Ch7Sols - CHAPTER 7 THE STRUCTURE OF FORWARD AND FUTURES...

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7-1 CHAPTER 7: THE STRUCTURE OF FORWARD AND FUTURES MARKETS END-OF-CHAPTER QUESTIONS AND PROBLEMS 1. A forward contract obligates the holder of the long position to purchase the commodity at a future date. A call option grants the holder of the call the right but not the obligation to purchase the commodity at a future date. A put option grants the holder of the put the right but not the obligation to sell the commodity at a future date. A call is more like a forward contract than a put because long positions in the two contracts are bullish. However, the holder of the forward contract is obligated to buy the good at the future date. The holder of the call can simply let the option expire if the market price of the commodity is less than the exercise price. A call holder pays a premium for the right to not exercise. The holder of a long 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 futures contract provides liquidity by having a central marketplace and standardized contract terms. This allows holders of futures contracts to sell them in the market at any time prior to expiration. Futures trading is governed by the formal regulations of the futures exchange. Most important, the losses incurred by futures traders are guaranteed by the clearinghouse, which requires the daily settlement of gains and losses. That is, the holders of profitable contracts do not have to worry about whether their gains will be paid by the holders of losing contracts. Forward contracts, however, are subject to default risk. Forward contracts can be tailored to the unique needs of firms. For example, a firm may need to execute a hedge in which the expiration is a specific date. Futures contracts expire only on certain dates, which may not fit the needs of the firm. 3. a. Eurodollars b. Crude oil c. Corn 4. A: 1,000 OL: 4,200 S: -5,200 A OL S Change in Open Interest a. 500 4,700 -5,200 none b. 1,700 3,500 -5,200 none c. 1,200 4,200 -5,400 increase by 200 d. 200 4,200 4,400 decrease by 800 If A trades with OL, one or the other is merely offsetting and, thus, open interest does not change. If A trades with the shorts, both are reducing or increasing their positions so open interest changes. In other words, if traders trade with others who hold the same positions, open interest will not change. If they trade 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 perfect substitutes for each other. c. Rules. The exchange establishes rules and regulations that permit trading to transpire in an orderly manner.
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