Econ 235 Exam 3 Prep

1\. To hedge against a decrease in prices using the futures market, you would:

A. Purchase futures contracts.

B. Sell futures contracts.

C. Purchase or sell futures contracts depending on the futures price.

D. Buy in the cash market.

B. Sell futures contracts

2\. The opening of an ethanol plant in your local area will likely _____________ the basis in the cash corn market.

A. weaken

B. strengthen

C. weaken or strengthen the basis depending on the initial price.

D. There is not enough information to determine what happens to the basis.

B. strengthen

3\. Would an unexpected decrease in the projected U.S. supply of soybeans in September likely be a favorable or unfavorable development for speculators who were holding short positions in January soybean futures contracts?

A. Favorable. Speculators holding a “short” position would expect the news to have a “bullish” effect on market prices.

B. Favorable. Speculators holding a “short” position would expect the news to have a “bearish” effect on market prices.

C. Unfavorable. Speculators holding a “short” position would expect the news to have a “bullish” effect on market prices.

D. Unfavorable. Speculators holding a “short” position would expect the news to have a “bearish” effect on market prices.

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D. Unfavorable. Speculators holding a “short” position would expect the news to have a “bearish” effect on market prices.

4\. If corn futures are selling at $4/bu and a hedger expects the basis to be -$0.20, the expected selling price is:

A. $3.20/bu

B. $4.00/bu

C. $4.20/bu

D. $3.80/bu

D. $3.80/bu

5\. In July, a corn producer hedged his crop by selling December corn futures at $4/bu. In November, the producer bought the December futures contracts back for $4.20/bu and sold in the cash market for $3.85/bu, will receive a net price of ______. Assume that basis remains unchanged between July and November.

A. $3.65/bu

B. $3.85/bu

C. $4.00/bu

D. $4.20/bu

A. $3.65/bu

6\. You own 10,000 bushels of corn. You hedge the 10,000 bushels on October 1, at a basis of 20 cents under. On November 2, you sell the corn at a basis of 25 cents under and offset (buy back) your futures contracts. What just happened?

A. You earned 5 cents/bu for a month’s storage.

B. You made a net profit of 5 cents/bu.

C. You lost 5 cents/bu (plus any storage and trading commission costs).

D. You gained $1000 less trading commission costs.

C. You lost 5 cents/bu (plus any storage and trading commission costs).

7\. If you buy an option on futures and pay a premium of $0.30, what is the most you can lose?

A. The maximum loss depends on the price.

B. Your potential gain is limited.

C. Your potential loss is unlimited.

D. The most you can lose is $0.30/bu.

D. The most you can lose is $0.30/bu.

9\. A September wheat call has a strike price of $6.00. The underlying September futures price is $6.50. The intrinsic value is _________.

A. $6.00

B. $6.50

C. $0.50

D. $0.00

C. $0.50

10\. A December wheat put has a strike price of $6.60. The underlying December futures price is $6.20. The intrinsic value is _________.

A. $6.60

B. $6.20

C. $0.40

D. $0.00

C. $0.40

12\. An options speculator thinks that May corn futures will decrease in price. What should he/she do to profit from this information in the options market?

A. Purchase a put option.

B. Purchase a call option.

C. Purchase both a put and a call option.

D. Purchase either a put or a call option (either option will work).

A. Purchase a put option.

14\. Premiums for options on futures contracts are

A. set by the exchange staff.

B. determined by buyers and sellers.

C. unaffected by futures prices.

D. none of the above.

B. determined by buyers and sellers.

15\. Assume you are a feed mill and decide to hedge your upcoming December purchase of soybeans. At the time (August 1), the January soybean futures are trading at $9.70/bu; the expected local basis for mid-November delivery is 24 cents under the January futures. If you hedge your position with futures, what is your expected purchase (buying) price if the basis is 24 cents under?

