy the francs at a discount to the future cash price. Since it is now January and you expect the move to occur at the end of the second quarter you would buy the June contracts.

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In South America, the orange harvest is coming to an end and it is becoming more and more apparent as the harvest closes that the harvest will be less than expected. A client of yours speculates that this will drive the cost of frozen orange juice up and so, your client buys 10 November contracts for frozen orange juice (each for 15,000 lbs). His order is filled at 80.5 cents per pound. After holding these futures for three weeks, your client is happy with the profit on the contracts and decides to sell. His position is closed at 95.1 cents. You charge your client $40 per contract in commissions. What was your client’s profit?

[A] $2,150
[B] $17,900
[C] $21,500
[D] $21,900

[C] $21,500

EXPLANATION

To figure out this equation use the following steps:

S 95.1 + (sold contract at 95.1 cents / lb)
B 80.5 - (bought contract at 80.5 cents / lb)
14.6 + (profit per lb on the transaction w/o commissions in cents)

$0.146 x 15,000 (lbs per contract) = 2,190
2,190 x 10 (number of contracts) = $21,900 (gross profit)
$21,900 - $400 ($40 per contract at 10 contracts) = $21,500 profit after commissions

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A short hedge is buying futures contracts to protect against possible declining prices of commodities.

[A] True
[B] False

[B] False

EXPLANATION

A short hedge is selling futures contracts to protect against possible declining prices of commodities as defined in the NFA Glossary of Terms.

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You are currently engaged in business with a British firm from whom you purchase parts for your final product assembly in your plant in Henderson, Nevada. You need to purchase a bulk order of parts from the British firm in two months and have already agreed to pay $1.9060 / British Pound for the delivery of the equipment. You are currently concerned that the value of the US dollar will further decline in relation to the British Pound and you decide to sell British Pound futures (62,500 British Pounds per contract) when the spot exchange rate has reached $1.8900 / British Pound. If you include the change in spot price of the British Pound, what amount should you expect to pay in gains or losses on the purchase of the contract?

[A] You should expect a gain of $1,000
[B] You should expect a loss of $1,000
[C] You should expect a gain of $2,000
[D] You should expect a loss of $2,000

[B] You should expect a loss of $1,000

EXPLANATION

Your agreed upon price was: B 1.9060 -
Your selling price at the spot rate was: S 1.8900 +
Leaving you with a loss of: 0.0160 -
Multiply this by the size of a single contract
0.0160 x 62,500 = $1,000

This could also be figured using the tick size of the British Pound which is $0.0002 = $12.50.
0.0160 or 160 / 2 = 80 x 12.50 = $1,000.

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A hog feeder places a hedge in May and sells 3 live hog futures @ 50.55 cwt (30,000 pounds per contract). Later the hog feeder removes the hedge and buys 1 live hog futures @ 50.00 and buys 2 live hog futures @ 49.79. Ignoring commissions, the hog feeders total profit or loss is?
[A]	$2.07 gain
[B]	$621.00 gain
[C]	$621.00 loss
[D]	$62,100 gain

[B] $621.00 gain

EXPLANATION

S 50.55 x 3 =	151.65 +		
B 50.00 x 1 =	50.00 -		
B 49.79 x 2 =	99.58 -		
2.07 +	=   0.0207 x 30,000   =	$621.00	+
Remember for hogs and cattle when you are going to multiply times the contract value you have to move the decimal to the left two spaces!

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Selling hedges are used for which of the following?

[A] To determine a price at which the hedger will buy the physical commodity.
[B] To determine a price at which the hedger will sell the physical commodity.
[C] To determine a price at which the hedger will breakeven on physical commodity.
[D] To determine a price at which the hedger will lose money on the hedge.

[B] To determine a price at which the hedger will sell the physical commodity.

EXPLANATION

Buyers of commodities buy futures to hedge and seller of commodities sell futures to hedge. Therefore a selling hedge would be used to establish a price at which the hedger would sell the commodity.

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Your company does business in France and imports products from France with payment made in the Euro, which is the French currency. As an importer you would hedge by selling Euro Futures contracts.

[A] True
[B] False

[B] False

EXPLANATION

If you must make payment in a foreign currency, to hedge, you would buy futures on the foreign currency.

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The investor that manages a large portfolio for an individual investor, keeps a percentage of the portfolio in high grade municipal bonds. The demand for these bonds is high and supply is tight. The forecast is for continued gains in the municipal bond values. Soon he will have 2.85 million available to invest in municipals. Which of the following futures position should the investor use to hedge: ($100,000 per contract)

[A] sell 3 muni bond futures to capture expected gain until investment of funds
[B] buy 3 muni bond futures to protect against a decline
[C] buy 29 muni bond futures to capture the expected gains until investment of funds
[D] sell 29 muni bond futures to protect against a decline

[C] buy 29 muni bond futures to capture the expected gains until investment of funds

EXPLANATION

Since he will be a “buyer” of municipal bonds, he would “buy” futures to protect against an increase in cost. ($2,850,000 divided by 100,000 = 28.5 or 29 contracts needed). Ordinarily we would NOT want to be over hedged when we use futures to hedge BUT there is not a choice that let’s us be perfectly hedeged or under hedged so we have to go with Buy 29 futures.

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On October 15 May plywood futures on the CBT is 145 per MSF and cash plywood at a particular western location is $151 per MSF. On that day, a plywood dealer in that western location places an order for one box car to be shipped in April at the cash price on the day of delivery. Both the miller and the dealer hedge the forward contract on the CBT. On April 14th when the order is shipped, the May future is $161 per MSF and the cash price is $157 per MSF. What is the result of the dealer’s hedge?

