Futures are a derivative security. Futures contracts are agreements to buy or sell an asset at a predetermined price and date in the future. They are used for hedging and speculation purposes.
Which of the following best describes a futures contract?
Correct!
Not Correct
Select an option above to see an explanation here.
A) A futures contract is an agreement to buy or sell an asset at a predetermined price and date in the future. B) This describes an options contract, not a futures contract. C) This describes a swap, not a futures contract. D) This describes a forward contract, not a futures contract.
What is the primary purpose of hedging with futures contracts?
A) This is the primary purpose of speculation, not hedging. B) Hedging with futures contracts protects against price fluctuations in the underlying asset. C) This describes the purpose of swaps, not hedging with futures contracts. D) This describes the purpose of forward contracts, not hedging with futures contracts.
Which of the following is NOT a characteristic of futures contracts?
A) Futures contracts are traded on an exchange. B) Futures contracts are standardized, not customized between two parties. This is a characteristic of forward contracts. C) Futures contracts require an initial margin deposit. D) Futures contracts can be settled through physical delivery or cash settlement.
In the 1970s, a severe drought caused the price of wheat to skyrocket. As a result, many farmers who had sold wheat futures contracts at lower prices were forced to buy back those contracts at much higher prices to fulfill their obligations, resulting in significant losses.
Become a Pro Member to see more questions
Example Series 65 Example Practice Question
A farmer expects to harvest 1,000 bushels of corn in six months. Concerned about a price decline, the farmer sells a corn futures contract for 1,000 bushels at $4 per bushel. If the price of corn falls to $3 per bushel at the contract's expiration, the farmer will still receive $4 per bushel, protecting her from the price decline.
Futures trade on exchanges, price changes they embrace; Forwards are private, terms set case by case.
- *Futures Contract Risk*: The risk associated with the underlying asset's price movement in a futures contract can lead to significant gains or losses. - *Contango*: A market condition where the futures price of a commodity is higher than the expected spot price at the contract's expiration. - *Backwardation*: A market condition where the futures price of a commodity is lower than the expected spot price at the contract's expiration.
- *Futures Contract Risk example*: An investor enters into a futures contract to buy 100 barrels of oil at $50 per barrel in 3 months. If the oil price rises to $60 per barrel at the contract's expiration, the investor will gain $10 per barrel. Conversely, if the oil price falls to $40 per barrel, the investor will lose $10 per barrel. - *Contango example*: If the current spot price of gold is $1,200 per ounce and the futures price for a contract expiring in 3 months is $1,250 per ounce, the market is in contango. - *Backwardation example*: If the current spot price of gold is $1,200 per ounce and the futures price for a contract expiring in 3 months is $1,150 per ounce, the market is in backwardation.