NISM Series - XVI Commodity Derivatives Cert. Mock Test -2

Explanation:

Immediate or Cancel (IOC) is an order requiring all or part of the order to be executed immediately after it has been placed. Any portion not executed immediately is automatically cancelled. Such orders will not remain in the order book.

Explanation:

Commodity options, on exercise, devolve into the underlying futures contracts. All such devolved futures positions are considered to be acquired at the strike price of exercised options, on the expiry date of options, during the EOD processing.

Explanation:

Mr. Mehta has bought a Put Option which means he is expecting the gold prices to fall (Bearish view). His view proved to be correct the prices have fallen from Rs.39000 to Rs. 37000. This means he has made a profit of Rs 2000.

Rs 2000 is for 10 grams. So for 1 kg i.e. 1000 grams, the profit is 2000 x 1000 / 10 = Rs 2,00,000. This is Gross Profit

When a person buys a Put Option, he pays a premium.

Mr. Mehta has paid a premium of Rs 250 per 10 gram. So for a lot of 1 kg ie. 1000 grams he pays a premium of 250 x 1000 / 10 = 25000

So his Net Profit will be Gross Profit less Premium paid = 200000 – 25000 = Rs. 175000

Explanation:

Black-Scholes option pricing model is used to calculate a theoretical price of options using the five key determinants of an option’s price: underlying price, strike price, volatility, time to expiration, and short-term (risk free) interest rate.

Explanation:

Comparative movement in the value of a currency of a country in relation to the major global currencies is very important for prices of commodities in that particular country. Most of the commodities globally are denominated in the US dollar (USD). Hence, when the currency of a particular country depreciates against the USD, the price of the commodity in that particular country becomes expensive and vice versa.

Explanation:

For call option which is in-the-money, intrinsic value is the excess of the assets spot price over the strike price.

For put option which is in-the-money, intrinsic value is the excess of strike price over the assets spot price.

Explanation:

To qualify for hedge accounting, the accounting standards require the hedge to be highly effective. There are separate tests to be applied prospectively and retrospectively.

Retrospective effectiveness testing is performed at each reporting date throughout the life of the hedge following a methodology set out in the hedge documentation. The objective is to demonstrate that the hedging relationship has been highly effective by showing that actual results of the hedge are within the range of 80-125%.

Explanation:

Fair Value of a Futures Contract = Spot Price ( 1 + Interest Rate / No. of times compounding)^ No. of compounding in a year X Number of years

In the above question, Spot price is Rs. 33000, Interest Rate is 12% = .12, Compounding is semi annually which means 2 times a year, Number of years = 1

Substituting –

33000 ( 1 + .12 / 2) ^ 2×1

33000 ( 1 + .06 ) ^ 2

33000 (1.06) ^ 2

On the Scientific Calculator of your computer, enter 1.06 , X^Y, 2 and you will get 1.1236

33000 x 1.1236 = 37078.80

Explanation:

Theta is a measure of an option’s sensitivity to time decay. It is the change in option price given a one-day decrease in time to expiration.

Explanation:

Volatility refers to the range to which the price of a commodity may increase or decrease.
A trader who is with short positions anticipates a decrease in volatility and are having short positions
in volatility / vega.
Similarly, Investors with Long options anticipates an increase in volatility and they are long on vega i.e., volatilities.

Explanation:

Theta is the change in option price given a one-day decrease in time to expiration. It is a measure of time decay. Theta is generally used to gain an idea of how time decay is affecting your option positions.

Explanation:

Speculation is a practice of engaging in trading to make quick profits from fluctuations in prices.

Short speculators are those who sell first and expect the price to decrease from current level.
Long speculators are those who buy first and expect the price to increase from current level.

Explanation:

Forward contracts, more often than not, were not honored by either of the contracting parties due to price changes and market conditions. A seller pulled out of the contract if the spot price was more profitable for him than the contracted price. A buyer also backed out from executing the contract on maturity if he was able to get the commodity at a cheaper price from the spot market.

Futures emerged as an alternative financial product to address these concerns of counterparty default, as the Exchange guaranteed the performance of the contract in case of the Futures.

Explanation:

Algo trading is permitted in commodity exchanges subject to the broad SEBI guidelines dated 27th Sept 2016.
High Frequency Trading (HFT) is part of algorithmic trading that comprises latency-sensitive trading strategies and deploys technology including high speed networks to connect and trade on the trading platform.

Explanation:

Trader P has purchased and Trader Q has sold Gold futures. The prices have fallen from Rs 39000 to Rs 38500. So trader P will make a loss on his long position and trader Q will make a profit on his short position.

The lot size is 1 kg i.e. 1000 grams. The price quoted is for 10 grams. The fall in price is of Rs 500

So the amount will be Rs 500 x 1000 / 10 = Rs 50000

The correct option from the above is – Trader Q made a profit of Rs 50000 on this futures position.