[A] $10 loss per MSF.
[B] $10 gain per MSF.
[C] $6 loss per MSF.
[D] $6 gain per MSF.

[B] $10 gain per MSF

EXPLANATION

Use Setup #3

CASH	FUTURES
S 151 +	B 145 -
B 157 -	S 161 +
- 6	+ 16
\+ 10 MSF
MSF M = Roman Numeral for 1000, therefore MSF = per thousand square feet

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During slower economic growth periods, interest rates are expected to decline and bond prices would be expected to rise thus making the purchase of bond futures more attractive.

[A] True
[B] False

[A] True

EXPLANATION

This statement is true. When the economy is sluggish and there is little or not growth it is expected, generally, that interest rates would decline in order to try to stimulate the economy. As interest rates decline outstanding bond prices would rise and with rising bond prices the purchase of bond futures would be more attractive to investors.

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One of your clients is a corporation which is planning to sell corporate bonds in the near future. The offering of bonds will be for $5,000,000 and your company is assured a face value cash price for the bond offering. Even though a price is assured and the transaction is less than a month away, the company treasurer wants to hedge the sale with T-bond futures. He enters an order to sell 50 of the current month, July, T-bond futures contracts when they are at a price of 101-16 ($100,000 per contract). Two weeks later, the bond deal is about to go through and the treasurer offsets the hedge with a T-bond price of 100-02. What will the treasurer, with this hedge included receive after the bonds are sold?

[A] The hedge and bond sale will bring in a total of $4,978,125.00.
[B] The hedge and bond sale will bring in a total of $4,998,562.50.
[C] The hedge and bond sale will bring in a total of $5,001,437.50.
[D] The hedge and bond sale will bring in a total of $5,071,875.00.

[D] The hedge and bond sale will bring in a total of $5,071,875.00.

EXPLANATION

The hedge went as follows:

S 101-16 +
B 100-02 -

This results in a gain per T-bond of 1-14

(14/32 = 14x31.24=437.50), so a total of $1,437.50 per bond x 50 bonds = $71,875.00 in gains on the hedge.
The face value cash price of the bonds is $5,000,000.00.
5,000,000 + 71,875 = $5,071,875.00 taken in including the hedge and sale.

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You are a distributor in propane. It is priced to the fourth decimal and quoted in dollars. Each contract contains 1,000 barrels, or 42,000 US gallons. You foresee the demand for propane rising, and thus the price rising in the upcoming months. It is May and you decide to buy a contract to be filled at the end of June for 15,000 barrels, or 630,000 gallons of propane which will be sold at the cash price of the propane at the time of delivery at the end of June. In order to hedge the forward contract, you hedge in futures contracts for propane when the price of propane in the cash market is currently $1.1605 per gallon and the price in the propane futures market is currently $1.2225. The end of June has now arrived and as the refinery loads the order, you lift your hedge with the current cash price at $2.0250, and the current futures price at $2.1055. Since you hedged your position in May, what ended up being your “net” cost of propane per gallon?

[A] Your “net” cost per gallon was $0.9450.
[B] Your “net” cost per gallon was $1.1420.
[C] Your “net” cost per gallon was $1.2225.
[D] Your “net” cost per gallon was $1.6238.

[B] Your “net” cost per gallon was $1.1420

To find the “net” cost per gallon, use the following basic formula:

First find the difference in futures prices: S 2.1055 +
B 1.2225 -
Leaving you with a difference of: 0.8830 +

Subtract this difference from the current cash price at which you purchased the propane:
2.0250 - 0.8830 = $1.1420 which is your “net” price per gallon.

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To offset a long futures contract one would:

[A] buy futures verses the sale of the actual commodity.
[B] sell an equal number of futures contracts with the same delivery.
[C] sell futures against the actual purchase of the commodity.
[D] Any of the above.

[B] sell an equal number of futures contracts with the same delivery

EXPLANATION

To offset or close a long position you must sell an equal number of contracts with the same delivery.

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You are the treasurer of a US Exporter which regularly does business with Japan. You have contracted out with a Japanese importer and you have agreed to take payment upon delivery in Japanese yen. There is concern over a possible rise in the value of the dollar and a subsequent decrease in the value of the yen prior to delivery of your contract. As a hedge, you sell yen futures at 115.550450 (12,500,000 yen per contract). Later you close the position at 115.540450. What is the result of this hedge per contract?

[A] The exporter has gained $1,250.00.
[B] The exporter has lost $1,250.00.
[C] The exporter has gained $125,000.00.
[D] The exporter has lost $125,000.00.

[C] The exporter has gained $125,000.00.

EXPLANATION

S 115.550450 +
B 115.540450 -
+ 0.01 x 12,500,000 = $125,000.00 in profits.

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A German company has contracted to buy the rights to a camera in American dollars. The dollar is expected to advanced against the EURO. To hedge, the investor should sell EURO Futures.

[A] True
[B] False

[A] True

EXPLANATION

Is true because if the dollar is strong, the EURO would be expected to decline, thus selling EURO futures would be best.

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A customer decides to sell 10 soybean meal futures contracts (each 100 tons) at $250 per ton. A month later prices have gone up to $275 and the customer offsets his position at 276. round-turn commissions are $30 per contract. The result of this trade was:

[A] $25,700 Loss
[B] $26,300 Loss
[C] $2,630 Loss
[D] $2,570 Loss

[B] $26,300 Loss

EXPLANATION

Use Setup #1

S 250.00+		
B 276.00-		
-26.00 -    x	100 	=     $2,600 loss  
x 10	
          	         $26,000 loss  
 	300         	
$26,300         	- Total Loss

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One of your clients is a small business. This small business has secured a sizeable $2,000,000 loan for operations activities that will be funded in June of 2008. The pricing for the loan is a floating rate to be paid quarterly through December of 2009. The months of payment are March, June, September, and December. Each month of payment, the loan’s interest rate is set at the 90-day T-bill rate. What investment strategy could this small business use to in-effect, lock in a fixed rate for the entire loan period?

