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CISI Derivatives study materials
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CISI Derivatives (CISI) practice questions

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Question 1Derivatives fundamentals and market structure

A UK fund manager wants to lock in today's price for buying 50,000 shares of a FTSE 100 company in three months' time. Which derivative contract most directly achieves this?

  1. An interest rate swap
  2. A currency forward
  3. A forward contract on the shares Correct answer.
  4. A put option on the shares

Explanation

A forward contract obliges both parties to trade the underlying at a price agreed today, with settlement at a future date, so it locks in the purchase price. Buying a put option would protect against a fall, not fix the cost of buying shares.

Question 2Derivatives fundamentals and market structure

What does the initial margin posted to a central counterparty (CCP) primarily protect against?

  1. Losses arising from a counterparty's default occurring before the position is closed Correct answer.
  2. A decline in the underlying asset's dividend
  3. The cost of brokerage commission on the trade
  4. Errors in the exchange's closing price calculation

Explanation

Initial margin is collateral collected at the outset to cover potential future exposure if a clearing member defaults before the position can be closed out. It is sized to a confidence level over a close-out period, not to cover fees or pricing errors.

Question 3Derivatives fundamentals and market structure

An investor buys a call option on a stock with a strike of 500p and pays a premium of 20p. At expiry the stock trades at 560p. What is the investor's net profit per share?

  1. 80p
  2. 40p Correct answer.
  3. 20p
  4. 60p

Explanation

The call's intrinsic value at expiry is 560p minus 500p, which equals 60p. Deducting the 20p premium paid gives a net profit of 40p per share.

Question 4Derivatives fundamentals and market structure

Which feature distinguishes an exchange-traded derivative from an over-the-counter (OTC) derivative?

  1. OTC contracts cannot be used for hedging
  2. OTC contracts are only available to retail investors
  3. Exchange-traded contracts always require physical delivery of the underlying
  4. Exchange-traded contracts are standardised and cleared through a central counterparty Correct answer.

Explanation

Exchange-traded derivatives use standardised contract terms and are cleared through a CCP, which manages counterparty risk. OTC contracts are negotiated bilaterally, allowing bespoke terms but exposing parties to bilateral counterparty risk.

Question 5Derivatives fundamentals and market structure

A trader holds a long futures position and the exchange's daily settlement price falls. What happens to the trader's margin account at the end of that day?

  1. It is unaffected until the contract expires
  2. It is credited with the price movement
  3. It is debited by the price movement and may trigger a margin call Correct answer.
  4. It is closed automatically at the previous day's price

Explanation

Futures are marked to market daily, so a long position is debited when the settlement price falls. If the balance drops below the maintenance margin, the trader must post variation margin to restore it.

Question 6Derivatives fundamentals and market structure

In option pricing terminology, what does implied volatility represent?

  1. The volatility input that makes a model price equal the observed market price Correct answer.
  2. The dividend yield expected over the option's life
  3. The risk-free interest rate used in the model
  4. The historical standard deviation of the underlying's returns over the past year

Explanation

Implied volatility is backed out of an option's market price by inverting a pricing model such as Black-Scholes. It reflects the market's current expectation of future volatility rather than past price movements.

Question 7Derivatives fundamentals and market structure

Which party to a swap typically faces the greatest credit exposure in a plain vanilla interest rate swap?

  1. The party that is currently owed money under the contract Correct answer.
  2. The clearing house, which bears no risk
  3. The party that is currently paying money under the contract
  4. The broker who arranged the trade

Explanation

Credit exposure in a swap lies with the party to whom the contract has positive value, because that party is owed future payments. If the counterparty defaults, that in-the-money party loses the expected cash flows.

Question 8Derivatives fundamentals and market structure

What is the primary economic function of a derivatives market for a corporate treasurer hedging future input costs?

