Finance 562 Winter 2011 - Mid-Term Exam Name:________________________

TEST QUESTIONS (Either circle the correct answer or fill in the blank)
(Each Question is worth 3 Points) SHOW ALL of YOUR WORK!!
ALSO: SHOW PRECISION TO 4 DECIMAL PLACES
1. Which of the following best describes a contango market?
a. the cost of carry is negative
b. the cost of carry is positive
c. the spot price is greater than the futures price
d. the futures price is less than the spot price

2. Find the non-arbitrage futures price of a CME Euro FX futures contract if the Euro
FX spot rate is $1.380, the U.S. interest rate is 1.00 percent (100 basis points), the

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Euro-FX interest rate is 2.00 percent (200 basis points), and the Euro-FX futures
contract has three (3) months until expiration.

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3. A market displaying backwardated futures prices is consistent with
a. a zero basis
b. a negative carry market
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c. a positive carry market

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d. all futures prices exceeding spot prices

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4. What is the spot price of a stock index if the full carry stock index futures price is
1,100.00, the risk-free rate is 0.50%, the dividend yield is 1.75%, and the futures
contract has one-year (12) months until expiration?
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5. Suppose it is currently January. The March futures price is $65 and the June
futures price is $68. What should this $3 spread represent?
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a. the cost of carry from March to June

b. the expected risk premium from January to March
c. the cost of carry from January to March
d. the expected risk premium from March to June

6. Suppose you buy a stock index futures contract at $1,155 today. At the end of the
day the futures price settles at $1,165. The short-term interest rate equals 2.50 per
cent. What is the mark to market value of your futures position?

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 7. What is the economic value of a short position in one December T-note futures
contract if you bought the futures contract at 100-00, and the futures price has not
changed?
a. $100,000
b. zero
c. $1,000,000
d. $100

8. Which of the following can explain a contango futures market pricing relationship?
a. the cost of carry is positive
b. the short-term financing rate is less than the dividend yield
c. futures prices exceed forward prices
d. the market is at less than full carry

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9. The spot price of a commodity plus the cost of carry equals

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a. the convenience yield

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b. the systematic risk premium

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c. the full carry futures price
d.
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the idiosyncratic risk premium
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10. Suppose you buy a 5,000 ounce silver forward contract at $20.50 per ounce with
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one-year to expiration . One year later, at expiration, the silver spot price is $22.50
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per ounce. The risk-free rate is 3 percent. What is the economic value of this
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forward contract on the expiration date?

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11. Suppose you sell a 3-month 5,000 bushel corn futures contract at $4.00/bushel.
One month later, the corn futures contract is trading at $3.50/bushel. The risk-free
rate is 3 percent. What is the economic value of your short position after the price
decline to $3.50 per bushel?
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12. Futures prices differ from spot prices by which one of the following factors?
a. the risk premium
b. the systematic risk
c. the calendar spread
d. the cost of carry

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 13. The cost of carry consists of all the following except
a. the systematic risk premium
b. the riskfree rate
c. the cost of storage
d. insurance on holding the asset position

14. The Initial Margin in a futures transaction differs from margin in a stock transaction
because
a. stock transactions are much smaller
b. delivery occurs immediately in a stock transaction
c. futures are much more volatile

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d. futures initial margin represents a performance bond

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15. If the initial margin is $3,000, the maintenance margin is $2,200 and your account

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balance has declined to $2,100, how much must you deposit?
a. nothing

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b.
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$800
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c. $100
d. $900
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16. If the initial margin of a futures contract is $3,000, the maintenance margin is
$2,200 and your trading account balance has declined to $2,250, how much must
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you deposit?
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a. $750
b. nothing
c. $800
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d. $50
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17. The number of futures contracts outstanding is called the

a. reportable position
b. minimum volume
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c. spread position
d. open interest
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18. Variation margin is represented by which of the following?

a. the difference in margin between hedgers and speculators
b. one-half of the maintenance margin level
c. cash flow as a result of the daily mark-to-market process
d. margin set by the variability of a futures price

