Deck 16: Stock Index Futures and Options

Question 1

Investing in stock index futures is one way to reduce or eliminate unsystematic risk.

Answer 1

False
Explanation: Two types of risks are associated with investments: systematic or market-related risks, and unsystematic or firm-related risks. Because many believe only systematic risk is assumed to be rewarded in an efficient capital market environment (unsystematic risk can be diversified away), the investor may wish to be exposed only to systematic risk. Stock index futures represent an efficient approach to only taking systematic, market-related risk.

Question 2

The profit on a stock index option is determined by the change in the underlying value of the futures contract.

Answer 2

False
Explanation: The profit depends on the movement of the index value.

Question 3

Futures provide a more efficient hedge than options, in that gains and losses can be more fully offset by futures contracts.

Answer 3

True
Explanation: Futures generally allow for a more efficient hedge than options.

Question 4

When the portfolio manager wants to hedge a stock portfolio using an index futures contract, he or she must know: 1) the total dollar value of the portfolio, 2) the current index futures price, and 3) the relative volatility of the portfolio to the market.

Question 5

The S&P 100 Index is composed of 100 blue chip stocks on which the CME currently has individual option contracts.

Question 6

The market for stock index futures began in February of 1982, when the NYSE began trading futures on the Dow Jones Industrial Average.

Question 7

Since there is never physical delivery of goods in the stock index futures market, all open transactions are automatically closed out on the settlement date.

Question 8

Stock index futures provide the portfolio manager a realistic alternative to selling either a part or the entirety of a portfolio in a declining market.

Question 9

A perfect hedge using stock index futures eliminates both losses and gains on a stock portfolio.

Question 10

Each of the major stock index futures markets has a corresponding stock index options market.

Question 11

Stock index options have very low speculative premiums since the unsystematic risk is almost zero.

Question 12

In a declining market, stock index futures can be used to hedge a stock portfolio to help offset losses in the portfolio.

Question 13

Stock index options tend to be more highly speculative than stock index futures.

Question 14

Options generally allow for a more efficient hedge than futures.

Question 15

Stock index futures contracts are limited to the Dow Jones Industrial Average.

Question 16

Stock index futures and options are sometimes referred to as derivatives.

Question 17

With stock options and stock index options, an investor's maximum loss is her premium on the contract.

Question 18

A tax hedge is used to reduce or eliminate tax on the capital gains on a portfolio.

Question 19

Value Line futures contracts trade on the Kansas City Board of Trade.

Question 20

The purpose of hedging with stock index futures is not to magnify the gains and losses on the hedged stock portfolio.

Question 21

One disadvantage to stock index futures is that there is no opportunity for arbitraging, as there is for stock index options.

Question 22

Options on stock index futures may settle on a cash basis or exercise the option to obtain the futures contract.

Question 23

Which of the following statements about hedging a stock portfolio with stock index futures is NOT true?

A)Futures contracts magnify gains (or losses) on the stock portfolio
B)In a declining market, futures contracts help offset losses on the portfolio
C)A risk-taker would probably not hedge the entire portfolio with stock index futures
D)All of the above are true

Question 24

The value of a stock index futures contract is the product of ____ and the appropriate multiplier.

A)the settle price
B)the change in the settle price
C)the difference between the settle price and the change
D)None of the above

Question 25

The margin requirement will be lower than the standard requirement on a stock index futures contract when:

A)the stock market is declining.
B)the futures are used to hedge a portfolio.
C)the investor is establishing a speculative position.
D)None of the above

Question 26

Stock specialists and OTC dealers hedge their positions with stock index futures:

A)to profit from major market movements.
B)to reduce market risk on his or her inventory.
C)to reduce the unsystematic risk on the stocks in his or her inventory.
D)More than one of the above

Question 27

If an investor can prove that he is hedging a long position, the margin requirement will be less.

Question 28

In order to effectively hedge a stock portfolio, the portfolio manager must know the total dollar value of the portfolio, the current index futures price, and:

A)the number of contracts available in the market.
B)the portfolio P/E ratio.
C)the relative volatility of the portfolio to the market.
D)More than one of the above

Question 29

Which of the following statements about the "basis" of stock index futures is true?

A)It is the difference between the futures price and the value of the actual underlying index
B)Negative basis is generally considered to foretell a declining market
C)The basis reflects market changes instantaneously, while the actual underlying index moves more slowly
D)All of the above are true

Question 30

The Mini S&P 500 contract is made up of different stocks than the traditional S&P 500 contract.

Question 31

The term basis represents the difference between the stock index futures price and the value of the underlying index.

Question 32

A combination of a futures and options contract is an option to purchase the futures contract.

Question 33

Which of the following is NOT an advantage of investing in stock index futures for the speculator?

A)The elimination of unsystematic risk
B)Manipulation by insiders is less likely than with individual securities
C)Maximum leverage potential
D)All of the above are advantages

Question 34

Some investors are prohibited by law from participating in the futures market.

Question 35

A primary difference between stock options and stock index options is:

A)stock index options tend to be more highly speculative.
B)stock index options are ALWAYS settled ONLY for cash.
C)there is rarely a premium on stock index options.
D)None of the above

Question 36

The value of an option to purchase a stock index futures contract depends on the outlook of the futures contract.