[A] The best strategy to fix this rate of interest would be to sell one June 2008 and buy one December 2009 Eurodollar futures contract.
[B] The best strategy to fix this rate of interest would be to sell short one each of every Eurodollar contract successively from the time of funding through the end of payment of the loan, and include the June 2008 and December 2009 contracts.
[C] The best strategy to fix this rate of interest would be to buy one June 2008 and one December 2009 Eurodollar futures contract.
[D] The best strategy to fix this rate of interest would be to buy one of every Eurodollar contract between and including June 2008 and December 2009 and do so successively.

[B] The best strategy to fix this rate of interest would be to sell short one each of every Eurodollar contract successively from the time of funding through the end of payment of the loan, and include the June 2008 and December 2009 contracts.

EXPLANATION

The small business wants to protect from rising interest rates, they would sell Eurodollar futures since if interest rates rise Eurodollar futures prices would go down and to ensure a fixed rate throughout the entire period, you would have to go short a contract for each period.

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One of your customers is a speculator in foreign currencies. She recently took a short position in Swiss francs with 8 Swiss franc futures contracts at a price of 1.2320 (each contract for 125,000 Swiss francs). The contracts are liquidated one week later when the Swiss franc has reached 1.2125 which produced which of the following:

[A] The position produced a gain of $2,437.50.
[B] The position produced a loss of $2,437.50.
[C] The position produced a gain of $19,500.00.
[D] The position produced a loss of $19,500.00.

[C] The position produced a gain of $19,500.00

EXPLANATION

The speculator took a short position. This implies that she sold short then bought to cover the original position. Swiss francs are traded in contracts of 125,000, so $0.0001 = $12.50. So:

S 1.2320 +
B 1.2125 -
0.0195 +

.0195 X 125,000 = $2,437.50

which equals 195 x $12.50 = $2,437.50.

There were a total of 8 contracts, so:
8 x $2,437.50 = $19,500.00 in gains.

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The IMM yen futures market requires delivery of 12.5 million yen which at this time is equal to about $50,000. A U. S. importer of South Japanese goods feels that the dollar will weaken due to a decline in interest rates. He expects to have payables in yen of about $1,000,000 in the next 3 months. He hedges using 20 yen futures contracts with the yen price at .005075 and the futures at .005128. He later closes the hedge when the yen is at .004737 and the futures are at .004518. Assuming that no hedge occurred what would have been the result of the importers exchange rates?

[A] A gain of $84,500
[B] A loss of $84,500
[C] A gain of $4.225
[D] A loss of $4,225

[B] A loss of $84,500

EXPLANATION

Since this question is about an “importer” he would have been a buyer. If the importer had not hedged, we would only consider the changes in the cash market, therefore:

B- .005075
S+ .004737
-.000338 X 12,500,000 = $4,225.00 loss X 20 contracts = $84,500 Loss

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In futures trading, a hedger normally pays more attention to:

[A] the probable direction of futures prices.
[B] the changing relationship between the cash and futures price.
[C] the changing spreads between different futures prices.
[D] the changing levels of volume and open interest.

[B] the changing relationship between the cash and futures price

EXPLANATION

The Basis, which is the difference between cash and futures prices, is the most important factor a hedger considers.

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A customer of yours is a speculator who puts on the following trades: Sells May T-bond futures at 104-28 at the open of the position. Buys May T-bond futures at 104-10 at the close of the position. The initial margin required per contract is $1,750. Each T-bond futures contract is for $100,000 per contract. Please give the gain or loss on this trader’s position in dollars and as a percentage of the margin required:

[A] The speculator will have a loss of $562.50 and as a percentage of margin it is 32.14%.
[B] The speculator will have a gain of $562.50 and as a percentage of margin it is 32.14%.
[C] The speculator will have a loss of $657.50 and as a percentage of margin it is 37.57%.
[D] The speculator will have a gain of $657.50 and as a percentage of margin it is 37.57%.

[B] The speculator will have a gain of $562.50 and as a percentage of margin it is 32.14%.

EXPLANATION

The following trades took place:

May S 104-28 +
B 104-10 -
+18/32

This leaves us with 18/32 = .5625 which, since we are talking about bonds, would be multiplied by 1000 to arrive at its cash value:
.5625 x 1000 = $562.50 in profit per contract
562.50 / 1750 = .3214385, or 32.14%

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A particular hedge position may not give full protection against an adverse price movement because:

[A] cash and futures prices normally move together.
[B] various futures months do not sell at the same price.
[C] during the time the hedge is operative, the basis may change.
[D] All of the above.

[C] during the time the hedge is operative, the basis may change

EXPLANATION

A “perfect hedge” only occurs when there is no change in the basis, therefore if there were a change in the basis during the life of a hedge, there would not always be full protection.

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One of your clients is retiring, and plans to receive the lump sum settlement from his IRA. The lump sum is expected to be transferred to his account in approximately two months. He wishes to invest in some S&P 500 securities, but he sees that the market has recently been rallying, and he is concerned that by the time he receives his money, prices will be higher than he would desire. He intends to invest $1,562,500, so for now, in order to protect against big moves in a rallying market, he decides to hedge with S&P 500 futures ($250 x index), when the value of the S&P 500 is at 1,250. What number of contracts are necessary to completely hedge his planned amount of investment?

