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Question 1 of 10
1. Question
Which of the following statements is false regarding spread, straddle, and strangle?
Correct
Spread, straddle, and strangle
Spreads, straddles, and strangles are trading strategies designed to minimize risk due to adverse changes in the prices of underlying commodities. Each involves a combination of long and short positions that use either futures contracts and options (for spreads) or options alone (for straddles and strangles). Spread example: A trader seeking to hedge a long position might purchase both a related futures contract and a put. If prices of the underlying commodities fall, the put can be exercised. If prices rise, gains are available from the futures. If prices remain relatively unchanged, the loss to the trader is limited to the premium paid for the put. A straddle is a similar strategy involving the purchase of either two put options or two call options, each having the same expiration date and strike price. A strangle is similar to a straddle in that the expiration dates of the puts or calls are the same, but the strike prices are different.Incorrect
Spread, straddle, and strangle
Spreads, straddles, and strangles are trading strategies designed to minimize risk due to adverse changes in the prices of underlying commodities. Each involves a combination of long and short positions that use either futures contracts and options (for spreads) or options alone (for straddles and strangles). Spread example: A trader seeking to hedge a long position might purchase both a related futures contract and a put. If prices of the underlying commodities fall, the put can be exercised. If prices rise, gains are available from the futures. If prices remain relatively unchanged, the loss to the trader is limited to the premium paid for the put. A straddle is a similar strategy involving the purchase of either two put options or two call options, each having the same expiration date and strike price. A strangle is similar to a straddle in that the expiration dates of the puts or calls are the same, but the strike prices are different. -
Question 2 of 10
2. Question
Regarding synthetic positions, which of the following statements is true?
Correct
Synthetic positions
A synthetic position is created by purchasing or selling a combination of two option or futures positions, which together can provide the same result as a single actual futures position. Synthetics have value to a trader when a discrepancy exists between the price of the actual position and the price of the synthetic position. For example, if a trader requires a long call position to establish a hedge, two alternatives are available. The first is an actual long call, and the second is a synthetic long call, which is a combination of a long futures contract and a long put. If the price of the synthetic long call is less than the price of the actual position, the trader could purchase the synthetic and achieve the desired hedge position at a lower cost.Incorrect
Synthetic positions
A synthetic position is created by purchasing or selling a combination of two option or futures positions, which together can provide the same result as a single actual futures position. Synthetics have value to a trader when a discrepancy exists between the price of the actual position and the price of the synthetic position. For example, if a trader requires a long call position to establish a hedge, two alternatives are available. The first is an actual long call, and the second is a synthetic long call, which is a combination of a long futures contract and a long put. If the price of the synthetic long call is less than the price of the actual position, the trader could purchase the synthetic and achieve the desired hedge position at a lower cost. -
Question 3 of 10
3. Question
From the statements below regarding margin requirements for futures traders, which one seems to be the most appropriate to you?
Correct
Margin requirements for futures traders
Margin requirements are established by each individual exchange, and they vary based upon the underlying commodity supporting the contract. Brokers may require higher margins of their customers than those set by an exchange, but these margins can never be lower than the ones set by an exchange. Various statistical analyses are used by exchanges to measure price volatility and set margin requirements accordingly. The amount of margin required is set at a per contract level. At this set level, traders can be expected to cover any probable losses in the case of normal price fluctuations. For example, margins on the Chicago Mercantile Exchange (CME) are expected to be sufficient to cover as much as 99% of the probable price changes during a given trading day or multiple trading days. Changes in the underlying factors that can cause price volatility (supply disruptions, conflicts, disasters, government policy, etc.) are monitored, and margin levels are adjusted as volatility is affected.Incorrect
Margin requirements for futures traders
Margin requirements are established by each individual exchange, and they vary based upon the underlying commodity supporting the contract. Brokers may require higher margins of their customers than those set by an exchange, but these margins can never be lower than the ones set by an exchange. Various statistical analyses are used by exchanges to measure price volatility and set margin requirements accordingly. The amount of margin required is set at a per contract level. At this set level, traders can be expected to cover any probable losses in the case of normal price fluctuations. For example, margins on the Chicago Mercantile Exchange (CME) are expected to be sufficient to cover as much as 99% of the probable price changes during a given trading day or multiple trading days. Changes in the underlying factors that can cause price volatility (supply disruptions, conflicts, disasters, government policy, etc.) are monitored, and margin levels are adjusted as volatility is affected. -
Question 4 of 10
4. Question
Which of the following statements is true regarding performance bond?
Correct
Performance bond
Margins used in futures markets are called performance bonds because their purpose is to function as a form of surety or earnest deposit to demonstrate good faith intent regarding contract execution. Both counterparties to a contract (i.e. both long and short positions) require futures margins. In contrast, margins established for trading in equity securities are a form of cash down payment. The balance is due (and ownership is transferred) at a later date. For futures transactions, most contracts are settled with offsetting trades, not through delivery of the underlying commodity.Incorrect
Performance bond
Margins used in futures markets are called performance bonds because their purpose is to function as a form of surety or earnest deposit to demonstrate good faith intent regarding contract execution. Both counterparties to a contract (i.e. both long and short positions) require futures margins. In contrast, margins established for trading in equity securities are a form of cash down payment. The balance is due (and ownership is transferred) at a later date. For futures transactions, most contracts are settled with offsetting trades, not through delivery of the underlying commodity. -
Question 5 of 10
5. Question
Which of the following statements is false regarding initial margin and maintenance margin?
