Question

Favorites say Questions (20 points each - Explain in detail) What are the differences between futures and forward markets in terms of counterparty credit risk (3pts). contract delivery expected (3pts), timing flexibility (3pts), regulation (3pts), liquidity requirements (3pts), and capital requirem Explain in details. 2. Should a corporation hedge? Why might it increase firm value? Are there any reasons why a firm would not want to he Explain in details. 3. In class we discuss that given a choice between liquidity and basis risk, futures markets chose institutional arrangements th favored liquidity, Who is most impacted by this choice and why do you think maximizing liquidity is more important than minimizing basis risk? Explain in details. 4. The movies Goldfinger James Bond Movie) and Die Hard 3 (Die Hard with a vengeance) both involve the perpetrators doing something to gold. Assume that the bad guys succeed with their plot, what would be the impact on gold prices and gold spreads In each case? Please explain how you reached that conclusion (see plot summaries of the movies below. Explanation Questions (10 Points each - Explain briefly) 5. For the cost of carry model to be effective, what physical characteristics should a commodity have? Definition & Short Answer Questions (5 Points each) 6. Define hedging effectiveness. 7. Why are relatively few futures contracts settled by delivery
i need help with #5

Answer 1

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Answed 1 IN gisk Easward & Futures Ccounterparty credit risk) Forward, there is no clearing house , so credit is higher In Futures, it is controlledu by credit risk is very low clearing house, so I contract delivery In Forward, contract delivery has flexibility, because this is not standardize. In Futures, contract doesn't have because, contract is standardize : flexibility, Timing futures Flexibity is there in forward; but not in Forward is not much regulated, where as future markets are highly regulated Liquidity Liquidity is low in forwards. liquidity is high in Futures: Capital requirement There is no capital or little margin is requiredo In Futures, Due to daily settlement of prices MTM margin is also required so in Futures, margin is higher as compared to forwards. 1

Answer a Yes corporation should definitely hedge remove huge price uncertainily. But Hedging would not increase firm value Reasons not to Hedge If a firm is not Hedging, it it can have uncertain profits in futures, but losses also. For example If a company sells oil it had not taken any hedging contract, If oil price rises it will earn profits, which can more than normal business But what If price will fally by 40.1 to 50%, the oitfompany oil firm may become Bankrupt. So Hedgeing is good for firme Answer 3 Liquidity risk is also important in Hedging: If there is no liquidity, then firm has to face losses while exiting the positions Yes Basis risk arises, when you select a contract that has huge Liquidity, but not matching delivery months, so basis risk arises. 7 3 months - Open Interest You want to hedge contract 300 for 4 months, but y 6months - Open Interest. you can't 3 months contract 100oooo Contract because of liquidity, go you are taking 6 months contract & Increasing B Basis risk

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