LOS b, (Part 2): Define initial margin, maintenance margin, variation margin, and settlement price.

Q1. The initiation of a futures position:

A)   is done through a bank or other large financial institution acting as a dealer.

B)   requires both a buyer and a seller.

C)   is at a price negotiated between the buyer and seller.

Q2. Which of the following statements regarding a futures trade of a deliverable contract is FALSE?

A)   The long is obligated to purchase the asset.

B)   The price is determined by open outcry.

C)   Equilibrium futures price is known only at the end of the trading day.

Q3. The settlement price for a futures contract is:

A)   the price of the last trade of a futures contract at the end of the trading day.

B)   an average of the trade prices during the ‘closing period’.

C)   the price of the asset in the future for all trades made in the same day.

Q4. If the margin balance in a futures account with a long position goes below the maintenance margin amount:

A)   a deposit is required to return the account margin to the initial margin level.

B)   a margin deposit equal to the maintenance margin is required within two business days.

C)   a deposit is required which will bring the account to the maintenance margin level.

Q5. If the balance in a trader’s account falls below the maintenance margin level, the trader will have to deposit additional funds into the account. The additional funds required is called the:

A)   margin call.

B)   variation margin.

C)   initial margin.

Q6. It is April 15, and a trader is entered into a short position in two soybean meal futures contracts. The contracts expire on August 15, and call for the delivery of 100 tons of soybean meal each. Further, because this is a futures position, it requires the posting of a $3,000 initial margin and a $1,500 maintenance margin per contract. For simplicity, however, assume that the account is marked to market on a monthly basis. Assume the following represent the contract delivery prices (in dollars per ton) that prevail on each settlement date:

What is the equity value of the margin account on the May 15 settlement date, including any additional equity that is required to meet a margin call?

A)   $1,350.

B)   $4,650.

C)   $2,300.

Q7. Based on the May 15 settlement date, which of the following is most accurate?

A)   Since the equity value of the margin account is above the initial margin, the trader can withdraw $1,350.

B)   Since the equity value of the margin account is below the maintenance margin, a variation margin is called to restore the equity value of the account to it's initial level.

C)   No margin call or disbursement occurs.

Q8. When a futures trader receives a margin call what must he or she do to bring the position up to the initial margin? The futures trader must:

A)   sell stock to cover the margin call.

B)   deposit maintenance margin.

C)   deposit variation margin.

Q9. The money added to a margin account to bring the account back up to the required level is known as the:

A)   daily settlement.

B)   variation margin.

C)   maintenance margin.

Q10. In the trading of futures contracts, the role of the clearinghouse is to:

A)   guarantee that all obligations by traders, as set forth in the contract, will be honored.

B)   stabilize the market price fluctuations of the underlying commodity.

C)   maintain private insurance that can be used to provide funds if a trader defaults.

LOS b, (Part 2): Define initial margin, maintenance margin, variation margin, and settlement price. fficeffice" />

Q1. The initiation of a futures position:

A)   is done through a bank or other large financial institution acting as a dealer.

B)   requires both a buyer and a seller.

C)   is at a price negotiated between the buyer and seller.

Correct answer is B)

Futures trades are done through open outcry on the futures exchange and require a buyer (long) and a seller (short) for a trade to take place. The other statements are generally true for forward contracts, which are all individually negotiated.

Q2. Which of the following statements regarding a futures trade of a deliverable contract is FALSE?

A)   The long is obligated to purchase the asset.

B)   The price is determined by open outcry.

C)   Equilibrium futures price is known only at the end of the trading day.

Correct answer is C)

Each trade is made at the then current equilibrium price, determined by open outcry on the floor of the exchange, and is reported as it is executed. The long is obligated to buy, and the short is obligated to sell, the specified quantity of the underlying asset.

Q3. The settlement price for a futures contract is:

A)   the price of the last trade of a futures contract at the end of the trading day.

B)   an average of the trade prices during the ‘closing period’.

C)   the price of the asset in the future for all trades made in the same day.

Correct answer is B)

The margin adjustments are made based on the settlement price, which is calculated as the average trade price over a specific closing period at the end of the trading day. The length of the closing period is set by the exchange.

