Chapter 13 - Financial Futures Markets

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POINT/COUNTER-POINT:
Has the Futures Market Created More Uncertainty for Stocks?

POINT: Yes. Futures contracts encourage speculation on indexes. Thus, an entire market can be influenced by the trading of speculators.

COUNTER-POINT: No. Futures contracts are commonly used to hedge portfolios, and therefore can reduce the effects of weak market conditions. Moreover, investing in stocks is just as speculative as taking a position in futures markets.

WHO IS CORRECT? Use the Internet to learn more about this issue. Offer your own opinion on this issue.

ANSWER: While excessive speculation could affect the underlying stock price or stock index, more informed investors should be able to correct for any mispricing, and therefore push the price toward its fundamental value. In addition, speculators could trade the underlying stocks as well and could have a direct effect on the stock price.

Questions

1.Futures Contracts. Describe the general characteristics of a futures contract. How does a clearinghouse facilitate the trading of financial futures contracts?

ANSWER: A futures contract is a standardized agreement to deliver or receive a specified amount of a specified financial instrument at a specified price and date.
The clearinghouse records all transactions and guarantees timely payments on futures contracts. This precludes the need for a purchaser of a futures contract to check the creditworthiness of the contract seller.

5.Gains from Purchasing Futures. Explain how purchasers of financial futures contracts can offset their position. How is their gain or loss determined? What is the maximum loss to a purchaser of a futures contract?

ANSWER: Purchasers of financial futures contracts can offset their positions by selling the identical contracts.

Their gain is the difference between what they sold the contracts for and their purchase price.

The maximum loss is the amount to be paid at settlement date as specified by the contract.

6.Gains from Selling Futures. Explain how sellers of financial futures contracts can offset their position. How is their gain or loss determined?

ANSWER: Sellers of financial futures contracts can offset their positions by purchasing identical contracts. Their gain is the difference between the selling price specified when they sold futures contracts versus the purchase price specified when they purchased futures contracts. 10.Long versus Short Hedge. Explain the difference between a long hedge and a short hedge used by financial institutions. When is a long hedge more appropriate than a short hedge?

ANSWER: A long hedge represents a purchase of financial futures and is appropriate when assets are more rate-sensitive than liabilities. A short hedge represents a sale of financial futures and is appropriate when liabilities are more rate-sensitive than assets.

12.Cross-Hedging. Describe the act of cross-hedging. What determines the effectiveness of a cross-hedge?

ANSWER: Cross-hedging represents the use of financial futures on one instrument to hedge a different instrument. The hedge will be more effective if the instruments are highly correlated.

14.Stock Index Futures. Describe stock index futures. How could they be used by a financial institution that is anticipating a jump in stock prices but does not yet have sufficient funds to purchase large amounts of stock? Explain why stock index futures may reflect investor expectations about the market more quickly than stock prices.

ANSWER: The institution could purchase stock index futures. If the stock market experiences increased prices, the stock index will rise. Thus, the stock index futures position will generate a gain.

As new information becomes available, investors can purchase stock index futures with a small up-front payment. The purchase of actual stocks may take longer because a larger investment would be necessary, and because time may be needed to select specific...
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