Question 37

When an investment banker hedges a stock for initial distribution with stock index futures,

A)the underwriter intends to reduce the risk of loss during the distribution period.
B)there is potential of gain or loss on both the stock and the stock index futures.
C)he or she sells futures contracts.
D)All of the above

Question 38

The primary use of stock index futures by the portfolio manager is:

A)to offset the loss on the portfolio in a declining market.
B)to profit from major market movements.
C)to increase the profit potential on the portfolio.
D)All of the above

Question 39

Stock index futures and options allow an investor to:

A)select a security from any of those included in the index.
B)gain or lose from the movement of the index.
C)trade any of the securities in the index.
D)None of the above

Question 40

The profit of an index option is determined by:

A)the total value of the increase in the index.
B)the total value of the option.
C)the size of the premium.
D)More than one above

Question 41

Program trading calls for:

A)computer-based trigger points for large trades.
B)the use of computer programs to measure performance.
C)the use of only call options.
D)All of the above

Question 42

The loss on option purchase is always:

A)limited to the premium paid.
B)limited to the margin maintenance requirement.
C)the difference between the strike price and the premium paid.
D)None of the above

Question 43

If you have a put option on a stock index, you hope the market will:

A)go up.
B)go down.
C)remain unchanged.
D)None of the above

Question 44

An investor bought a March S&P 500 Index futures contract in December for $1,490.05. After six months the contract value went up to $1,539.95. The contract has a multiplier of 250. With an initial margin of $20,000, what is the percent return on margin?

A)62.38%
B)60.32%
C)7.70%
D)7.45%
E)6.32%

Question 45

With a given size portfolio, the higher the portfolio beta,

A)the more likely the portfolio is to go up, rather than down.
B)the more likely the portfolio is to go down, rather than up.
C)the fewer contracts necessary to hedge the portfolio.
D)the more contracts necessary to hedge the portfolio.

Question 46

Stock index futures represent an efficient approach to:

A)only taking on unsystematic risk.
B)only taking on systematic risk.
C)taking on zero risk, because the index is fully diversified.
D)taking on lots of risk, due to the fact that the indexes are usually composed of lots of stocks, not just a few.

Question 47

Futures contracts exist for the:

A)Dow Jones Industrial Average.
B)NASDAQ 100 Stock Index.
C)S&P 500.
D)All of the above

Question 48

An investor bought a March S&P 500 Index futures contract in December for $1,490.05. After six months the contract value went up to $1,539.95. The contract has a multiplier of 250. What is the dollar profit?

A)$1,996
B)$19,960
C)$12,475
D)$1,247.50
E)$199.60

Question 49

You buy an S&P 500 Index Call Option for $15. The strike price is $1,250. If the index closes at $1,290, what is your total profit?

Question 50

One of the major uses of a stock index future is the ability:

A)to use it to hedge.
B)to make an unlimited amount of money.
C)to increase risk.
D)All of the above

Question 51

An investor earns a profit on a put option when:

A)the increase in the index is greater than the premium paid.
B)the index decreases.
C)the decrease in the index is greater than the premium paid.
D)None of the above

Question 52

The settle price shown in a stock index futures table is the:

A)highest price the contract hit during the day.
B)closing price for the contract at the end of the day.
C)price for the contract only for the last day of the contract.
D)None of the above are true

Question 53

The overuse of portfolio insurance in the market may be dangerous because:

A)a large amount of selling may take place simultaneously.
B)a small amount of arbitraging may take place simultaneously.
C)in a down market, the insurance companies may not be able to pay for the losses.
D)All of the above

Question 54

An arbitrage is trading in:

A)options and futures at the same time.
B)two different markets when the price of the same item is different.
C)two different markets when the price of two different items is the same.
D)two different markets when there is no correlation between the markets.

Question 55

Stock index futures and options are sometimes referred to as derivative products because they:

A)are often used as part of program trading.
B)make the market less volatile.
C)have intrinsic characteristics.
D)derive their existence from actual market indexes.

Question 56

Options may have advantages over futures for some investors because:

A)options have a lower margin requirement.
B)options provide more efficient hedging.
C)some investors are prohibited by law from participating in the futures market.
D)None of the above

Question 57

An investor bought a March S&P 500 Index futures contract in December for $1,490.05. After six months the contract value went down to $1,466.00. The contract has a multiplier of 250. With an initial margin of $20,000, and a $16,000 maintenance margin requirement, would there be a call for more margin?

A)No, the account would have an excess of $2,012.50
B)Yes, an additional $3,677.19 would be required
C)No, the account would have exactly enough cash for margin
D)Yes, an additional $2,012.50 would be required
E)No, the account would have an excess of $3,677.19

Question 58

An investor bought a March S&P 500 Index futures contract in December for $1,490.05. After six months the contract value went up to $1,539.95. The contract has a multiplier of 250. With an initial margin of $20,000, what is the annualized percent return on margin?

A)25.28%
B)29.8%
C)30.8%
D)120.64%
E)124.76%

Question 59

When basis increases with the passage of time, this is thought to be:

A)a neutral indictor.
B)a negative sign.
C)a positive sign.
D)an indication of market manipulation.