Explanation:

As per the Guidance Note of ICAI – When sales of the hedged inventory occur in the future, the hedging related fair value adjustment to inventory will be released to the statement of profit and loss and can be classified as part of ‘cost of goods sold’.

Explanation:

The above question implies that if the oil content in castor seed is below 47 percent but within 45 percent,
the contracted price will attract discount. For every 1 percent decrease in oil content or part thereof, there will be a discount of 2 percent or part thereof in price.

Contracted price of castor seeds i.e., Rs 9000 will be discounted by 2 percent because the quality content has decreased by 1 percent (from 47 percent to 46 percent).

Contracted price of castor seeds (at discount) = 9000 – 2% of 9000 = 9000 – 180 = Rs. 8820

Explanation:

If all the other factors remain constant but the strike price of option increases, intrinsic value of the call option will decrease and hence its value will also decrease.

For eg. The Spot price is Rs. 100 and the Strike Price is Rs 90. Here the Intrinsic value for a call option is Rs 10 ( 100 – 90)
The Intrinsic value for a Rs 95 strike price will be Rs 5. ( 100 – 95) .
So as the Strike price increase, the intrinsic value decreases for a Call option.

Explanation:

Volatility refers to the range to which the price of a commodity may increase or decrease.

Investors with Long options anticipates an increase in volatility and they are long on vega i.e., volatilities. Similarly, one who is with short positions anticipates a decrease in volatility and are having short positions in volatility / vega.

Explanation:

To qualify for hedge accounting, the accounting standards require the hedge to be highly effective. There are separate tests to be applied prospectively and retrospectively.

Retrospective effectiveness testing is performed at each reporting date throughout the life of the hedge following a methodology set out in the hedge documentation.

Explanation:

Comparative movement in the value of a currency of a country in relation to the major global currencies is very important for prices of commodities in that particular country. Most of the commodities globally are denominated in the US dollar (USD). Hence, when the currency of a particular country appreciates against the USD, the price of the commodity in that particular country becomes cheaper and vice versa.

Explanation:

In the commodity Pay in process the clearing member will transfer the warehouse receipt to the clearing corporation.

(A Warehouse Receipt is a document of title to goods issued by a warehouse service provider to a person depositing commodities in the warehouse, evidencing storage of goods.)

Explanation:

Settlement process involves matching the outstanding buy and sell instructions, by transferring the commodities ownership against funds between buyer and seller.

In other words, settlement refers to the process of adjusting financial positions of the parties to the trade transactions to reflect the net amounts due to them or due from them.

Explanation:

In a forward contract, the terms of the contract is tailored to suit the needs of the buyer and the seller. Generally, no money changes hands when the contract is first negotiated and it is settled at maturity. These forward contracts, many a times are not honored by either of the contracting parties due to price changes and market conditions. Hence, counter-party credit risk exists and settlement failure is a possibility in case of forwards contracts.

Explanation:

The Securities Contract (Regulation) Act, 1956 (SCRA) gives SEBI the jurisdiction over stock exchanges through recognition and supervision. It also gives SEBI the jurisdiction over contracts in securities and listing of securities on stock exchanges.

Explanation:

By selling gold in the forward contract, the bank has already gone short.

Now it has to hedge its position to avoid losses in case price of gold rises.

Buy buying a call option, it will protect it self against any rise in gold prices by paying the option premium

In case the prices fall, it will benefit as it has already sold gold in the forward contract. The only loss in this will be the small call option premium it has paid.

Explanation:

Volatility is the magnitude of movement in the underlying asset’s price, either up or down. It affects both call and put options in the same way.

Higher volatility = Higher premium, Lower volatility = Lower premium (for both call and put options).

Explanation:

Position Traders are the subset of speculators who maintain overnight positions, which may run into weeks or even months, in anticipation of favourable movement in the commodity futures prices.

They may hold positions in which they run huge risks and with a possibility to earn big profits if their directional call proved to be correct.

Explanation:

In a market order, the trade is executed at the immediately available current market price, prevailing at the time of placing the order.

Explanation:

In a limit order, the buyer or seller specifies the price at which the trade should be executed. For a buyer, the limit order generally remains below the on-going asking price and for a seller the limit order remains above the then bid price.

Explanation:

Reduction in interest rate increases put option price but reduces call option price.

Lower interest rate leads to lower cost of finance of paying the call option premium, so the value of call option decreases.

For put options, the opposite holds true, that is, the lower the interest rates the higher the put option price.

Explanation:

Types of hedge accounting – The Guidance Note of ICAI recognizes the following types of hedging:

– The fair value hedge accounting model is applied when hedging the risk of a fair value change of assets and liabilities already recognized in the balance sheet, or a firm commitment that is not yet recognized.

– The cash flow hedge accounting model is applied when hedging the risk of changes in highly probable future cash flows or a firm commitment in a foreign currency.

Explanation:

Strike price is the price for which the underlying security may be purchased (in case of call) or sold (in case of put) by the option holder, by exercising the option.

Explanation:

If futures price is lower than spot price of an asset, market participants may expect the spot price to come down in future. This expectedly falling market is called “Backwardation market”.

