SM_Chapter_10 - Answers to Chapter 10 Questions 1. A...

Info iconThis preview shows pages 1–2. Sign up to view the full content.

View Full Document Right Arrow Icon
Answers to Chapter 10 Questions 1. A derivative security is a financial security whose payoff is linked to another, previously issued security. Derivative securities generally involve an agreement between two parties to exchange a standard quantity of an asset or cash flow at a predetermined price and at a specified date in the future. As the value of the underlying security to be exchanged changes, the value of the derivative security changes. 2. A spot contract is an agreement between a buyer and a seller at time 0, when the seller of the asset agrees to deliver it immediately and the buyer agrees to pay for that asset immediately. Thus, the unique feature of a spot market is the immediate and simultaneous exchange of cash for securities, or what is often called delivery versus payment . A forward contract is a contractual agreement between a buyer and a seller at time 0, to exchange a pre-specified asset for cash at some later date. Market participants take a position in forward contracts because the future (spot) price or interest rate on an asset is uncertain. A futures contract, like a forward contract, is an agreement between a buyer and a seller at time 0 to exchange a standardized, pre-specified asset for cash at some later date. Thus, a futures contract is very similar to a forward contract. The difference relates to the contract = s price, which in a forward contract is fixed over the life of the contract, whereas a futures contract is marked to market daily. This means that the contract = s price is adjusted each day as the futures price for the contract changes and the contract approaches maturity. Therefore, actual daily cash settlements occur between the buyer and seller in response to these price changes (this is called marking-to-market). 3. Trades from the public are placed with a floor broker. When an order is placed, a floor broker may trade with another floor broker or with a professional trader. Professional traders are similar to specialists on the stock exchanges in that they trade for their own account. Professional traders are also referred to as position traders, day traders, or scalpers. Position traders take a position in the futures market based on their expectations about the future direction of prices of the underlying assets. Day traders generally take a position within a day and liquidate it before day = s end. Scalpers take positions for very short periods of time, sometimes only minutes, in an attempt to profit from this active trading. Scalpers do not have an affirmative obligation to provide liquidity to futures market, but do so in expectation of earning a profit. Scalper = s profits are related to the bid-ask spread and the length of time a position is held. Specifically, it has been found that scalper trades held longer than 3 minutes, on average, produce losses to scalpers. Thus, this need for a quick turnover of a scalper = s position enhances futures market liquidity and is therefore valuable. 4. Clearinghouses are able to perform their function as guarantor of an exchange
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 2
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 10/17/2010 for the course BUSINESS 201 taught by Professor Ban during the Spring '10 term at École Normale Supérieure.

Page1 / 7

SM_Chapter_10 - Answers to Chapter 10 Questions 1. A...

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online