Correct
Initial margin and maintenance margin
The amount of initial margin is that which is required to open a trading account and establish a market position. Thereafter, if a trader experiences adverse changes that reduce the account value below a certain level, additional funding (often called a margin call) is required. This maintenance margin amount is the minimum that must remain on deposit over the life of the account, and is analogous to a minimum balance required for a bank account.Incorrect
Initial margin and maintenance margin
The amount of initial margin is that which is required to open a trading account and establish a market position. Thereafter, if a trader experiences adverse changes that reduce the account value below a certain level, additional funding (often called a margin call) is required. This maintenance margin amount is the minimum that must remain on deposit over the life of the account, and is analogous to a minimum balance required for a bank account. -
Question 6 of 10
6. Question
Regarding margin agreements, which of the following statements is true?
Correct
Margin agreements
Brokers are required to maintain documentation regarding the terms and conditions of margins. These so-called margin agreements specify the procedures that customers are required to follow to respond to margin requirements. For example, a brokerage may require customers to respond to margin deficiencies the same day such deficiencies are incurred. Other brokers may allow customers to respond to margin deficiencies the following day. Some brokers may accept a check as payment, while others may require payment by wire transfer that is supported by a wire transfer agreement.Incorrect
Margin agreements
Brokers are required to maintain documentation regarding the terms and conditions of margins. These so-called margin agreements specify the procedures that customers are required to follow to respond to margin requirements. For example, a brokerage may require customers to respond to margin deficiencies the same day such deficiencies are incurred. Other brokers may allow customers to respond to margin deficiencies the following day. Some brokers may accept a check as payment, while others may require payment by wire transfer that is supported by a wire transfer agreement. -
Question 7 of 10
7. Question
From the statements below regarding SPAN, which one seems to be the most appropriate to you?
Correct
SPAN
The growing sophistication of trading strategies employing both futures and options led to the development of portfolio based risk assessment tools for margin requirements. The current industry standard is a tool called Standard Portfolio Analysis of Risk (SPAN), which was developed by the Chicago Mercantile Exchange (CME). Using SPAN, the overall portfolio risk of a position is determined by calculating the gains and losses that a portfolio could be expected to incur under various market conditions. The results are used to identify the worst possible loss that a portfolio of derivative and physical instruments might reasonably incur over a specified time period (usually a single trading day). This worst loss scenario serves as the basis for an evaluation of the adequacy of existing margin requirements and the need for modifications.Incorrect
SPAN
The growing sophistication of trading strategies employing both futures and options led to the development of portfolio based risk assessment tools for margin requirements. The current industry standard is a tool called Standard Portfolio Analysis of Risk (SPAN), which was developed by the Chicago Mercantile Exchange (CME). Using SPAN, the overall portfolio risk of a position is determined by calculating the gains and losses that a portfolio could be expected to incur under various market conditions. The results are used to identify the worst possible loss that a portfolio of derivative and physical instruments might reasonably incur over a specified time period (usually a single trading day). This worst loss scenario serves as the basis for an evaluation of the adequacy of existing margin requirements and the need for modifications. -
Question 8 of 10
8. Question
Which of the following statements is true regarding net liquidating value component?
Correct
Net liquidating value component
As the term implies, the net liquidating value component represents the value of both the futures and options components of a portfolio in the event of liquidation. The calculation includes three elements: cash on deposit, unrealized profit/loss on open futures positions, and net value of open option positions.Incorrect
Net liquidating value component
As the term implies, the net liquidating value component represents the value of both the futures and options components of a portfolio in the event of liquidation. The calculation includes three elements: cash on deposit, unrealized profit/loss on open futures positions, and net value of open option positions. -
Question 9 of 10
9. Question
Which of the following statements is false regarding equity amounts?
Correct
Equity amounts
A margin call requires a trader to immediately increase the funds or collateral on deposit as a performance bond. In the same way that a loss of funds that causes the value of an account to drop below the maintenance margin requirement must be compensated for with a deposit, any amounts that exceed the maintenance margin requirement (so-called equity amounts) may be withdrawn from the account.Incorrect
Equity amounts
A margin call requires a trader to immediately increase the funds or collateral on deposit as a performance bond. In the same way that a loss of funds that causes the value of an account to drop below the maintenance margin requirement must be compensated for with a deposit, any amounts that exceed the maintenance margin requirement (so-called equity amounts) may be withdrawn from the account. -
Question 10 of 10
10. Question
Regarding margin requirements for hedge and speculative accounts, which of the following statements is true?
Correct
Margin requirements for hedge and speculative accounts
Due to the inherent differences in trading strategy risk, margins for speculators are typically set at a premium compared to those for hedgers. For example, recent initial margins for corn futures traded on the CBOT were set at $2,700 for speculators and at $2,000 for hedgers. Traders typically engage in hedging only in those markets in which a cash position is maintained. That is, trading is intended to protect the value of an existing inventory or cash position. The risk of such activity is much lower than that associated with speculative trades, and this risk is further reduced by the ability of the hedger to make or accept delivery if the contract is held until the expiration date.Incorrect
Margin requirements for hedge and speculative accounts
Due to the inherent differences in trading strategy risk, margins for speculators are typically set at a premium compared to those for hedgers. For example, recent initial margins for corn futures traded on the CBOT were set at $2,700 for speculators and at $2,000 for hedgers. Traders typically engage in hedging only in those markets in which a cash position is maintained. That is, trading is intended to protect the value of an existing inventory or cash position. The risk of such activity is much lower than that associated with speculative trades, and this risk is further reduced by the ability of the hedger to make or accept delivery if the contract is held until the expiration date.