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Hull: Op(ons, Futures and Other Deriva(ves, Ninth Edi(on, Global Edi(on
Chapter 3: Hedging Strategies Using Futures
Mul(ple Choice Test Bank: Ques(ons with Answers

1. The basis is de,ned as spot minus futures. A trader is hedging the sale of an asset with a short
futures posi9on. The basis increases unexpectedly. Which of the following is true?
A. The hedger’s posi9on improves.
B. The hedger’s posi9on worsens.
C. The hedger’s posi9on some9mes worsens and some9mes improves.
D. The hedger’s posi9on stays the same.

Answer: A

The price received by the trader is the futures price plus the basis. It follows that the trader’s
posi9on improves when the basis increases.

2. Futures contracts trade with every month as a delivery month. A company is hedging the
purchase of the underlying asset on June 15. Which futures contract should it use?
A. The June contract
B. The July contract
C. The May contract
D. The August contract

Answer: B

As a general rule the futures maturity month should be as close as possible to but aKer the
month when the asset will be purchased. In this case the asset will be purchased in June and so
the best contract is the July contract.

3. On March 1 a commodity’s spot price is $60 and its August futures price is $59. On July 1 the
spot price is $64 and the August futures price is $63.50. A company entered into futures
contracts on March 1 to hedge its purchase of the commodity on July 1. It closed out its posi9on
on July 1. What is the eSec9ve price (aKer taking account of hedging) paid by the company?
A. $59.50
B. $60.50
C. $61.50
D. $63.50

Answer: A

The user of the commodity takes a long futures posi9on. The gain on the futures is 63.50−59 or
$4.50. The eSec9ve paid realized is therefore 64−4.50 or $59.50. This can also be calculated as
the March 1 futures price (=59) plus the basis on July 1 (=0.50).

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4. On March 1 the price of a commodity is $1,000 and the December futures price is $1,015. On
November 1 the price is $980 and the December futures price is $981. A producer of the
commodity entered into a December futures contracts on March 1 to hedge the sale of the
commodity on November 1. It closed out its posi9on on November 1. What is the eSec9ve price
(aKer taking account of hedging) received by the company for the commodity?
A. $1,016
B. $1,001
C. $981
D. $1,014

Answer: D

The producer of the commodity takes a short futures posi9on. The gain on the futures is
1015−981 or $34. The eSec9ve price realized is therefore 980+34 or $1014. This can also be
calculated as the March 1 futures price (=1015) plus the November 1 basis (=−1).

5. Suppose that the standard devia9on of monthly changes in the price of commodity A is $2. The
standard devia9on of monthly changes in a futures price for a contract on commodity B (which
is similar to commodity A) is $3. The correla9on between the futures price and the commodity
price is 0.9. What hedge ra9o should be used when hedging a one month exposure to the price
of commodity A?
A. 0.60
B. 0.67
C. 1.45
D. 0.90

Answer: A

The op9mal hedge ra9o is 0.9×(2/3) or 0.6.

6. A company has a $36 million porbolio with a beta of 1.2. The futures price for a contract on an
index is 900. Futures contracts on $250 9mes the index can be traded. What trade is necessary
to reduce beta to 0.9?
A. Long 192 contracts
B. Short 192 contracts
C. Long 48 contracts
D. Short 48 contracts

Answer: D

To reduce the beta by 0.3 we need to short 0.3×36,000,000/(900×250) or 48 contracts.

7. A company has a $36 million porbolio with a beta of 1.2. The futures price for a contract on an

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index is 900. Futures contracts on $250 9mes the index can be traded. What trade is necessary
to increase beta to 1.8?
A. Long 192 contracts
B. Short 192 contracts
C. Long 96 contracts
D. Short 96 contracts

Answer: C

To increase beta by 0.6 we need to go long 0.6×36,000,000/(900×250) or 96 contracts

8. Which of the following is true?

A. The op9mal hedge ra9o is the slope of the best ,t line when the spot price (on the y-axis) is
regressed against the futures price (on the x-axis).
B. The op9mal hedge ra9o is the slope of the best ,t line when the futures price (on the y-
axis) is regressed against the spot price (on the x-axis).
C. The op9mal hedge ra9o is the slope of the best ,t line when the change in the spot price
(on the y-axis) is regressed against the change in the futures price (on the x-axis).
D. The op9mal hedge ra9o is the slope of the best ,t line when the change in the futures price
(on the y-axis) is regressed against the change in the spot price (on the x-axis).

Answer: C

The op9mal hedge ra9o reeects the ra9o of movements in the spot price to movements in the
futures price.

9. Which of the following describes tailing the hedge?

A. A strategy where the hedge posi9on is increased at the end of the life of the hedge
B. A strategy where the hedge posi9on is increased at the end of the life of the futures
contract
C. A more exact calcula9on of the hedge ra9o when forward contracts are used for hedging
D. None of the above

Answer: D

Tailing the hedge is a calcula9on appropriate when futures are used for hedging. It corrects for
daily seflement

10. A company due to pay a certain amount of a foreign currency in the future decides to hedge
with futures contracts. Which of the following best describes the advantage of hedging?
A. It leads to a befer exchange rate being paid
B. It leads to a more predictable exchange rate being paid
C. It caps the exchange rate that will be paid
D. It provides a eoor for the exchange rate that will be paid

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Answer: B

Hedging is designed to reduce risk not increase expected pro,t. Op9ons can be used to create a
cap or eoor on the price. Futures afempt to lock in the price

11. Which of the following best describes the capital asset pricing model?
A. Determines the amount of capital that is needed in par9cular situa9ons
B. Is used to determine the price of futures contracts
C. Relates the return on an asset to the return on a stock index
D. Is used to determine the vola9lity of a stock index

Answer: C

CAPM relates the return on an asset to its beta. The parameter beta measures the sensi9vity of
the return on the asset to the return on the market. The lafer is usually assumed to be the
return on a stock index such as the S&P 500.