  1. To increase the firm's reported earnings volatility
  2. To guarantee a profit on the underlying purchase
  3. To transfer price risk to parties willing to bear it Correct answer.
  4. To avoid all regulatory reporting obligations

Explanation

Derivatives allow risk to be separated from the underlying asset and transferred to counterparties better able or willing to bear it. For a hedger, the aim is to reduce uncertainty rather than to generate profit.

Question 9Derivatives fundamentals and market structure

A stock currently trades at 400p. A three-month European put has a strike of 380p and costs 12p. What is the option's intrinsic value today?

  1. 20p
  2. 12p
  3. 0p Correct answer.
  4. 380p

Explanation

Intrinsic value for a put is the strike minus the underlying price, floored at zero. Since 380p is below the 400p market price, the put is out of the money and its intrinsic value is zero; the 12p is entirely time value.

Question 10Derivatives fundamentals and market structure

An index futures contract has a multiplier of £10 per point and the index stands at 7,200. What is the notional value of one contract?

  1. £720,000
  2. £7,200,000
  3. £72,000 Correct answer.
  4. £7,200

Explanation

Notional value equals the index level multiplied by the contract multiplier: 7,200 × £10 = £72,000. This figure represents the exposure controlled by one contract.

Question 11Derivatives fundamentals and market structure

A trader expects the price difference between two related futures contracts to widen and takes offsetting long and short positions in them. Which strategy is being used?

  1. A conversion arbitrage
  2. A protective put
  3. A covered call
  4. A calendar spread Correct answer.

Explanation

A spread strategy involves simultaneous long and short positions in related contracts, such as different expiry months of the same futures. The trader profits from a change in the price relationship rather than the outright direction of the market.

Question 12Derivatives fundamentals and market structure

Which statement correctly describes the payoff of a short position in a futures contract at expiry?

  1. Its loss is limited to the initial margin posted
  2. It profits when the settlement price rises above the entry price
  3. Its maximum profit is limited to the premium received
  4. It profits when the settlement price falls below the entry price Correct answer.

Explanation

A short futures position gains when the price at expiry is below the price at which the contract was sold. The payoff is linear and symmetric, so losses are unlimited as prices rise.

Question 13Derivatives fundamentals and market structure

What is the effect of an increase in the risk-free interest rate on the theoretical price of a European call option, all else equal?

  1. The call price rises because the forward price of the underlying increases Correct answer.
  2. The call price falls because volatility declines
  3. The call price is unaffected by interest rates
  4. The call price falls because discounting reduces the strike's present value

Explanation

Higher interest rates raise the forward price of the underlying, which increases the value of a call. The present value of the strike also falls, reinforcing the upward effect on the call premium.

Question 14Derivatives fundamentals and market structure

A company agrees a three-month forward to sell US dollars and buy sterling at a fixed rate. Which risk is it hedging?

  1. Interest rate risk on its sterling borrowings
  2. Commodity price risk on raw materials
  3. Equity price risk on its share portfolio
  4. Currency risk on future dollar receipts Correct answer.

Explanation

By fixing the exchange rate at which it will sell dollars for sterling, the company removes uncertainty over the sterling value of future dollar receipts. This is a classic currency hedging transaction using a forward.

Question 15Derivatives fundamentals and market structure

In a centrally cleared derivatives market, what is the role of the clearing member?

  1. To act as intermediary between clients and the CCP and to post margin for client positions Correct answer.
  2. To guarantee the CCP's obligations to the exchange
  3. To provide investment advice to retail clients
  4. To set the official settlement price each day

Explanation

Clearing members are firms admitted to the CCP that clear trades for themselves and their clients, posting margin to the CCP and managing their clients' obligations. They stand between the client and the CCP in the clearing chain.

Question 16Derivatives fundamentals and market structure

A portfolio manager wants protection against a fall in a stock index but wishes to retain the dividends and any upside. Which strategy best matches this objective?

  1. Writing index call options
  2. Selling index futures
  3. Entering a pay-fixed interest rate swap
  4. Buying index put options Correct answer.