[A] 5
[B] 50
[C] 500
[D] 1250

[A] 5

$1,562,500 to invest
Current market level: 1,250
(250 x index)= 1,250 x 250 = 312,500
1,562,500 / 312,500 = 5

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An investor is short 3 soybean futures $10.25 3/4, and places a stop order $ 9.75. The order is later filled at $9.75 1/2. Commissions are $25 per contract. The investor’s profit is:

[A] $7,537.50
[B] $7,512.25
[C] $7,511.75
[D] $7,462.50

[D] $7,462.50

EXPLANATION

Use Setup #1

S 10.2575 +		
B 9.7550 -		
\+.5025    x   	5,000 =	$2,512.50 +
x 3  	
7,537.50 +
($25 x 3)	- 75.00  	
$7,462.50 +

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A French camera manufacturer entered into an agreement to buy manufacturing rights for a new lens from a United States manufacturer in dollars. In recent weeks the United States dollar has been advancing against the French Franc. To protect itself against changes on the relative value of the French Franc and U.S. dollar the French firm should: [A] buy French Francs futures. [B] sell French Francs futures. [C] buy U.S. dollar futures. [D] sell U.S. dollar futures.

[B] sell French Francs futures EXPLANATION Remember first that here in the U.S. we cannot trade our own currency, therefore, we would never hedge in U.S. Dollars, but also keep in mind that we generally expect foreign currency values to move in the opposite direction of the U.S. Dollar, thus if the U.S. Dollar has been advancing, we would expect the French Franc to decline and should therefore sell French Franc futures.

You are a trader in the agricultural sector of the futures market. You anticipate that soybean prices are on the rise. Prices are currently at $5.68 1/4 per bushel for a January contract (5,000 bushels per contract), and you decide to buy 8 contracts at that price. In January, you cover the contract when the price of the soybeans has appreciated to $5.80 3/4 per bushel. The commissions charges on these contracts is $50 per contract, and the initial margin required was $1,013 per contract. What was your overall profit in this situation, both in dollars, and as a percentage of the margin that you had to deposit? [A] Your overall profit in this situation was $625, and as a percentage of margin required was 61.70%. [B] Your overall profit in this situation was $575, and as a percentage of margin required was 56.76%. [C] Your overall profit in this situation was $5,000, and as a percentage of margin required was 61.70%. [D] Your overall profit in this situation was $4600, and as a percentage of margin required was 56.76%.

[D] Your overall profit in this situation was $4600, and as a percentage of margin required was 56.76%. EXPLANATION They are asking for your overall profit (for all 8 contracts), and overall as a percentage of margin required (which will be the same as per contract). So: S 5.8075 + (3/4 = .75) B 5.6825 - (1/4 = .25) (0.1250+) x 5,000 (bushels per contract) = $625 $625 - 50 (commissions per contract) = $575.00. $575 / 1013 (margin required per contract) = 0.5676209 or 56.76% $575 x 8 (# of contracts) = $4600 overall profit.

[B] $10 gain per MSF. EXPLANATION Use Setup #3 ``` CASH FUTURES S 151 + B 145 - B 157 - S 161 + - 6 + 16 + 10 MSF ```

A speculator is long three wheat contracts @ $2.00 per bushel and deposits the required initial margin of $300. A week later the price of wheat has declined to $1.95 per bushel and the speculator closes his/her position. The speculators account will be: [A] Credited $250 [B] Credited $750 [C] Debited $250 [D] Debited $750

[D] Debited $750 EXPLANATION The speculator has suffered a loss of $ .05 per bushel, ($2.00 - $1.95), 5,000 bu. x $.05 = $250 loss per contract times 3 contracts = $750 debited to the customer’s account. Use set up #1. B- 2.00 S+ 1.95 - .05 X 5,000 bushels = -$250 per contract X 3 contracts $750 Total Loss - 0 Commission $750 Gain Debited to the account

When considering the basis on a long hedge, if the basis strengthens or narrows this would generate a profit. [A] True [B] False