Q4. If the margin balance in a futures account with a long position goes below the maintenance margin amount:

A)   a deposit is required to return the account margin to the initial margin level.

B)   a margin deposit equal to the maintenance margin is required within two business days.

C)   a deposit is required which will bring the account to the maintenance margin level.

Correct answer is A)

Once account margin (based on the daily settlement price) falls below the maintenance margin level, it must be returned to the initial margin level, regardless of subsequent price changes.

Q5. If the balance in a trader’s account falls below the maintenance margin level, the trader will have to deposit additional funds into the account. The additional funds required is called the:

A)   margin call.

B)   variation margin.

C)   initial margin.

Correct answer is B)

If the margin balance falls below a specified level (the maintenance margin), additional capital (the variation margin) must be deposited in the account. Initial margin is the capital that must be in the trader’s account before the initiation of the margin trade.

Q6. It is April 15, and a trader is entered into a short position in two soybean meal futures contracts. The contracts expire on August 15, and call for the delivery of 100 tons of soybean meal each. Further, because this is a futures position, it requires the posting of a $3,000 initial margin and a $1,500 maintenance margin per contract. For simplicity, however, assume that the account is marked to market on a monthly basis. Assume the following represent the contract delivery prices (in dollars per ton) that prevail on each settlement date:

What is the equity value of the margin account on the May 15 settlement date, including any additional equity that is required to meet a margin call?

A)   $1,350.

B)   $4,650.

C)   $2,300.

Correct answer is B)

Use the following steps to calculate the margin account balance as of May 15.

At initiation: (Beginning Balance, April 15)

Initial margin × number of contracts = 3,000 × 2 = 6,000

Maintenance margin × number of contracts = 1,500 × 2 = 3,000

As of May 15: (Ending contract price per ton ? beginning contract price per ton ) × tons per contract × # contracts = (179.75 ? 173.00) × 100 × 2 = 1,350

Since the trader is short, this amount is subtracted from the beginning margin balance, or 6,000 ? 1,350 = 4,650.

Q7. Based on the May 15 settlement date, which of the following is most accurate?

A)   Since the equity value of the margin account is above the initial margin, the trader can withdraw $1,350.

B)   Since the equity value of the margin account is below the maintenance margin, a variation margin is called to restore the equity value of the account to it's initial level.

C)   No margin call or disbursement occurs.

Correct answer is C)

As of May 15, the margin balance is $4,650 (see solution to previous question). Since this is below the initial margin of $6,000 (both contracts), but still above the maintenance margin of $3,000, (for both contracts) no action is required.

There are three types of margin. The first deposit is called the initial margin. Initial margin must be posted before any trading takes place. Initial margin is fairly low and equals about one day’s maximum price fluctuation. The margin requirement is low because at the end of every day there is a daily settlement process called marking-the-account-to-market. In marking-to-market, any losses for the day are removed from the trader’s account and any gains are added to the trader’s account. If the margin balance in the trader’s account falls below a certain level (called the maintenance margin), the trader will get a margin call and have to deposit more money (called the variation margin) into the account to bring the account back up to the initial margin level.

Q8. When a futures trader receives a margin call what must he or she do to bring the position up to the initial margin? The futures trader must:

A)   sell stock to cover the margin call.

B)   deposit maintenance margin.

C)   deposit variation margin.

Correct answer is C)

When a futures trader receives a margin call, he/she must deposit variation margin to bring the account up to the initial margin value.

Q9. The money added to a margin account to bring the account back up to the required level is known as the:

A)   daily settlement.

B)   variation margin.

C)   maintenance margin.

Correct answer is B)

The money added to a margin account to bring the account back up to the required level is known as the variation margin. The minimum allowed in the account is called the maintenance margin. The daily settlement process requires marking-to-market each day.

Q10. In the trading of futures contracts, the role of the clearinghouse is to:

A)   guarantee that all obligations by traders, as set forth in the contract, will be honored.

B)   stabilize the market price fluctuations of the underlying commodity.

C)   maintain private insurance that can be used to provide funds if a trader defaults.

Correct answer is A)

The clearinghouse does not originate trades, it acts as the opposite party to all trades. In other words, it is the buyer to every seller and the seller to every buyer. This action guarantees that all obligations under the terms of the contract will be fulfilled.

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