A. $9.70/bu

B. $9.94/bu

C. $9.46/bu

D. $9.22/bu

C. $9.46/bu

16\. A wheat producer is interested in establishing a hedge for part of his production and is considering options. He/she would most likely:

A. buy a call option.

B. buy a put option.

C. sell a put option.

D. sell a call option.

B. buy a put option

17\. Assume you are a food processor and decide to hedge your upcoming purchase of soybean oil. At the time (August 1), December soybean oil futures are trading at 54 cents per pound; the expected local basis for midNovember delivery is 4 cents under December futures. If you hedge your position with futures, what is your expected purchase price if the basis is 4 cents under?

A. 58 cents per pound

B. 54 cents per pound

C. 50 cents per pound

D. Cannot be determined

C. 50 cents per pound

18\. Hedgers and speculators have similar interests in futures markets in that

A. the more market participants, the greater the futures market’s liquidity and usefulness in the process of price discovery.

B. they are both interested in buying and selling the underlying commodity.

C. trades of speculators can only be offset by trades of a hedger.

D. None of the above, as hedgers and speculators have no similar interests.

A. the more market participants, the greater the futures market’s liquidity and usefulness in the process of price discovery.

19\. Hedging involves

A. holding only a futures market position.

B. holding only a cash market position.

C. taking a futures position identical to one’s current cash market position.

D. taking a futures position opposite to one’s current cash/spot market position.

D. taking a futures position opposite to one’s current cash/spot market position.

20\. Assume you are a feed mill and decide to hedge your upcoming December purchase of soybeans. At the time (August 1), the January soybean futures are trading at $9.70/bu; the expected local basis for mid-November delivery is 24 cents under the January futures. When you set your hedge, what action do you take in the futures market?

A. Buy soybean futures contract(s).

B. Sell soybean futures contract(s).

C. Buy and sell soybean futures contract(s).

D. Either buy or sell soybean futures contract(s) (either trade works in this situation).

A. Buy soybean futures contract(s).

21\. A hedger who sells a futures contract at a certain price will:

A. receive that price plus the actual basis if the market goes higher.

B. receive that price plus the actual basis if the market goes lower.

C. receive that price plus the actual basis both if the market goes higher and also if the market goes lower.

D. None of the above answers are correct.

C. receive that price plus the actual basis both if the market goes higher and also if the market goes lower.

22\. On May 1st, the December Futures price for corn is $3.70 per bushel. You expect that the basis in October will be 28 cents under the December Futures price. You estimate your expected net selling price as _______ and decide to hedge by _________ two December corn futures contracts.

A. $3.70/bu, selling two Dec contracts

B. $3.98/bu, selling two Dec contracts

C. $3.70/bu, buying two Dec contracts

D. $3.42/bu, selling two Dec contracts

D. $3.42/bu, selling two Dec contracts

23\. Suppose that the basis for soybeans is -$0.25/bu and you believe it will be $0.00/bu in two months. Which of the following strategies will give you a positive payoff?

A. Take a long position in the cash market and a long position in the futures market.

B. Take a long position in the cash market and a short position in the futures market.

C. Take a short position in the cash market and a short position in the futures market.

D. Take a short position in the cash market and a long position in the futures market.

B. Take a long position in the cash market and a short position in the futures market.

24\. You feed cattle and would like to hedge against an increase in the price of corn. It is December and you purchase a May Corn futures contract at $3.88 per bushel. You expect basis to be 5 cents under. In April, you offset your futures position and purchase corn in the cash market. The May futures price is $3.97/bu and basis is 7 cents under when you actually buy corn from your supplier. In this case when the May corn futures price is $3.97, what would be the net purchase price (per bu) in April? \n A. $3.90/bu

B. $3.81/bu

C. $3.95/bu

D. $3.99/bu

B. $3.81/bu

25\. Which statement best describes who benefits (in cash) from basis weakening over a hedge?

A. Buyers gain, sellers lose

B. Buyers lose, sellers gain

C. Both gain

D. Neither since buyers and sellers offset basis risk by hedging.

A. Buyers gain, sellers lose

27\. You hold a put option on December corn with a strike price of $4.00/bu. The December corn futures price is $4.75/bu. The intrinsic value of the option is:

A. $4.00/bu

B. $0.00/bu

C. $0.75/bu

D. -$0.75/bu

B. $0.00/bu

28\. You hold a call option on December corn with a strike price of $3.50/bu. The December corn futures price is $4.00/bu, and the option premium is $1.20/bu. What is the time value?

