CFA 2018 Quest bank 01 Derivative Investments Forwards and Futures

Test ID: 7441790

Derivative Investments: Forwards and Futures

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Question #3 of 85

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Considera9-month forward contractona10-year7% Treasury note justissuedat par. Theeffectiveannual risk-freerateis 5_% overt_heneartermandt_hefirst _cou_ponisto _be _paidin18₂ da_ys_. T_he _pri_ceoft_heforwardiscl_osestto:

1,037.27. 1,001.84.

965.84.

Explanat_io_n

The_fo_{rward pric}e_is _calculate_dast_he _bo_{nd pric}e_minust_he _prese_nt_valueo_ft_he _co_upo_n,t_imeso_ne _plust_he_ris_k-free_rate_fo_r thete_rmo_fthe_fo_rward.

(1,000 - 35/1.05 )1.05 = $1,001.84

Ho_wis_market _backwardat_io_nre_late_dto_anasset_'s _co_nve_nie_nce _yie_{ld? If}t_he _co_nve_nie_nce _yie_ldis_:

positive, causing the futures price to be below the spot price and the market is in backwardation.

negative, causingthefutures priceto be belowthespot priceandthemarketisin

backwardat_io_n.

largerthanthe borrowingrate, causingthefutures priceto be belowthespot price

andthemarketisin backwardation.

Explanation

Whenthe convenience yieldismorethanthe borrowingrate,theno-arbitrage cost-of-carry model will notapply. Itmeansthat t_he_valueo_ft_he _co_nve_nie_nceo_{f h}o_ldingt_he_asset_it_is_wo_rt_{h m}o_ret_hant_he _costo_ffundsto _purchase_it_{. Thi}s_us_{ually appli}esto

no_{n-financial fu}t_ures _co_nt_racts_.

A portfoliomanager holds100,000sharesofIPRDCompany (which istradingtoday for $9 pershare)fora client. The client

informsthemanagerthat hewould liketo liquidatethe positiononthe lastday ofthe quarter,which is 2 monthsfromtoday.

To _he_dge_against_{a p}oss_ible_de_cline_{in pric}e_duringt_he_ne_xtt_wo_mo_nt_hs_,t_he_manage_re_nte_rs_into_afo_{rward c}o_nt_racttose_ll t_he

IPRDshares_in 2 mo_nths. The_risk-free_rate_is 2.5%,andno_divide_nds_areexpecte_dto be_rece_ive_dduringthist_ime. Ho_we_ve_r,

IPRD hasa historical dividend yieldof3.5%. Theforward priceonthis contractisclosestto: $905,175.

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Question #4 of 85

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Question #5 of 85

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$903,712. $901,494.

Explanation

The historical dividend yieldisirrelevantfor calculatingtheno-arbitrageforward price becausenodividendsareexpectedto be paidduringthe lifeoftheforward contract. Intheabsenceofanarbitrageopportunity,thevalueof should

be_0.

Therefore,FP = S (1 + R) 903,712 = 900,000(1.025)

At co_nt_ract_init_iat_io_n,the_valueo_fafo_rward co_nt_ract_: is set to 100 byconvention.

dependsonthemarket priceoftheunderlyingasset.

ist_{ypically z}e_ro_re_gardlesso_ft_he _priceo_ft_he_unde_rlyingasset_.

Explanation

Duetot_he_no_-arbit_rage _principle_,t_he _priceo_fafo_{rward c}o_nt_ract_is _calculate_dto_maket_he_valueo_ft_he _co_nt_ract _ze_ro_at _co_nt_ract

initiation. Neitherthe longnortheshorttypically makesany paymenttoenterintotheforwardagreement. Aspecial caseisan

off-marketforwardwhere,forwhateverreason,the contract priceisnotsetequal totheno-arbitrage price,andthe longor

short positionmakesa paymenttotheopposite counterparty tooffsetthedifference.

Thevalueofafutures contractis:

zero when the account is marked to market for an account that has sufficient margin.

calculatedinthesamemannerasthevalueofaforward contract. equal tothe_variat_io_nmargin paido_nany give_nday.

Explanation

Thevalueofafutures contractis zerowhentheaccountismarked-to-marketandthereisnomargin call. The priceofthe contractisadjustedtothenew 'no-arbitrage'value,which istheoretically thesameasthesettle priceattheendoftrading,as longas price change limits havenot beenreached. Notethatthisisdifferentfromaforward contract. With aforward contract,

t_he_fo_{rward pric}e_is_fixe_dfo_rt_he _lifeo_ft_he _co_nt_ractsot_he _co_nt_ract_{may accumula}tee_it_he_{ra p}os_it_iveo_rne_gat_ive_value_ast_he

fo_rward price_fo_rne_w co_nt_racts changeso_ve_rthe lifeo_fthe co_nt_ract.

