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Series 3 study materials
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Series 3 practice questions

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Question 1Futures Trading Theory and Basic Functions/Terminology

A futures contract is best described as:

  1. a security that represents an ownership interest in a corporation
  2. a contract granting the right, but not the obligation, to trade an asset later
  3. a standardized exchange-traded agreement to buy or sell at a set future price Correct answer.
  4. a customized, privately negotiated agreement between two parties outside an exchange

Explanation

Futures contracts are standardized and traded on regulated exchanges, with terms such as quantity, quality, and delivery date set by the exchange. Both parties are obligated to perform, and the clearinghouse guarantees performance.

Question 2Futures Trading Theory and Basic Functions/Terminology

An investor who sells a futures contract to establish a position is said to be:

  1. short the market Correct answer.
  2. locked the market
  3. long the market
  4. flat the market

Explanation

Selling a futures contract creates a short position, obligating the seller to deliver or offset later. Buying a contract creates a long position.

Question 3Futures Trading Theory and Basic Functions/Terminology

Under a futures contract, which party is obligated to buy the underlying asset?

  1. the clearinghouse
  2. the broker
  3. the buyer (long) Correct answer.
  4. the seller (short)

Explanation

The long (buyer) is obligated to take delivery and pay the contract price, while the short is obligated to deliver. The clearinghouse guarantees performance but does not take the buyer's side of the trade.

Question 4Futures Trading Theory and Basic Functions/Terminology

The minimum amount a customer must deposit to open a futures position is called:

  1. maintenance margin
  2. settlement margin
  3. initial margin Correct answer.
  4. variation margin

Explanation

Initial margin is the good-faith deposit required to establish a new position. Maintenance margin is the lower level that must be kept thereafter, and variation margin covers daily settlement.

Question 5Futures Trading Theory and Basic Functions/Terminology

A speculator in futures markets primarily:

  1. guarantees contract performance on behalf of the clearinghouse
  2. sets the exchange's daily price limits for each contract
  3. seeks to profit from price changes without taking delivery Correct answer.
  4. owns the physical commodity and delivers it against the contract

Explanation

Speculators accept price risk in pursuit of profit and typically offset positions before expiration rather than making or taking delivery. Hedgers, by contrast, use futures to manage risk tied to the physical commodity.

Question 6Futures Trading Theory and Basic Functions/Terminology

The month in which a futures contract expires and delivery may occur is called the:

  1. basis month
  2. tick month
  3. delivery month Correct answer.
  4. margin month

Explanation

Each futures contract specifies a delivery month, the month in which the contract expires and delivery can be made. Contract specifications also define size, grade, and delivery location.

Question 7Futures Trading Theory and Basic Functions/Terminology

Basis is generally calculated as:

  1. cash price minus futures price Correct answer.
  2. change in futures price minus change in cash price
  3. futures price minus cash price
  4. cash price plus futures price

Explanation

Basis equals the local cash price minus the price of the nearby futures contract. It reflects transportation, storage, and local supply-demand factors.

Question 8Futures Trading Theory and Basic Functions/Terminology

A futures market is in contango when:

  1. deferred futures trade above nearby futures Correct answer.
  2. open interest exceeds trading volume
  3. the cash price is above the nearby futures price
  4. nearby futures trade above deferred futures

Explanation

Contango describes an upward-sloping futures curve in which later delivery months trade above nearby months, often due to storage costs. Backwardation is the opposite.

Question 9Futures Trading Theory and Basic Functions/Terminology

A producer who will sell a commodity in three months and wants protection against falling prices should:

  1. buy a call option and also sell futures contracts
  2. buy futures now and sell them after three months
  3. sell futures now and offset at the time of sale Correct answer.
  4. wait and do nothing until the commodity is sold

Explanation

A short hedge protects a future sale price: selling futures now locks in a price, and gains or losses in the cash market are offset by the futures position when it is offset.

Question 10Futures Trading Theory and Basic Functions/Terminology

The primary function of a futures clearinghouse is to:

  1. set the official price of each futures contract
  2. lend margin money to speculators and hedgers
  3. guarantee performance and settle daily gains and losses Correct answer.
  4. match buyers with sellers on the exchange floor

Explanation

The clearinghouse becomes the counterparty to every trade, guaranteeing performance and administering daily mark-to-market payments. This reduces counterparty credit risk for market participants.

