CHAPTER 11: FORWARD AND FUTURES HEDGING, SPREAD, AND TARGET STRATEGIES

7. Which technique can be used to compute the minimum variance hedge ratio?

a. duration analysis

b. present value

c. regression

d. all of the above

e. none of the above

8. Which of the following measures is used in the price sensitivity hedge ratio for bond futures?

a. beta

b. duration

c. correlation

d. variance

e. none of the above

9. Suppose you buy an asset at $50 and sell a futures contract at $53. What is your profit at expiration if the asset price goes to $49? (Ignore carrying costs)

a. -$1

b. -$4

c. $3

d. $4

e. none of the above

10. Suppose you buy an asset at $70 and sell a futures contract at $72. What is your profit if, prior to expiration, you sell the asset at $75 and the futures price is $78?

a. -$1

b. $2

c. $1

d. -$6

e. none of the above

11. Which of the following is not a reason for firms to hedge?

a. Firms can hedge less expensively than can their shareholders

b. Shareholders cannot tolerate mark-to-market losses

c. Hedging by corporations can have tax advantages

d. Shareholders are not always aware of their firms' risks

e. none of the above

12. Find the profit if the investor buys a July futures at 75, sells an October futures at 78 and then reverses the July futures at 72 and the October futures at 77.

a. -3

b. -2

c. 2

d. 1

e. none of the above

13. Determine the optimal hedge ratio for Treasury bonds worth $1,000,000 with a modified duration of 12.45 if the futures contract has a price of $90,000 and a modified duration of 8.5 years.

a. 16.27

b. 15.93

c. 7.42

d. 11.11

e. none of the above

14. What is the profit on a hedge if bonds are purchased at $150,000, two futures contracts are sold at $72,500 each, then the bonds are sold at $147,500 and the futures are repurchased at $74,000 each?

a. -$2,500

b. -$5,500

c. -$500

d. -$3,000

e. none of the above

15. Find the optimal stock index futures hedge ratio if the portfolio is worth $1,200,000, the beta is 1.15 and the S&P 500 futures price is 450.70 with a multiplier of 250.

a. 10.65

b. 12.25

c. 6123.80

d. 5325.05

e. none of the above

16. In which of the following situations would you use a short hedge?

a. the planned purchase of a stock

b. the planned purchase of commercial paper

c. the planned issuance of bonds

d. the planned repurchase of stock to cover a short position

e. none of the above

17. You hold a stock portfolio worth $15 million with a beta of 1.05. You would like to lower the beta to 0.90 using S&P 500 futures, which have a price of 460.20 and a multiplier of 250. What transaction should you do? Round off to the nearest whole contract.

a. sell 130 contracts

b. sell 9,778 contracts

c. sell 20 contracts

d. buy 50,000 contracts

e. sell 50,000 contracts

18. You hold a bond portfolio worth $10 million and a modified duration of 8.5. What futures transaction would you do to raise the duration to 10 if the futures price is $93,000 and its implied modified duration is 9.25? Round up to the nearest whole contract.

a. buy 109 contracts

b. buy 17 contracts

c. buy 669 contracts

d. sell 100 contracts

e. sell 669 contracts

19. Which of the following statements about the use of futures in tactical asset allocation is correct?

a. Implementing tactical asset allocation using futures is a form of market timing.

b. Futures can be used to synthetically buy or sell stocks but you cannot simultaneously adjust the beta or duration

c. A difference between the portfolio held and the index on which the futures is based will generate a gain for the investor.

d. The use of futures in tactical asset allocation will generate cash from the synthetic sale, which is then used in the synthetic purchase.

e. None of the above

20. Though a cross hedge has somewhat higher risk than an ordinary hedge, it will reduce risk if which of the following occurs?

a. futures prices are more volatile than spot prices

b. the spot and futures contracts are correctly priced at the onset

c. spot and futures prices are positively correlated

d. futures prices are less volatile than spot prices

e. none of the above

21. Which of the following correctly expresses the profit on a hedge?

a. the basis when the hedge is closed

b. the change in the basis

c. the spot profit minus the futures profit

d. the futures profit minus the spot profit

e. none of the above

22. What happens to the basis through the contract's life?

a. it initially decreases, then increases

b. it initially increases, then decreases

c. it remains relatively steady

d. it moves toward zero

e. none of the above

23. Find the profit if the investor enters an intramarket spread transaction by selling a September futures at $4.5, buys an December futures at $7.5 and then reverses the September futures at $5.5 and the December futures at $9.5.

a. -3

b. -2

c. 2

d. 1

e. none of the above

24. Quantity risk is

a. the difficulty in measuring the volatility

b. the uncertainty about the size of the spot position

c. the risk of mismatching the futures maturity to the spot maturity

d. the possibility of regression error

e. none of the above

25. The relationship between the spot yield and the yield implied by the futures price is called

a. the yield beta

b. the price sensitivity

c. the tail

d. the hedge ratio

e. none of the above

26. All of the following are futures contract choice decisions related to hedging, except

a. which future underlying asset

b. which strike price

c. which futures contract expiration

d. whether to go long or short

e. all of the above are futures contract choice decisions

27. Hedging with futures contracts entails all of the following risks, except

a. marking to market may require large cash outflows

b. changes in margin requirements

c. basis risk

d. quantity risk

e. all of the above are potential risks

28. Based on the minimum variance hedge ratio approach, what is the optimal number of futures contracts to deploy, given the following information. The correlation coefficient between changes in the underlying instrument’s price and changes in the futures contract price is 0.95, the standard deviation of the changes in the underlying position’s value is 300%, and the standard deviation of the changes in the futures contract’s price is 11.4%.

a. long 35 futures contracts

b. long 25 futures contracts

c. long 15 futures contracts

d. short 25 futures contracts

e. short 15 futures contracts

29. Based on the minimum variance hedge ratio approach what is the hedging effectiveness, given the following information. The correlation coefficient between changes in the underlying instrument’s price and changes in the futures contract price is 0.70, the standard deviation of the changes in the underlying position’s value is 40%, and the standard deviation of the changes in the futures contract’s price is 50%. (Select the closest answer.)

a. 50%

b. 45%

c. 40%

d. 35%

e. 30%

30. Based on the price sensitivity hedge ratio approach, what is the optimal number of futures contracts to deploy, given the following information. The yield beta is 0.65, the present value of a basis point change for the underlying bond portfolio is $33,000, and the present value of a basis point change for the bond futures contract is $325. (Select the closest answer.)

a. long 100 futures contracts

b. long 55 futures contracts

c. short 66 futures contracts

d. short 22 futures contracts

e. short 11 futures contracts