This backwardation inspite of cost-of-carry arises due to seasonality factors in commodities especially in agricultural products. For e.g. during sowing season, spot supplies are less while it increases during harvesting month which will come after around 3 months. Hence, spot prices are expected to be lower during harvesting months (i.e., 3 months later) than the present spot price (i.e., while sowing).

Explanation:

Most commodities follow a certain schedule of production cycle, which impacts the price trend. For example, in agricultural commodities, during the harvesting season, due to an increased supply, prices tend to come down, whereas during the sowing season the overall supply (availability) remains lower, which leads to an increase in prices.

Explanation:

Intrinsic Value = Market price – Strike price

= 1900 – 2000 = -100

Intrinsic value can never be negative, so it will be considered as Zero.

A Call Option is ‘In the Money’ when Market Price is greater than Strike Price. Its ‘At the Money’ when Market Price is equal to Strike Price and its ‘Out of the Money’ when Market Price is less than Strike Price.

Only an ‘In the Money’ ie. a profitable option will have an intrinsic value. Otherwise it will have only time value.

In the above question, the market price (Rs 1900) is below the Strike price (Rs 2000). So this is an Out of the Money Call Option and will have NIL intrinsic value. The option premium of Rs 200 is only the time value.

Explanation:

Weights of commodities in the index are decided by the Exchanges, based on their scoring on production value and liquidity value.

Production Value is average value of deliverable supply in the past 5 financial years. Liquidity Value is the average trading volume of its futures in the last 12 months. Deliverable supply is Production plus Import.

Explanation:

In the case of a both option, the delivery will be executed only when both buyers and sellers agree to take/give delivery. If they do not give intention for delivery, such open positions are cash settled at the Due Date Rate (DDR).

Due date rate is the rate at which contracts is settled by the exchange. Usually it is the average of spot prices (polled) in last few days of Futures contract which is defined under the contract specification of the exchange. It is also referred as final settlement price of the contract.

Explanation:

Index Futures and Index Options are cash settled and hence, delivery period margins do not apply to it. Option on Commodity Futures devolve into Commodity Futures before those futures go into staggered delivery period. Thus, delivery period margin does not apply to Options on Futures.

Explanation:

A Stop Loss order has two prices ie. Trigger Price and Limit Price.

For eg. A trader has sold a commodity at Rs 96 and wants to restrict his losses to Rs 5. For this, he will use a Stop Loss purchase order, the trigger price will be Rs 100 and the Limit price will be Rs 101. Which means if the price rises and reaches Rs 100, it will trigger the Buy Order and the commodity will be bought till Rs 101.

Thus, stop loss trigger acts as the maximum price level to buy.

Explanation:

In commodities futures, there are two types of settlement price: one is the daily settlement price (DSP) that is known as closing price and the other is the final settlement price (FSP) that is known as Due Date Rate (DDR). The daily settlement price is used to calculate the daily mark-to-market profit or loss.

The Final settlement price is the price used for “delivery default penalty” in case of non-delivery of short sell quantity. There are prescribed methodologies to arrive at delivery default penalty and working out compensation to the buyer in such cases, using FSP.

Explanation:

Volatility is the magnitude of movement in the underlying asset’s price, either up or down. It affects both the Call and Put options in the same way. Higher the volatility of the underlying stock, higher the premium.

Explanation:

Principal risk arises when the buyer/seller has not received the goods/funds but has fulfilled his obligation of making payment/delivery of goods. This is eliminated by having a central counterparty such as clearing corporation

Explanation:

Cash-and-carry arbitrage refers to buying of a physical commodity with borrowed funds and simultaneously selling the futures contract. The physical commodity is delivered upon the expiry of the contract. This opportunity arises when the futures price of the commodity is more than the sum of spot price and the cost of carrying it till the expiry date.

Explanation:

Hedge ratio indicates the number of lots/contracts that the hedger is required to buy or sell in the futures market to cover his risk exposure in the physical / spot market. It helps to neutralize the volatility difference between Spot and Futures.

Explanation:

An ‘In the Money’ (ITM) option would give holder a positive cash flow, if it were exercised immediately. ( A profitable situation)

A put option is said to be ITM when spot price is lower than strike price.

A call option is said to be ITM, when spot price is higher than strike price.

Explanation:

Futures relating to currency rates (currency futures), interest rates (bond futures) and equity prices (stock or equity index futures) are known as financial futures.

Futures on crude oil, metals like Gold, etc, agriculture products, etc are known as Commodity futures.

Explanation:

An option seller cannot demand an exercise of the option. He can only square off his position before the expiry date. Only an option buyer can exercise the option.

Explanation:

A forward contract is an agreement for the delivery of goods or the underlying asset on a specific date in the future at a price agreed on the date of the contract.

Explanation:

The Daily Price Range is 7%.

7% of Rs. 300 is Rs. 21

So the price range will be 300 – 21 and 300 + 21 = Rs. 279 to Rs.321