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 Using the following information answer questions 19 to 21
Assume that markets are imperfect in the sense of not being free from transaction
costs and restrictions on short selling. The current spot price of gold is $1,350 per
ounce. Current interest rates are 0.25% per year on lending and 0.50% per year on
borrowing. Round-trip futures trading costs are $4 per 100-ounce gold contract.
Gold can be stored at zero cost per month per ounce. (Ignore interest on the
transaction costs.) Restrictions on short selling effectively mean that the reverse
cash-and-carry trader in the gold market receives the use of only 85 percent of the
value of the gold that is sold short. The futures contract in question has a 100
ounce standard size and four (4) months remain until the gold futures contract
expiration

19. What is the cash and carry boundary price for arbitrage for gold in this example?

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20. What is the reverse cash and carry boundary price or arbitrage for gold in this

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example?
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21. A decrease in the futures trading fee from $4 per contract to $3 per contract would
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have what impact on the non-arbitrage futures pricing band?

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22. The buyer of a futures contracted is obligated to:

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a. Take delivery of the underlying commodity if the futures position isnt

offset by contract expiration.
b. Sell the underlying futures contract prior to expiration
c. Make delivery of the underlying commodity if the futures position isnt
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offset by contract expiration.

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d. Earn a profit by holding the futures position.

23. The seller of a futures contracted is obligated to:

a. Take delivery of the underlying commodity if the futures position isnt
offset by contract expiration.
b. Buy the underlying futures contract prior to expiration
c. Make delivery of the underlying commodity if the futures position isnt
offset by contract expiration.
d. Earn a profit by holding the futures position.

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 Use the data in the following table to answer questions 24 to 28.
Semi-Annual Period Spot Rate & Spot &/or
= 180 days FRA Period FRA Rates
1 0-months X 6-months 0.0100
2 6-months X 12-months 0.0150
3 12-months X 18-months 0.0200
4 18-months X 24-months 0.0225

24. What would the zero coupon price or present value factor be for period 1?

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25. What would the zero coupon price or present value factor be for period 2, i.e. for

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1 year?

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26. What is the sum of the zero coupon prices or present value factors for the 4
periods?
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27. What is the Swap Fixed Rate (SFR) associated with this problem?
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28. You enter the above Interest Rate swap as the fixed rate payer at the swap fixed
rate (SFR) calculated in question 27. Immediately, all spot & FRA rates (0x6,
6x12; 12x18; 18x24) decline by 25 basis points. As the fixed rate payer, do you
benefit (mark-to-market profit) or are you negatively impacted (mark-to-market
loss) due to the 25 basis point decrease in the FRA rates?

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 Use the following information to answer questions 29 to 32.
Alex Trebek has just returned from a futures hedging seminar. He makes a decision
to hedge $200 million face value of U.S. long-term corporate debt that his firm plans
to issue in May. If the debt could be issued today, it would be priced at 105-16/32 to
yield 5.50%. With its 6.00% coupon rate paid semi-annually and 10 years to maturity,
the Macauley Duration of the debt would be 7.60 years. The T-note futures price is
equal to 103-00. The cheapest-to-deliver (CTD) T-notes yield to maturity is 5.80%.
with a Macauley Duration equal to 6.38 years. The conversion factor of the CTD T-
note is equal to 1.0000. The face value of the T-note futures contract is $100,000.
Treasuries pay semi-annual coupons.

29. What is the Modified Duration of the Treasury futures contract in the above example?

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30. What is the Modified Duration of the corporate debt Mr. Trebeks firm wishes to
issue?
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31. How many T-note futures would you use to hedge the $200 million face value
corporate debt position?
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32. What futures position would Alex tell his friend Monty Hall to use to hedge the
issuance of corporate debt, i.e. to hedge against higher interest rates?
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33. If the money market yield curve is downward sloping such that 3-month spot
interest rate is higher than the 6-month spot interest rates. The 3-month spot rate
is equal to 4.00%. Where should the 3 X 6-month FRA rate be trading?
a. Greater than 4%
b. Equal to 4%
c. Less than 4%
d. Insufficient information to answer the question

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 34. You have been assigned to fully hedge a $500 million stock portfolio using E-mini
S&P 500 futures. The portfolio has a 0.85 Beta. The S&P 500 spot index is
currently at 1160 and the nearby futures contract price is 1155. Remember that the
futures contract has a $50 multiplier. How may S&P 500 E-mini futures would you
use to fully hedge this stock portfolio?