Explanation

Buying puts provides downside protection while leaving the underlying portfolio and its dividends intact, and the manager retains upside beyond the premium paid. Selling futures would remove both downside and upside exposure.

Question 17Derivatives fundamentals and market structure

What does a futures basis represent?

  1. The total commission charged on a futures trade
  2. The difference between the futures price and the spot price Correct answer.
  3. The difference between the bid and offer price quoted by a market maker
  4. The margin required to open a position

Explanation

Basis is the spot price minus the futures price, or equivalently the futures price relative to spot depending on convention. It converges towards zero as the contract approaches expiry, reflecting cost of carry and expectations.

Question 18Derivatives fundamentals and market structure

An investor writes a European call option on a stock and receives a premium. What is the maximum profit the investor can achieve?

  1. Unlimited, as the stock can rise indefinitely
  2. The strike price minus the premium
  3. The premium received, if the option expires worthless Correct answer.
  4. The stock price at expiry minus the strike

Explanation

A call writer's best outcome is that the option expires out of the money, leaving the premium as the entire profit. Beyond the strike, losses grow as the stock rises and are theoretically unlimited.

Question 19Derivatives fundamentals and market structure

Why does the fair value of an equity index futures contract typically exceed the spot index level when interest rates are positive?

  1. Because the exchange adds a risk premium to the futures price
  2. Because futures contracts carry voting rights
  3. Because futures are always more liquid than the cash market
  4. Because the cost of financing the underlying exceeds the expected dividend yield Correct answer.

Explanation

The futures price reflects the cost of carry: financing the cash basket at the risk-free rate less dividends received on it. When financing costs exceed the dividend yield, the futures trades at a premium to spot.

Question 20Derivatives fundamentals and market structure

A bank enters an interest rate swap in which it pays a fixed rate and receives a floating rate. Which market movement benefits the bank?

  1. A fall in the floating reference rate
  2. A rise in the fixed rate it agreed to pay
  3. A rise in the floating reference rate Correct answer.
  4. A widening of its credit spread

Explanation

A pay-fixed, receive-floating swap gains value when the floating reference rate rises, because the received leg increases while the fixed payment stays constant. A fall in the floating rate would reduce the swap's value to the bank.

Question 21Derivatives fundamentals and market structure

An option trader observes that the implied volatility of out-of-the-money equity index puts is well above that of equivalent calls. What does this pattern, known as skew, most likely reflect?

  1. The absence of any time value in put options
  2. A guaranteed arbitrage opportunity for buyers of calls
  3. Persistent demand for downside protection against market crashes Correct answer.
  4. A mechanical error in the pricing model used by the exchange

Explanation

Equity index options typically display negative skew because investors pay up for crash protection, raising implied volatility on low-strike puts. The pattern reflects supply and demand for downside insurance rather than a model error.

Question 22Derivatives fundamentals and market structure

A trader buys a call and a put on the same underlying with the same strike and expiry. Which statement about this straddle is correct?

  1. It has a maximum loss equal to the strike price
  2. It profits from a large move in either direction, having paid two premiums Correct answer.
  3. It is equivalent to a long futures position
  4. It profits only if the underlying price stays unchanged

Explanation

A long straddle combines a call and a put at the same strike and expiry, so it gains from a large move in either direction. The maximum loss is limited to the two premiums paid, and it loses if the price stays near the strike.

Question 23Derivatives fundamentals and market structure

A corporate bond portfolio manager expects credit spreads to widen sharply and wants to hedge without selling the bonds. Which derivatives approach is most consistent with this view?

  1. Writing equity index puts
  2. Selling protection through a credit default swap
  3. Buying protection through a credit default swap Correct answer.
  4. Buying a receiver interest rate swap

Explanation

Buying credit protection via a CDS pays off if the reference entity defaults or spreads widen, offsetting losses on the physical bonds. Selling protection would increase exposure to widening spreads rather than hedge it.

Question 24Derivatives fundamentals and market structure

Under put-call parity for European options on a non-dividend-paying stock, which relationship holds?

