Derivatives chp 6
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Questions and Answers

What was the main purpose of forward contracts in the agricultural markets?

  • To speculate on future price movements
  • To standardize the quality of agricultural produce
  • To eliminate the need for exchanges
  • To guard against price fluctuations caused by gluts or shortages (correct)

    • Why did farmers and merchants enter into forward contracts?

  • To avoid trading their produce on regulated exchanges
  • To create uncertainty in commerce
  • To ensure they only exchange goods at the market price
  • To guard against shortages due to drought and price fluctuations (correct)

    • What was the significance of the Chicago Board of Trade (CBOT) in derivatives history?

  • It was the first exchange to allow speculation
  • It was the first derivatives exchange, established in 1848 (correct)
  • It focused exclusively on agricultural products
  • It introduced standardized contracts for commodity trading

    • How did early derivative contracts bring certainty into commerce?

    <p>By guaranteeing fixed prices for agricultural produce</p> Signup and view all the answers

    What do commodity markets specialize in trading?

    <p>Raw or primary products like agricultural produce and metals</p> Signup and view all the answers

    Why are standardized contracts essential in commodity markets?

    <p>To ensure conformity in amount, timing, and quality of the contract</p> Signup and view all the answers

    What is the main purpose of using derivatives in investment management?

    <p>Hedging</p> Signup and view all the answers

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

    <p>Counterparty involvement</p> Signup and view all the answers

    In the context of derivatives, what is arbitrage?

    <p>Deriving a risk-free profit from price differences</p> Signup and view all the answers

    Which type of contract allowed for standardised trading of grain for a fixed future price on a specific delivery date?

    <p>Futures contract</p> Signup and view all the answers

    What is a key characteristic of futures contracts that distinguishes them from forward contracts?

    <p>Ability to be traded</p> Signup and view all the answers

    Why do portfolio managers use hedging techniques with futures contracts?

    <p>To reduce adverse price impact</p> Signup and view all the answers

    What is the primary function of derivatives in trading financial assets?

    <p>Price speculation</p> Signup and view all the answers

    Do futures contracts help in making swift changes to asset allocation without directly buying or selling securities?

    <p>Yes, they allow for swift adjustments</p> Signup and view all the answers

    What is the primary objective of asset allocation changes using derivatives?

    <p>Market timing</p> Signup and view all the answers

    Which of the following statements holds true about commodity derivatives trading?

    <p>It involves financial firms and speculators seeking profits.</p> Signup and view all the answers

    What is the main function of a futures contract?

    <p>To agree on the price of an asset or commodity to be traded in the future</p> Signup and view all the answers

    In a futures contract, what does 'going long' mean?

    <p>Committing to buying the underlying asset</p> Signup and view all the answers

    What does 'going short' refer to in a futures contract?

    <p>Committing to selling the underlying asset</p> Signup and view all the answers

    What term is used for the initial trade when entering into a futures contract?

    <p>Open</p> Signup and view all the answers

    When do most futures contracts get closed out instead of being delivered?

    <p>Before the delivery date</p> Signup and view all the answers

    What does 'naked' refer to in relation to a futures contract?

    <p>Having unlimited risk</p> Signup and view all the answers

    Why do buyers in futures contracts often close out before the delivery date?

    <p>To speculate on the price using futures</p> Signup and view all the answers

    'Covered' in a futures contract refers to:

    <p>'Covering' potential delivery requirements with having the asset</p> Signup and view all the answers

    'Long' in a futures contract means:

    <p>Being committed to buying at a future price</p> Signup and view all the answers

    What is the main difference between 'long' and 'short' positions in a futures contract?

    <p>Long commits to buying, while short commits to selling.</p> Signup and view all the answers

    What was the key development that allowed options to be readily priced and led to the opening of the Chicago Board Options Exchange in 1973?

    <p>Publication of an option pricing model by Black and Scholes</p> Signup and view all the answers

    What is the main difference between a future and an option?

    <p>Options give the right to buy or sell, while futures are an obligation to buy or sell.</p> Signup and view all the answers

    Which class of option gives the buyer the right to buy the underlying asset at a specified price?

    <p>Call option</p> Signup and view all the answers

    What term is used to refer to the seller of an option who is obliged to take delivery if the buyer exercises the option?

    <p>Writer</p> Signup and view all the answers

    How are exchange-traded options contracts typically settled between buyers and sellers?

    <p>Through a clearing house that is part of the exchange</p> Signup and view all the answers

    What is the function of the premium paid in an options contract?

    <p>Compensate the writer for granting the option</p> Signup and view all the answers

    In what market can options be traded with contract specifications that are not standardised?

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

    Which party in an options contract has the right but not the obligation to exercise the option?

    <p>Holder</p> Signup and view all the answers

    What does a put option allow a buyer to do?

    <p>Sell an asset at a specified price.</p> Signup and view all the answers

    What is a key characteristic that distinguishes a call option from a put option?