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Question #7 of 85

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JimTre_nt_,CFA has bee_naske_dto price_athree_mo_nth fo_rward co_nt_racto_n10,000shareso_f Global Indust_riesstock. The stock is currently tradingat $58andwill pay adividendof $2 today. Iftheeffectiveannual risk-freerateis 6%,what price shouldtheforward contract have? Assumethestock pricewill changevalueafterthedividendis paid.

$56.85.

$58.85. $56.82.

Explanation

Onemethodistosubtractthefuturevalueofthedividendfromthefuturevalueoftheasset calculatedattherisk freerate (i.e. theno-arbitrageforward pricewith nodividend).

FP = 58(1.06) - 2(1.06) = $56.82

Thisisequivalenttosubtractingthe presentvalueofthedividendfromthe current priceoftheassetandthen calculatingthe

no-arbitrageforward price basedonthatvalue.

Cre_dit_risk tothe lo_ng (pos_it_io_n)inafo_rward co_nt_ract_will incre_aseo_ve_rthe lifeo_fthe co_nt_ract_dueto_all o_fthe_follo_wing EXCEPTthe:

short partyhas deteriorating finances.

settlementdateisgetting closer.

co_nt_ract_valuetot_hes_ho_rt_is_ne_gat_ive_andde_cre_as_ing.

Explanation

Deterioratingfinancesofthe counterparty increasethe probability ofdefault. Theamountowedtothe longincreasesasthe

valueoftheunderlyingassetincreases,which isthesameasanincreaseinthevalueofthe contract. Anincreaseinthe

amount 'owed' andanincreaseinthe probability ofdefault can both beviewedasincreasing creditrisk. By itself,the passage o_ft_ime_does_not_ne_cess_{arily incr}e_ase _cre_dit_ris_k.

The priceofa3 × 5forwardrateagreement (FRA)isthe: 2-month implied forward rate 5 months from today. 3-month impliedforwardrate5monthsfromtoday. 2-mo_nth implie_dfo_rwardrate_3mo_nths_fro_mto_day.

Explanation

ThenotationforFRAsisunique. Therearetwonumbersassociatedwith anFRA:thenumberofmonthsuntil the contract expiresandthenumberofmonthsuntil theunderlying loanissettled. Thedifference betweenthesetwoisthematurity ofthe

underlying loan. Forexample,a3 × 5FRAisa contractthatexpiresinthreemonths (90days),andtheunderlying loanis

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sett_le_dinfive_mo_nt_hs _(150days_{). Th}e _priceo_ft_he_{3 × 5FRAi}s _calculate_{d by annualizing}t_he_implie_dfo_rwardrate_{. Th}e_implie_d

fo_rwardrate_is calculate_dfro_mthe₃-mo_nth rate_andthe₅-mo_nth rate.

The U.S. risk-freerateis 2.96%,the Japanese yenrisk-freerateis1.00%,andthespotexchangerate betweenthe United

St_ates_{and Japani}s _{$0.00757 p}e_{r y}e_{n. B}ot_{h ra}tes_are _co_nt_inuo_us_{ly c}o_mpo_unde_{d. Th}e _priceo_{fa180-day f}o_{rward c}o_nt_racto_n the ye_nandthe_valueo_fthe_fo_rward pos_it_io_n90days_intothe co_nt_ract_whe_nthespot_rate_is $0.00797arecl_osestto_:

Forward Price Valu

e_Afte_r90

Days

$0.00764 $0.00212

$0.00764 $0.00037

$0.00750 $0.00212

Explanation

The_no-arbit_rage priceo_fthe₁₈₀-day fo_rward co_nt_ract_is_:

F = $0.00757 × e _{= $0.00764}

Thevalueofthe contractin90dayswith 180 - 90 = 90daysremainingis:

As_it_uat_io_nwhe_rethe_fut_ures price_is_abo_vethespot priceo_fthe_unde_rlyingasset_is calle_d:

positive carry.

contango.

no_{rmal backwarda}t_io_n.

Explanation

As_it_uat_io_nwhe_ret_he_fut_ures _price_is_abo_vet_hes_pot _priceo_ft_he_asset_is _calle_{d c}o_nt_ango_.

Overthe lifeofaforward contract,theamountof creditrisk isleastlikelyto: change signs.

incre_ase_. stay thesame.

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Question #13 of 85

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Explanation

Theamountof creditrisk is least likely tostay thesame. Theamountof creditrisk is basedonthe contractvalue,which is zero

at contractinitiation. Forthevaluetostay thesame (at zero),theexpectedfuture priceoftheassetmustnot changeoverthe life_oft_he _cont_ract_,anunlike_{ly circum}st_ance_{. A}st_he_value_oft_he _cont_ractt_ot_he _longgoes_{from po}s_it_ivet_one_gat_ive_,t_he

amount_of cre_dit_risk changes_ins_ign.