[B] False EXPLANATION When establishing a long hedge, the hedger wants the basis to weaken, widen or become more negative.

``` An investor is short 3 soybean futures @ 11.23. Later the investor liquidates 2 soybean futures @ 10.25 and 1 @ 10.22. Commissions per contract at $30. The investor's profit or loss? [A] $14,850 profit [B] $14,760 profit [C] $14,940 loss [D] $14,850 loss ```

[B] $14,760 profit EXPLANATION ``` S 11.23 x 3 = 33.69 + B 10.25 x 2 = 20.50 - B 10.22 x 1 = 10.22 - 2.97 + x 5,000 = $14,850 + - 90 $14,760 + ```

Mr. Jones sells soybean oil futures since he is concerned about a price decrease in the price of cotton seed oil. This is an example of: [A] A bull spread. [B] A bear spread. [C] A cross hedge. [D] A synthetic hedge.

[C] A cross hedge. EXPLANATION Mr. Jones creates a Cross Hedge by hedging with soybean oil futures, since cotton seed oil and soybean oil are similar commodities used for the same purposes and because there are no futures traded on cotton seed oil.

A hedger decides to short 2 September Eurodollar contracts at 96.44 (.01 = $25). Later he feels that the Eurodollar has stabilized and covers his futures at 96.56. What is the result of the hedger's trades? [A] A loss of 12 basis points or $300.00 [B] A gain of 12 basis points or $300.00 [C] A gain of 12 basis points or $600.00 [D] A loss of 12 basis points or $600.00

[D] A loss of 12 basis points or $600.00 EXPLANATION Use Setup #1 ``` S 96.44 + B 96.56 - .12 - x 25 = -$300 x 2 -$600 - 0 $600 - ```

The treasurer of a large corporation has a long position in Treasury Bills and decides that it is a good idea to hedge his position. He puts on a short hedge when T-Bill futures are @ 94.04. Later he covers his hedge when T-Bills are at 93.08. What is the treasurers profit per contract on this hedge? [A] $96 per contract [B] $2,400 per contract [C] $960 per contract [D] $24,000 per contract

[B] $2,400 per contract EXPLANATION Using Set up #1 S+ 94.04 B - 93.08 .96 = 96 X $25 (basis point on T-Bills) = $2,400 X 1 $2,400 0 Commission $2,400 Profit Per Contract

The sale of corn futures by a hog feeder is a bona fide hedge. [A] True [B] False

[B] False EXPLANATION A hog feeder would be a buyer of corn, thus should buy (not sell) futures to hedge

What would be a speculator's return, both as a percentage of margin deposited and in dollars on the following trades? - Speculator buys 8 contracts (5,000 bushels each) of oats at $4.40 and 1/2, per bushel. - Speculator covers the 8 contracts at $4.45 and 3/4. - Speculator pays commissions of $45 per contract with an initial margin of $1,250 per contract. [A] 13.20% return and a profit of $1,320 [B] 15% return and a profit of $1,500 [C] 17.40% return and a profit of $1,740 [D] 20% return and a profit of $2,000

[C] 17.40% return and a profit of $1,740 EXPLANATION The speculator performed the following actions: Sold at: S 4.4575 + Bought at: B 4.4050 - For a total of 0.0525 + 0. 0525 x 5000 = 262.50 - 45 (commission) = 217.50 (profit per contract after commissions) 217. 50 x 8 (number of contracts) = $1,740 217. 50 / 1250 (deposit per contract) = .174, or 17.40%

In a normal market when the future price decreases and the cash price stays about the same, that causes the basis to strengthen, narrow or become less negative. [A] True [B] False

[A] True EXPLANATION This statement is true. Remember that the basis is the difference between the cash price and the futures price. In a normal market we expect the futures price to be higher than the cash price, therefore if the futures price declines while the cash price stays the same, the difference between the two would get closer together or narrow which is considered to be a strengthen.

When considering the basis on a short hedge, the hedger wants the basis to weaken or widen. [A] True [B] False

[B] False EXPLANATION When establishing a short hedge, the hedger wants the basis to strengthen, narrow or become less negative.

A Long hedge is selling futures contracts to protect against possible increasing prices of commodities. [A] True [B] False

[B] False EXPLANATION A long hedge is buying futures contracts to protect against possible increasing prices of commodities

The purchase of corn futures by a cattle feeder would be a legitimate hedge. [A] True [B] False

[A] True EXPLANATION This is true because the cattle feeder would be a buyer of corn and would, therefore, buy futures to hedge (Buyers - Buy)

An exporter will be accepting payment in Japanese Yen. He is concerned that the value of the Yen may decline. Therefore, he sells the yen futures at .006928 (12,500,000 Yen per contract), and later offsets his position at .006840. The result is: [A] 110 gain per contract [B] 110 loss per contract [C] 1,100 gain per contract [D] 1,100 loss per contract

[C] 1,100 gain per contract EXPLANATION ``` S .006928 + B .006840 - + .000088 x 12,500,000 = $1,100 + x 1 $1,100 + + 0 $1,100 + ```

Mr. Dow follows the stock market and feels that it is in line for a moderate rally after a period of declines. The DJIA is at 1,103. He goes long 5 March CBOT major market index contracts. (This index future has a cash value of the index number x $100) Minimum speculative margin is $2,300 per contract. His order is filled at 222 7/8. He later places a stop loss order at 251 and it is activated and filled at 250 3/8. He would have a gain of: [A] $17,500 [B] $13,750 [C] $10,000 [D] $2,750

[B] $13,750 EXPLANATION Use Setup #1 ``` B 222 7/8 - S 250 3/8 + 27 1/2 x 100 = $2,750 x 5 $13,750 - 0 $13,750 + ```

A farmer expects some volatility in live cattle and currently holds 10 contracts which he purchased at 92.05 cents per pound (40,000 pounds per contract). He sells 4 of the contracts at a price of 92.00 and the remaining 6 at 90.45. What was the speculator's total gain or loss without commissions charges? [A] The speculator will have a loss of $3,920.00. [B] The speculator will have a gain of $3,920.00. [C] The speculator will have a loss of $6,600.00. [D] The speculator will have a gain of $6,600.00.

[A] The speculator will have a loss of $3,920.00. EXPLANATION This question requires a slightly different setup. We see in the question that four (4) of the ten contracts were sold at a different price than the other six (6). All contracts were purchased at the same price, so simply set it up as two different problems: 4 contracts: 6 contracts: B 92.05 - B 92.05 - S 92.00 + S 90.45 + 0.05 - 1.60 - 0.05 cents = $0.0005 1.60 cents = $0.0160 4 contracts @ 40,000 lbs each 6 contracts @ 40,000 lbs each 160,000 lbs x 0.0005 = 240,000 lbs x 0.0160 = -$80 for this portion of the position - $3840 for this portion of the position This leaves us with a loss of $3920 for the entire position.

A mortgage investor will have surplus funds in four months. He now wants to lock in the current GNMA yield. He wants to hedge with GNMA futures. He would: [A] Go long in the futures market and short in the cash market. [B] Go long in the futures market. [C] Go short in the futures market and long in the cash market. [D] Go short in the futures market.

[B] Go long in the futures market. EXPLANATION A mortgage investor with surplus funds would be a buyer -- and buyers always buy futures to hedge.

An investor is short 3 soybean futures $10.25 3/4, and places a stop order $ 9.75. The order is later filled at $9.75 1/2. Commissions are $25 per contract. The investor's profit is: [A] $7,537.50 [B] $7,512.25 [C] $7,511.75 [D] $7,462.50

D] $7,462.50 EXPLANATION Use Setup #1 ``` S 10.2575 + B 9.7550 - +.5025 x 5,000 = $2,512.50 + x 3 7,537.50 + ($25 x 3) - 75.00 $7,462.50 + ```

Hedging in futures contracts may lead to which of the following results? [A] Decrease in purchasing costs. [B] A reduction in market capital requirements. [C] An increase in sales income. [D] Any of the above.

[D] Any of the above. EXPLANATION Hedging could cause all of those to occur.

A hog feeder on June 16 hedges at the prices below and sells the hogs on September 17 (40,000 pounds per contract). CASH HOG FUTURES PRICES PRICES June 16 51.25 53.79 July 12 52.60 55.00 August 18 51.10 53.20 September 17 50.65 52.30 Over the life of the hedge above, the Basis: [A] worsened by .89 or $356 per contract [B] improved by 1.61 or $483 per contract [C] improved by .89 or $356 per contract [D] worsened by 2.50 or $750 per contract

[C] improved by .89 or $356 per contract EXPLANATION ``` CASH FUTURES B 51.25 - S 53.79 + S 50.65 + B 52.30 - -.60 1.49 + .89 (.89 = .0089 x 40,000) = $356.00 + ```

Green Bay Hogs Futures Cash Futures July 8 41.25 43.75 August 12 42.60 45.00 September 9 41.10 43.20 October 14 40.69 42.30 A hog farmer hedged at the above prices per CWT on July 8th. The farmer lifted his hedge on October 14th and sold his hogs in the Green Bay cash market. In the course of his hedge the basis has: [A] improved causing a loss of 98 cents per CWT. [B] weakened causing a loss of 89 cents per CWT. [C] improved causing a gain of 89 cents per CWT. [D] weakened causing a gain of 98 cents per CWT.

[C] improved causing a gain of 89 cents per CWT. EXPLANATION Use Setup #3 ``` CASH FUTURES B 41.25 - S 43.75 + S 40.69 + B 42.30 - - .56 + 1.45 Improved + .89 ```

A major client is expecting to make a purchase in U.S. Treasury Bonds in August. The client intends to purchase $10,000,000 in the cash market. Because it is only April, the client wants to hedge their anticipated purchase. The client purchases future contracts on the T-Bonds with a price of 103-00. As August approaches, the client offsets their futures position at 101-16. The client had purchased and offset a total of 100 contracts at the prices listed above with $100,000 contract sizes. August rolls around and the investor buys at a price of $9,730,000.00. What was the result of these transactions? [A] Gain of $270,000 [B] Loss of $270,000 [C] Gain of $120,000 [D] Loss of $120,000

[C] Gain of $120,000 EXPLANATION B- 103-00 $10,000,000 S+ 101-16 - - 9,730,000 - 1-16 + 270,000 -1 = 1000 16/32 = 500 $1,500 per contract - 1,500 x 100 = -$150,000 $270,000 Savings on bond purchase -150,000 Loss on futures $ +120,000 gain on overall transaction

