2019 CFA level 3 qbank reading 32 risk management applications of forward and futures strategies questions

Question #5 of 49 When using stock index futures contracts and cash to create a synthetic stock index, the larger the index multiplier: A there is no such thing as an index multiplier..

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Question #1 of 49

An S&P500 index manager knows that he will have $60,000,000 in funds available in three

months He is very bullish on the stock market and would like to hedge the cash in ow using

S&P 500 futures contracts The S&P 500 futures contract stands at 1100.00 and one contract is

worth 250 times the index Which of the following is the most accurate hedge for this portfolio?

A) Sell 218 contracts.

B) Buy 284 contracts.

C) Buy 218 contracts.

Michael Hallen, CFA, manages an equity portfolio with a current market value of $78 million and

a beta of 0.95 Convinced the market is poised for a signi cant upward movement, Hallen

would like to increase the beta of the portfolio by 40 percent, using S&P 500 futures currently

trading at 856 The multiplier is 250 What is the number of futures contracts, rounded up to

the nearest whole number, that will be needed to achieve Hallen's objective?

A) 139

B) 143

C) 144

A manager of $40 million of mid-cap equities would like to move $5 million of the position to

large-cap equities The beta of the mid-cap position is 1.1, and the average beta of large-cap

stocks is 0.9 The betas of the corresponding mid and large-cap futures contracts are 1.1 and

0.95 respectively The mid and large-cap futures prices are $252,000 and $98,222 respectively

What is the appropriate strategy? Short:

A) 23 mid-cap futures and go long 42 large-cap futures.

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B) 29 mid-cap futures and go long 29 large-cap futures.

C) 20 mid-cap futures and go long 48 large-cap futures.

To synthetically create the risk/return pro le of an underlying common equity security:

A) Sell short the corresponding futures contract and invest in a T-bill.

B) Buy the corresponding futures contract and invest in a T-bill.

C) Buy the corresponding futures contract and borrow at the risk-free rate.

When using stock index futures contracts and cash to create a synthetic stock index, the larger

the index multiplier:

A) there is no such thing as an index multiplier.

B) the fewer the number of needed contracts.

C) the greater the number of needed contracts.

A manager has a 70/30 stock and bond portfolio To synthetically create a portfolio that is 60

percent stock and 40 percent bonds, the manager should:

A) go long the bond futures and short the stock index futures.

B) short the bond futures and go long the stock index futures.

C) go long both bond futures and stock index futures.

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A manager has a position in Treasury bills worth $175 million with a yield of 2% For the next 6

months, the manager wishes to have a synthetic equity position approximately equal to this

value The manager chooses S&P 500 index futures, which has a dividend yield of 3% The

futures price is 1,050 and the multiplier is $250 How many contracts will this take?

A) 673 contracts.

B) 421 contracts.

C) 655 contracts.

A manager has a $100 million portfolio that consists of 50% stock and 50% bonds The beta of

the stock position is 1 The modi ed duration of the bond position is 5 The manager wishes to

achieve an e ective mix of 60% stock and 40% bonds The price and beta of the stock index

futures contracts are $277,000 and 1.1 respectively (The futures price includes the e ect of the

index multiplier.) The price, modi ed duration, and yield beta of the futures contracts are

$98,000, 6, and 1 respectively What is the appropriate strategy?

A) Short 40 bond futures and go long 106 stock index futures.

B) Short 85 bond futures and go long 33 stock index futures.

C) Go long 53 bond futures and go long 40 stock index futures.

Which of the following statements about portfolio hedging is least accurate?

A) To synthetically create the risk/return pro le of an underlying common equity security,

buy the corresponding futures contract, sell the common short, and invest in a T-bill

B) For a xed portfolio insurance horizon, using put options generally requires less

rebalancing and monitoring than with the use of futures contracts

C) Futures contracts have a symmetrical payo pro le.

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An investor has a cash position currently invested in T-Bills but would like to "equitize" it by

using S&P futures contracts Which of the following trades will create the desired synthetic

equity position?

A) Selling S&P 500 futures contracts short.

B) Selling the T-Bills and buying S&P 500 futures contracts.

C) Buying S&P 500 futures contracts.

An asset manager says he has perfectly hedged an equity portfolio that is denominated in a

foreign currency by only using forward currency contracts We know then that the:

A) asset manager is not telling the truth.

B) number of contracts used is greater than that used on a comparable equity position.

C) number of contracts used is equal to that used on a comparable equity position.

