Q&A Hero

Q: The 3-year swap price on a new oat swap agreement is $5.94. Interest rates immediately rise on 1, 2, and 3-year zero coupon bonds from 5.1%, 5.4%, and 5.7% to 5.2%, 5.6%, and 6.0%, respectively. What is net swap payment per year if the reverse transaction occurs? Assume year 1, 2, and 3 forward prices are $2.05, $2.15, and $2.30, respectively and do not change. A) $0.35 B) $0.49 C) $0.64 D) $0.75

Q: Assume oat forward prices over the next 3 years are $2.25, $2.35, and $2.28, respectively. Effective annual interest rates over the same period are 5.2%, 5.5%, and 5.8%. What is the 2-year swap price on a hypothetical "forward swap" that begins at the end of year 1? A) $2.14 B) $2.32 C) $2.41 D) $2.53

Q: Assume oat spot prices over the next 3 years are $2.20, $2.35, and $2.28, respectively. The original swap price was $2.30 per bushel. If cash settlement occurs, what transaction will the counter-party make in year 2 on a 5,000-bushel swap agreement? A) $250 payment B) $250 receipt C) $100 payment D) $100 receipt

Q: What is the 3-year swap price on corn? Assume interest rates over the next 3 years are 2.0%, 2.5%, and 2.8%. The prepaid swap price is given as $15.50. A) $5.10 B) $5.30 C) $5.43 D) $5.64

Q: Given zero-coupon bond yields are 2.0%, 2.5%, and 2.8% in years 1, 2, and 3, respectively, calculate the prepaid swap price for corn. Assume corn forward prices for the proceeding 3 years are $5.00, $5.20, and $5.35, respectively.A) $14.87B) $15.04C) $16.12D) $16.20

Q: How is duration calculated? What is the nature and use of duration? How does duration compare to the linear concept of the bond price and interest rate relationship? Is duration better than convexity or worse?

Q: Why can repos be used to simulate borrowing?

Q: What is the rationale behind cheapest-to-deliver calculations and why do we perform such calculations?

Q: Explain the process of creating a synthetic Forward Rate Agreement.

Q: Explain the expectations hypothesis and its ability to accurately forecast interest rates.

Q: What is the pure yield curve and why is it common to present coupon-based yield curves in practice?

Q: The price of a 6-month T-bill is 96.73. You wish to enter into a repurchase agreement that provides for your purchase of a $100,000 bond in 10 days at a price of 97.02. What is the implied 10 day repo rate in this transaction?A) 0.10%B) 0.20%C) 0.30%D) 0.40%

Q: You wish to create a synthetic forward rate agreement in which you would lock in a return between 150 and 310 days. The price of a 150-day zero coupon bond is 0.9823 and the price of 310-day zero coupon bond is 0.9634. What are the transactions used to create this instrument? A) Borrow one 150-day bond and invest in 1.02 of the 310-day bonds B) Borrow two 150-day bonds and invest in 0.98 of the 310-day bonds C) Lend one of the 150-day bonds and borrow 1.02 of the 310-day bonds D) Lend two of the 150-day bonds and borrow 0.98 of the 310-day bonds

Q: You wish to create a synthetic forward rate agreement in which you would lock in a return between 150 and 310 days. The price of a 150-day zero coupon bond is 0.9823 and the price of 310-day zero coupon bond is 0.9634. What is the approximate yield on the synthetic FRA? A) 1.8% B) 2.0% C) 2.9% D) 3.8%

Q: The conversion factor on a deliverable bond is 1.03 and the bond price is 100.50. The observed futures price is 97.5 and the YTM is 5.8%. What is invoice less market price on the security? A) +0.08 B) -0.08 C) -0.02 D) +0.02

Q: Compute the conversion factor on a semi-annual 6.8% coupon bond, which matures in exactly 5 years. A) 1.037 B) 1.046 C) 1.052 D) 1.068