30daysago, J. Kleintook ashort positionina $10million (3X6)forwardrateagreement (FRA) basedonthe London Inte_{rbank Off}e_re_{d Ra}te _{(LIBOR)and pric}e_dat_{5%. Th}e _curre_nt _{LIBOR curv}e_is_:

30-day = 4.8% 60-day = 5.0% 90-day = 5.1% 120-day = 5.2% 150-day = 5.4%

The _curre_nt_value_oft_he_FRA,t_ot_hes_hort_,isc_losestto:

−$15,280. −$15,495. −$15,154.

Explanation

FRAsareenteredinto hedgeagainstinterestraterisk. A personwould buy aFRAanticipatinganincreaseininterestrates. If

interestratesincreasemorethantherateagreeduponintheFRA (5% inthis case)thenthe long positionisoweda payment fromtheshort position.

Step1:Findtheforward90-day LIBOR 60-daysfromnow.

[(1 + 0.054(150 / 360)) / (1 + 0.05(60 / 360)) − 1](360 / 90) = 0.056198. Since projectedinterestratesattheendoftheFRA haveincreasedtoapproximately 5.6%,which isabovethe contractedrateof5%,theshort position currently owesthe long position.

Step2:Findtheinterestdifferential betweena loanatthe projectedforwardrateanda loanattheforward contractrate. (0.056198 − 0.05) × (90 / 360) = 0.0015495 × 10,000,000 = $15,495

Step3:Findthe presentvalueofthisamount 'payable' 90daysafter contractexpiration (or 60 + 90 = 150daysfromnow)and noteonceagainthattheshort (whomust 'deliver' the loanattheforward contractrate) loses becausetheforward90-day LIBOR of5.6198% isgreaterthanthe contractrateof5%.

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Question #14 of 85

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Question #15 of 85

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Whatisthesituation calledwhenafutures price continuously increasesoverits life becausemost hedgingstrategiesareshort hedges?

Contango.

Normal backwardation.

Anormal market.

Explanation

Normal backwardationmeansthatexpected futures spot prices are greaterthan futures prices. Itsuggeststhat when hedgers

are netshortfutures contracts, they mustsell them at a discounttotheexpectedfuturespot pricesto getinvestorsto buy them. Thefutures pricerises asthe contract maturesto converge with spot prices.

All ofthefollowing areexamplesofthemonetary benefitsor costsof holding an assetunderlying a futures contract EXCEPT: having a ready supply of the asset for business purposes.

dividend paymentsfrom a portfolioofstocks. storage andinsurance costsforstoringgold.

Explanation

Having a ready supply of an assetfor business purposesis a non-monetary benefitof holdingthe asset. This convenience yield can resultin backwardation.

Comparedtofutures priceson a six-month contract,forward priceson an identical contract are: always higher.

equal.

higher, lower,orequal.

Explanation

Futures prices may be higheror lowerthan forward priceson a contractwith identical terms,dependingon the correlation between interestrate changes andthe price changesoftheunderlying asset. When interestrates and assetvalues are positively correlated,thefutures pricetendsto be higher, andwhen interestrates and assetvalues are negatively correlated,

thefutures pricetendsto be lower.

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Question #17 of 85

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Question #18 of 85

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-$297. $553. -$553.

Explanation Theformula is:

V=S / (1 + R ) − F / (1 + R ) .

Thevalueis0.08211 / 1.06 − 0.08254/1.05 = 0.08132763 − 0.08188065 = -0.00055302. The answerisin USD/ Peso, becausewhen multiplying by Pesos,the answerisin USD.

0.00055302 × 1 million Pesos = -$553.02.

Thevalueof a futures contract between thetimeswhen the accountis marked-to-marketis: never less than the value of a forward contract entered into on the same date.

equal tothedifference between the priceof a newly issued contract andthesettle price atthe mostrecent mark-to-market period.

thesame asthe contract price.

Explanation

Between the mark-to-market account adjustments,the contractvalueis calculated just likethatof a forward contract; itisthe

difference between the price atthe last mark-to-market andthe currentfutures price, (i.e. thefutures priceon a newly issued contract). The mark-to-marketof a futures contractisthe paymentorreceiptoffunds necessary to adjustforthegainsor

losseson the position. This adjuststhe contract pricetothe 'no-arbitrage' price currently prevailingin the market.

Thetheoretical priceof a forward contract: is the no-arbitrage price.

equalsthe long'sexpectation ofthefuture priceoftheunderlying asset. is alwaysgreaterthan the current priceoftheunderlying asset.

Explanation

Thetheoretical priceof a forward contractisthefuture priceoftheunderlying assetimposed by the no-arbitrage conditions. It can be lessthan the current priceofthe assetifthe cost-of-carry is negative. Accruedinterestis paid by the long atdelivery under a bondforward, butis notincludedin the price quote,which isusually in termsof yieldto maturity atthesettlement

date.

t t for(T−t) T dom(T−t)

Question #19 of 85

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Toinitiate an arbitragetradeifthefutures contractisunderpriced,thetradershould: borrow at the risk-free rate, short the asset, and sell the futures. shortthe asset,invest attherisk-freerate, and buy thefutures. borrow attherisk-freerate, buy the asset, andsell thefutures.

