Derivatives【Reading 61】Sample forward, following, 2012, statements

clearlycanadian

Which of the following statements about forward contracts is least accurate?

A) A forward contract can be exercised at any time.

B) The long promises to purchase the asset.

C) Both parties to a forward contract have potential default risk.

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Forward contracts typically require a purchase/sale of the asset on the expiration/delivery date specified in the contract. The other statements are true.

clearlycanadian

The short in a forward contract:

A) is obligated to deliver the asset upon expiration of the contract.

B) has the right to deliver the asset upon expiration of the contract.

C) is obligated to deliver the asset anytime prior to expiration of the contract.

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The short in a forward contract is obligated to deliver the asset (in a deliverable contract) on (or close to) the expiration date.

clearlycanadian

Default risk in a forward contract:

A) is the risk to either party that the other party will not fulfill their contractual obligation.

B) only applies to the short, who must make the cash payment at settlement.

C) only applies to the long, and is the probability that the short can not acquire the asset for delivery.

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Default risk in forward contracts is the risk to either party that the other party will not perform, whether that means pay cash or deliver the asset.

clearlycanadian

Some forward contracts are termed cash settlement contracts. This means:

A) at contract expiration, the long can buy the asset from the short or pay the difference between the market price of the asset and the contract price.

B) at settlement, the long purchases the asset from the short for cash.

C) either the long or the short in the forward contract will make a cash payment at contract expiration and the asset is not delivered.

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In a cash settlement forward contract there is a cash payment at settlement by either the long or the short depending on whether the market price of the asset is below or above the contract price at expiration. The underlying asset is not purchased or sold at settlement.

clearlycanadian

A forward contract that must be settled by a sale of an asset by one party to the other party is termed a:

A) take-and-pay contract.

B) deliverable forward contract.

C) physicals-only contract.

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A deliverable forward contract can be settled at expiration only by actual delivery of the asset in exchange for the contract value. The other terms are made up.

clearlycanadian

When a party to a forward contract terminates the contract prior to the original expiration date by entering into a perfectly offsetting forward contract with a second counterparty:

A) there is no future liability, but default risk remains for all parties until the original contract settlement date.

B) the party terminating the contract is exposed to default risk, but has no further asset price risk.

C) the party terminating the forward contract has no default risk, but both counterparties face default risk.

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When a forward contract is terminated by an offsetting contract with a second counterparty, there is no further asset price risk, but since there are two separate contracts with different counterparties, all parties are exposed to default risk until both contracts are settled. Since the two contracts may have different forward prices, the terminating party may have a future liability at settlement, but the amount is fixed at the time the offsetting contract is initiated. The terminating party may have ‘locked in’ a future gain or loss, depending on the difference between the forward prices of the two offsetting contracts.

clearlycanadian

An investor can exit a forward position prior to contract expiration by all of the following methods EXCEPT:

A) exercising the early delivery option.

B) making a cash payment or accepting a cash payment by agreement with the original counterparty.

C) entering into an offsetting contract with the original counterparty.

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There is typically no early delivery option in a forward contract. The other two methods are both usual ways of terminating a forward contract prior to the settlement date specified in the contract.

clearlycanadian

Which of the following is NOT a method of terminating a forward contract prior to expiration?

A) Exercise a swaption.

B) Make an agreed upon payment to the counterparty.

C) Enter into an offsetting forward contract with the original counterparty.

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A swaption can be used to terminate a swap. The others are both ways to terminate a forward contract prior to expiration.

clearlycanadian

Which of the following statements regarding forward contracts is NOT correct?

A) Dealers make the majority of their profits by anticipating price moves in the underlying asset.

B) End users of forwards most often have a business exposure to price risk from the asset covered by the contract.

C) Dealers will enter into forward contracts with other dealers.

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Dealers do not make most of their profits from speculating on price moves or interest rate moves. They profit from the bid-ask spread. They take offsetting positions with different end users to hedge their price risk.

clearlycanadian

Which statement regarding forward contract dealers is least accurate?

A) Not all of them are banks.

B) They try to balance their long and short positions to limit risk.

C) They bear default risk but not asset-price risk.

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Dealers bear both default risk as well as asset-price risk from unhedged positions. Nonbank financial institutions can deal in forward contracts. Ideally, dealers will balance their long contract positions with other parties who seek the opposite risk exposure.