Question

Please explain on why that is the answer? Im trying to comprehend it.

A pension fund manager who plans on purchasing bonds in the future:
a. Wants to insure against the price of bonds falling.
b. Can offset the risk of bond prices rising by selling a futures contract.
C. Will take the long position in a futures contract.
d. Will take the short position in a futures contract.

A wheat farmer who must purchase his inputs now but will sell his wheat at a market price at a
future date:
a. Faces a market risk that cannot be offset.
b. Is a good example of what the chapter refers to as a speculator.
C. Would hedge by taking the short position in a wheat futures contract.
d. Would hedge by taking the long position in a wheat futures contract.

A baker of bread has a long-term fixed-price contract to supply bread. Which of the following
would NOT reduce her risk?
a. Taking the long position in wheat futures contract.
b. Hedging this risk in the wheat futures market.
c. Finding a wheat farmer who will take the short position in a wheat futures contract.
D. Finding a wheat farmer who will take the long position in a wheat futures contract.

There is a futures contract for the purchase of 100 bushes of wheat at $2.50 per bushel. If the
market price of wheat increases to $3.00 per bushel:
a. The buyer (long position) needs to transfer $50 to the seller (short position).
B. The seller (short position) needs to transfer $50 to the buyer (long position).
c. Nothing happens since with a futures contract all payments are made at the settlement date.
d. Nothing happens since marked to market adjustments only take place when the market price falls
below the contract price.

14. (p. 199) There is a futures contract for the purchase of 1000 bushels of corn at $3.00 per bushel. If the
market price of corn falls to $2.50:
A. The buyer (long position) needs to transfer $500 to the seller (short position).
b. The seller (long position) needs to transfer $500 to the buyer (short position).
c. Nothing happens since marked to market adjustments only occur if the market price rises above the
contract price.
d. Nothing happened since no funds are transferred until the settlement date.

Answer 1

Pension fund manager

(c) Will take long position in futures contract.

A futures contract is a legal agreement to buy or sell a particular commodity or asset at a predetermined price at a specified time in the future.

Since he want to purchase bond in future,he is afraid of bond prices rising.Taking long position in future will mitigate this risk.If the bond prices rise in future,he will benefit from future contract. (increased bond price-contracted future price) will be his benefit from this long position

Wheat farmer

(c) would hedge by taking a short position in wheat futures contract.

Since future contract gives right to sell (for short position) at contracted price,even if the actual rate is less than contracted price in future,the farmer will be able to sell at future contracted price.

Baker of bread

(D) finding a farmer who will take a long position in wheat future contract

Since the baker will need wheat to produce bread,he will be afraid of wheat price rising.Therefore he should purchase wheat future contract (The farmer will sell wheat future contract).If the farmer buys (and baker sells),it would be complete opposite of what is actually required.Hence this would not reduce his risk

Future contract of 100 bushes

(B)The seller (short position) needs to transfer $50 to buyer (long position)

The buyer of future contract has right to receive the difference between Actual price & contracted price if there is increase in price.Similarly the seller has to pay in this case.

Here the price has increased,hence the seller will pay to buyer.[(3-2.5)*100=$50]

14)

(A)The buyer (long position) will pay $50 to seller (short position)

The seller of future contract has right to receive the difference between contracted price & Actual price if there is decrease in price.Similarly the Buyer has to pay in this case.

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