Explanation

Ifthefutures priceistoo lowrelativetothe no-arbitrage price, buy futures,shortthe asset, andinvestthe proceeds attheris k-freerateuntil contractexpiration. Takedelivery ofthe asset atthefutures price, pay foritwith the loan proceeds and keep the profit. ForTreasury bill (T-bills),shortingthe assetisequivalentto borrowing attheT-bill rate.

Which ofthefollowing bestdescribesthe priceof a forward contract? Theforward priceis: always equal to the market price at contract termination.

alwaysexpressedin dollars.

the pricethat makesthevaluesofthe long andshort positions zero at contract

initiation.

Explanation

Theforward priceisthe contract priceoftheunderlying assetunderthetermsoftheforward contract, andisthe pricethat makesthevaluesofthe long andshort positions zero at contractinitiation. Itis notthe amountit coststo purchasetheforward contract. Theforward priceisexpressedin termsoftheunderlying asset, and may be a dollarvalue,exchangerate,or

interestrate. Thevalueof a forward contract comesfrom thedifference between theforward contract price andthe market pricefortheunderlying asset. Thesevalues are likely to bedifferent at contracttermination,which will resultin a profitfor

eitherthe longortheshort position.

The no-arbitrage priceof a futures contractwith a spotrateof990, a timeto maturity of 2 years, and a risk-free-rateof5% is closestto:

792. 1040. 1091.

Explanation

The no-arbitrage priceof a futures contractis basedon thespotrate,thetimeto maturity, andtherisk-free-rate. FP = S × (1 + R)

= 990(1.05)

= 1091

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Question #24 of 85

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Question #25 of 85

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Thetheoretical question ofwhetherfutures prices areunbiased predictorsoffuturespotratesfocuseson: whether futures markets are efficient.

the correlation between interestrate changes and asset price changes. whetherfutures buyers aretakingon assetowners' pricerisk.

Explanation

Thetheoretical analysisofwhetherfutures prices areunbiased predictorsofspotrates atfuturesexpiration datesdependson whetherfutures buyers are being compensatedfortakingon the asset pricerisk thatfuturessellers are avoiding. Underthe assumption thatfuturestransactions aredriven by thosewith natural short pricerisk transactingwith thosewho have natural long positions,expectedfuturespot prices areequal tofutures prices.

The priceof a forward contract:

depends on forward interest rates. changesovertheterm ofthe contract. isdetermined at contractinitiation.

Explanation

The priceof a forward contractisestablished attheinitiation ofthe contract andisexpressedin differentterms,dependingon theunderlying assets. Itisthe pricethat makesthe contractvalue zero, anddependson currentinterestratesthrough the cost-of-carry calculation.

Thedifference betweenthespotandthefutures pricemust convergeto zeroatfuturesexpiration because:

the futures contract becomes equivalent to the underlying asset at expiration.

thefutures contract hasto beworth thesameasall otherdelivery months.

anarbitragetrade can beimplementedusingonly otherfutures contracts.

Explanation

Ifthefuturesandspot pricesarenotequal,arbitrageactivity will occur.

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Question #26 of 85

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Question #27 of 85

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Question #28 of 85

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on a one-yearindex forward contractifthe continuously compoundedrisk-freerateis5%. 991.1.

991.4. 987.2.

Explanation

Thefutures price FP = S e (e ) = S e

= 965e = 991.4

Attheexpiration of a futures contract,thedifference between thespot andthefutures priceis: at its point of highest volatility.

equal to zero. always positive.

Explanation

Thedifference must be zero atexpiration because both thespot price andthefutures price are, atthat pointin time,the price

oftheunderlying assetforimmediatedelivery.

Which ofthefollowingstatementsregarding Eurodollarfuturesismost accurate? Eurodollars futures are based on 60-day LIBOR, which is an add-on yield. Every basis point (0.01%) movein annualized 60-day LIBOR represents a $25gain or

losson the contract.

Eurodollarfutures are priced as a discount yield and LIBOR issubtractedfrom 100to

getthe quote.

Explanation

Eurodollarfutures are priced as a discount yield and are quoted as100 minus90-day LIBOR.

The creditrisk in a forward contractis: only an issue for the long. directly relatedtothe contractvalue.

0 -δT RT 0 (R-δ)T

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Question #29 of 85

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Question #30 of 85

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Question #31 of 85

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positively relatedtotheterm ofthe contract.

Explanation

The creditrisk tothe party with the position with the positivevalue (longorshort)isgreater,thegreaterthevalueofthe

forward contract at a pointin time. A contractwith a longerterm may have a lower contractvalue.