A. $1.20/bu

B. $4.00/bu

C. -$0.70/bu

D. $0.70/bu

D. $0.70/bu

29\. All else equal, opening an ethanol plant will increase corn basis in a local area.

A. True

B. False

A. True (29)

30\. An individual that is short in cash needs to purchase a commodity in the future. \n A. True

B. False

A. true (30)

31\. Hedging involves taking an opposite futures market position relative to a cash position to guard against production risk.

A. True

B. False

B False (31)

32\. Hedging with futures allows farmers to limit downside risk and still make money when prices increase.

A. True

B. False

B. false (32)

33\. Hedgers can always count on basis to improve over time.

A. True

B. False

B. False (33)

34\. A trader that wants the right but not the obligation to go short in the futures market should purchase a put.

A. True

B. False

A. true (34)

35\. The strike price of an option is set by the market and can change daily.

A. True

B. False

B. false (35)

36\. There is no downside to buying an option.

A. True

B. False

B. false (36)

1\. In a long position in the cash market, a trader has the ability to deliver a commodity.

A. True

B. False

A. true (1)

2\. A trader that wants the right but not the obligation to go short in the futures market purchases a put option.

A. True

B. False

A. true (2)

3\. Agribusiness firms hedge by taking an opposite position in the cash market to offset gains or losses from a futures position.

A. True

B. False

B. false (3)

4\. A hedger can profit from a change in the basis.

A. True

B. False

A. true (4)

5\. A farmer can remove price and basis risk by hedging with futures contracts.

A. True

B. False

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B. false (5)

7\. The strike price is the price a trader pays to purchase a put option.

A. True

B. False

B. false (7)

10\. The time value of an option is zero at the expiration date.

A. True

B. False

A. true (10)

11\. The owner of a call option can buy a futures contract at the premium price.

A. True

B. False

B. false (11)

15\. By hedging with futures, buyers and sellers are eliminating futures price level risk and assuming basis level risk.

A. True

B. False

A. true (15)

16\. The strike price of an option is determined by the market.

A. True

B. False

B. false (16)

22\. In which of the following situations would you hedge using a futures contract?

A. You are long in the cash market, the price is at a historical high, and you are certain that the price will decline.

B. You are long in the cash market, the price is at a historical low, and you are certain that the price will increase.

C. You are short in the cash market, the price is at a historical high, and you are certain that the price will decrease.

D. You are short in the cash market, the price is at a historical low, and you are certain that the price will decrease further.

A. You are long in the cash market, the price is at a historical high, and you are certain that the price will decline.

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23\. Complete the sentence - A put option on a futures contract gives its owner:

A. The right to sell a futures contract at the strike price.

B. The right to sell a futures contract at the market price.

C. The right to buy a futures contract at the strike price.

D. The right to buy a futures contract at the market price.

A. The right to sell a futures contract at the strike price.

25\. When hedging with options, what is the cost to enter into your hedging position?

A. The basis.

B. The maintenance margin.

C. The strike price.

D. The option premium.

D. The option premium.

26\. What is the strike price of an option?

A. The intrinsic value of the option.

B. The price you pay to purchase the option.

C. The futures price at which an option can be exercised.

D. The price of the underlying futures contract when you purchase the option.

C. The futures price at which an option can be exercised.

27\. You hold a put option on December corn with a strike price of $4.00/bu. The December corn futures price is $4.75/bu. The intrinsic value of the option is:

A. $4.00/bu

B. $0.00/bu

C. $0.75/bu

D. -$0.75/bu

B. $0.00/bu

28\. You hold a call option on December corn with a strike price of $3.50/bu. The December corn futures price is $4.00/bu, and the option premium is $1.20/bu. What is the time value?

A. $1.20/bu

B. $4.00/bu

C. $0.70/bu

D. -$0.70/bu

C. $0.70/bu

29\. Which statement best describes who benefits from basis strengthening over a hedge with a futures contract?

