Deck 10: Futures Arbitrage Strategies

Question 1

If the stock index is at 148, the three-month futures price is 151, the dividend yield is 5 percent and the interest rate is 8 percent, determine the profit from an index arbitrage if the stock ends up at 144 at expiration. (Ignore transaction costs.)

A) 1.89
B) 4.00
C) 7.00
D) 5.11
E) -7.00

Answer 1

A

Question 2

The opportunity to lock in the invoice price and purchase the deliverable Treasury bond later is called

A) bond insurance
B) program trading
C) the wild card
D) delivery arbitrage
E) none of the above

Answer 2

C

Question 3

Determine the annualized implied repo rate on a Treasury bond spread in which the March is bought at 98.7 and the June is sold at 99.5. The March CF is 1.225 and the June CF is 1.24. The accrued interest as of March 1 is 0.75 and the accrued interest as of June 1 is 1.22.

A) 5.21 percent
B) 10.03 percent
C) 1.28 percent
D) 2.42 percent
E) 0.81 percent

Answer 3

B

Question 4

If the futures price at 3:00 p.m. is 122, the spot price is 142.5 and the CF is 1.1575, by how much must the spot price fall by 5:00 p.m. to justify delivery?

A) 1.285
B) 1.1102
C) 20.50
D) 17.71
E) 42.94

Question 5

The end-of-the-month option is

A) the right to exercise an option on the last day of the month
B) an option expiring on the last day of the month
C) the right to deliver during the last seven business days of the month
D) an option that trades only at the end of the month
E) none of the above

Question 6

The implied repo rate is similar to the

A) internal rate of return
B) cost of hedging
C) yield on the futures contract
D) all of the above
E) none of the above

Question 7

How is the cost of a delivery option paid?

A) the long pays the short with a cash settlement
B) the short pays the long with a cash settlement
C) a higher closing futures price
D) a lower closing futures price
E) none of the above

Question 8

The transaction in which money is borrowed by selling a security and promising to buy it back in several weeks is called a

A) term repo
B) overnight repo
C) term arbitrage
D) MOB spread
E) none of the above

Question 9

If you buy both a 30-day Eurodollar CD paying 6.7 percent and a 90-day futures on a 90-day Eurodollar CD with a price implying a yield of 7.2 percent, what is your total annualized return? (Both yields are based on 360-day years.)
A) 6.95 percent

A) 7.25 percent
B) 7.07 percent
C) 10.15 percent
D) 7.75 percent

Question 10

Deep Check
If a firm is planning to borrow money in the future, the rate it is trying to lock in is
A) none of the above

A) the current forward rate
B)
B) the current spot rate
C) the difference between the spot rate and the forward rate

Question 11

Which of the following is not a risk of program trading?

A) the stocks cannot be simultaneously sold at expiration
B) fractional contracts cannot be purchased or sold
C) the dividends are not certain
D) the stocks cannot be purchased simultaneously
E) none of the above

Question 12

Find the annualized implied repo rate on a T-bond arbitrage if the spot price is 112.25, the accrued interest is 1.35, the futures price is 114.75, the CF is 1.0125, the accrued interest at delivery is 0.95, and the holding period is three months.

A) 1.85 percent
B) 0.77 percent
C) 14.77 percent
D) 13.04 percent
E) 2.23 percent

Question 13

Determine the conversion factor for delivery of the 7 1/4's off May 15, 2026 on the March 2010 T-bond futures contract.

A) 1.225
B) 0.932
C) 1.083
D) 1.127
E) 1.509

Question 14

On the basis of liquidity, the best futures contract for hedging short-term interest rates is

A) Treasury bills
B) the prime rate
C) commercial paper
D) Eurodollars
E) none of the above

Question 15

What reason might be given for not wanting to hedge the future issuance of a liability if interest rates are unusually high?
A) the margin cost will be expensive

A) you are locking in a high rate
B) transaction costs are higher
D) futures prices are lower
E) none of the above

Question 16

The transaction designed to exploit mispricing in the relationship between futures and spot prices is called

A) a repurchase agreement
B) a hedge
C) speculation
D) carry arbitrage
E) none of the above

Question 17

The transaction in which a Treasury bond futures spread is combined with a Fed funds futures transaction is called a

A) Bond-bill spread
B) MOB spread
C) designated order turnaround
D) turtle trade
E) none of the above

Question 18

Determine the amount by which a stock index futures is mispriced if the stock index is at 200, the futures is at 202.5, the risk-free rate is 6.45 percent, the dividend yield is 2.75 percent, and the contract expires in three months.

A) underpriced by 0.64
B) overpriced by 2.5
C) overpriced by 9.76
D) overpriced by 0.64
E) underpriced by 2.5

Question 19

Which one of the following options is not associated with the Treasury bond futures contract?

A) end-of-the-month
B) spread option
C) wild card option
D) quality option
E) none of the above

Question 20

A deliverable Treasury bond has accrued interest of 3.42 per $100, a coupon of 9.5 percent, a price of 135 and a conversion factor of 1.195. The futures price is 112.25. What is the invoice amount?

A) 137.56
B) 143.64
C) 161.33
D) 134.14
E) none of the above

Question 21

Fed fund futures arbitrage is based on the assumption that LIBOR and Fed funds are perfect substitutes.

Question 22

It is important to identify the cheapest bond to deliver because it is the one the futures contract is priced off of.

Question 23

Suppose you observe the spot euro at $1.38/€ and the three month euro futures at $1.379/€. Based on carry arbitrage, you conclude

A) this futures market is inefficient because the futures price is below the spot price
B) this futures market is indicating that the spot price is expected to fall
C) the spot price is too high relative to the observed futures price
D) the risk-free rate in Europe is higher than the risk-free rate in the U. S.
E) none of the above

Question 24

Which of the following is a form of program trading?