Q: A 4-year bond with a price of 100.696 exists. The duration on the bond is 3.674. If the yield rises from 5.8% to 6.2%, what is the new bond price as estimated by the duration? A) $98.40 B) $99.30 C) $100.60 D) $101.40

Q: Given a 3-year, 8.0% annual coupon bond with a par value of $1,000, what is the bond's Macaulay duration if the yield to maturity is 9.5%? A) 2.779 B) 2.634 C) 2.535 D) 2.442

Q: Two months from today you plan to borrow $3 million for 6 months at LIBOR. You hedge your interest rate risk with a euro dollar futures contract priced at 93.6. If settled in arrears, what is your payment if the 6-month LIBOR is 2.5% in two months? A) $8,500 B) $10,500 C) $13,500 D) $15,500

Q: A Forward Rate Agreement contains an agreed interest rate of 3.1% on a 6-month loan. If settled in arrears, what amount would the borrower pay or receive on an $800,000 loan if the prevailing 6-month interest rate is 3.6%? A) $4,000 payment B) $4,000 receipt C) $1,729 payment D) $1,729 receipt

Q: A Forward Rate Agreement contains an agreed interest rate of 3.1% on a 6-month loan. If settled at the time of borrowing, what amount would the borrower pay or receive on a $500,000 loan if the prevailing 6-month interest rate is 2.9%? A) $1,000 payment B) $1,000 receipt C) $972 payment D) $972 receipt

Q: The annual coupon rate on a 1-year treasury bond is 5.5%. The coupon on a 2-year treasury bond is 5.8%. What is the continuously compounded yield on a 2-year zero coupon bond? A) 5.55% B) 5.65% C) 5.75% D) 5.85%

Q: The annual coupon rate on a 1-year treasury bond is 5.5%. The coupon on a 2-year treasury bond is 5.8%. What is the implied YTM on a hypothetical 2-year zero coupon treasury bond? A) 5.45% B) 5.50% C) 5.75% D) 5.81%

Q: The prices of 1, 2, 3, and 4-year zero coupon government bonds are 95.42, 90.36, 85.16, and 78.81, respectively. What is the continuously compounded 3-year zero yield? A) 5.35% B) 5.85% C) 6.12% D) 6.40%

Q: The prices of 1, 2, 3, and 4-year zero coupon government bonds are 95.42, 90.36, 85.16, and 78.81, respectively. What is the par coupon on a 4-year coupon bond selling at par? A) 5.02% B) 5.43% C) 5.81% D) 6.06%

Q: The prices of 1, 2, 3, and 4-year zero coupon government bonds are 95.42, 90.36, 85.16, and 78.81, respectively. What is the implied 2-year forward rate between years 2 and 4? A) 4.8% B) 5.2% C) 5.5% D) 6.4%

Q: The price of a 3-year zero coupon government bond is 85.16. The price of a similar 4-year bond is 78.81. What is the 1-year implied forward rate from year 3 to year 4? A) 4.6% B) 5.5% C) 5.8% D) 6.7%

Q: The price of a 3-year zero coupon government bond is 85.16. The price of a similar 4-year bond is 78.81. What is the yield to maturity (effective annual yield) on the 3-year bond? A) 4.6% B) 5.5% C) 5.8% D) 6.7%

Q: The price of a 3-year zero coupon government bond is 85.16. The price of a similar 4-year bond is 79.81. What is the yield to maturity (effective annual yield) on the 4-year bond? A) 4.6% B) 5.5% C) 5.8% D) 6.7%

Q: A review of seasonality forward curves may lead students to adopt a technical analysis mentality. Ask students to explain why such ideas may pop into their heads. Proceed to inquire as to why the curves have the appearances they do. An actual numerical example may be in order. If any still hold fast to their technical roots, insist that they show the profit numerically after considering all storage and other costs.

Q: When is it possible for the lease rate to fall below zero?

Q: What function does the convenience yield serve in setting forward prices and how does this influence arbitrage opportunities?

