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Question 1 of 10
1. Question
Regarding effect of government policy on interest rates, which of the following statements is true?
Correct
Effect of government policy on interest rates
Fiscal policy refers to government actions that are intended to secure funds through taxation, disburse funds through a budget, and borrow funds by issuing debt instruments, all of which impact interest rates. For example, government borrowing at levels sufficient to reduce the availability of capital to private markets might cause rates to rise. Conversely, a highly conservative tax policy that increases taxpayers’ disposable income might lead to lower demand for borrowing and, consequently, lower interest rates.Incorrect
Effect of government policy on interest rates
Fiscal policy refers to government actions that are intended to secure funds through taxation, disburse funds through a budget, and borrow funds by issuing debt instruments, all of which impact interest rates. For example, government borrowing at levels sufficient to reduce the availability of capital to private markets might cause rates to rise. Conversely, a highly conservative tax policy that increases taxpayers’ disposable income might lead to lower demand for borrowing and, consequently, lower interest rates. -
Question 2 of 10
2. Question
From the statements below regarding purpose of hedge, which one seems to be the most appropriate to you?
Correct
Purpose of hedge
The purpose of a hedge is to establish a counterbalance to a risk in the cash market. A trader who enters into a hedge is typically trying to protect the value of an asset, such as a commodity or a financial instrument. Hedging transfers the risk of an adverse event to a counterparty that has an opposite risk management requirement, or to a speculator who is looking for an opportunity to make a profit.Incorrect
Purpose of hedge
The purpose of a hedge is to establish a counterbalance to a risk in the cash market. A trader who enters into a hedge is typically trying to protect the value of an asset, such as a commodity or a financial instrument. Hedging transfers the risk of an adverse event to a counterparty that has an opposite risk management requirement, or to a speculator who is looking for an opportunity to make a profit. -
Question 3 of 10
3. Question
Which of the following statements is true regarding decision to purchase in cash market or enter into a futures contract?
Correct
Decision to purchase in cash market or enter into a futures contract
Taking delivery of a commodity can involve meeting significant logistical requirements after the actual purchase is made. Consider a cereal company that requires certain grains to use as raw material during the production process. The company can buy the grain on the cash market and take responsibility for the cost of transportation and storage, as well as any costs associated with financing and risk management (i.e. the cost of carry). Instead of accepting the logistical headaches that may be involved, the company can also choose to buy a futures contract with an expiration date that will coincide with the company’s need for more grain to meet manufacturing requirements.Incorrect
Decision to purchase in cash market or enter into a futures contract
Taking delivery of a commodity can involve meeting significant logistical requirements after the actual purchase is made. Consider a cereal company that requires certain grains to use as raw material during the production process. The company can buy the grain on the cash market and take responsibility for the cost of transportation and storage, as well as any costs associated with financing and risk management (i.e. the cost of carry). Instead of accepting the logistical headaches that may be involved, the company can also choose to buy a futures contract with an expiration date that will coincide with the company’s need for more grain to meet manufacturing requirements. -
Question 4 of 10
4. Question
Which of the following statements is false regarding decision to purchase in cash market or enter into a futures contract?
Correct
Decision to purchase in cash market or enter into a futures contract
At expiry, the company would buy the grains in the cash market and sell the futures contract. Note that in an efficient market, the price of a contract will include the cost of carry. Therefore, it would not matter whether the company purchased a cash or a futures contract, assuming prices are not expected to change in the future. The company may pay more for a futures contract, but it also saves money because the time and effort required to store the good are vastly reduced.Incorrect
Decision to purchase in cash market or enter into a futures contract
At expiry, the company would buy the grains in the cash market and sell the futures contract. Note that in an efficient market, the price of a contract will include the cost of carry. Therefore, it would not matter whether the company purchased a cash or a futures contract, assuming prices are not expected to change in the future. The company may pay more for a futures contract, but it also saves money because the time and effort required to store the good are vastly reduced. -
Question 5 of 10
5. Question
Regarding basis, which of the following statements is true?
Correct
Basis
Basis is calculated as the difference between the cash or spot price of a commodity and an equivalent futures contract. Basis is an important concept because it reflects the pricing relationship between a cash position and a futures position. If the price of each position always reacted to changes in influential market factors (i.e. the prices were perfectly correlated), the basis would never change during the life of a futures contract. As a result, the establishment of a perfect hedge would be a simple exercise in arithmetic.Incorrect
Basis
Basis is calculated as the difference between the cash or spot price of a commodity and an equivalent futures contract. Basis is an important concept because it reflects the pricing relationship between a cash position and a futures position. If the price of each position always reacted to changes in influential market factors (i.e. the prices were perfectly correlated), the basis would never change during the life of a futures contract. As a result, the establishment of a perfect hedge would be a simple exercise in arithmetic. -
Question 6 of 10
6. Question
From the statements below regarding basis, which one seems to be the most appropriate to you?