``` A hog feeder places a hedge in May and sells 3 live hog futures @ 50.55 cwt (30,000 pounds per contract). Later the hog feeder removes the hedge and buys 1 live hog futures @ 50.00 and buys 2 live hog futures @ 49.79. Ignoring commissions, the hog feeders total profit or loss is? [A] $2.07 gain [B] $621.00 gain [C] $621.00 loss [D] $62,100 gain ```

[B] $621.00 gain EXPLANATION ``` S 50.55 x 3 = 151.65 + B 50.00 x 1 = 50.00 - B 49.79 x 2 = 99.58 - 2.07 + = 0.0207 x 30,000 = $621.00 + Remember for hogs and cattle when you are going to multiply times the contract value you have to move the decimal to the left two spaces! ```

[D] The hedge and bond sale will bring in a total of $5,071,875.00. EXPLANATION The hedge went as follows: S 101-16 + B 100-02 - This results in a gain per T-bond of 1-14 (14/32 = 437.50), so a total of $1,437.50 per bond x 50 bonds = $71,875.00 in gains on the hedge. The face value cash price of the bonds is $5,000,000.00. 5,000,000 + 71,875 = $5,071,875.00 taken in including the hedge and sale.

November Gasoline futures are trading at 2.75 per gallon and the cash price is 2.60 in July. A gasoline distributor decides to hedge against an increase in gasoline prices and buys the November futures. In October the distributor lifts the hedge and buys in the cash market when the November futures are at 2.90 and the cash price is at 2.80. The result of these trades caused the distributor to in part reduce the increased price in the cash market. [A] True [B] False

[A] True EXPLANATION Since the distributor would have ended up having to pay an increased cash price of .20 cents per gallon but made a profit of .15 per gallon on the futures, these trades did partially offset the increased cost of the gasoline to the distributor.