Q: Why is the cash-and-carry strategy employed in the financial futures market not readily available in the commodity futures market?

Q: Give one example of how price discovery functions in the commodity futures market.

Q: Explain how a negative correlation between agricultural production and commodity prices creates a natural hedge.

Q: Oil is selling at a spot price of $42.00 per barrel. Oil can be stored at a cost of $0.42 per barrel per month. The opportunity cost of capital is 7.2% per year (or 0.6% per month). What is the gain or loss realized by an oil refinery that floats its exposure and purchases oil on the spot market in 2 months at a price of $43.00 per barrel, instead of hedging with a forward contract?A) $0.35 gainB) $0.35 lossC) $1.00 gainD) $1.00 loss

Q: The spot price of corn is $5.82 per bushel. The opportunity cost of capital for an investor is 0.6% per month. If storage costs of $0.03 per bushel per month are factored in, all else being equal, what is the future value of storage costs over a 6-month period? A) $0.1534 B) $0.1684 C) $0.1772 D) $0.1827

Q: The spot price of corn is $5.85 per bushel. The opportunity cost of capital for an investor is 0.5% per month. If storage costs of $0.04 per bushel per month are factored in, all else being equal, what is the likely price of a 4-month forward contract? A) $5.808 B) $5.736 C) $5.968 D) $6.006

Q: The 6-month futures price for oil is $96.60 per barrel (or 2.30 cents per gallon). The 6-month futures prices for gasoline and heating oil are 2.50 cents and 2.15 cents, respectively. What is the gross margin on a simple 3-2-1 crack spread? A) $0.25 B) $0.35 C) $0.54 D) $0.68

Q: Forward prices for gold, in dollars per ounce, for the next five years are 1350, 1400, 1560, 1675, and 1756, respectively. A mine can be opened for 3 years at a cost of $2,000. Annual mining costs are a constant $500 and interest rates are 5.0%. When should the mine be opened to maximize NPV? A) Year 1 B) Year 2 C) Year 3 D) Never

Q: Nine-month gold futures are trading for $1565 per ounce. The spot price is $1509 per ounce. LIBOR during each of the upcoming 4 quarters is listed as 1.04%, 1.22%, 1.30%, and 1.35%, respectively. Calculate the 9-month lease rate on the futures contract. A) 2.4% B) 2.1% C) 1.3% D) 0.0%

Q: The spot price of gasoline is 258 cents per gallon and the annualized risk free interest rate is 4.0%. Given a lease rate of 1.0%, a continuously paid storage rate of 0.5%, and a convenience yield of 0.75%, what is the no-arbitrage price range of a 1-year forward contract (in cents)? A) 265.19 to 267.19 B) 258 to 265.19 C) 258 to 267.19 D) 247.16 to 265.19

Q: Refer to the table 6.1. The lease rate on the 6-month soybean contract is 0.35%. What is the implied annual storage cost if the cost is continuously paid and proportional? A) 0.84% B) 1.62% C) 2.30% D) 4.0%

Q: Refer to the table 6.1. Given a lease rate of 7.0% on the 24-month corn forward contract, what is the approximate potential arbitrage profit per contract? A) 3.68 cents B) 4.48 cents C) 5.84 cents D) 6.90 cents

Q: Refer to the table 6.1. Which of the following terms most accurately describes the forward curve for soybeans over the next two years? A) Contango B) Backwardation C) Contango and backwardation D) None of the above

Q: Refer to the table 6.1. If wheat farmers expect a return of 8.0% on their investment in wheat, what is the approximate implied increase in wheat commodity prices over the next 6 months? A) 3.75% B) 4.59% C) 5.26% D) 6.37%

Q: Refer to the table 6.1. What is the approximate annualized lease rate on the 18-month soybean forward contract? A) 0.69% B) 1.52% C) 2.69% D) 3.31%

Q: When answering the questions below, refer to the following table of commodity forward and spot prices. The annual risk free interest rate is 4.0%.Table 6.1Refer to the table 6.1. What is the approximate annualized lease rate on the 12-month corn forward contract?A) 0.00%B) 2.25%C) 3.92%D) 7.84%

Q: Throughout the chapter the topic of arbitrage is mentioned. Ask the class to explain arbitrage. Follow-up the answers by asking what role arbitrage plays in futures and forward markets. Finish up the Q & A with a group discussion of why arbitrage exists, given the limited opportunity for arbitrage profits. Guide students towards an understanding of the necessity of the arbitrage function, despite the limited opportunity for profit.

