Download True False Questions – set 2

True False Questions – Econ 351 set 2
1. Suppose I am the manger of funds and I expect my firm to receive a large sum of money in the future,
say in late June, 2011. Suppose also that I want to park these funds in US Treasuries when I receive them.
One way to hedge against higher (Treasury) prices in the future would be to buy June 2011 futures
contracts now so that I can lock in the price of Treasuries today!
2. If you are a speculator and you buy a futures contract on wheat then you are a bear, since if wheat prices
(both spot and expected) are lower at some future date, you can buy the futures contract back at a lower
price than you sold it for and pocket the capital gain!
3. If I go short on 10 year Treasuries by selling 5 futures contracts for 110 each, and prices rise to 112 and
I close my position, then I make a profit of $10,000 (excluding transactions costs).
4. Suppose I am the manger of funds and I know I need to pay out a large sum of money for Christmas
(2011) bonuses. I have the cash now and I decided to buy US Treasuries and hold them until bonus time.
One way to protect the value of these Treasuries is to sell Treasury futures contracts (Dec 2011 contracts).
5. If you write a futures options put on crude oil then we say you are ‘bullish’ on crude oil.
6. A futures options put gives the owner
A) the right to sell the underlying futures contract.
B) the obligation to sell the underlying futures contract.
C) the right to buy the underlying futures contract.
D) the obligation to buy the underlying futures contract.
7. If you owned a gasoline station (a user of gasoline) and wanted to hedge against higher prices in the
future then you could do so by buying a futures contract (in gasoline).
8. When someone says that stocks follow a random walk they are implying that movements (changes) in
stock prices occur randomly – that is, changes in stock prices are unpredictable.
9. The efficient market theory implies that there is no information that is available today that will help us
predict the stock price tomorrow.
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The expected earning stream for Sprint for the next three years is expected to be $40,000, $50,000, and
$50,000 respectively (assume the firm falls off the face of the earth in three years as we did in class).
Meanwhile, interest rates are expected to be 3 % for the next three years. Given 1,000 shares of existing
stock, answer the following questions:
10. The price earnings ratio for this firm is (use the first year earnings as we always do for your calculation)
is:
a) between 2 and 3
b) between 3and 4
c)greater than 4
d) none of the above
11. The actual stock price is above $100.
Suppose that AT&T inc. buys T-Mobile that basically leaves Sprint in the “dust.” As a result, the expected
earnings stream of Sprint falls and is now expected to be $20,000, $20,000, and $20,000 respectively. The
expected path of interest rates remain unchanged. Given this new conditions, answer the following
questions:
12. The price earnings ratio for this firm is:
a) between 2 and 3
b) between 3 and 4
c)greater than 4
d) none of the above
13. If you had previously purchased put options with a strike price of 50, then your options went from
being ‘out of the money’ to being ‘in the money’
14. We argued that according to the efficient market theory, the best investment strategy is to simply put
your money in a well diversified stock index and just keep it there since you ‘can’t’ beat the market.
Consider the following equations:
1) St+1 = α0 + α1 St + FEt+1
2) St+1 = α0 + α1 St + α2 St-1 + α3 St-2 + FEt+1
15. According to the efficient market theory, α 1 in equation 1) should equal one and thus, when we subtract
St from both sides of the equation we are left with an equilibrium return (α0) and an unpredictable forecast
error term (FEt+1) on the right hand side of the equation.
16. According to the efficient market theory regarding equation 2), α 2 and α3 should be insignificantly
different from zero since all the relevant and available information is already captured by St.
Consider the following equation:
3) FEt+1 = β0 + β1 FEt + β2 FEt-1 + β3 FEt-2 + β4 FEt-3
17. Given equation 3) above, according to efficient markets, the R2 should be low and close to zero.
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Futures / Futures Option Questions
Suppose you are in charge of an oil refinery which means you, as in your firm, are a user of crude oil and a
producer of gasoline. As we know, both crude oil and gasoline are part of a well developed financial
market so that futures and futures options markets exist that are extremely liquid for these two
commodities. Suppose that the current (spot) and futures price of crude oil, per barrel, is $100. Suppose
also that the current (spot) and futures price of gasoline is $3.00 per gallon. Each futures contract in oil
represents 1,000 bbl and each futures contract in gasoline represents 50,000 gallons (its 42, 000 in the real
world but we will use 50,000 since it is easier to work with). So you have this contract with Exxon, the
user of the gasoline, to sell them 500,000 gallons of gas at the end of December. In order to produce the
500,000 gallons of gasoline you need 10,000 barrels of oil. The producer of crude oil is Saudi Arabia.
Please answer the following TF questions. (WE ASSUME THAT YOU CAN TURN CRUDE INTO GAS
IMMEDIATELY)
18. When you buy futures contracts in crude oil you are protecting (hedging) yourself from high (oil)
prices in the future.
19. Suppose you sell 10 contracts of December gasoline where the spot and futures price is $3.00 per
gallon. If (spot) gas prices fall and end up at $2.80 at the end of December then your boss wants to give you
a bonus, since entering the futures contract was profitable for your company (as compared to not entering a
futures contract at all).
20. To protect against low gas prices at the end of December, when you sell the gas, you could sell a
futures contract to Exxon since Exxon has the opposite concerns in terms of the price of gasoline in the
future and thus, Exxon would be willing to buy a futures contract to lock in a price (per gallon) now.
21. If Saudi Arabia (the producer of the crude) wanted to lock in a price of crude to protect against low
prices in the future then they would sell futures contracts in crude oil.
Futures Options
We now consider the futures options market for oil and gas. Suppose futures options calls and puts are
available. In particular, futures options calls and puts in oil, with a strike price of $100 per barrel, are
selling for $5,000 (per contract); futures options calls and puts in gasoline, with a strike price of $3.00 per
gallon are selling for $3,000 (per contract). Each futures option represents one futures contract.
22. Exxon, to hedge against high gas prices in the future, would purchase futures options puts in gasoline.
23. Suppose you buy 10 futures options calls in oil and 10 futures options puts in gasoline. Given that the
spot price of oil at expiration is $90 per barrel of oil and $2.80 per gallon of gasoline, you did good and the
boss wants to give you a bonus since it was better for you (in terms of profits = total revenue minus total
costs) to play this futures options market than it was for you to ‘go naked’ and take your chances in the spot
market.
24. If you are bullish on Treasuries, then you hope interest rates fall since this is consistent with being
bullish on Treasuries.
25. Futures options are more attractive relative to futures for various reasons one of which is that the
amount that you can lose is limited to the premium (excluding other transactions costs) you pay for the
futures option. As a result, if you lose the bet as in prices going in the wrong direction, it is always better
(in terms of lower losses) to play the futures options market rather than the futures market.
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