With respect to the practice of using forward contracts to eliminate the exchange-rate risk

associated with a receiving a future payment in a foreign currency, which of the following is

correct? A rm that expects to receive a foreign-currency payment is:

A) “short” the currency and should short the forward contract on the foreign currency.

B) “short” the currency and should go long the forward contract on the foreign currency.

C) “long” the currency and should short the forward contract on the foreign currency.

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The exchange-rate risk associated with falling asset values in foreign subsidiaries caused by

currency uctuations is called:

A) transaction exposure.

B) translation exposure.

C) economic exposure.

Tom Corser is the manager of the $140,000,000 Intrepid Growth Fund Corser's long-term view

of the equity market is negative, and as a result, his portfolio is allocated defensively with a

beta of 0.85 Despite his negative long-term outlook, Corser thinks the market is temporarily

mispriced, and could rise signi cantly over the next few weeks Corser has implemented tactical

asset allocation measures in his fund sporadically over the years, and thinks now is another

time to do so Because he likes his long-term holdings, he decides to use a futures overlay

rather than trading assets to implement his view of the market Corser decides he wants to

increase the beta of his portfolio to 1.25 The appropriate futures contract has a beta of 1.03

and the total futures price is $310,000 What is the appropriate tactical allocation strategy for

Corser to accomplish his objective?

A) Sell 175 equity futures contracts.

B) Buy 175 equity futures contracts.

C) Buy 373 equity futures contracts.

An investor has a $100 million stock portfolio with a beta of 1.2 He would like to alter his

portfolio beta using S&P 500 futures contracts The contracts are currently trading at 596.90

The futures contract has a multiple of 250 Which of the following is the CORRECT trade

required to double the portfolio beta?

A) Buy 1608 contracts.

B) Sell 804 contracts.

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C) Buy 804 contracts.

A manager of a $20,000,000 portfolio wants to decrease beta from the current value of 0.9 to

0.5 The beta on the futures contract is 1.1 and the futures price is $105,000 Using futures

contracts, what strategy would be appropriate?

A) Short 69 contracts.

B) Short 19 contracts.

C) Long 69 contracts.

In the hedging of currency risk, the issue of basis risk is:

A) not a concern when using either futures contracts or options.

B) a concern when using futures contracts and not options.

C) a concern when using options and not futures contracts.

A manager wishes to make a synthetic adjustment of a mid-cap stock portfolio The goal is to

increase the beta of the portfolio by 0.5 The beta of the futures contract the manager will use

is one If the value of the portfolio is 10 times the futures price, then the futures contract

position needed is a:

A) long position in 20 contracts.

B) short position in 5 contracts.

C) long position in 5 contracts.

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A portfolio holds $20 million of its assets in an index fund that mimics the return of the Dow

Jones Industrial Average (DJIA) The dividend yield on the DJIA index is 2.8% The manager of the

portfolio would like to synthetically convert half of the position to cash for a one month period

The futures contract on the DJIA that expires in a month is priced at 14520.01 It has a

multiplier equal to $10 The risk-free rate is 3.85% The number of contracts the fund needs to

use is closest to:

A) 66

B) 69

C) 72

If a manager shorts a forward currency contract to hedge the expected value of a foreign-equity

portfolio in one year The worst-case scenario is if the portfolio's return is:

A) less than the expected value and the currency appreciates.

B) less than the expected value and the currency depreciates.

C) greater than the expected value and the currency appreciates.

If a manager plans to use currency forwards to hedge a long position in foreign equities, then

which of the following would represent a strategy that would prevent over-hedging?

A) Short an amount that is less than the current equity position.

B) Short an amount that is more than the current equity position.

C) Go long an amount that is more than the current equity position.

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The practice of taking long positions in futures contracts to create an exposure that converts a

yet-to be received cash position into a synthetic equity or bond position is:

A) called pre-investing.

B) illegal.

C) called leveraging down.

A maker of large computers has just received an order for some of its products The agreed

upon price is in British pounds: ₤8 million The rm will receive the pounds in 60 days The

current exchange rate is $1.32/₤ and the 60-day forward rate is $1.35/₤ If the rm uses the

forward contract to hedge the corresponding exchange rate risk, how many dollars will it

expect to receive?

A) $5,925,926.00

B) $10,560,000.00

C) $10,800,000.00

A portfolio manager knows that a $10 million in ow of cash will be received in a month The

portfolio under management is 70% invested in stock with an average beta of 0.8 and 30%

invested in bonds with a duration of 5 The most appropriate stock index futures contract has a

price of $233,450 and a beta of 1.1 The most appropriate bond index futures has a duration of

6 and a price of $99,500 How can the manager pre-invest the $10 million in the appropriate

proportions? Take a:

A) long position in 25 of the stock futures and 28 of the bond futures.