A) index arbitrage
B) wild card arbitrage
C) triangular arbitrage
D) timing arbitrage
E) none of the above

Question 25

The cheapest bond to deliver is the one that has the lowest spot price.

Question 26

The implied repo rate on a spread is the implicit return on a risk-free spread transaction.

Question 27

Transaction costs in program trading are so small that they are not much of a factor.

Question 28

The implied repo rate is the return on an overnight repurchase agreement.

Question 29

Suppose you observe the spot euro at $1.50/€, the U. S. risk-free interest rate of 3.25% (continuously compounded), and the six month futures price of $1.50/€. Identify the correct implied European risk-free interst rate (select the closest answer).

A) -3.25%
B) -1.0%
C) 0.0%
D) 1.0%
E) 3.25%

Question 30

Which of the following is not needed when calculating the implied repo rate for stock index futures?

A) futures price
B) conversion factor
C) time-to-expiration
D) spot price
E) none of the above
Use the following information to answer questions 22 through 24. On October 1, the one-month LIBOR rate is 4.50 percent and the two month LIBOR rate is 5.00 percent. The November Fed funds futures is quoted at 94.50. The contract size is $5,000,000.

Question 31

Suppose you observe the spot S&P 500 index at 1,210 and the three month S&P 500 index futures at 1,205. Based on carry arbitrage, you conclude

A) this futures market is inefficient because the futures price is below the spot price
B) this futures market is indicating that the spot price is expected to fall
C) the spot price is too high relative to the observed futures price
D) the dividend yield is higher than the risk-free interest rate
E) none of the above

Question 32

Much of the volume of stock transactions in program trading occurs through the New York Stock Exchange's DOT system.

Question 33

The dollar value of a one basis point rise in the Fed funds futures price is

A) -$25.00
B) $41.67
C) $5,000
D) $25.00
E) none of the above

Question 34

Covered interest arbitrage from a U. S. dollar perspective when the euro futures price (expressed in $/€) is too high involves

A) buying foreign exchange futures contracts
B) selling interest rate futures contracts
C) lending funds in risk-free euro investment
D) selling euros
E) buying euro stock index ETFs

Question 35

Suppose you observe the spot euro at $1.38/€, the U. S. risk-free interest rate of 0.25% (continuously compounded), and the European risk-free interest rate of 0.75% (continuously compounded). Identify the theoretical value of a six month foreign exchange futures contract (select the closest answer).

A) $1.3815/€
B) $1.3765/€
C) $1.3785/€
D) $1.3825/€
E) $1.3755/€

Question 36

The most common means of financing a cash-and-carry arbitrage is a repurchase agreement.

Question 37

Compute the dollar profit or loss from borrowing the present value of $5,000,000 at one month LIBOR and lending the same amount at two month LIBOR while simultaneously selling one November Fed funds futures contract. Assume that rates on November 1 were 7 percent, there is no basis risk, and the position is unwound on November 1. Select the closest answer.

A) -$3,150
B) $0
C) $3,150
D) $940
E) -$940

Question 38

The wild card option exists because of the difference in the closing times of the spot and futures markets for Treasury bills.

Question 39

All of the following are limitations to Fed funds futures arbitrage, except

A) Fed funds rates are determined by Federal Reserve Bank policy
B) basis risk between Fed funds and LIBOR
C) repo rate is variable for the trading horizon
D) settlement is based on average in delivery month
E) transaction costs

Question 40

The timing option will lead to early delivery if the coupon rate is higher than the repo rate.

Question 41

Covered interest arbitrage relates to program trading and the need to cover the interest on funds borrowed.

Question 42

The timing option results from the difference in closing times of the spot and futures market.

Question 43

The invoice price of a Treasury bond futures contract is based on the settlement price on position day and the conversion factor.

Question 44

The opportunity to exercise the quality option will occur when one deliverable bond becomes more favorably priced than another.

Question 45

The unusual volatility that sometimes occurs at stock index futures expirations is because of the greater uncertainty.

Question 46

The implied interest rate based on Treasury bond carry arbitrage will decrease when the cheapest-to-deliver bond price increases, everything else held constant.

Question 47

If the invoice price of bond A is 122, the invoice price of bond B is 95, the adjusted spot price of bond A is 127 and the adjusted spot price of bond B is 97, the better bond to deliver is bond B.

Question 48

In theory, the foreign exchange futures price is based on four parameters only, the spot foreign exchange rate, the risk-free rate in the domestic currency, the risk-free rate in the foreign currency, and time to maturity.

Question 49

The coupon assumption for the conversion factor is 8 percent.

Question 50

Foreign exchange carry arbitrage is based on a trader's expectations regarding purchasing power parity.

Question 51

If a stock index futures is at 455 and the pricing model says it should be at 458, an arbitrageur should buy the futures and sell short the stock.

Question 52

Selling an index futures and holding an undiversified portfolio would eliminate unsystematic risk.

Question 53

The conversion factor is the price of a bond with a face value of $1, coupon and maturity equal to that of the deliverable bond, and yield of 6 percent.

Question 54

Suppose the number of days between two coupon payment dates is 181, the number of days since the last coupon payment is 100, the annual coupon rate is 8 percent and the par value is $100,000, then the accrued interest is $2,210.

Question 55

The quality option is sometimes referred to as the switching option.

Question 56

Stock index arbitrage will earn, at no risk, the difference between the futures price and the theoretical futures price.

Question 57

An increase in dividends will lower the theoretical value of the stock index futures contract.

Question 58

The implied interest rate based on stock index carry arbitrage will increase when the spot price increases, everything else held constant.

Question 59

The settlement price, conversion factor and accrued interest are necessary to calculate the invoice price.