Comparedtothe priceon an otherwiseidentical forward contract,the priceof a futures contractis: always the same at contract initiation.

higherwhen asset price changes are positively correlatedwith interestrate changes. lowerwhen asset price changes are positively correlatedwith interestrate changes.

Explanation

A positive correlation between asset price changes andinterestrate changes makesthe mark-to-marketfeature attractiveto a futures buyer. This leadsto a higherfutures price comparedtotheforward priceon an otherwiseidentical contract.

Thereturn from the non-monetary benefitsof holdingthe assetunderlying a futures contractis (are) called: the non-monetary return.

negative-storage costs. the convenience yield.

Explanation

Thereturn from the non-monetary benefitsof holdingthe assetunderlying a futures contractis calledtheconvenienceyield.

Regardingfutures contracts,thespot pricereferstothe:

price of the underlying asset in a particular location, or 'spot', in the future. presentvalueoftheexpectedfuture price.

current market priceofthe assetunderlyingthefutures contract.

Explanation

Thespot pricereferstothe current market priceofthe assetunderlyingthe contract. Itisthe priceforimmediatedelivery of

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Questions #33-36 of 85

Question #33 of 85

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Backwardation refersto a situation where:

the futures price is above the spot price.

thefutures priceis belowthespot price. long hedgersoutnumbershort hedgers.

Explanation

Backwardation refersto a situation wherethefutures priceis belowthespot price. For backwardation tooccur,there must be a significant benefitto holdingthe asset,either monetary or non-monetary.

CraigChampion,CFA, manages portfoliosof U.S. securitiesfor European investors. His clients haveeach holddifferent kinds

ofsecurities, andeach hasdifferingviewswith respectto hedgingexchangeraterisk. Francois Levisqueis a Belgian investor

who holds a largediversified portfolioof U.S. equities. Levisque has a reputation forsomesuccessin timingthe U.S. equity market. Forexample, he hasoften lockedin gainson his portfoliowith derivativesshortly before a market correction.

Sometimes he also hedges his portfolio's currency risk. Levisque has justinstructedChampion totake a largeshort position in S&P 500index,eitherwith futuresorwith a forward contract. Champion noticesthatthefutures priceis lessthan the current

spot price and consultswith his colleagueDanielle Silvers,CFA. Champion says hethinksthatthefutures priceis lessthan the

spot price becausethedividend yieldofthe S&P 500isgreaterthan theTreasury Bill rate. Silverssaysthatit could just be backwardation. Silvers also notesthattheuseof a forward contract might be a goodidea becausethe contractwill not attract the attention ofother market participantswho mightreactto Levisque's move. Champion tells Silversthatthereason Levisque

wantsto hedge hisequity position isthat hethinks all U.S. interestrateswill increasesoon. This, he believes,is bearish for

equities, and he alsothinksthe negativerelationship between equity prices andinterestrates makes a shortforward contract more attractivethan a shortfutures contract.

Ragnar Hvammen is a Norwegian investorwith a largeinvestmentin oil-related assetsthat heoften hedgeswith futures contracts. Champion noticesthatthe priceof an oil futures contractisusually higherthan thespot price. Hvammen usesshort -term borrowingsin dollars,from both European and U.S. banks,to meetthe liquidity needsof hisoil investments, and he has Champion hedgethese loan positionswith Eurodollarfutures. SilverssuggeststhatChampion should considerusingT-bill futuresto hedgethe loansfrom U.S. banks, anduse Eurodollarfuturesonly forthe Eurodollar loans. Champion says hewill look intothat, aswell asforwardrate agreements, as alternative hedgingtoolsfor Hvammen.

Champion is alsoevaluating pricingofT-bondfutures. Specifically, heis lookingfor pricingon a 1.2-year contract. TheCTDis a 6.5% 30-year bondissued10 years ago currently yielding5%. The conversion factorforthe bondis1.08. Assumethatthe

risk-freerateoverthe contract periodis3%.

Champion and Silverseach gave a reason forwhy thefutures priceofthe S&P 500index might be lessthan thespot price. With respecttotheirstatements,itismostaccurateto concludethat:

Champion's statement is invalid while Silver's statment is valid. neitherstatementisvalid.

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Question #38 of 85

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Question #39 of 85

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not justified becausethe Eurodollarfutures marketis notvery liquid, and LIBOR is more correlatedwith short-term loan ratesthatT-bills.

Explanation

Eurodollarfutures arefutureson dollar LIBOR, and LIBOR isthe prevailingrateon very large bank loans called Eurocurrency loans. Therateson T-bills can bedriven by influences (e.g., a flightto quality)that aredifferentthan thosethatdrivedollar

LIBOR rates. As a result, Eurodollarfutures are more highly correlatedwith (dollar) bank loan ratesshould provide a better

hedgeforthe client's bank loan exposure. Moreover,the Eurodollarfutures marketis large andvery liquid.