Question 11Futures Trading Theory and Basic Functions/Terminology

Open interest refers to the:

  1. total number of orders still working in the market
  2. number of contracts traded during a single session
  3. contracts that remain open and have not been offset Correct answer.
  4. number of traders who currently hold positions

Explanation

Open interest counts the total futures contracts outstanding, meaning positions that have been established but not yet offset or delivered. It changes only when new positions are created or existing ones are closed.

Question 12Futures Trading Theory and Basic Functions/Terminology

A futures contract has a tick size of 0.25 cents per bushel and a contract size of 5,000 bushels. The value of one tick is:

  1. $25.00
  2. $0.25
  3. $12.50 Correct answer.
  4. $1.25

Explanation

0.25 cents equals $0.0025 per bushel; multiplying by the 5,000-bushel contract size gives $12.50 per tick. Tick value equals tick size times contract multiplier.

Question 13Futures Trading Theory and Basic Functions/Terminology

Daily settlement, or marking to market, means that:

  1. margin requirements are recalculated only when the contract expires
  2. accounts are adjusted daily to the settlement price Correct answer.
  3. the contract price remains fixed at the original trade price
  4. the clearinghouse closes out all positions at each day's end

Explanation

At the end of each session the clearinghouse marks open positions to the settlement price, crediting gains and debiting losses. This daily cash flow keeps margin accounts current and limits accumulated credit risk.

Question 14Futures Trading Theory and Basic Functions/Terminology

If an account's equity falls below the maintenance margin level, the customer must:

  1. add funds to restore the account to initial margin Correct answer.
  2. sell the position directly to the clearinghouse
  3. wait until the contract expires for final settlement
  4. immediately take delivery of the underlying commodity

Explanation

A margin call requires the customer to deposit enough funds to bring equity back to the initial margin level. If the call is not met, the broker may liquidate the position.

Question 15Futures Trading Theory and Basic Functions/Terminology

Futures positions are highly leveraged because:

  1. a small margin controls a much larger notional value Correct answer.
  2. the exchange guarantees all losses
  3. prices cannot move against a position
  4. contracts never require any cash deposit

Explanation

Margin is a small fraction of the contract's notional value, so a modest price change can produce a large percentage gain or loss on the margin deposited. This leverage works in both directions.

Question 16Futures Trading Theory and Basic Functions/Terminology

A limit-up move in a futures market occurs when:

  1. the price rises to the exchange's maximum daily limit Correct answer.
  2. the clearinghouse raises margin requirements
  3. trading volume exceeds open interest
  4. the exchange closes the market early

Explanation

Exchanges set daily price limits; a limit-up move means the price has reached the upper limit and trading may be restricted. The limits are designed to damp excessive volatility.

Question 17Futures Trading Theory and Basic Functions/Terminology

Compared with a forward contract, a futures contract is characterized by:

  1. counterparty credit risk borne by each of the two parties
  2. daily settlement and standardized exchange-traded terms Correct answer.
  3. delivery that always occurs at the very end of the contract
  4. customized terms and no daily cash flows between parties

Explanation

Futures are standardized, exchange-traded, cleared, and marked to market daily. Forwards are private, customized contracts that settle at maturity and carry counterparty credit risk.

Question 18Futures Trading Theory and Basic Functions/Terminology

At expiration, the futures price and the cash price of the same commodity tend to:

  1. converge to the same price, apart from small delivery costs Correct answer.
  2. remain separated by the basis at the start of the contract
  3. diverge by the amount of the initial margin
  4. move in opposite directions

Explanation

Convergence occurs because delivery arbitrage forces the expiring futures price toward the cash price. Any remaining difference reflects delivery and transaction costs.

Question 19Futures Trading Theory and Basic Functions/Terminology

A trader buys the nearby crude oil futures and sells the deferred crude oil futures. This position is:

  1. a covered call
  2. a long hedge
  3. an intercommodity spread
  4. a calendar spread Correct answer.

