Ch7Sols - 7-1CHAPTER 7: THE STRUCTURE OF FORWARD AND FUTURES

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Unformatted text preview: 7-1CHAPTER 7: THE STRUCTURE OF FORWARD AND FUTURES MARKETSEND-OF-CHAPTER QUESTIONS AND PROBLEMS1.A forward contract obligates the holder of the long position to purchase the commodity at a future date. Acall option grants the holder of the call the right but not the obligation to purchase the commodity at afuture date. A put option grants the holder of the put the right but not the obligation to sell the commodityat a future date. A call is more like a forward contract than a put because long positions in the twocontracts are bullish. However, the holder of the forward contract is obligated to buy the good at thefuture date. The holder of the call can simply let the option expire if the market price of the commodity isless than the exercise price. A call holder pays a premium for the right to not exercise. The holder of along forward contract does not pay a premium and gives up the right to not exercise.2.While both forward and futures contracts are agreements to purchase a good at a future date, a futurescontract provides liquidity by having a central marketplace and standardized contract terms. This allowsholders of futures contracts to sell them in the market at any time prior to expiration. Futures trading isgoverned by the formal regulations of the futures exchange. Most important, the losses incurred byfutures traders are guaranteed by the clearinghouse, which requires the daily settlement of gains andlosses. That is, the holders of profitable contracts do not have to worry about whether their gains will bepaid by the holders of losing contracts. Forward contracts, however, are subject to default risk. Forwardcontracts can be tailored to the unique needs of firms. For example, a firm may need to execute a hedge inwhich the expiration is a specific date. Futures contracts expire only on certain dates, which may not fitthe needs of the firm.3.a.Eurodollarsb.Crude oilc.Corn4.A:1,000OL:4,200S:-5,200AOLSChange in Open Interesta.5004,700-5,200noneb.1,7003,500-5,200nonec.1,2004,200-5,400increase by 200d.2004,2004,400decrease by 800If A trades with OL, one or the other is merely offsetting and, thus, open interest does not change. If Atrades with the shorts, both are reducing or increasing their positions so open interest changes. In otherwords, if traders trade with others who hold the same positions, open interest will not change. If theytrade with those holding opposite positions, open interest will change.5.a.A centralized trading facility. The exchange is a formal market place for trading the contracts.b.Standardized terms. This establishes that certain contracts are identical and, thus, are perfectsubstitutes for each other.c.Rules. The exchange establishes rules and regulations that permit trading to transpire in anorderly manner....
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Ch7Sols - 7-1CHAPTER 7: THE STRUCTURE OF FORWARD AND FUTURES

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