Derivatives MCQ - Derivatives Section 1

21 While dealing with futures contracts, the maintenance margin requirement most likely refers to:

Futures position holders are required to maintain a minimum level of account balance which is called the maintenance margin requirement. The amount sufficient to bring ending account balance back to initial margin requirement is called the variation margin. Initial margin is the collateral or performance bond that ensures the fulfillment of the obligation.

22 In which of the following contracts would the buyer face the least default risk?

While forward contracts and over-the-counter options are customized private contracts between parties with a presence of default risk, futures contracts have the least risk of default because of the presence of a clearinghouse as an intermediary guaranteeing the parties against default through the practice of daily settlement.

23 Microsoft issues 10-year fixed-rate bonds. Its treasurer expects interest rates to increase for all maturities for at least the next 2 years. He enters into a 2-year agreement with SCB to receive semi-annual floating-rates payments benchmarked on 6-month LIBOR and to make payments based on a fixed-rate. This agreement is best described as a:

A swap is an agreement between two parties to exchange a series of future cash flows. Microsoft receives floating interest rate payments and makes fixed interest rate payments. The given agreement is a swap.

24 Ali takes a long position in 50 futures contracts on Day 1. The futures have a daily price limit of €10 and closes with a settlement price of €105. On Day 2, the futures trade at €115 and the bid and offer move to €116 and €118, respectively. The futures price remains at these price levels until the market closes. The marked-to-market amount the trader receives in his account at the end of Day 2 is closest to:

Because the future has a daily price limit of €10, the highest possible settlement price on Day 2 is €115. Therefore, the marked to market value would be (€115 - €105) * 50 = €500.

25 A market participant has a view regarding the potential movement of a stock. He sells a customized over-the-counter put option on the stock when the stock is trading at $46. The put has an exercise price of $44 and the put seller receives $2.5 in premium. The price of the stock is $43 at expiration. The profit or loss for the put seller at expiration is:

Profit = max (0, premium – value of put at expiration) = max (0, premium- (X-S)) = 2.5 – 1 = 1.5.