Explanation

A calendar spread involves simultaneous long and short positions in the same commodity with different delivery months. Intercommodity spreads use different but related commodities.

Question 20Futures Trading Theory and Basic Functions/Terminology

If price rises, volume rises, and open interest rises, this typically suggests:

  1. the existing uptrend is weakening
  2. shorts are covering their positions only
  3. longs are liquidating their positions in the market
  4. new buying is entering and the uptrend is supported Correct answer.

Explanation

Rising price with rising open interest indicates new positions are being established on the long side, which supports the uptrend. Rising volume confirms the strength of the move.

Question 21U.S. Futures Markets

A customer's futures contract is guaranteed to both the buyer and the seller by which party?

  1. The National Futures Association
  2. The exchange's clearing organization Correct answer.
  3. The party on the other side of the trade
  4. The customer's futures commission merchant

Explanation

Every accepted futures trade is novated to the exchange's clearing organization, which becomes the buyer to every seller and the seller to every buyer. Because the clearinghouse stands behind each side, a customer's exposure is to the clearing system rather than to an individual counterparty. FCMs carry accounts and collect margin, but they do not guarantee contract performance themselves.

Question 22U.S. Futures Markets

In futures trading, a "round turn" refers to:

  1. The purchase and subsequent offset of one contract Correct answer.
  2. The delivery process at contract expiration
  3. A single purchase of one contract
  4. The rolling of a position to a later delivery month

Explanation

A round turn is a completed transaction consisting of opening a position and later offsetting it, so it involves two executions but counts as one round turn. Commissions are commonly quoted on a per-round-turn basis. A single entry or exit is sometimes called a side or half turn.

Question 23U.S. Futures Markets

A customer who wants to establish a long futures position immediately at the best available price should enter:

  1. A market order Correct answer.
  2. A stop-limit order
  3. A limit order
  4. A stop order

Explanation

A market order instructs the broker to execute immediately at the best price obtainable, with no price restriction. It offers certainty of execution but not certainty of price. Limit and stop instructions depend on specified prices that may never be reached.

Question 24U.S. Futures Markets

A trader who is long one futures contract will realize a profit when:

  1. margin requirements are increased by the exchange
  2. the futures price rises above the purchase price Correct answer.
  3. the position is offset at a price lower than the purchase price
  4. the contract's price falls below the purchase price

Explanation

A long position gains value as the futures price rises, because the contract can be offset by selling at the higher price. The gain is credited to the account through daily settlement rather than at offset. A decline in price creates a loss for the long.

Question 25U.S. Futures Markets

Which agency administers the Commodity Exchange Act and oversees U.S. futures markets at the federal level?

  1. The SEC
  2. The CFTC Correct answer.
  3. The Federal Reserve
  4. The NFA

Explanation

The Commodity Exchange Act is the federal statute governing commodity futures trading, and the Commodity Futures Trading Commission administers it. The NFA performs self-regulatory functions under CFTC oversight rather than being the federal regulator itself. The SEC regulates securities markets, and the Federal Reserve has no jurisdiction over futures trading.

Question 26U.S. Futures Markets

Basis is conventionally defined as:

  1. the cash price minus the futures price Correct answer.
  2. the change in the settlement price from the prior day
  3. the difference between two futures delivery months
  4. the futures price minus the cash price

Explanation

Basis is the cash price of the commodity at a given location minus the price of the relevant futures contract. It reflects local supply and demand, transportation costs, and storage costs. Basis tends to converge toward zero as the futures contract approaches expiration.

Question 27U.S. Futures Markets

A grain futures contract calls for delivery of 5,000 bushels and its minimum price fluctuation is 1/4 cent per bushel. What is the dollar value of one tick?

  1. $1.25
  2. $50.00
  3. $12.50 Correct answer.
  4. $5.00

Explanation

Tick value equals the contract size multiplied by the minimum price increment: 5,000 bushels times $0.0025 per bushel equals $12.50. That is the amount credited to or debited from the account for each one-tick move in the price. The calculation must use the decimal equivalent of 1/4 cent.

