LOS c: Differentiate between a dealer and an end user of a forward contract.

Q1. Which of the following statements regarding forward contract dealers is FALSE?

A)   Forward contract dealers are often banks.

B)   Dealers are compensated through up-front payments by the parties to forward contracts.

C)   Dealers offer long and short forward contracts at different prices.

Q2. All of the following are typically end users of forward contracts EXCEPT:

A)   non-profit institutions.

B)   a forwards dealer.

C)   governmental units.

Q3. Which statement regarding forward contract dealers is least accurate?

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

B)   Not all of them are banks.

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

Q4. Which of the following statements regarding forward contracts is FALSE?

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

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

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

LOS c: Differentiate between a dealer and an end user of a forward contract. fficeffice" />

Q1. Which of the following statements regarding forward contract dealers is FALSE?

A)   Forward contract dealers are often banks.

B)   Dealers are compensated through up-front payments by the parties to forward contracts.

C)   Dealers offer long and short forward contracts at different prices.

Correct answer is B)        

There is typically no payment from either the long or the short to enter into a forward contract. Dealers make money through the bid-ask spread, the difference between the forward prices they offer to buyers and sellers.

Q2. All of the following are typically end users of forward contracts EXCEPT:

A)   non-profit institutions.

B)   a forwards dealer.

C)   governmental units.

Correct answer is B)        

A dealer is not an end user. Dealers typically take offsetting positions with different end users to limit their exposure to the asset price risk in individual forward contracts.

Q3. Which statement regarding forward contract dealers is least accurate?

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

B)   Not all of them are banks.

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

Correct answer is A)        

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.

Q4. Which of the following statements regarding forward contracts is FALSE?

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

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

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

Correct answer is B)        

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.

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