FMI QUIZ Week 10

The spot price of the British pound is currently $1.50. If the risk-free interest rate on 1-year government bonds is 1% in the United States and 2% in the United Kingdom, what must be the forward price of the pound for delivery one year from now? 

• $1.20 per pound

• $1.38 per pound

• $1.49 per pound

• $0.65 per pound

Answer explanation

Since the interest rate of the UK is higher than the US, pound will depreciate.

Using I/R Parity Formula, 

F = 1.50 * (1+1%)/(1+2%) = $1.485 per pound

Consider the following information:

r_US  = 4% ; r_UK = 7%

E₀ = $2.00 per pound;

F₀ = $1.98 per pound (1-year delivery), where the interest rates are annual yields on US or UK bills.

Would you long or short UK pounds? 

• long UK pounds

• short UK pounds

Answer explanation

Using I/R Parity Formula, 

F₀  = 2 * (1+4%)/(1+7%) = $1.9439 per pound.

Since the actual future price is $1.98 per pound (given), the value of the pound is overvalued in the forward market, you will short the UK pounds.

You manage a $19.5M portfolio, currently all invested in equities, and believe that the market is on the verge of a big but short-lived downturn. You would move your portfolio temporarily into T-bills, but you do not want to incur the transaction costs of liquidating and reestablishing your equity position. Instead, you decided to temporarily hedge your equity holdings with an S&P 500 index futures contract. 

What should you do?

• Long S&P futures contracts

• Short S&P futures contracts

• Do nothing ◡̈

Answer explanation

Long asset (equity) position and short futures.

When the price decreases, the loss on underlying assets can be offset by gains in futures contracts. 

You manage a $19.5M portfolio, currently all invested in equities, and believe that the market is on the verge of a big but short-lived downturn. You would move your portfolio temporarily into t-bills, but you do not want to incur the transaction costs of liquidating and reestablishing your equity position. Instead, you decided to temporarily hedge your equity holdings with an S&P 500 index futures contract. 

Given that S&P index is now 1950 and the contract multiplier is $50, if your equity holdings are invested in a market index fund, how many contracts should you enter?

• 100

• 150

• 200

• 250

Answer explanation

1 contract controls 1950*$50 = $97,500 worth of equity 

Size per contract = $97,500

To fully hedge = 19,500,000/97,500 = 200 contracts

Farmer Brown grows red corn and would like to hedge the value of the coming harvest.  If he grows 100,000 brussels, and each futures contract calls for delivery of 5,000 brussels, how many contracts should Farmer Brown buy or sell to hedge his position? 

• Long 12 contracts

• Short 17 contracts

• Long 19 contracts

• Short 20 contracts

Answer explanation

Long asset → short futures 

Assume futures Brussels = underlying asset 

To fully hedge: 100,000/5000 = 20 contracts needed

An oil distributor plans to sell 10,000 barrels of oil in June. 

The size of one contract is 100 barrels.

Original futures price = F₀ = $52

Given that the spot price = $51, what are the total proceeds? 

• 500,000

• 520,000

• 540,000

• 560,000

Answer explanation

Revenue from sale = 10,000 * 51 = 510,000

Profit on futures = (52-51) * 10,000 = 10,000

Total proceeds = 510,000 + 10,000 = 520,000 

Assuming no arbitrage opportunity, futures price will converge towards the spot price at maturity. 

• TRUE

• FALSE

Answer explanation

It's like that.

Assume you bought 100 shares of ABC share at $50 per share with an initial margin requirement of 50% and maintenance margin of 30%. 

Suppose the stock has fallen to $30. Is there a margin call? If so, how much? 

• No margin call.

• Margin call, $250

• Margin call, $1000

• Margin call, $2000

Answer explanation

Underlying asset (stock) = 100 * $50 = $5,000

Initial margin = $5,000 * 50% = $2,500

Maintenance margin

= 30% * initial margin

= 30% * 250 = 750

Underlying asset (stock) after fall in price = $30 * 100 = $3,000

Loss = $5,000 - $3,000 = $2,000 

Margin account balance after fall in stock price 

= $2.500 - $2,000 = $500 

The margin account balance has fallen below the maintenance margin requirement, so there will be a margin call to top up back to initial margin. 

You will need to top up: $2,500 - $500 = $2,000

If you are going to buy an apartment in Singapore next year, are you long or short Singapore Real Estate now? Would you long or short futures?

• Long SG Real Estate; Long Futures

• Long SG Real Estate; Short Futures

• Short SG Real Estate; Short Futures

• Short SG Real Estate; Long Futures

Answer explanation

Since you are only going to buy the apartment next year, it would mean that you have yet to own the apartment → Short SG Real Estate.

Since you will be worried of the hike in the price of real estate next year, you would long futures.

FMI used to be called FIIM. What do you think it stands for? 🤔

• Financial Independence from Institutions and Markets

• Financial Instruments, Institutions and Markets

• Financial Institutions with Instruments and Markets

• Financial Inference of Instrumental Markets