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Chapter 2 - Practice Questions

This document contains practice problems related to mechanics of futures markets. It addresses key concepts like distinguishing between open interest and trading volume, calculating profits and losses from long and short futures positions, determining price changes that trigger margin calls, explaining stop-limit orders, and discussing how open interest can increase, decrease or stay the same when contracts are traded on an exchange. It also contains problems about hedging with futures contracts and how profits are taxed for hedgers versus speculators.

Uploaded by

Siddhant Aggarwal
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© © All Rights Reserved
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Download as DOC, PDF, TXT or read online on Scribd
411 views

Chapter 2 - Practice Questions

This document contains practice problems related to mechanics of futures markets. It addresses key concepts like distinguishing between open interest and trading volume, calculating profits and losses from long and short futures positions, determining price changes that trigger margin calls, explaining stop-limit orders, and discussing how open interest can increase, decrease or stay the same when contracts are traded on an exchange. It also contains problems about hedging with futures contracts and how profits are taxed for hedgers versus speculators.

Uploaded by

Siddhant Aggarwal
Copyright
© © All Rights Reserved
Available Formats
Download as DOC, PDF, TXT or read online on Scribd
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CHAPTER 2

Mechanics of Futures Markets

Practice Questions

Problem 2.1.
Distinguish between the terms open interest and trading volume.

Problem 2.3.
Suppose that you enter into a short futures contract to sell July silver for $17.20 per ounce. The
size of the contract is 5,000 ounces. The initial margin is $4,000, and the maintenance margin is
$3,000. What change in the futures price will lead to a margin call? What happens if you do not
meet the margin call?

Problem 2.4.
Suppose that in September 2012 a company takes a long position in a contract on May 2013
crude oil futures. It closes out its position in March 2013. The futures price (per barrel) is
$68.30 when it enters into the contract, $70.50 when it closes out its position, and $69.10 at the
end of December 2012. One contract is for the delivery of 1,000 barrels. What is the company’s
total profit? When is it realized?

Problem 2.11.
A trader buys two July futures contracts on frozen orange juice. Each contract is for the delivery
of 15,000 pounds. The current futures price is 160 cents per pound, the initial margin is $6,000
per contract, and the maintenance margin is $4,500 per contract. What price change would lead
to a margin call? Under what circumstances could $2,000 be withdrawn from the margin
account?

Problem 2.14.
Explain what a stop-limit order to sell at 20.30 with a limit of 20.10 means.

Problem 2.22.
“When a futures contract is traded on the floor of the exchange, it may be the case that the open
interest increases by one, stays the same, or decreases by one.” Explain this statement.

Problem 2.23.
Suppose that on October 24, 2012, a company sells one April 2013 live-cattle futures contracts.
It closes out its position on January 21, 2013. The futures price (per pound) is 91.20 cents when
it enters into the contract, 88.30 cents when it closes out its position, and 88.80 cents at the end
of December 2012. One contract is for the delivery of 40,000 pounds of cattle. What is the total
profit? How is it taxed if the company is (a) a hedger and (b) a speculator? Assume that the
company has a December 31 year end.

Problem 2.24.
A cattle farmer expects to have 120,000 pounds of live cattle to sell in three months. The live-
cattle futures contract traded by the CME Group is for the delivery of 40,000 pounds of cattle.
How can the farmer use the contract for hedging? From the farmer’s viewpoint, what are the
pros and cons of hedging?

Problem 2.28
One orange juice future contract is on 15,000 pounds of frozen concentrate. Suppose that in
September 2011 a company sells a March 2013 orange juice futures contract for 120 cents per
pound. In December 2011 the futures price is 140 cents. In December 2012 the futures price is
110 cents. In February 2013 it is closed out at 125 cents. The company has a December year
end. What is the company's profit or loss on the contract? How is it realized?

Problem 2.29.
A company enters into a short futures contract to sell 5,000 bushels of wheat for 450 cents per
bushel. The initial margin is $3,000 and the maintenance margin is $2,000. What price change
would lead to a margin call? Under what circumstances could $1,500 be withdrawn from the
margin account?

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