Future Contract in Cattle Farming Scenario
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Questions and Answers

What does the futures contract obligate Ramu to do?

  • Sell his cows to the investor in a year (correct)
  • Raise the market price of cows
  • Buy cows from the investor
  • Invest in the stock market
  • In the event of mad cow disease outbreak, who experiences a potential loss as described in the text?

  • Neither Ramu nor the investor
  • Both Ramu and the investor
  • The investor (correct)
  • Ramu
  • How can the investor limit potential losses due to a drop in market price?

  • Increase the buying price
  • Sell the cows immediately
  • Utilize a stop-loss agreement (correct)
  • Stop raising cows
  • What is the primary reason for Ramu entering into a futures contract?

    <p>To avoid any potential loss from mad cow disease</p> Signup and view all the answers

    How does the investor benefit if the market price of cows soars?

    <p>By making a profit of 100 rupees per cow</p> Signup and view all the answers

    What is the purpose of the stop-loss agreement mentioned in the text?

    <p>To restrict the investor's potential losses if market prices drop</p> Signup and view all the answers

    Which of the following is a key difference between OTC derivatives and ETD derivatives?

    <p>ETD derivatives are highly customizable, while OTC derivatives are standardized contracts.</p> Signup and view all the answers

    What is a characteristic of OTC derivatives according to the text?

    <p>Highly customizable to meet specific risk management and investment needs.</p> Signup and view all the answers

    Which statement accurately describes ETD derivatives?

    <p>Standardized contracts traded on exchanges.</p> Signup and view all the answers

    What makes counterparty risk a major concern in OTC derivatives?

    <p>The absence of a central clearing house.</p> Signup and view all the answers

    Why are ETD derivatives considered to have reduced counterparty risk compared to OTC derivatives?

    <p>They have standardized contracts traded on exchanges.</p> Signup and view all the answers

    What is the key difference between over-the-counter (OTC) and exchange-traded (ETD) derivatives?

    <p>OTC derivatives are standardized contracts traded on exchanges, while ETD derivatives are customized contracts traded directly between two parties.</p> Signup and view all the answers

    Which type of derivative is more customizable in terms of contract terms and specifications?

    <p>OTC derivatives</p> Signup and view all the answers

    In the context of risk management, which type of investor would typically prefer over-the-counter (OTC) derivatives over exchange-traded (ETD) derivatives?

    <p>Hedgers with specific risk management needs</p> Signup and view all the answers

    What is a potential drawback of exchange-traded (ETD) derivatives compared to over-the-counter (OTC) derivatives?

    <p>Standardization leading to limited flexibility in contract terms</p> Signup and view all the answers

    Which statement accurately describes the role of clearinghouses in exchange-traded (ETD) derivatives?

    <p>Clearinghouses reduce counterparty risk by acting as intermediaries between buyers and sellers.</p> Signup and view all the answers

    Study Notes

    • Ramu, a farmer, has ten cows and plans to sell them in a year, with an investment of 300 rupees for their raising
    • Ramu is concerned about potential loss if mad cow disease outbreaks, so he enters a futures contract with an investor's broker
    • The futures contract obligates Ramu to sell his cows to the investor for 100 rupees each in a year, and the investor to buy them for 100 rupees
    • If market price soars, the investor makes a profit of 100 rupees per cow, while Ramu profits from his investment in raising the cows
    • If mad cow disease occurs and market price drops, the investor experiences a loss of up to 80 rupees per cow, but can limit losses with a stop-loss agreement.

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    Description

    Learn about futures contracts in a cattle farming context where Ramu, a farmer, hedges against potential losses due to market fluctuations like mad cow disease. Understand the dynamics of futures contracts and their impact on both farmer and investor.

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