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35. You wish to decrease the Beta exposure of your portfolio in question 34 from 0.85
to 0.70. How may S&P 500 eMini futures would you use to change the beta of this
portfolio and would you be a buyer or a seller of futures to extend the Beta?

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BUY or SELL?. How Many Futures? .
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36. Which of the following would represent the Cheapest to Deliver Treasury T-note
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into a Treasury futures contract?

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a. The T-note with the lowest implied repo rate and the smallest net basis
b. The T-note with the lowest implied repo rate and the largest net basis
c. The T-note with the highest implied repo rate and the largest net basis
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d. The T-note with the highest implied repo rate and the smallest net basis
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37. Today you went long a $20 million 90X270 Day FRA at 1.25%. In 90-days the
reference rate for 180-day LIBOR is 2.25%. What is the settlement value of your
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long FRA position?

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38. What factors will lead to an increase in a bonds duration?

a. Longer maturity & higher coupon
b. Higher coupon and shorter term to maturity
c. Lower yield to maturity & lower coupon
d. Lower yield to maturity & higher coupon
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 Use the information in the following Table to answer questions 39 to 43.
This information illustrates CTD Treasury notes and bonds and their respective pricing
based on recent market conditions. Treasury notes and bonds pay semi-annual
coupons. Assume $100,000 Notional Value for Futures.
Issue Maturity Coupon Yield to Market Conversion Macauley
Date Rate Maturity Price Factor Duration
5-year T-note 02/28/2015 2.375% 1.00% 106-00/32 0.8680 4.18 years
10-year T-note 08/15/2017 4.750% 1.75% 119-16/32 0.9335 5.95 years
39. What is the Basis Point Value (BPV) for the CTD 5-Year T-note per $100,000
face value?

. PER $100,000 FACE.

40. What is the BPV for the CTD 10-Year T-note per $100,000 face value?

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. PER $100,000 FACE.

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What is the BPV for the 5-Year T-note futures contract per $100,000 face value?
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. PER $100,000 FACE.
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42. What is the BPV for the 10-Year T-note futures contract per $100,000 face value?

. PER $100,000 FACE.

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43. To create a yield neutral (or equal BPV weighted) spread between the 5-year and
10-year T-note futures contracts, how many 5-year T-note futures would you
SELL if you were BUYING 100 10-year T-note futures contracts?
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44. If you BOUGHT 100 10-year T-note futures and SOLD the requisite number of
5-year T-note futures to establish a neutral BPV weighted position, what type of
yield curve change/shift would generate a profit?
a. A parallel shift in the yield curve
b. A flattening yield curve
c. A steepening yield curve
d. An unchanged yield curve

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 45. If the 3-month spot rate is equal to 0.75% and the 6-month spot rate is equal to
1.50%, then what should the non-arbitrage 3 X 6-month FRA rate be equal to?
Assume 3-months = 90-days and 6-months = 180 days. SHOW ANSWER TO 4
DECIMAL PLACES

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46. How does the presence of delivery options such as the Wild Card delivery
option or the Switching option impact the equilibrium price of a Treasury
futures contract? Increase, Decrease, or No Impact. ( A one sentence answer is
sufficient!!)

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Consider the following futures pricing model for a stock index futures contract.
(r q)T
(Assumes a continuous dividend yield): F0 = S0 e
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Assume the following:

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F0 = 1195.50
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S0 = 1200.00
q = 2.00%
T = 0.25 (3-months)
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What is the implied interest rate (r) that equates the Spot Price with the Futures
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Price? Hint: take ln of both sides of the expression and solve for r.
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. r= .
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