  1. Call plus put equals the present value of the strike
  2. Call minus put equals the stock price minus the present value of the strike Correct answer.
  3. Call minus put equals the strike minus the stock price
  4. Call plus put equals the stock price plus the strike

Explanation

Put-call parity states that a call minus a put equals the stock price minus the strike discounted to present value. Rearranging shows that a fiduciary call and a protective put have identical payoffs at expiry.

Question 25Derivatives fundamentals and market structure

An exchange raises initial margin requirements on a futures contract during a period of extreme volatility. What is the most likely immediate consequence for leveraged traders?

  1. Their maximum permitted position size rises without extra funding
  2. They must post additional collateral or reduce positions to remain compliant Correct answer.
  3. Their existing contracts are automatically repriced at the previous settlement
  4. Their exposure to the clearing house becomes unlimited

Explanation

Higher initial margin means more collateral is required per contract, so leveraged traders must fund the difference or cut positions. This reduces the risk the CCP faces during stressed market conditions.

Question 26Derivatives fundamentals and market structure

In a futures market, what is the function of the initial margin deposited by a trader?

  1. It is a part-payment of the contract's purchase price
  2. It provides a performance bond against potential future losses on the position Correct answer.
  3. It is a fee paid to the broker for executing the trade
  4. It caps the trader's maximum possible loss on the contract

Explanation

Initial margin is collateral, not a price payment or a transaction fee. It gives the clearing house protection against the risk that the trader fails to meet variation margin calls as the position moves against them.

Question 27Derivatives fundamentals and market structure

Which statement best describes the role of a market maker on a derivatives exchange?

  1. They guarantee final settlement of every trade on the exchange
  2. They set the official settlement price used for daily mark-to-market
  3. They continuously quote bid and offer prices and stand ready to trade at those prices Correct answer.
  4. They act as the legal counterparty to every cleared transaction

Explanation

A market maker provides liquidity by displaying two-way prices and trading when others wish to deal. This narrows spreads and improves the ease with which other participants can enter and exit positions.

Question 28Derivatives fundamentals and market structure

A wheat farmer agrees today to sell 200 tonnes of wheat in six months at a fixed price of £180 per tonne. What is the primary purpose of this forward agreement for the farmer?

  1. To speculate on a rise in the wheat price before harvest
  2. To transfer the obligation to deliver the wheat to a third party
  3. To lock in a selling price and remove exposure to adverse price movements Correct answer.
  4. To obtain immediate cash payment for grain not yet harvested

Explanation

By fixing the sale price in advance, the farmer converts an uncertain future revenue into a known amount and eliminates the risk of the price falling before delivery. This is a classic hedge of an anticipated long cash position in the underlying.

Question 29Derivatives fundamentals and market structure

An investor holds a long position in one futures contract and the exchange raises the initial margin requirement from £2,000 to £3,000 per contract. What is the immediate effect on the investor's account?

  1. The exchange pays the investor £1,000 to compensate for the higher requirement
  2. The investor must deposit an additional £1,000 of collateral to maintain the position Correct answer.
  3. The investor's position is automatically liquidated at the next settlement
  4. The investor's profit or loss on the position changes by £1,000

Explanation

Raising initial margin increases the collateral that must be posted against an open position, so the holder must fund the shortfall of £1,000. The change in margin does not alter the contract's market value or the profit and loss already accrued.

Question 30Derivatives fundamentals and market structure

A trader buys a September futures contract at 4,250 and the contract has a tick value of £12.50 per point. The trader closes the position at 4,222. What is the trader's profit or loss?

  1. A profit of £28
  2. A loss of £350 Correct answer.
  3. A loss of £28
  4. A profit of £350

Explanation

The price fell by 28 points (4,250 − 4,222). Each point is worth £12.50, so the loss is 28 × £12.50 = £350 on the long position.

Question 31Derivatives fundamentals and market structure

A futures contract trades at 96.20 while the underlying cash asset trades at 95.60. Which term describes the 0.60 difference?