Unlike U.S. T-bills andtheirfutures contracts, noriskless arbitragerelation exists between LIBOR andthe Eurodollarfutures contract:

but Eurodollar futures contracts are still a useful, widely used hedging vehicle for exposure to LIBOR.

thereforeinvestors mustutilizesynthetic instrumentsto hedgetheirexposureto

LIBOR.

resultingin mostinvestors hedgingtheir LIBOR exposurewith 90-day T-bill contracts.

Explanation

Although an imperfect hedge, Eurodollarfutures arestill widely usedto hedgeexposureto LIBOR.

The best measureofthe amountof creditrisk exposurefor a forward contract, at a pointin time,isthe: notional amount of the contract.

liabilitiesofthe counterparty. valueofthe contract.

Explanation

The amountof creditrisk is best measured by the contractvalue at a pointin time. Thisisthe presentvalueofthesettlement payment, basedon current market prices,interestrates,orexchangerates. The party towhom the paymentwould be made hasthe creditrisk,therisk thatthe paymentwill not be madeorthatthe assetwill not bedelivered/purchased at contract expiration.

Atexpiration,thevalueof a forward contractis:

ᅚ B)

ᅞ C)

Question #40 of 85

QuestionID:464011

ᅞ A) ᅞ B) ᅚ C)

Question #41 of 85

QuestionID:464028

ᅞ A) ᅞ B) ᅚ C)

Question #42 of 85

QuestionID:464022

thedifference between the contract price andthe marketvalueoftheunderlying asset.

alwaysgreaterthan orequal to zero.

Explanation

In a forward contract,the longisobligatedto buy, andtheshortisobligatedtosell,theunderlying asset atthe contract price. Thedifference between the contract price andthe market priceofthe assetiswhatgivesthe contractvalue. The contract has a positivevalue atexpiration tothe long/shortonly ifthe contract priceis below/abovethe market price.

Theforward pricein a 90-day forward contracton a non-dividend-payingstock currently (at contractinitiation)sellingfor $55 when the90-day risk-freerateis5% isclosestto:

$54.32. $52.38. $55.67.

Explanation

Whatisthevalueof a 6.00% 1x4 (30days x 120days)forwardrate agreement (FRA)with a principal amountof $2,000,000, 10days afterinitiation ifL is 6.15% andL is 6.05%?

$700.00. $767.40. $745.76.

Explanation

The current90-day forwardrate atthesettlementdate, 20daysfrom nowis: ([1+ (0.0615 x 110/360)]/[1+ (0.0605 x 20/360)] - 1) x 360/90 = 0.061517

Theinterestdifferenceon a $2 million,90-day loan made 20daysfrom now atthe aboverate comparedtotheFRArateof 6.0% is:

[(0.061517 x 90/360) - (0.060 x 90/360)] x 2,000,000 = $758.50 Discountthis amount atthe current110-day rate:

758.50/[1+ (0.0615 x 110/360)] = $745.76

ᅞ A) ᅚ B) ᅞ C)

ᅞ A) ᅚ B) ᅞ C)

Question #44 of 85

QuestionID:464073

Question #43 of 85

QuestionID:464053

issue. The currentterm structurefor LIBOR is asfollows: Term InterestRate

180days 5.65%

270days 5.95%

Whatisthe priceofthisforwardrate agreement (FRA)?

3.19% 6.37% $6.37

Explanation

The priceof an FRAisthefixedrate. TodeterminetheFRA'sfixedrate,thefollowingformula should beused:

TheFRA"sfixedratewould be quoted as 6.37%.

The priceof an FRAisgiven as a rate percentage, never as a dollar amount.

Attheexpiration of a futures contract,thefutures priceis: the same as the price at the initiation of the contract. equal tothemarket priceforimmediatedelivery ofthe asset. aboveor belowthemarket price,dependingon supply anddemand.

Explanation

Atexpiration,thefutures priceisequal tothe priceofthe assetforimmediatedelivery becausethe contract callsfordelivery of the asseton thatdate. Notethat atexpiration,thespot price andthefutures price areequal.

ᅞ A)

ᅚ B) ᅞ C)

Questions #45

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50 of 85

Sell the soybeans in the spot market, buy an appropriate futures, and profit $1,250.

Sell thesoybeansin thespotmarket, buy an appropriatefutures, and profit $2,500. Do nothingsincethe convenience yieldisso high.

Explanation

Sincethetraderdoes not needthesoybeans now heshouldmonetizethe convenience yield by sellingin thespotmarket and

simultaneously buy soybean futuresfor his later needs. Thetotal profitis computed asfollows: Total profit = (Cash Price − Futures Price) × Amount = ($6.50 − $6.00) × 5,000 = $2,500.