A. Buyers gain, sellers lose

B. Buyers lose, sellers gain

C. Both gain

D. Neither gains or loses since they have offset their basis risk by hedging

B. Buyers lose, sellers gain

30\. A Nov Soybean call has a strike price of $11.50. The underlying November futures price is $12.00. The intrinsic value is _.

A. -$0.50/bu

B. $0.00/bu

C. $1.00/bu

D. $0.50/bu

D. $0.50/bu

31\. A May Corn put has a strike price of $5.80. The underlying May futures price is $5.55. The intrinsic value is _.

A. -$0.25/bu

B. $0.00/bu

C. $0.25/bu

D. $0.50/bu

C. $0.25/bu

33\. If you pay a premium of 10 cents per bushel for a Corn put option with a strike price of $6.60, what’s the most you can lose?

A. $0.10/bu

B. $6.60/bu

C. $6.70/bu

D. Your potential loss is unlimited.

A. $0.10/bu

34\. What types of risk can firms mitigate using futures contracts?

A. Price Risk

B. Price spread risk

C. Production risk

D. A and B

D. A and B

35\. July corn futures are trading at $6.00. A $5.50 July corn call is trading at a premium of 60 cents. The time value is ______.

A. $0.00/bu

B. $0.10/bu

C. $0.50/bu

D. $0.60/bu

B. $0.10/bu

36\. September soybean futures are trading at $12.20. A $12.50 September soybean put is trading at a premium of 38 cents. The time value is ______.

A. $0.00/bu

B. $0.08/bu

C. $0.30/bu

D. $0.38/bu

B. $0.08/bu

37\. The components of option premiums are:

A. Intrinsic value, if any

B. Time value, if any

C. The sum of (A) and (B)

D. The strike price and brokerage commission

C. The sum of (A) and (B)

38\. The premise that makes hedging possible is cash and futures prices:

A. move in opposite directions.

B. move upward and downward by identical amounts.

C. generally change in the same direction by similar amounts.

D. are regulated by the exchange.

C. generally change in the same direction by similar amounts.

39\. What is the difference between purchasing a futures contract and purchasing a call option?

A. Purchasing a call option obligates the trader to sell a futures contract.

B. Purchasing a call option obligates the trader to purchase a futures contract.

C. Purchasing a call option requires a margin account.

D. Purchasing a call option requires the upfront payment of a premium.

D. Purchasing a call option requires the upfront payment of a premium.

1\. If you write an option and receive a premium of $0.30/bu, what is the most you can lose?

A. $0.30/bu

B. The initial margin deposit

C. Your potential loss is almost unlimited

D. Not enough information is provided

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C. Your potential loss is almost unlimited

3\. Assume you pay a premium of $0.80/bu for a soybean call option with a strike price of $9.00/bu and that the current futures price is $9.30/bu. What is the option’s current intrinsic value?

A. $0.20/bu

B. $0.30/bu

C. $0.50/bu

D. $0.80/bu

B. $0.30/bu

4\. Assume you pay a premium of $0.80/bu for a soybean call option with a strike price of $9.00/bu and that the current futures price is $9.30/bu. What is the option’s current time value?

A. $0.20/bu

B. $0.30/bu

C. $0.50/bu

D. $0.80/bu

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C. $0.50/bu

5\. Assume you pay a premium of $0.50/bu for a soybean call option with a strike price of $9.20/bu and that the current futures price is $8.90/bu. What is the option’s current intrinsic value?

A. $0.50/bu

B. $0.30/bu

C. $0/bu

D. $-0.50/bu

C. $0/bu

6\. Assume you pay a premium of $0.50/bu for a soybean call option with a strike price of $9.20/bu and that the current futures price is $8.90/bu. What is the option’s time value?

A. $0.50/bu

B. $0.30/bu

C. $-0.50/bu

D. $0/bu

A. $0.50/bu

11\. It would require the most money to maintain a margin account when

A. You went short at $4.00 and futures are now at $3.00

B. You went long at $4.00 and futures are now at $3.00

C. You went short at $4.00 and offset your position when futures were at $3.50

D. Either A or B as you need margin money whether you are short or long

B. You went long at $4.00 and futures are now at $3.00

15\. What action did the owner of the position illustrated above take in the futures or options market?