A client establishes a short position in S & P 500 index futures at 312.70. Later he covers the position at 308.10. (The cash value equals the index number x 500). Initial speculative margin was 15,000. What was the result of the trade before commissions? [A] Loss of $2,300 or 15% of margin [B] Gain of $2,300 or 15% of margin [C] Loss of $6,250 or 42% of margin [D] Gain of $6,250 or 42% of margin

[B] Gain of $2,300 or 15% of margin EXPLANATION Use Setup #1 ``` S 312.70 + B 308.10 - 4.60 x 500 = 2,300 + x 1 $2,300 + - 0 $2,300 You do not actually need to calculate the % of profit because there is only one answer of +$2,300 but if you did want to calculate it you would take the profit of $2,300 divided by the margin of $15,000 to arrive at 15% of margin. ```

In futures trading, a hedger normally pays more attention to: [A] the probable direction of futures prices. [B] the changing relationship between the cash and futures price. [C] the changing spreads between different futures prices. [D] the changing levels of volume and open interest.

[B] the changing relationship between the cash and futures price. EXPLANATION The Basis, which is the difference between cash and futures prices, is the most important factor a hedger considers.

It is June and a gasoline distributor is worried that price of gasoline will be rising in the next few months and decides to hedge with September futures when the cash price is 2.75 and the September futures 2.80. In September the distributor closes the hedge when the cash price is $3.20 and the September futures are $3.30. What was the distributors net price paid for gasoline? [A] $3.70 [B] $3.30 [C] $2.80 [D] $2.70

[D] $2.70 EXPLANATION Use Set-up #2 Net Price Paid Future $2.80 $3.20 Closing Cash Price $3.30 - .50 .50 $2.70 Net Price Paid for Gasoline

A city's bus department is concerned about an increase in gas prices and buys 3 November gasoline Futures (42,000 gallons per contract) at 2.2228 when the spot price is 2.1010. Later the bus department buys the gasoline at $2.1885 per gallon and lifts the hedge at $2.3177. After accounting for the results of the hedge, what was the bus department's actual cost per gallon of gasoline? [A] 2.0936 [B] 2.1885 [C] 2.3177 [D] 2.2834

[A] 2.0936 EXPLANATION Use Setup #2 Futures Cash S 2.3177 + $2.1885 Closing Cash R. B 2.2228 - - .0949 Profit on futures + 0.0949 $2.0936 Net Price Paid

speculator wants to go short 15,000 bushels of July corn at $2.50 per bushel when initial speculative margin is $1,000 per contract and the maintenance margin is $750 per contract. To establish an opening position, the speculator would have to deposit: [A] $750 [B] $1,000 [C] $3,000 [D] $2,250

[C] $3,000 EXPLANATION The speculator would have to deposit the initial margin requirement of $1,000 per contract times 3 contracts = $3,000. Remember that each contract represents 5,000 bushels and the speculator is going short 15,000 bushels which equals 3 contracts. An opening position is an initial position, therefore initial margin would be required.

A speculative investor with a large portfolio of large cap stocks would protect his portfolio by Selling NASDAQ 100 futures. [A] True [B] False

[A] True EXPLANATION The investor would choose the NASDAQ 100 futures because it is broad based index of large cap stocks and would protect his portfolio from a decline market value by the sale of futures.

A stop order to sell will become a market order when the market sells or is: [A] bid at or above the stop price. [B] offered at or above the stop price. [C] offered at or below the stop price. [D] bid at or below the stop price.

[C] offered at or below the stop price. EXPLANATION A stop order to sell becomes a market order when the contract sells or is offered at or below the stop price.

Placement of a contingent order can only be entered at a set price and may not include time limits on the order. [A] True [B] False

[B] False EXPLANATION A contingency order can make stipulation limits as to both price and time or both.

A buy stop order would be entered above the current market price and is used to cover a short in a rising market. [A] True [B] False

[A] True EXPLANATION A stop order to buy would be used by someone who wanted to cover or liquidate a short futures position in a rising market to either protect or lock in a profit.

When entering a "market if touched" order to buy, it would become a market order if the futures trade at or below the price in the order. [A] True [B] False

[A] True EXPLANATION An MIT order to buy becomes a market order if the contract sells or is offered at or below the order price.

Purchasing futures to offset a short position is known as short covering. [A] True [B] False

[A] True

The price that a customer wishes their order to be executed at is indicated in a limit order. [A] True [B] False

[A] True EXPLANATION If customer wishes their order to be executed AT a specific price or better they would enter a limit order. Buy limits are entered below the current market price and sell limits are entered above the current market price.

A Fill or Kill (FOK) is an order which must filled at a specific price in its entirety or canceled immediately. [A] True [B] False

[A] True EXPLANATION A Fill or Kill order is an order which must be filled at a specific price in its entirety or canceled immediately.

In March a speculator goes long 20 soybean futures (5,000 Bushels) at $6.20 per bushel. He deposits $2,500 margin and pays a commission of $30 per contract. Later soybean prices rise to $6.35 per bushel and the speculator sells 10 contracts. Several weeks later soybean prices move to $6.40 and the speculator sells his remaining contracts. What is the speculator's profit or loss? [A] + 17,500 [B] - 17,500 [C] + 16,900 [D] - 16,900

[C] + 16,900 EXPLANATION This is answered using a variation of Setup #1 ``` B- 6.20 x 20 = -124.00 S+ 6.35 x 10 = + 63.50 S+ 6.40 x 10 = + 64.00 + 127.50 S+ 127.50 B- 124.00 +3.50 x 5000 = $17,500 + - 600 commission $16,900 + ```

In futures trading, Cost of Carry is defined as the difference between the nearby futures month and the next futures month. [A] True [B] False

[A] True EXPLANATION Cost of Carry or Carrying Charge is defined as the difference between the nearby futures month and the next futures month, not to be confused with Basis which is the difference between the cash market price and the futures market price. Carrying Charge or Cost of Carry includes insurance, storage and interest on the invested funds as well as incidental costs.

What is Cost of Carry?