Chantal DuPontistheCFO of Vetements Verdun, a manufacturerofspecialty clothing anduniforms, locatedin northern France. Thefirmis currently undergoing an expansion which will requireDuPonttodrawdown 25million on Vetements Verdun's credit line as a 90-day bridge loan beforethemortgage closes. Themoney will not be neededfor 60days, atwhich pointtheinterestratewill bedetermined. Theinterestrateon the loan will be basedoff90-day LIBOR.

DuPontis becoming concerned becauseofsignsthatinterestratesmay begin torise. Thefirm cannot affordto haveits borrowing costsincreasesignificantly over currentrates. In responsetoDuPont's concerns,the company'sCEO, Viviane Lamarre, has askedDuPontto hedgethefirm's borrowing costs,even ifthatentailssome near-termoutlays.

DuPont and Lamarrediscussenteringinto a forwardrate agreement (FRA)to hedge Vetements Verdun'sinterestrate exposureon the credit line. Current LIBOR rates are:

L

i

b

o

r

rate

30

-

d

a

y

2.6%

6

0

-

d

a

y

2.

8

%

90

-

d

a

y

3

.

0

%

1

2

0

-

d

a

y

3

.2%

150

-

d

a

y

3

.

3

%

180

-

d

a

y

3

.

4

%

They decidetogoforwardwith the hedge andDuPontentersintothe appropriateFRAforthefull amountof 25million. In thefirst30daysoftheFRA,thefixedincomemarketsrally sharply. The newsetof LIBOR rates,on thethirtieth day ofthe FRA,is:

L

i

b

o

r

rate

30

-

d

a

y

2.2%

6

0

-

d

a

y

2.

4

%

90

-

d

a

y

3

.6%

ᅚ A) ᅞ B) ᅞ C)

ᅞ A) ᅚ B) ᅞ C)

ᅞ A) ᅚ B) ᅞ C)

Question #47 of 85

QuestionID:464041

Question #4

6

of 85

QuestionID:464040

Question #45 of 85

QuestionID:464039

150

-

d

a

y

3

.

8

%

180

-

d

a

y

3

.

8

%

Atthesettlementdate,theinterestsavingson the loan termis 23,750. DuPonttells Lamarre, "I am lookingforwardto cashing oursettlement check for 23,750." Lamarre adds, "Yes, andon top ofthatwegetto borrowfor90days at a below-market

rate." Both DuPont and Lamarre are pleasedwith theirdecision to hedge.

Which statementmost accurately describes a 2 x 3forwardrate agreement?

Contract expires in two months on an underlying loan settled in three months. Underlying loan oftwomonth maturity under a contractthatexpiresin threemonths. Two-month underlyinginterestrateon a contractsettledin threemonths.

Explanation

A 2 x 3forwardrate agreementis a contractthatexpiresin twomonths andtheunderlying loan issettledin threemonths. The underlyingrateis a 30-day (1-month)rateon a 30-day (1-month) loan in 60days (2 months). (Study Session 16, LOS 48.a)

Which forwardrate agreementwouldmosteffectively hedge Vetements Verdun'sexposureto LIBOR? 2x 3.

2 x 5. 3 x 2.

Explanation

Vetements Verdun needsto be hedged against90-day LIBOR ratesthatwill prevail 60daysfrom now. Such a hedgewould

require a two-month contracton three-month rates,to besettledin fivemonths: a 2 x 5. (Study Session 16, LOS 48.c)

Which valueisclosesttothe priceofthemosteffective hedgefor Vetements Verdun? 3.3%.

3.6%. 3.0%.

Explanation

The actual,unannualizedrateon the 60-day loan is: R60 = 0.028 × 60/360 = 0.00467

The actual,unannualizedrateon the150-day loan is: R150 = 0.033 × 150/360 = 0.01375

ᅚ A) ᅞ B) ᅞ C)

ᅞ A) ᅚ B) ᅞ C)

Question #49 of 85

QuestionID:464043

Question #48 of 85

QuestionID:464042

FR (60,90) = ((1 + R150)/(1 + R60)) − 1 FR (60,90) = (1.01375/1.00467) − 1 FR (60,90) = 1.00904 − 1

FR (60,90) = 0.904%

We annualizethisrateusingtheformula: 0.904% × (360/90) = 3.62%

(Study Session 16, LOS 48.c)

Whatmustthe90-day LIBOR rate have been attheexpiration ofthe contract? 4.0%.

3.6%. 3.4%.

Explanation

Since Vetements Verdun is longtheFRA,themarketrateofinterest atsettlementmust be higherthan the priceofthe contract andthe 23,750 has a positivevalue. Theinterestsavings attheendofthe loan termwill be:

Interestsavings = ( (marketrate × (90/360)) − (0.0362 × (90/360))) × 25,000,000 23,750 = ((marketrate × 90/360) − 0.00905) × 25,000,000

0.000950 = marketrate × 90/360 − 0.00905 0.0100 = marketrate × 0.25

0.0400 = marketrate

Themarketratemust have been 4.0%. (Study Session 16, LOS 48.c)

Regardingthestatementsmade by Lamarre andDuPont abouttheultimatevalueoftheir hedge:

Lamarre's statement is correct; DuPont's statement is incorrect. Lamarre'sstatementisincorrect; DuPont'sstatementisincorrect. Lamarre'sstatementisincorrect; DuPont'sstatementis correct.