A. Buy a futures.

B. Sell a call option on futures.

C. Sell a futures.

D. Buy a put option on futures.

A. Buy a futures

18\. If you buy an option for a premium of $0.30/bu what is the most you can lose?

A. $0.30/bu

B. The initial margin deposit plus $0.30/bu.

C. Your potential loss is “unlimited”.

D. The accumulated profit or loss as shown in the margin account.

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A. $0.30/bu

21\. What action did the owner of the position illustrated above take in the futures or options market?

A. Buy a futures.

B. Sell a call option on futures.

C. Sell a futures.

D. Buy a put option on futures

C. Sell a futures.

By hedging with futures, buyers and sellers are eliminating futures price level risk and assuming basis level risk.

A. True

B. False

A. True

The premise that makes hedging possible is cash and futures prices:

A. generally change in the same direction by similar amounts.

B. move upward and downward by identical amounts.

C. are regulated by the exchange.

D. move in opposite directions.

 

A. Generally change in the same direction by similar amounts

Basis risk involves:

A. the inherent volatility of futures prices.

B. the absolute level of futures prices.

C. the fact that basis cannot be predicted exactly.

 

C. The fact that basis cannot be predicted exactly

Select all correct answers:

A. The more negative (or less positive) the basis becomes, the weaker it is.  

B. The basis is generally more stable and predictable than either the cash market or futures market prices.

C. The more positive (or less negative) the basis becomes, the stronger it is.

D. A short hedger benefits from a strengthening basis.

 

All of them

Refer to the table below when answering the next two questions:

Short Hedge - Price Decrease and Basis Strengthens     

  Futures             Cash           Basis              

September Price 3.5  -0.3    

December Price 3.0  -0.1    

Gain / Loss           

Price of corn at beginning of hedge      

Gain / loss from cash position       

Gain / loss from futures position      

 Net selling price       

What is the net selling price?

A. 3.2

B. 3.6

C.3.4

D. 3

C. 3.4

What is the total gain / loss of the trader in $/bu due to the strengthening of the basis?

  

A. Loss of $0.3/bu.

B. Gain of $0.3/bu.

C. Gain of $0.2/bu.

D. Loss of $0.2/bu.

 

C. Gain of $0.2/bu

Refer to the table below when answering the next two questions:

Short Hedge - Price Decrease and Basis Strengthens     

  Futures             Cash           Basis              

September Price 3.5  -0.3    

December Price 3.0  -0.5   

Gain / Loss           

Price of corn at beginning of hedge      

Gain / loss from cash position       

Gain / loss from futures position      

 Net selling price       

What is the net selling price?

A. 3.2

B. 3

C.3.4

D. 2.8

B. 3

What is the total gain / loss of the trader in $/bu due to the weakening of the basis?

A. Loss of $0.2/bu.

B. Gain of $0.5/bu.

C. Loss of $0.7/bu.

D. Gain of $0.2/bu.

 

A. Loss of $0.2/bu

What would be the total gain / loss of the trader if he had purchased a forward contract to sell corn at $3.5/bu instead of entering into the short hedge described in question 8?

A. loss of .$0.3/bu

B.loss of $0.5/bu

C. gain of $0.5/bu

D. gain of $0.3/bu

B. Gain of $0.5/bu

Refer to the table below to answer the question.

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Long Hedge - Price Increase    Long Hedge - Price Decrease   

Futures Cash Basis  Futures Cash Basis

September Price. 5.5  September Price. 5.5

December Price. 7.5  December Price. 3.5

Gain / Loss    Gain / Loss       

Price of corn at beginning of hedge    Price of corn at beginning of hedge  

Gain / loss from cash position    Gain / loss from cash position  

Gain / loss from futures position    Gain / loss from futures position        

 Net buying price    Net buying price         

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The basis is -0.50 in September and strengthens to -0.20 in December.

What is the new net purchasing (buying) price taking into account the change in basis?

  

A. 4.7

B. 5.3

C. 5.5

D. 5.7

B. 5.3