Q: Explain the steps necessary to take advantage of an arbitrage opportunity, which may exist between the dollar and yen, when a future yen payment is required.

Q: What are some uses for index futures contracts?

Q: What is the process involved in creating a cash-and-carry strategy?

Q: Name some advantages that futures contracts have over forward contracts.

Q: Explain the impact transaction costs have on the ability to make arbitrage profits in forward and futures markets.

Q: The current currency spot rate is $1.31 per euro. If dollar denominated interest rates are 3.0% and euro denominated interest rates are 4.0%, what is the likely dollar per euro exchange rate for a 2-year forward contract? A) $1.28 B) $1.30 C) $1.31 D) $1.33

Q: The manager of a blue chip growth stock mutual fund is trying to fully hedge the $650 million portfolio position during the last two months of the calendar year. The current price of the S&P 500 Index futures contract is 1200. If the mutual fund has a beta of 1.24, how many contracts will be needed to hedge the fund? A) 1,083 B) 3,033 C) 242,963 D) 541,666

Q: An investor wants to hold 200 euro two years from today. The spot exchange rate is $1.31 per euro. If the euro denominated annual interest rate is 3.0% what is the price of a currency prepaid forward? A) $200 B) $206 C) $231 D) $247

Q: Interest rates on the U.S. dollar are 6.5% and euro rates are 5.5%. The dollar per euro spot rate is 0.950. What is the arbitrage profit on a required 1 million euro payment if the forward rate is 0.980 dollars per euro and the exchange occurs in one year? A) $10,000 B) $21,000 C) $28,000 D) $34,000

Q: Interest rates on the U.S. dollar are 5.4% and euro rates are 4.6%. Given a dollar per euro spot rate of 0.918, what is the 6-month forward rate ($/E)? A) 0.912 B) 0.917 C) 0.922 D) 0.934

Q: The S&P 500 Index price is $925.28 and its annualized dividend yield is 1.40%. LIBOR is 4.2%. How many futures contracts will you need to hedge a $25 million portfolio with a beta of 0.9 for one year? A) 105 B) 120 C) 80 D) 95

Q: Consider an investment in five S&P 500 Index futures contracts at a price of $924.80. The initial margin requirement is 15.0% and the maintenance margin is 10.0%. If the continuously compounded interest rate is 5.0% what will the futures price need to be for a margin call to occur 10 days from now? Assume no settlement within the 10 days. A) $852.64 B) $872.79 C) $898.63 D) $905.25

Q: The price of an S&P 500 Index futures contract is $988.26 when you decide to enter a long position. When the position is closed the futures price is $930.32. If there are no settlement requirements, what is your percentage gain or loss under a 15.0% margin requirement? (Ignore opportunity costs.) A) 39% gain B) 39% loss C) 43% gain D) 43% loss

Q: The price of an S&P 500 Index futures contract is $988.26 when you decide to enter a long position. When the position is closed the futures price is $930.32. If there are no settlement requirements, what is your dollar gain or loss? (Ignore opportunity costs.) A) $14,485 loss B) $14,485 gain C) $57.94 loss D) $57.94 gain

Q: The annualized dividend yield on the S&P 500 Index is 1.40%. The continuously compounded interest rate is 6.4%. If the 9-month forward price is $925.28 and the index is priced at $950.46, what is the profit/loss from a cash-and-carry strategy? A) $25.18 loss B) $25.18 gain C) $61.50 loss D) $61.50 gain