    <p>The right to buy an asset</p> Signup and view all the answers

    What is the term used to describe oil with low sulphur content?

    <p>Sweet</p> Signup and view all the answers

    Which organization consists of oil-producing countries that sometimes restrict oil supply to influence prices?

    <p>OPEC</p> Signup and view all the answers

    What is one advantage of investing in derivatives mentioned in the text?

    <p>Increased certainty on future commodity prices</p> Signup and view all the answers

    One of the drawbacks mentioned in the text about derivatives investing is:

    <p>Potential for unlimited losses</p> Signup and view all the answers

    What is a key requirement in the OTC derivatives markets according to the text?

    <p>High counterparty risk assessment</p> Signup and view all the answers

    What enables investors to reduce risks associated with their investment portfolios?

    <p>Hedging through derivatives</p> Signup and view all the answers

    What is the purpose of credit derivatives?

    <p>To reduce the risk faced by organizations</p> Signup and view all the answers

    In a credit default swap (CDS), what does the party buying credit protection do?

    <p>Receive a periodic payment</p> Signup and view all the answers

    What does the term 'floating rate' typically refer to in financial contexts?

    <p>An interest rate that fluctuates based on LIBOR</p> Signup and view all the answers

    How is a derivative commonly used to manage risk?

    <p>To reduce the risk faced by organizations</p> Signup and view all the answers

    What is the main function of a credit default swap (CDS)?

    <p>Act as insurance against credit default events</p> Signup and view all the answers

    What is the purpose of using commodities as an investment asset class?

    <p>To diversify investment portfolios</p> Signup and view all the answers

    Why are derivatives mostly used in financial markets?

    <p>To reduce risks faced by different entities</p> Signup and view all the answers

    What differentiates credit derivatives from traditional insurance policies?

    <p>They involve third-party credit events influencing value</p> Signup and view all the answers

    What is a common feature of derivatives markets?

    <p>They provide mechanisms to hedge market price risk</p> Signup and view all the answers

    In what way does a floating rate differ from a fixed rate?

    <p>It involves a benchmark rate plus a fixed percentage</p> Signup and view all the answers

    What is the main difference between OTC derivatives and exchange-traded derivatives?

    <p>OTC derivatives involve a marketplace, while exchange-traded derivatives are traded directly between parties.</p> Signup and view all the answers

    Which region predominantly engages in trading interest rate swaps through the OTC market?

    <p>Europe</p> Signup and view all the answers

    What is the primary function of a central counterparty (CCP) in derivatives trading?

    <p>To provide a guarantee that trades will be settled</p> Signup and view all the answers

    Which of the following is not a leading derivatives exchange mentioned in the text?

    <p>NASDAQ</p> Signup and view all the answers

    Where is Eurex, one of the leading derivatives exchanges, based?

    <p>Frankfurt, Germany</p> Signup and view all the answers

    What percentage of business conducted by the London Metal Exchange (LME) comes from overseas?

    <p>&gt;95%</p> Signup and view all the answers

    In which type of markets are non-ferrous metals like copper and zinc traded as derivatives?

    <p>Energy markets</p> Signup and view all the answers

    'Gold is often seen as a safe haven' in times of crisis. What does this statement imply about gold's price during crises?

    <p>$The price of gold tends to rise during crises.$</p> Signup and view all the answers

    'Field of origin' and 'Density' are primary factors used to define what type of commodity?

    <p>$Energy$ $Markets$</p> Signup and view all the answers

    'Producers use the market for hedging their production.' Why do producers engage in hedging their production?

    <p>$To protect against price fluctuations.$</p> Signup and view all the answers

    What happens if Jersey shares are below US$3.50 three months later?

    <p>Frank abandons the option and it expires worthless</p> Signup and view all the answers

    What is the maximum loss for Frank when he paid a premium of 42 cents to Steve?

    <p>42 cents</p> Signup and view all the answers

    What level do Jersey plc shares have to reach for Frank to make a profit?

    <p>US$3.92</p> Signup and view all the answers

    What is the most Steve can gain from the premium?

    <p>42 cents</p> Signup and view all the answers

    What is Steve's potential loss when writing an option?

    <p>Unlimited unless he holds the underlying shares</p> Signup and view all the answers

    'Covered' and 'naked' refer to what distinction in writing options?

    <p>'Covered' means having the underlying asset, while 'naked' means not having it</p> Signup and view all the answers

    What is the main purpose of interest rate swaps?

    <p>To manage exposure to changes in interest rates</p> Signup and view all the answers

    'Legs of a swap' refer to what in an interest rate swap?

    <p>'Legs of a swap' refer to the fixed and variable payment terms in the swap agreement</p> Signup and view all the answers

    'Notional amount' in an interest rate swap represents what?

    <p>'Notional amount' represents an arbitrary amount used for calculating payments in a swap</p> Signup and view all the answers

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