Question 28U.S. Futures Markets

A customer holds a long futures position with initial margin of $5,000 and maintenance margin of $3,500. Account equity falls to $3,200. How much must the customer deposit to restore the account to the initial margin level?

  1. $1,800 Correct answer.
  2. $300
  3. $1,500
  4. $3,200

Explanation

Because equity of $3,200 is below the $3,500 maintenance level, a margin call is issued. The customer must restore equity to the initial margin level of $5,000, which requires a deposit of $5,000 minus $3,200, or $1,800. Restoring only to the maintenance level would leave the account immediately vulnerable to another call.

Question 29U.S. Futures Markets

A wheat farmer will harvest and sell in September and wants protection against a decline in prices. The appropriate futures action is to:

  1. Buy December wheat futures contracts
  2. Sell September wheat futures Correct answer.
  3. Remain unhedged and rely on the cash market
  4. Buy September wheat futures contracts

Explanation

A producer who will sell the crop later is harmed by falling prices, so the hedge is to sell (go short) futures now. If prices fall, the loss on the cash crop is offset by a gain on the short futures position. The hedge is placed in the delivery month closest to the anticipated cash sale.

Question 30U.S. Futures Markets

When deferred delivery months trade at a premium to the nearby month, the market is described as:

  1. a contango market Correct answer.
  2. a basis market
  3. a backwardated market
  4. an inverted market

Explanation

When deferred months trade above the nearby month, the market is in a carrying-charge, or contango, condition that reflects the cost of storing the commodity between months. The opposite condition, with deferred months below nearby, is an inverted or backwardated market. Basis, by contrast, compares cash and futures prices at one point in time.

Question 31U.S. Futures Markets

Which organization operates a self-regulatory arbitration forum for resolving futures-related disputes between customers and futures firms?

  1. The SEC
  2. The CFTC
  3. The Federal Reserve
  4. The NFA Correct answer.

Explanation

The National Futures Association runs arbitration and mediation programs for disputes between customers and futures industry firms, and it is the industry's self-regulatory organization. The CFTC is the federal regulator and does not arbitrate individual customer claims. The SEC and the Federal Reserve have no role in futures customer disputes.

Question 32U.S. Futures Markets

A customer is long a futures contract and wants protection against a sharp decline in price. Which order is most appropriate?

  1. A sell limit order
  2. A sell stop order Correct answer.
  3. A buy stop order
  4. A buy limit order

Explanation

A sell stop is placed below the current market and becomes a market order once that price trades, which limits further loss on a long position. A sell limit is placed above the market to exit at a favorable price and provides no downside protection. Buy orders would increase rather than reduce the long exposure.

Question 33U.S. Futures Markets

The primary economic function of speculators in futures markets is to:

  1. Assume price risk and add liquidity to the market Correct answer.
  2. Take delivery of the physical commodity at expiration
  3. Establish the daily settlement price for each contract
  4. Guarantee the performance of every contract traded

Explanation

Speculators accept the price risk that hedgers want to transfer and supply liquidity, which narrows bid-ask spreads and makes it easier for commercial users to execute hedges. They do not guarantee contracts or set settlement prices. Those are functions of the clearinghouse and the exchange, respectively.

Question 34U.S. Futures Markets

Futures accounts are marked to market daily, which means that:

  1. delivery is required at the end of each trading day
  2. the exchange collects the full contract value from the buyer
  3. gains and losses are credited or debited each day Correct answer.
  4. the contract price is fixed on the date of purchase

Explanation

Each day the clearinghouse computes gains and losses from the change in settlement price and credits or debits them to the margin account. This daily cash settlement is why futures positions carry no accumulated credit exposure and why margin must be maintained. Delivery occurs only when a position is held through expiration.

Question 35U.S. Futures Markets

A customer buys 5 July corn contracts and sells 5 December corn contracts in a single account. How are margin requirements for this position typically determined?

  1. No margin is required because the position is hedged.
  2. Margin is required only on the long leg.
  3. A reduced spread margin rate applies. Correct answer.
  4. Full initial margin is required on both legs.

Explanation

An intra-commodity spread such as long July corn against short December corn is less risky than either outright position because the two legs tend to move together. Exchanges therefore apply a reduced spread margin rate, frequently charging only the larger side of the spread. Charging full margin on both legs would overstate the risk of the combined position.

