Understanding Forwards and Futures

What is the formula for pricing a forward contract?

• Forward Price = Spot Price * e^(rT)

• Forward Price = Spot Price + rT

• Forward Price = Spot Price / e^(rT)

• Forward Price = Spot Price * (1 + rT)

How do you calculate the value of a futures contract at expiration?

• Value = Average Price x Contract Size

• Value = Initial Margin x Contract Size

• Value = Final Settlement Price x Contract Size

• Value = Market Price x Number of Contracts

Explain the cost of carry model in the context of futures pricing.

• The cost of carry model relates the futures price to the spot price by accounting for storage, financing, and income associated with holding the asset.

• The cost of carry model only considers the historical price of the asset.

• It ignores any costs associated with holding the asset.

• The model suggests that futures prices are always lower than spot prices.

What are the key differences between forwards and futures contracts?

• Futures contracts have no counterparty risk, unlike forwards which do.

• Forwards are always traded on exchanges, while futures are private agreements.

• Forwards require daily settlements and margins, while futures do not.

• Key differences include: forwards are private and customizable, while futures are standardized and traded on exchanges; forwards have counterparty risk, whereas futures have reduced risk due to clearinghouses; futures require daily settlements and margins, unlike forwards.

How can futures be used for hedging against price fluctuations?

• Futures are primarily used for short-term investments.

• Futures can only be used for speculation.

• Futures can be used to lock in prices and protect against adverse price movements.

• Futures are not effective in managing price risks.

What is the role of interest rates in the cost of carry model?

• Interest rates have no impact on asset valuation.

• Interest rates only affect short-term investments.

• Higher interest rates increase the value of holding an asset.

• Interest rates determine the opportunity cost of holding an asset in the cost of carry model.

Describe an arbitrage opportunity in the context of futures markets.

• Sell the underlying asset at the higher spot price and buy the futures contract at the lower price.

• Buy the futures contract at the lower price and hold it until expiration without any other actions.

• Buy the underlying asset at the lower spot price and sell the futures contract at the higher price.

• Sell the futures contract at the lower price and buy the underlying asset at the higher price.

How does the settlement process work for futures contracts?

• Futures contracts are always settled by exchanging the underlying asset only.

• All futures contracts must be settled in cash regardless of the asset type.

• Futures contracts are settled either through physical delivery of the asset or cash settlement based on the final settlement price.

• The settlement process for futures contracts is determined by the buyer's preference only.

What factors influence the pricing of a forward contract?

• Market demand and supply

• Spot price, risk-free interest rate, time to maturity, storage costs, and dividends.

• Currency exchange rates

• Historical price trends

Explain how margin requirements work in futures trading.

• Margin requirements are optional in futures trading.

• Margin requirements in futures trading are deposits required to open and maintain positions, ensuring security against losses.

• Margin requirements are only needed for stock trading.

• Margin requirements are determined by the stock market's performance.