1.Which one of these statements related to forward contracts is correct? The buy
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Question
1.Which one of these statements related to forward contracts is correct?
The buyer of a forward contract on corn benefits if the price of corn increases during the contract period.
Forward contracts cannot be sold but must be executed by the original parties to the contract.
The buyer of a forward contract has the right, but not the obligation, to execute the contract any time up to and including the settlement date.
The price at which a forward contract closes is set equal to the closing spot price on the settlement date.
2.Which one of the following statements related to swaps is correct?
Swap contracts are limited to a single payment at expiration.
Brokerage firms are the dominate swap dealers in the U.S.
Swaps contracts are limited to interest rates.
Swaps can be custom tailored to a firm's needs.
3.When a futures call option on a commodity is exercised the option owner receives a futures contract on the commodity plus a cash payment equal to the difference between the:
Spot and forward futures prices.
Current options price and the current futures price.
Exercise price and the strike price.
Strike price on the option and the current futures price.
4. A stock currently sells for $32 a share. This stock is expected to increase in value over the next six months to at least $36 a share. Assume there are 6-month options on this stock with an exercise price of $35. Which of these options should have the most value today?
European put
American call
American put
European call
a.The buyer of a forward contract on corn benefits if the price of corn increases during the contract period.
b.Forward contracts cannot be sold but must be executed by the original parties to the contract.
c.The buyer of a forward contract has the right, but not the obligation, to execute the contract any time up to and including the settlement date.
d.The price at which a forward contract closes is set equal to the closing spot price on the settlement date.
Explanation / Answer
1) A is the corect option because the delivery price is locked in at the time the buyer enters into a contract. So, if the comodity price goes up, the delviery price does not change and the buyer benefits from the forward contract.
2) B is the correct option. Swaps are customized products according to the needs of a firm,. They can have multiple payouts and are not limited to single payout at expiration. Swaps can be over interest rate, foreign exchange rate, equity price or commodity price. Swaps are traded in the over-the-counter (OTC) market between private parties dominated by firms and financial institutions.
3) D is the corect answer. Futures call option gives the option owner the right to enter into a futures contract at the strike price. So, the payoff of the call option on a future contract is a cash payment equal to strike price to enter the futures contract and the current futures price.
4) B is the correct answer. American call can be exercised anytime on or before the six-month time period but European call can be exercised only after the end of 6-month contract period. Since currently the stock price is $32 a share, so the payoff for a American call would be $36-$32=$4. Whereas, maximum payoff for European call would be only $36-$35=$1. Hence, American call is most valued today.
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