Question 36U.S. Futures Markets

A trader holds a long futures position through the last trading day and does not offset it. Which outcome applies?

  1. The trader must meet delivery obligations under the contract. Correct answer.
  2. The position is automatically rolled into the next delivery month.
  3. The account is charged an additional clearing fee to cancel it.
  4. The exchange offsets the position at the final settlement price.

Explanation

A futures contract is a binding agreement, so a long that fails to offset before expiration must accept delivery, or make or take a cash settlement if the contract so provides. The clearinghouse assigns delivery notices among carrying long positions. Nothing is rolled forward or canceled automatically.

Question 37U.S. Futures Markets

A grain elevator holds 40,000 bushels of corn and hedges with a grain futures contract of 5,000 bushels using a hedge ratio of 0.75. How many futures contracts should be sold?

  1. 4 contracts
  2. 12 contracts
  3. 8 contracts
  4. 6 contracts Correct answer.

Explanation

The number of contracts equals the cash position divided by the contract size, multiplied by the hedge ratio: 40,000 divided by 5,000 equals 8 contracts, and 8 times 0.75 equals 6 contracts. The hedge ratio adjusts for the fact that cash and futures prices do not move in lockstep. Rounding to a whole contract is required because fractional contracts cannot be traded.

Question 38U.S. Futures Markets

A futures market is locked limit down and a customer enters an order to sell at the market. Which outcome is most likely?

  1. It is offset by the clearinghouse automatically.
  2. It is filled at the exchange's opening price.
  3. It is filled at the prior day's settlement price.
  4. It is likely to go unfilled at the price limit. Correct answer.

Explanation

When the market is locked limit down, bids at the limit have been exhausted and sell orders cannot find buyers, so market and limit orders generally go unfilled. The position cannot be liquidated until trading occurs within the limit on that day or on a later day. The customer remains exposed until an execution is obtained.

Question 39U.S. Futures Markets

A customer purchases a call option on a futures contract. The customer:

  1. receives the premium from the option writer at expiration
  2. may buy the futures at the strike, but is not obligated Correct answer.
  3. is obligated to buy the underlying futures contract
  4. must post initial margin equal to the futures margin

Explanation

A call buyer pays a premium and acquires the right, but not the obligation, to buy the underlying futures contract at the strike price before expiration. Because exercise is at the buyer's discretion, the maximum loss is the premium paid. The writer receives the premium and carries the obligation, and the writer posts margin.

Question 40U.S. Futures Markets

In the Treasury bond futures contract, the short decides which eligible bond to deliver. The short will generally deliver the bond that:

  1. is cheapest to deliver after conversion-factor adjustment Correct answer.
  2. has the longest remaining term to maturity of the eligible issues
  3. was most recently issued by the U.S. Treasury
  4. pays the highest coupon rate of the eligible issues

Explanation

The short may deliver any bond in the deliverable basket, and the invoice price is the futures price multiplied by the conversion factor plus accrued interest. The short therefore selects the bond that produces the lowest net cost, known as the cheapest to deliver. That choice depends on the bond's price and conversion factor rather than on maturity, coupon, or issue date alone.

Question 41Hedging with Futures

A soybean farmer expects to harvest 50,000 bushels in October and is concerned that prices will fall before the crop is sold. To hedge with futures, the farmer should:

  1. Sell soybean futures now and buy them back when the crop is sold Correct answer.
  2. Sell soybean futures and hold the position until the crop is delivered against the contract at expiration
  3. Buy soybean futures now and sell them when the crop is sold
  4. Buy soybean futures only after the crop is harvested and stored

Explanation

A producer who owns or expects to own the cash commodity protects against falling prices with a short hedge by selling futures now. A decline in the cash price is offset by a gain on the short futures position, and the futures leg is closed out when the cash sale is made.

Question 42Hedging with Futures

Which market participant is the typical user of a long hedge?

