LOS d, (Part 1): Describe the characteristics of equity forward contracts.

Q1. A portfolio manager is long an equity index contract at 995.6 with a notional value of $40 million. If the index is at 969.2 on the settlement date, the amount the manager must pay is closest to:

A)   $1.06 million.

B)   $1.09 million.

C)   $41.06 million.

Q2. Which statement about equity forward contracts is least accurate?

A)   Dividend payments are usually included in equity forward contracts.

B)   Equity forward contracts may require asset delivery or cash settlement.

C)   Investors can use equity forward contracts to speculate on stock-price increases.

Q3. The manager of a large equity portfolio is short a $10 million forward contract on the S& 500 Index at 1000. The index is currently 940 and at contract expiration, the index is 950. At expiration the manager:

A)   will make a payment of $105,263 since the index has increased 1.05263%.

B)   receives a payment of 50 times the contract multiplier at expiration.

C)   will receive a payment of $500,000.

Q4. The buyer (long) in a deliverable equity forward contract on a portfolio of stocks:

A)   will profit on the contract if the price of the equity asset rises over the life of the contract.

B)   will profit if the equity declines in price over the life of the contract.

C)   is obligated to buy the portfolio in the future at the forward price.

Q5. An equity forward contract may be on all of the following assets EXCEPT a(n):

A)   specific portfolio of five stocks.

B)   index.

C)   bond.

LOS d, (Part 1): Describe the characteristics of equity forward contracts. fficeffice" />

Q1. A portfolio manager is long an equity index contract at 995.6 with a notional value of $40 million. If the index is at 969.2 on the settlement date, the amount the manager must pay is closest to:

A)   $1.06 million.

B)   $1.09 million.

C)   $41.06 million.

Correct answer is A)

The actual index price is 2.6517% below the contract price (969.2 / 995.6 ? 1 = -2.6517%). Since the long manager agreed to pay the higher price but could only sell at the lower price, she must settle in cash for 2.6517% of the $40 million notional amount, or about $1.06 million.

Q2. Which statement about equity forward contracts is least accurate?

A)   Dividend payments are usually included in equity forward contracts.

B)   Equity forward contracts may require asset delivery or cash settlement.

C)   Investors can use equity forward contracts to speculate on stock-price increases.

Correct answer is A)

Dividend payments are usually not included in equity forward contracts. Investors can use equity forwards to speculate on stock price movements. Most equity index forward contracts are settled in cash, but since they are custom instruments, forwards may specify either cash settlement or delivery of the equity shares specified in the contract.

Q3. The manager of a large equity portfolio is short a $10 million forward contract on the S& 500 Index at 1000. The index is currently 940 and at contract expiration, the index is 950. At expiration the manager:

A)   will make a payment of $105,263 since the index has increased 1.05263%.

B)   receives a payment of 50 times the contract multiplier at expiration.

C)   will receive a payment of $500,000.

Correct answer is C)        

The short position will receive $10 million times 5%, the amount by which the index is below the contract price at expiration (50 / 1,000).

Q4. The buyer (long) in a deliverable equity forward contract on a portfolio of stocks:

A)   will profit on the contract if the price of the equity asset rises over the life of the contract.

B)   will profit if the equity declines in price over the life of the contract.

C)   is obligated to buy the portfolio in the future at the forward price.

Correct answer is C)        

In a deliverable contract, the long is obligated to buy the portfolio at the forward price. The forward contract price will generally (except for a very high dividend paying portfolio) be higher than the current market price; a rise in price from the current level is no guarantee of profits on the contract.

Q5. An equity forward contract may be on all of the following assets EXCEPT a(n):

A)   specific portfolio of five stocks.

B)   index.

C)   bond.

Correct answer is C)        

A forward contract on a bond is not an equity forward contract.

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