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?

To avoid any potential loss from mad cow disease Signup and view all the answers

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

By making a profit of 100 rupees per cow Signup and view all the answers

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

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

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

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

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

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

Which statement accurately describes ETD derivatives?

Standardized contracts traded on exchanges. Signup and view all the answers

What makes counterparty risk a major concern in OTC derivatives?

The absence of a central clearing house. Signup and view all the answers

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

They have standardized contracts traded on exchanges. Signup and view all the answers

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

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

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

OTC derivatives 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?

Hedgers with specific risk management needs Signup and view all the answers

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

Standardization leading to limited flexibility in contract terms Signup and view all the answers

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

Clearinghouses reduce counterparty risk by acting as intermediaries between buyers and sellers. 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.