Correct
Basis
The correlation between cash and futures prices is far from perfect, however, even though they are closely related. Cash markets can be immediately affected by economic and market events that are short-term or transient (such as a transportation interruption). These types of events have a lesser effect on futures. Supply or demand imbalances may move short-term prices but not long-term ones, or vice versa. Therefore, in order to establish an effective hedge, changes in basis must be considered to ascertain the appropriate composition of a futures position.Incorrect
Basis
The correlation between cash and futures prices is far from perfect, however, even though they are closely related. Cash markets can be immediately affected by economic and market events that are short-term or transient (such as a transportation interruption). These types of events have a lesser effect on futures. Supply or demand imbalances may move short-term prices but not long-term ones, or vice versa. Therefore, in order to establish an effective hedge, changes in basis must be considered to ascertain the appropriate composition of a futures position. -
Question 7 of 10
7. Question
Which of the following statements is false regarding long the basis and short the basis?
Correct
Long the basis and short the basis
A selling hedge is a position consisting of a long position in the cash market and a short position in the futures market. Such a position is considered to be long the basis since any price increase (i.e. a strengthening of the basis) will benefit the long cash position. In contrast, a buying hedge is a position consisting of a short position in the cash market and a long position in the futures market. Such a position is considered to be short the basis since any price decrease (i.e. a weakening of the basis) will benefit the short cash position.Incorrect
Long the basis and short the basis
A selling hedge is a position consisting of a long position in the cash market and a short position in the futures market. Such a position is considered to be long the basis since any price increase (i.e. a strengthening of the basis) will benefit the long cash position. In contrast, a buying hedge is a position consisting of a short position in the cash market and a long position in the futures market. Such a position is considered to be short the basis since any price decrease (i.e. a weakening of the basis) will benefit the short cash position. -
Question 8 of 10
8. Question
Regarding long the basis and short the basis, which of the following statements is true?
Correct
Long the basis and short the basis
In terms of the basis (futures price – cash price), if conditions are such that the cash price rises more than the futures price (or declines less than the futures price), the basis will narrow. This is referred to as strengthening. The relative price increase accrues to the benefit of the long position. A trader with a selling or short hedge has such a long position, and is thus described as being long the basis. Conversely, when cash prices fall more than futures prices (or rise less than futures prices), the basis will widen. This is referred to as weakening. The relative price decrease accrues to the benefit of the short position. A trader with a buying or long hedge has such a short position, and is thus described as being short the basis.Incorrect
Long the basis and short the basis
In terms of the basis (futures price – cash price), if conditions are such that the cash price rises more than the futures price (or declines less than the futures price), the basis will narrow. This is referred to as strengthening. The relative price increase accrues to the benefit of the long position. A trader with a selling or short hedge has such a long position, and is thus described as being long the basis. Conversely, when cash prices fall more than futures prices (or rise less than futures prices), the basis will widen. This is referred to as weakening. The relative price decrease accrues to the benefit of the short position. A trader with a buying or long hedge has such a short position, and is thus described as being short the basis. -
Question 9 of 10
9. Question
From the statements below regarding Contango market and inverted market, which one seems to be the most appropriate to you?
Correct
Contango market and inverted market
A normal market condition (contango) exists when the future price of a commodity (a futures contract) is greater than its present price (the cash price). In a normal market, the basis is negative, and usually reflects the cost of carry. An inverted market condition (backwardation) exists when the future price of a commodity is less than the cash market price of the commodity. In an inverted market, the basis is positive, and this may be the result of near-term supply shortages.Incorrect
Contango market and inverted market
A normal market condition (contango) exists when the future price of a commodity (a futures contract) is greater than its present price (the cash price). In a normal market, the basis is negative, and usually reflects the cost of carry. An inverted market condition (backwardation) exists when the future price of a commodity is less than the cash market price of the commodity. In an inverted market, the basis is positive, and this may be the result of near-term supply shortages. -
Question 10 of 10
10. Question
Which of the following statements is true regarding basis risk?
Correct
Basis risk
A fundamental concept that underlies an effective hedging strategy is that the basis between a cash and a futures contract will remain relatively unchanged. Therefore, pricing fluctuations in the cash market will be closely correlated with fluctuations in the futures market, enabling a net zero offset from the eventual liquidation. Basis risk represents the probability that the correlation described above will be weaker than anticipated. If this occurs, cash and futures prices will diverge, leading to an unfavorable result at the time of liquidation.Incorrect
Basis risk
A fundamental concept that underlies an effective hedging strategy is that the basis between a cash and a futures contract will remain relatively unchanged. Therefore, pricing fluctuations in the cash market will be closely correlated with fluctuations in the futures market, enabling a net zero offset from the eventual liquidation. Basis risk represents the probability that the correlation described above will be weaker than anticipated. If this occurs, cash and futures prices will diverge, leading to an unfavorable result at the time of liquidation.