  1. A farmer who has already forward-contracted the entire crop
  2. A food processor that will need to buy corn in three months Correct answer.
  3. A speculator who expects corn prices to fall
  4. A grain elevator holding inventory it plans to sell

Explanation

A long hedge is the purchase of futures by a party that will buy the cash commodity later, so that a rise in price is offset by a gain on the futures position. The hedge fixes the approximate cost of the later purchase.

Question 43Hedging with Futures

The basis in a hedging context is best defined as:

  1. the spread between two futures delivery months
  2. the cash price minus the futures price Correct answer.
  3. the difference between the exchange settlement price and the closing spot quote published by the government
  4. the futures price minus the cash price

Explanation

Basis is the cash price of a specified grade at a specified location minus the price of the related futures contract. It reflects transportation, storage, and local supply and demand conditions.

Question 44Hedging with Futures

As a futures contract nears expiration, the basis for the deliverable grade at the delivery location:

  1. widens in proportion to the remaining carrying charges
  2. remains fixed at its initial level until the last trading day
  3. tends toward zero Correct answer.
  4. becomes strongly negative as delivery approaches

Explanation

Delivery links the futures market to the cash market, so at expiration the futures price and the cash price for the deliverable grade at the delivery point must come together. The basis therefore converges toward zero, leaving only a small delivery-related spread.

Question 45Hedging with Futures

An anticipatory hedge is a futures position taken:

  1. to profit from an expected change in the basis alone
  2. only after the cash commodity has been delivered
  3. in a contract month that expires before the cash transaction occurs
  4. before the cash market transaction it is intended to protect Correct answer.

Explanation

An anticipatory hedge is established in advance of the actual cash purchase or sale, fixing a price before the cash transaction occurs. The futures position is later offset when the cash transaction takes place.

Question 46Hedging with Futures

Hedging a cash commodity with futures on a different but related commodity is known as:

  1. a calendar spread
  2. a basis trade
  3. a cross hedge Correct answer.
  4. a strip hedge

Explanation

A cross hedge uses futures on a related commodity when futures on the actual commodity are unavailable or illiquid. It carries ordinary basis risk plus the risk that the price relationship between the two commodities shifts.

Question 47Hedging with Futures

A producer wants to hedge 100,000 bushels of corn using corn futures that call for 5,000 bushels per contract. If the producer uses a hedge ratio of 0.80, how many contracts should be sold?

  1. 8
  2. 20
  3. 16 Correct answer.
  4. 25

Explanation

The number of contracts equals the cash quantity divided by the contract size, multiplied by the hedge ratio: (100,000 / 5,000) x 0.80 = 16 contracts.

Question 48Hedging with Futures

A grain producer sells December corn futures at $4.90 per bushel, later buys back the futures at $4.60, and sells the cash corn at $4.55. What is the effective selling price?

  1. $4.85 Correct answer.
  2. $4.55
  3. $4.25
  4. $4.90

Explanation

The effective price is the cash selling price plus the gain on the short futures position: $4.55 + ($4.90 - $4.60) = $4.85 per bushel. Equivalently, it is the initial futures price plus the basis when the hedge is lifted: $4.90 + ($4.55 - $4.60) = $4.85.

Question 49Hedging with Futures

A short hedger establishes a hedge when the basis is -$0.20 and lifts the hedge when the basis is -$0.05. The realized price compared with the price expected at initiation is:

  1. higher by $0.20, because the basis moved toward zero from a negative value
  2. lower by $0.15, because the basis weakened
  3. higher by $0.15, because the basis strengthened Correct answer.
  4. unchanged, because the futures gain offsets the cash price exactly

Explanation

A short hedger's realized price equals the initial futures price plus the basis when the hedge is lifted. The basis rose from -$0.20 to -$0.05, a strengthening of $0.15, which accrues to the short hedger.

Question 50Hedging with Futures

Basis risk exists for a hedger primarily because:

  1. hedgers are required to make or take delivery at expiration
  2. margin requirements are set daily by the clearinghouse
  3. cash and futures prices do not move in perfect lockstep Correct answer.
  4. futures exchanges may change contract terms mid-hedge

Explanation

Basis risk is the risk that the difference between the cash price and the futures price changes between the time the hedge is placed and the time it is lifted. It stems from differences in grade, location, and timing between the cash exposure and the futures contract.