  1. The contract's contango
  2. The contract's basis Correct answer.
  3. The contract's variation margin
  4. The contract's tick size

Explanation

Basis is the difference between the cash price and the futures price of the same underlying, commonly quoted as cash minus futures. Here 95.60 − 96.20 gives a basis of −0.60, meaning futures trade above cash.

Question 32Derivatives fundamentals and market structure

An airline expects to buy 1,000 tonnes of jet fuel in three months and hedges by buying 20 futures contracts, each covering 50 tonnes. Which risk remains after the hedge is placed?

  1. Funding risk, because futures require full payment of the contract value upfront
  2. Currency risk, because futures premiums are paid in a foreign currency
  3. Basis risk, because the futures price may not move exactly with the airline's local fuel price Correct answer.
  4. Delivery risk, because futures contracts cannot be cash-settled

Explanation

The hedge fixes the futures price but the airline's actual purchase price may diverge from it, so basis risk remains. Cross-hedging with a related contract, or a mismatch between the futures specification and the physical grade, widens that residual risk.

Question 33Derivatives fundamentals and market structure

What does novation achieve when a trade is submitted to a central counterparty?

  1. It transfers ownership of the underlying asset to the clearing house
  2. It converts a futures contract into an option contract
  3. It replaces the original bilateral contract with two contracts, one with each clearing member Correct answer.
  4. It cancels the trade and returns margin to both parties

Explanation

Through novation the central counterparty interposes itself between the buyer and seller, becoming the seller to every buyer and the buyer to every seller. This mutualises counterparty credit risk and allows participants to deal anonymously with the clearing house as their counterparty.

Question 34Derivatives fundamentals and market structure

A speculator believes the price of a commodity will fall and therefore sells one futures contract at 610. The next day the settlement price is 625 and the day after it is 598. Ignoring transaction costs and with a tick value of £10 per point, what is the cumulative variation margin credited to or debited from the account?

  1. A net credit of £270
  2. A net debit of £120
  3. A net credit of £120 Correct answer.
  4. A net debit of £270

Explanation

Daily settlement is applied step by step. On day one the short loses 15 points (£150); on day two the price falls 27 points, giving a gain of £270. The net result is a credit of £120, not a gain measured from the entry price to the final price.

Question 35Derivatives fundamentals and market structure

An investor wants exposure to a stock index but prefers to avoid the operational work of buying every constituent. Which derivative structure most directly achieves this?

  1. Selling a put option on a single constituent share
  2. Entering a fixed-for-floating interest rate swap
  3. Buying a stock index futures contract Correct answer.
  4. Buying a forward rate agreement

Explanation

A stock index futures contract delivers the return of the index basket in a single tradable instrument, giving broad equity exposure with low operational burden. The other instruments either reference a single share or reference interest rates rather than equity prices.

Question 36Derivatives fundamentals and market structure

A pension fund holds a large equity portfolio and expects a temporary market fall but does not want to sell the shares. Which use of derivatives best matches this objective?

  1. Buying index futures to increase market exposure during the expected fall
  2. Selling index futures to reduce net market exposure while retaining the shares Correct answer.
  3. Writing put options on the index to generate premium income
  4. Entering a payer interest rate swap on the portfolio's value

Explanation

A short index futures position offsets losses on the physical portfolio, lowering net equity beta without triggering a sale of the shares. When the view changes, the futures position can be closed and full exposure restored cheaply.

Question 37Derivatives fundamentals and market structure

A corporate treasurer wants the right, but not the obligation, to buy foreign currency at a fixed rate in three months and is unwilling to post collateral against future mark-to-market moves. Which instrument best fits?

  1. A bought currency call option Correct answer.
  2. A currency swap
  3. A currency forward contract
  4. A currency futures contract

Explanation

A bought call option gives the holder a right without an obligation and the premium is paid upfront, so no variation margin arises from adverse price moves. Futures and forwards create binding obligations with ongoing collateral or credit exposure.