Explanation

Theinterestsavings attheendofthe loan termmust bediscounted back tothe presentvalueon theFRAsettlementdate: Settlement payment = Presentvalueofinterestsavings

Settlement payment = 23,750 / (1 + (0.040 × 90/360)) Settlement payment = 23,750 / (1 + 0.010)

Settlement payment = 23,750 / 1.010 Settlement payment = 23,515

Thesettlement check would befor 23,515. DuPont'sstatementisincorrect. Lamarre'sstatementis alsoincorrect becausethe

ᅚ A) ᅞ B) ᅞ C)

Question #50 of 85

QuestionID:464044

settlementon theFRAwill offsettheinterest coston the loan. (Study Session 16, LOS 48.c)

Thirty daysintotheFRA,whatisthevalueofthe contractfrom Vetements Verdun's perspective? Due 43,943.

Due45,000. Owes43,943.

Explanation

Sincewe havemoved30daysintotheFRA,the newratefortheendofthe contractisthe30-day rate (60daysoriginally minus30days passed) andthe newrateforthesettlementofthe loan isthe120-day rate (150daysoriginally minus30days passed).

With thatinformation,the pricingisstraightforward: The actual,unannualizedrateon the30-day loan is: R30 = 0.022 × 30/360 = 0.00183

The actual,unannualizedrateon the120-day loan is: R120 = 0.038 × 120/360 = 0.01267

Therateon a 90-day loan to bemade30daysfrom nowis: 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) = 1.010820 − 1 FR (30,90) = 1.0820%

We annualizethisrateusingtheformula: 1.082% × (360/90) = 4.33%

Theinterestsavingis:

Interestsaving = ( (0.0433 × 90/360) − (0.0362 × 90/360)) × 25,000,000

Interestsaving = (0.01083 − 0.00905) × 25,000,000

Interestsaving = 0.00178 × 25,000,000

Interestsaving = 44,500

Theinterest "saving" is a positive44,500. Discountingthat back atthe current120-day ratewe have: FRAvalue = 44,500 / (1 + ( 0.038 × 120/360))

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

ᅞ A)

ᅚ B)

ᅞ C)

ᅞ A) ᅞ B) ᅚ C)

Question #55 of 85

QuestionID:464032

Questions #55

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0 of 85

Question #54 of 85

QuestionID:464014

S .

Normal contangooccurswhen thefutures priceisgreaterthan theexpected asset price at contractexpiration. Thestatement that high demandto buy the contract couldincreasethe contract priceis also correct. Notethe contrastwith contango,which meansthefutures priceis abovethe asset'sspot price. (LOS 49.f)

Duringthe lifeof a forward contract,thevalueofthe contractisbestdescribed as: the difference between the future value of the spot price and the expected future price of the underlying asset.

thedifference between thespot price andthe presentvalueoftheforward priceofthe underlying asset.

the presentvalueoftheexpectedfuture priceoftheunderlying asset.

Explanation

Thevalueof a forward contracton an assetwith no cash flowsduringitstermisequal tospot − (forward price) / (1 + R) ),the difference between thespot price andthe presentvalueoftheforward priceoftheunderlying asset.

Monica Lewis,CFA, has been hiredtoreviewdata on a seriesofforward contractsfor a major client. The client has askedfor

an analysisof a contractwith each ofthefollowing characteristics: 1. Aforward contracton a U.S. Treasury bond

2. Aforwardrate agreement (FRA) 3. Aforward contracton a currency

Information related to a forward contract on a U.S. Treasurybond:TheTreasury bond carries a 6% coupon and has a currentspot priceof $1,071.77 (including accruedinterest). A coupon has just been paid andthe next coupon isexpectedin 183days. The annual risk-freerateis5%. Theforward contractwill maturein 195days.

Information related to a forward rate agreement:Therelevant contractis a 3 × 9FRA. The current annualized90-day money marketrateis3.5% andthe 270-day rateis4.5%. Basedon the best availableforecast,the180-day rate atthe expiration ofthe contractisexpectedto be4.2%.

Information related to a forward contract on a currency:Therisk-freeratein the U.S. is5% and4% in Switzerland. The currentspotexchangerateis $0.8611 per SwissFrance (SFr). Theforward contractwill maturein 200days.

Basedon theinformation given,whatinitial priceshould Lewisrecommendfor a forward contracton theTreasury bond? $1,073.54.

$1,035.12. $1,070.02. 0