B) short position in 25 of the bond futures and 22 of the stock futures.

C) long position in 22 of the stock futures and 25 of the bond futures.

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Jackson Inc is a multi-national company based in the U.S that makes freight cars One third of

Jackson's freight car sales occur in the Netherlands To manufacture the cars, the rm must

import approximately one half of their raw materials from Canada

Heretofore, Jackson's CFO Pete Moore ignored exchange rate risk, guring that currency

uctuations even out over time However, Jackson is doing more and more business abroad,

and Moore is beginning to rethink his position In addition, Moore believes that exchange rates

have become more volatile, thus hedging currency exposure might make sense Given his new

mindset, Moore decides to hedge some of the company's currency exposure

Two months from now, Jackson plans to sell freight cars to a Dutch rm for 15 million To

protect the company from any adverse moves in exchange rates, Moore enters into a 15 million

forward contract due in 60 days Moore also enters into a 60-day forward contract to lock in 8.5

million Canadian dollars which will be used to purchase steel from a Canadian supplier to be

delivered in 2 months

The current Euro-to-U.S dollar exchange rate is 0.79/$, while the Canadian dollar-to-U.S dollar

exchange rate is C$1.30/$ The 60-day forward Euro-to-U.S dollar exchange rate is 0.80/$, while

the 60-day forward Canadian dollar-to-U.S dollar exchange rate is C$1.33/$ At the end of two

months, the actual Euro/U.S dollar exchange rate is 0.90/$ and the actual Canadian dollar/U.S

dollar rate is C$1.20/$

In addition to his duties at Jackson, Moore is a Level III CFA Candidate To assist with his studies

and gain insights that will help him with Jackson's hedging strategy, Moore has put together the

following two tables

Table 1: Types of Exchange Rate Risks

Economic Exposure

The risk that exchange rate uctuations will make contracted future cash ows from foreign trade partners' decrease in domestic currency value.

Translation Exposure

The risk that multinational corporations might see a decline in the value of their assets that are

denominated in foreign currencies when those foreign currencies depreciate.

Transaction Exposure

It is the loss of sales that a domestic exporter might experience if the domestic currency appreciates relative to a foreign currency.

Table 2: Hedging Currency Positions

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Currency Exposure Position Action

Receiving foreign

Paying foreign currency Short Sell forward contract

Up to now, Moore has used only forward contracts to hedge the foreign currency exposure

However, after reading about futures contracts, he thinks futures may be appropriate To help

him decide, Moore makes a list of the advantages and disadvantages of using futures contracts

Pros & Cons of Futures vs Forwards

Futures contracts are standardized contracts, forward contracts are not

Futures contracts are less regulated than forward contracts, and thus have higher default risk

Forward contracts can be established for any settlement date, futures contracts have a limited number of available settlement dates

With respect to Table 1, which of the following statements is most accurate? The de nition for:

A) economic exposure is correct; the de nition for transaction exposure is correct.

B) translation exposure is correct; the de nition for transaction exposure is incorrect.

C) translation exposure is incorrect; the de nition for transaction exposure is incorrect.

When hedging their exchange rate risk on the freight car sale, Moore used a forward contract

to:

A) buy 15 million in exchange for $18.75 million.

B) sell 15 million in exchange for $18.75 million.

C) sell 15 million in exchange for $16.67 million.

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To hedge the foreign exchange risk relative to the Canadian dollar, Jackson should:

A) sell a forward contract to exchange $6,390,977 for CAD 8.5 million.

B) buy a forward contract to exchange $6,390,977 for CAD 8.5 million.

C) buy a forward contract to exchange $7,083,333 for CAD 8.5 million.

In regard to Table 2 , which of the following is CORRECT? The:

A) receiving foreign currency position is incorrect; the action is also incorrect.

B) paying foreign currency position is correct; the action is correct.

C) receiving foreign currency position is correct; the action is incorrect.

Regarding the advantages of futures contracts, which statement is least accurate?

A) Statement 1.

B) Statement 3.

C) Statement 2.

All of the following are advantages of using futures and forward contracts to hedge risk in a

portfolio, relative to adjusting the actual debt and equity positions, EXCEPT:

A) the manager gets a leverage e ect with futures because the only required “investment”

is the margin deposit

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