Cost of Carry or Carrying Charge is defined as the difference between the nearby futures month and the next futures month. Carrying Charge or Cost of Carry includes insurance, storage and interest on the invested funds as well as incidental costs

What is Basis?

The difference between the cash market price and the futures market price

Mr. Smith is concerned that there will be a decline in long-term interest rates and decides to go long 1 T-Bond future at 112.08 ($100,000 per contract) and simultaneously sells 1 T-Note future at 113.19 ($100,000 per contract). Mr. Smith later offsets his positions when T-Bonds are at 112.31 and T-Notes are 113.31. What is the result of Mr. Smith's spread? [A] Gain $343.75 [B] Loss $343.75 [C] Gain $24.69 [D] Loss $24.69

[A] Gain $343.75 EXPLANATION ``` T-Bonds T-Notes B- 112.08 S+ 113.19 S+ 112.31 B- 113.31 + .23 - .12 + .11 +.11 = 11 x 31.25 = + $343.75 x 1 + $343.75 ``` Remember, when doing this calculation you are using 32nds, so for the T-Bonds, you would… S+ 112.11 = 111.43 (32+11) B- 111.20 = 111.20 + .23/32nds

When establishing a spread, if the speculator buys the nearby contract and sells the deferred contract, it is a Bull Spread and is expected to weaken or narrow. [A] True [B] False

[A] True EXPLANATION A Bull Spread or Long Spread is one in which the trader is long the nearby contract and short the deferred contract. Bull Spreads must weaken or narrow to be profitable.

What is a Bull Spread?

A Bull Spread or Long Spread is one in which the trader is long the nearby contract and short the deferred contract. Bull Spreads must weaken or narrow to be profitable.

Your customer is watching this spread and has noted that the current spread is around $2.00 per bushel. With higher than normal prices, it is expected that this spread will narrow. Your client decides to enter into a spread, buying 5 November oats futures at $2.15 per bushel (5,000 bushels per contract), and selling 5 November wheat futures at $4.25 per bushel (5,000 bushels per contract). In late June, the spread has now widened to normal levels and your customer decides to unwind his position with oats now at $2.25 per bushel and wheat now at $4.05 per bushel. Your customer's spread position resulted in:

[C] A gain of $7,500.00. EXPLANATION ``` Oats Wheat B 2.15 - S 4.25 + S 2.25 + B 4.05 - 0.10 + 0.20 + For a total gain of 0.30 cents per bushel 0.30 x 5,000 (bushels per contract) = 1,500 x 5(contracts) = $7,500.00. ```

When establishing a spread, if the speculator sells the nearby contract and buys the deferred contract, it is a Bear Spread and is expected to strengthen or widen. [A] True [B] False

[A] True EXPLANATION A Bear Spread or Short Spread is one in which the trader is short the nearby contract and long the deferred contract. Bear Spreads must strengthen or widen to be profitable.

What is a Bear Spread?

A Bear Spread or Short Spread is one in which the trader is short the nearby contract and long the deferred contract. Bear Spreads must strengthen or widen to be profitable.

When establishing a spread, if the speculator sells the nearby contract and buys the deferred contract, it is a Bull Spread and is expected to weaken or narrow. [A] True [B] False

[B] False EXPLANATION A Bull Spread or Long Spread is one in which the trader is long the nearby contract and short the deferred contract. Bull Spreads must weaken or narrow to be profitable.

Gold spread prices are: September October December February April 155.70 156.10 158.10 158.00 159.30 The spread between which months would be expected to be the most profitable? [A] Sell September & Buy October [B] Buy October and Sell December [C] Buy February and Sell April [D] Sell April and Buy September

[B] Buy October and Sell December EXPLANATION When looking at these spreads we always look for the "widest" spread and expect the widest spread to narrow which should result in the most profit. 158.10 - 156.10 = 2.00 Sept to Oct = .40 Oct to Dec = 2.00 Dec to Feb = -.10 Feb to Apr = 1.20 So, the widest spread is Oct to Dec. Remember you always compare one month to the next month in the list - you would NOT compare September to April

Assuming the following Corn Futures quotes are: Sept 4.93 Dec 4.90 Mar 4.89 May 4.87 This list of prices would indicate that which of the following would be true of the cash market? [A] There is currently very little interest in the Cash Corn market. [B] There is currently a very big interest in the Cash Corn market and there is a short cash market supply of corn available. [C] There is currently a very big interest in the Cash Corn market and there is a large cash market supply of corn available. [D] There is currently no interest in the Cash Corn market since prices are too high.

[B] There is currently a very big interest in the Cash Corn market and there is a short cash market supply of corn available. EXPLANATION Since near-by prices are high and get lower and lower, it indicates that there is not much corn available for sale in cash market which is referred to as a Short Cash Market supply of corn.

When establishing a spread if the speculator buys the nearby contract and sells the deferred contract it is a Bear Spread and is expected to strengthen or widen. [A] True [B] False

[B] False EXPLANATION A Bear Spread or Short Spread is one in which the trader is short the nearby contract and long the deferred contract. Bear Spreads must strengthen or widen to be profitable.

An Inverted Market is a futures market in which the nearer months are selling at premiums over the more distant months; characteristically, a market in which supplies are currently in shortage. [A] True [B] False

[A] True EXPLANATION Let's start with a Normal Market - in a normal the cash market price of a commodity is lower than the futures prices because investors will generally expect a "premium" for longer term investments but that normal market can become inverted when there is not very much of the actual commodity available in the cash market - investors push up the near term prices at the expense of the later months due to the short cash market supply.

What is a Normal Market?

Cash market price of a commodity is lower than the futures prices because investors will generally expect a "premium" for longer term investments

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