Question 38Derivatives fundamentals and market structure

A trader notes that the three-month futures price for a storable commodity is significantly above the spot price plus the cost of carry. Assuming no convenience yield and no arbitrage barriers, which action would a rational arbitrageur take?

  1. Buy the futures, sell the commodity short and invest the proceeds
  2. Do nothing, because futures must always trade at the cost of carry
  3. Buy the commodity, finance it and sell the futures Correct answer.
  4. Buy both the commodity and the futures to capture the convergence

Explanation

When futures are rich relative to the cost of carry, the arbitrage is to buy the physical asset, fund the purchase and carry it, and sell the futures to lock in the overpricing. At delivery the futures position is settled against the asset held, capturing the excess.

Question 39Derivatives fundamentals and market structure

An exchange introduces a position limit that caps the number of contracts any single entity may hold in a deliverable month. What is the main regulatory purpose of such a limit?

  1. To prevent a single participant from cornering the market and distorting settlement Correct answer.
  2. To ensure the underlying asset is delivered to the exchange
  3. To increase the exchange's fee income from large traders
  4. To guarantee that all traders make a profit on their positions

Explanation

Position limits restrict the size of exposure one entity can build, reducing the risk of market manipulation and disorderly squeezes around expiry. They protect the integrity of settlement and the functioning of the deliverable market.

Question 40Derivatives fundamentals and market structure

A dealer quotes a client a two-way price on a forward contract as 104.10 bid / 104.40 offer. Which statement best describes the dealer's compensation if the client immediately buys at the quoted offer?

  1. The dealer earns the 0.30 spread between the bid and the offer, being the compensation for making a two-way market and bearing the associated risk. Correct answer.
  2. The dealer earns the bid price itself, since the client pays the offer and the dealer keeps the difference in full as principal profit.
  3. The dealer earns nothing on the transaction because forward contracts are always traded at zero cost.
  4. The dealer earns a commission charged separately by the exchange clearing house on the matched trade.

Explanation

A market maker quotes a bid at which it will buy and an offer at which it will sell, and the gap between them, the bid-offer spread, is the compensation for standing ready to trade and for carrying the resulting position risk. When the client buys at the offer of 104.40, the dealer has effectively sold at a price 0.30 above the level at which it would buy back, so the spread is its gross margin on the round trip. The size of that spread widens with volatility, illiquidity and the dealer's own inventory risk.

Question 41Futures and forward contracts

A UK pension fund will receive GBP 5 million in three months and wants to lock in a three-month interest rate now. Which contract most directly achieves this?

  1. A long sterling three-month interest rate future Correct answer.
  2. A long gilt future
  3. A short FTSE 100 index future
  4. A short sterling three-month interest rate future

Explanation

A future buyer of a deposit benefits when rates rise, so the fund takes a long position in the interest rate future to fix the rate at which it will place the cash. The short position would hedge a borrower, not a depositor. Index and gilt futures hedge equity and bond price risk, not the short-term interest rate.

Question 42Futures and forward contracts

On a futures exchange, which party is obliged to make good any losses if a clearing member defaults?

  1. The original counterparty to the trade
  2. The defaulting client's introducing broker only
  3. The exchange's central counterparty Correct answer.
  4. The other clearing members collectively

Explanation

The central counterparty interposes itself between buyer and seller through novation and guarantees performance to each side. It manages default through margin, a default fund and its own capital. Individual clients and brokers are not the ultimate guarantors of the market.

Question 43Futures and forward contracts

A trader holds a long futures position in a contract that is physically deliverable. Which statement describes the standard obligation at expiry?

  1. The position is automatically cash settled at the last traded price
  2. The trader must buy the underlying at the agreed price and take delivery Correct answer.
  3. The trader must sell the underlying at the agreed price
  4. The trader may walk away with no further obligation

Explanation

A long futures holder who does not close out before expiry is obliged to take delivery and pay the contract price in a physically settled contract. Closing the position before expiry, or rolling it, is what avoids delivery. Cash settlement applies only where the contract specifies it.