12. Which of the following best describes “stack and roll”?

A. Creates long-term hedges from short term futures contracts
B. Can avoid losses on futures contracts by entering into further futures contracts
C. Involves buying a futures contract with one maturity and selling a futures contract with a
diSerent maturity
D. Involves two diSerent exposures simultaneously

Answer: A

Stack and roll is a procedure where short maturity futures contracts are entered into. When
they are close to maturity they are replaced by more short maturity futures contracts and so on.
The result is the crea9on of a long term hedge from short-term futures contracts.

13. Which of the following increases basis risk?

A. A large diSerence between the futures prices when the hedge is put in place and when it is
closed out
B. Dissimilarity between the underlying asset of the futures contract and the hedger’s exposure
C. A reduc9on in the 9me between the date when the futures contract is closed and its delivery
month
D. None of the above

Answer: B

Basis is the diSerence between spot and futures at the 9me the hedge is closed out. This
increases as the 9me between the date when the futures contract is put in place and the
delivery month increases. (C is not therefore correct). It also increases as the asset underlying
the futures contract becomes more diSerent from the asset being hedged. (B is therefore
correct.)

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14. Which of the following is a reason for hedging a porbolio with an index futures?
A. The investor believes the stocks in the porbolio will perform befer than the market but is
uncertain about the future performance of the market
B. The investor believes the stocks in the porbolio will perform befer than the market and the
market is expected to do well
C. The porbolio is not well diversi,ed and so its return is uncertain
D. All of the above

Answer: A

Index futures can be used to remove the impact of the performance of the overall market on the
porbolio. If the market is expected to do well hedging against the performance of the market is
not appropriate. Hedging cannot correct for a poorly diversi,ed porbolio.

15. Which of the following does NOT describe beta?

A. A measure of the sensi9vity of the return on an asset to the return on an index
B. The slope of the best ,t line when the return on an asset is regressed against the return on the
market
C. The hedge ra9o necessary to remove market risk from a porbolio
D. Measures correla9on between futures prices and spot prices for a commodity

Answer: D

A, B, and C all describe beta but beta has nothing to do with the correla9on between futures
and spot prices for a commodity

16. Which of the following is true?

A. Hedging can always be done more easily by a company’s shareholders than by the company itself
B. If all companies in an industry hedge, a company in the industry can some9mes reduce its risk by
choosing not to hedge
C. If all companies in an industry do not hedge, a company in the industry can reduce its risk by
hedging
D. If all companies in an industry do not hedge, a company is liable increase its risk by hedging

Answer: D

If all companies in a industry hedge, the price of the end product tends to reeect movements in
relevant market variables. Afemp9ng to hedge those movements can therefore increase risk.

17. Which of the following is necessary for tailing a hedge?

A. Comparing the size in units of the posi9on being hedged with the size in units of the futures
contract
B. Comparing the value of the posi9on being hedged with the value of one futures contract

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C. Comparing the futures price of the asset being hedged to its forward price
D. None of the above

Answer: B

When tailing a hedge the op9mal hedge ra9o is applied to the ra9o of the value of the
posi9on being hedged to the value of one futures contract.

18. Which of the following is true?

A. Gold producers should always hedge the price they will receive for their produc9on of gold over
the next three years
B. Gold producers should always hedge the price they will receive for their produc9on of gold over
the next one year
C. The hedging strategies of a gold producer should depend on whether it shareholders want
exposure to the price of gold
D. Gold producers can hedge by buying gold in the forward market

Answer: C

Some shareholders buy gold stocks to gain exposure to the price of gold. They do not
want the company they invest in to hedge. In prac9ce gold mining companies make their
hedging strategies clear to shareholders.

19. A silver mining company has used futures markets to hedge the price it will
receive for everything it will produce over the next 5 years. Which of the following is true?
A. It is liable to experience liquidity problems if the price of silver falls drama9cally
B. It is liable to experience liquidity problems if the price of silver rises drama9cally
C. It is liable to experience liquidity problems if the price of silver rises drama9cally or falls
drama9cally
D. The opera9on of futures markets protects it from liquidity problems

Answer: B

The mining company shorts futures. It gains on the futures when the price decreases and
loses when the price increases. It may get margin calls which lead to liquidity problems
when the price rises even though the silver in the ground is worth more.

20. A company will buy 1000 units of a certain commodity in one year. It decides to
hedge 80% of its exposure using futures contracts. The spot price and the futures price are
currently $100 and $90, respec9vely. The spot price and the futures price in one year turn
out to be $112 and $110, respec9vely. What is the average price paid for the commodity?
A. $92
B. $96

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C. $102
D. $106

Answer: B

On the 80% (hedged) part of the commodity purchase the price paid will 112−(110−90) or
$92. On the other 20% the price paid will be the spot price of $112. The weighted average
of the two prices is 0.8×92+0.2×112 or $96.

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