Q: Which of the following statements does NOT accurately reflect the relationship between securities and synthetic forward contracts? A) Forward = stock - zero coupon bond B) Zero coupon bond = stock - forward C) Prepaid forward = forward - zero coupon bond D) Stock = forward + zero coupon bond

Q: The S&P 500 Index is priced at $950.46. The annualized dividend yield on the index is 1.40%. The continuously compounded annual interest rate is 8.40%. What is the price of a forward contract that expires 9 months from today? A) $937.48 B) $942.66 C) $984.36 D) $1001.69

Q: HAW, Inc. plans to pay a $1.10 dividend per share in 3 months and a $1.15 dividend in 6 months. HAW's share price today is $45.60 and the continuously compounded quarterly interest rate is 2.1%. What is the price of a forward contract, which expires immediately after the second dividend? A) $45.28 B) $45.96 C) $45.60 D) $46.24

Q: The S&P 500 Index is priced at $950.46. The annualized dividend yield on the index is 1.40%. What is the price of a 6-month prepaid forward contract on the S&P 500 Index? A) $943.83 B) $950.00 C) $964.26 D) $984.21

Q: KMW, Inc. plans to pay a dividend of $0.50 per share both 3 and 6 months from today. KMW's share price today is $36.00 and the continuously compounded quarterly interest rate is 1.5%. What is the price of a 6-month prepaid forward contract, which expires immediately after the second dividend? A) $35.00 B) $35.02 C) $36.98 D) $37.00

Q: Engage the class in a discussion of why firms hedge risks. Steer them towards an understanding that firms manufacture products, they do not speculate in commodity markets. Now, turn the tables and ask why manufacturers do not employ pure hedge strategies with forward contracts. Try to get the class to arrive at the conclusion that since firms are experts in their respective industries, their knowledge may benefit them by implementing creative strategies, while still hedging losses.

Q: Why are synthetics created and/or calculated when the actual derivative is available?

Q: Why are managerial controls over option and forward trading departments vital to proper risk control?

Q: Explain the relationship between options costs and profits under a put option insurance strategy.

Q: Why would a manufacturer elect to use a long call strategy instead of a forward contract to hedge the risk associated with variable costs?

Q: From a strictly conceptual perspective, why would any manufacturer consider hedging their variable costs? Answer as if you own the company.

Q: A farmer sells 4 million bushels of corn at a spot price of $2.10 per bushel. The total cost of production was $9.2 million. The farmer has an effective tax rate of 25%. If the farmer entered into a futures contract at a price of $2.40 per bushel on 4 million bushels, what is the farmer's net loss or gain?A) $100,000 lossB) $800,000 lossC) $300,000 gainD) $400,000 gain

Q: Given a 25% chance of a 600,000 bushel yield and a 75% chance of a 500,000 bushel yield, what quantity should the farmer hedge in order to protect against an uncertain harvest? Assume the farmer is willing to take reasonable risk. A) 0 B) 500,000 C) 525,000 D) 600,000

Q: A farmer expects to harvest 800,000 bushels of corn. To eliminate price risk, the farmer elects to short corn futures. What would cause the farmer to short only 720,000 bushels of corn? A) Basis risk B) Illiquid futures markets C) Margin requirements D) Quantity uncertain

Q: A $1.75 strike call option has a $0.14 premium. The $1.75 strike put option premium is $0.12. What is the net cost for Farmer Jayne to create a synthetic short forward contract? (Assume 4.0% interest.) A) $0.0208 B) -$0.0208 C) $0.000 D) -$0.0424

Q: Farmer Jayne bought a $1.70 strike put option for $0.11 and sold a $1.75 strike call option for a premium of $0.14. Her total costs are $1.65 per bushel and interest rates are 4.0% over this period. What is the floor in her strategy assuming a 20,000-bushel crop? A) $624 B) $1,624 C) $2,624 D) $3,624