Question 44Futures and forward contracts

A forward contract is traded directly between two parties. What is the principal consequence of this structure?

  1. It can be closed out at any time on an exchange
  2. It carries counterparty credit risk on each side Correct answer.
  3. It requires an initial margin paid to a central counterparty
  4. It is marked to market daily by a clearing house

Explanation

Bilateral forwards are not novated to a clearing house, so each party bears the risk that the other fails to perform. There is no daily variation margin or exchange-based close-out mechanism unless the parties agree one. This is a core distinction from exchange-traded futures.

Question 45Futures and forward contracts

An investor buys one futures contract at 250.0. The contract multiplier is GBP 10 per point and initial margin is GBP 1,500. If the price rises to 262.0, what is the effect on the investor's margin account before any withdrawal?

  1. A credit of GBP 12,000
  2. No change until the position is closed
  3. A credit of GBP 120 Correct answer.
  4. A debit of GBP 120

Explanation

The gain is 12 points multiplied by GBP 10, giving GBP 120 credited through daily variation margin. Futures are marked to market each day, so profit is realised in the account without closing the position. Margin is a performance deposit and is not a cost of the trade.

Question 46Futures and forward contracts

Which best describes the role of the initial margin in a futures account?

  1. A tax withheld on realised futures gains
  2. A performance bond held to cover potential adverse price moves Correct answer.
  3. A fee paid to the broker for executing the trade
  4. A prepayment of the full contract value

Explanation

Initial margin is a good-faith deposit that protects the clearing chain against default; it is returned when the position is closed and settled. It is not a transaction fee and does not represent the full value of the contract. It is held, and may earn interest, rather than being spent.

Question 47Futures and forward contracts

What does the basis of a futures contract represent?

  1. The difference between the bid and offer in the futures order book
  2. The daily variation margin payment
  3. The difference between the futures price and the underlying spot price Correct answer.
  4. The exchange's clearing fee per lot

Explanation

Basis is normally quoted as spot minus futures, and it converges towards zero as expiry approaches for a deliverable contract. It reflects carry, storage and convenience yield considerations. It is not a spread or a fee.

Question 48Futures and forward contracts

An oil producer wants to fix the sale price of 100,000 barrels for delivery in six months. Which futures position is the appropriate hedge?

  1. Buy crude oil futures sized to 100,000 barrels
  2. Buy 100 crude oil futures contracts and take delivery
  3. Sell crude oil futures sized to 100,000 barrels Correct answer.
  4. Sell crude oil futures sized to 50,000 barrels

Explanation

A producer is long the physical commodity and hedges by selling futures, so a fall in price is offset by a gain on the short futures position. The number of contracts should match the exposure, adjusted for contract size. Buying futures would add to the producer's price risk.

Question 49Futures and forward contracts

A futures price is quoted at 96.25 on a three-month interest rate future with a contract size of GBP 500,000 and a tick of 0.01 worth GBP 12.50. What does the quoted price imply about the three-month rate?

  1. 96.25%
  2. 3.75% Correct answer.
  3. 2.25%
  4. 0.9625%

Explanation

Short-term interest rate futures are quoted as 100 minus the implied rate, so a price of 96.25 implies a rate of 3.75%. The contract is a price index, not a direct percentage yield. The tick value simply translates price movement into cash.

Question 50Futures and forward contracts

Which feature distinguishes a futures contract from a forward contract in terms of standardisation?

  1. Futures have standardised contract sizes and delivery dates set by the exchange Correct answer.
  2. Forwards are always cash settled
  3. Futures are always settled on the day of trade
  4. Futures terms are negotiated individually for each trade

Explanation

Exchange-traded futures use standardised specifications, which makes them fungible and easy to offset. Forwards are bespoke and tailored to the parties' needs. Standardisation is what allows an active secondary market in futures.