NISM Series - XVI Commodity Derivatives Cert. Mock Test -1

Explanation:

The most important of the ‘Greeks’ is the option’s “Delta”. This measures the sensitivity of the option value to a given small change in the price of the underlying asset.
Delta = Change in option premium / Unit change in price of the underlying asset

Explanation:

The initial margin must be maintained throughout the time the position is open and is refundable at the time of delivery or cash settlement on the date of expiry or if the open position is squared off – which ever is earlier.

Explanation:

Hedging means taking a position in the derivatives market that is opposite of a position in the physical market with the objective of reducing or limiting risks associated with the price changes.

Hedger enters into the derivatives contract to mitigate the risk of adverse price fluctuation in respect of his existing position.

Explanation:

Clearing and Settlement Process –

Clearing refers to the process of accounting to update and reconcile obligations/payments of the parties involved in the trade.

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

Explanation:

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

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

Explanation:

Option premium consists of two components : Intrinsic value and Time value.

Time value is the difference between the option premium and intrinsic value.

Explanation:

Vega (ν) is a measure of the sensitivity of an option price to changes in market volatility. It is the
change of an option premium for a given change (typically 1%) in the underlying volatility.

Vega = Change in an option premium / Change in volatility

(Note – Please memorise the features of all – Delta, Gamma, Rho, Theta and Vega)

Explanation:

If all other factors affecting an option’s price remain same, the time value portion of an option’s premium will decrease with the passage of time. This is also known as time decay.

The rate at which the time value of the option erodes (time decay) is not linear and the erosion speeds up as expiry date approaches. This means that the time decay is slow in the initial days buy speeds up as the expiry approaches.

Explanation:

Clearing banks play an important role in the smooth transfer of funds between the clearing members and clearing corporation to effect settlement of funds.

The clearing corporation computes and advises the clearing member’s obligation and the clearing member makes funds available in the clearing account for the pay-in and receives funds in case of a pay-out. The clearing banks communicate the status of fund flow in respect of each trading and clearing member to the clearing house to facilitate monitoring.

Explanation:

The Clearing Corporation makes a commodity pay out to the clearing member by transferring the ownership of warehouse receipt on the concerned buyer’s name.

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 6000 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) = 6000 – 2% of 6000 = 6000 – 120 = Rs. 5880

Explanation:

Exchange traded commodity markets facilitates efficient price discovery as the market brings together buyers and sellers of divergent needs in a transparent online system.

Explanation:

Trading cum Clearing Member (TCM): This category of membership entitles a member to execute trades on his own account as well as for his clients and also to clear and settle trades executed by himself as well as of his clients.

Clearing members are members of the clearing corporation. They carry out risk management activities and confirmation/inquiry of trades through the trading system.

Explanation:

On a Screen based computerised trading system, the order matching is done on a price-time priority basis. This means that all the orders received are sorted on ‘best-price’ basis

A Member is permitted to modify or cancel his orders. The order can be modified by effecting changes in the order input parameters. Time priority for an order modification will not change due to decrease in its quantity or decrease in disclosed quantity. In other circumstances, the time priority of the order will change.

Explanation:

Self Clearing Members (SCM) / Trading cum Clearing Member (TCM): This category of membership entitles a member to execute trades on his own account as well as for his clients and also to clear and settle trades executed by himself as well as of his clients.

Clearing members are members of the clearing corporation. They carry out risk management activities and
confirmation/inquiry of trades through the trading system.

Explanation:

In a Mandi, the farmers bring their produce, and the traders or middlemen known as commission agents inspect the quality and bid for the same. The buyer with the highest bid acquires the produce.

Thus mandis are physical spot markets in which the commodities are physically bought and sold by the buyers and sellers respectively for immediate delivery.

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:

If a trader is expecting a large decrease in volatility, he will try to gain from it by selling a call and a put with same expiry dates but with different strike prices. This is known as Short Strangle.

Explanation:

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

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

Explanation:

A Trading Member can trade either on their own account or on behalf of the clients. This category of membership entitles a member to execute trades on his own account as well as for clients registered with him.

Explanation:

A hedger seeks to transfer price risk by taking a futures position opposite to an existing position in the underlying commodity.

By hedging, the hedger reduces to a large extent or even eliminates the possibility of a loss from a decline in the price of the commodity. However, he has also eliminated the possibility of a gain from a price increase.

Explanation:

The option premium of an option is made up of Intrinsic Value + Time Value.

Only ‘In the Money’ options have Intrinsic Value.

In the above question, the Call Option is ‘Out of the Money’ as Market Price is lower than Strike Price. So there is no intrinsic value.

So the option premium is entirely due to Time Value.

The option premium is Rs 25 and this is the Time Value

(Note : 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)

Explanation:

A covered short call position is created by combining a long underlying position ie. holding the commodity stock with a short call option.

A covered call option attempts to enhance the return in a stagnant market and at the same time partially hedge a long underlying position.

Explanation:

Swaps are agreements between two counterparties to exchange a series of cash payments for a stated period of time. The periodic payments can be charged on fixed or floating price, depending on the terms of the contract.

Swap is a pure financial transaction that is used to lock in the long-term price and there is no physical delivery of the commodity and there is net cash settlement on maturity.

Explanation:

An E-registry maintains electronic records of ownership of goods against negotiable warehouse receipts (NWRs) and warehouse receipts (WRs) and effects transfer of ownership of such goods by electronic process.

Explanation:

A futures contract is a legally binding agreement between the buyer and the seller, entered on an exchange, to buy or sell a specified amount of an asset, at a certain time in the future, for a price that is agreed at the time of entering into the contract.

Explanation:

The term “securities” has been defined in the Section 2(h) of the Securities Contract (Regulation) Act, 1956 (SCRA).

The term ‘Securities’ include:

– Shares, scrips, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate
– Derivative
– Units or any other instrument issued by any collective investment scheme to the investors in such schemes
– Government securities etc.

Explanation:

The cost of carry determines the differential between spot and futures price and is associated with costs involved in holding the commodity till the date of delivery, it follows that the cost of carry diminishes with each passing day and the differential must narrow and on the date of delivery, the cost of carry becomes zero and the spot and futures price converge. This is known as convergence.

Explanation:

When a person buys a Put option, it means he is bearish on the commodity.

On exercise, the commodity options devolve into commodity futures in India. So, this means on exercise the long PUT option will be short position (bearish) in underlying commodity futures.

Explanation:

A bought CALL option can only be squared up by selling the same CALL option.

Explanation:

All the commodities are not suitable for futures trading. For a commodity to be suitable for futures trading, it must possess the following characteristics:
(i) The commodity should have a suitable demand and supply conditions i.e., volume and marketable surplus should be large.
(ii) Prices should be volatile to necessitate hedging through derivatives. As a result, there would be a demand for hedging facilities.
(iii) The commodity should be free from substantial control from Government regulations (or other bodies) imposing restrictions on supply, distribution and prices of the commodity.
(iv) The commodity should be homogenous or, alternately it must be possible to specify a standard, as it is necessary for the futures exchange to deal in standardized contracts.
(v) The commodity should be storable. In the absence of this condition, arbitrage would not be possible and there would be no relationship between spot and futures markets.

Explanation:

The price discovery in futures markets refers to the process of determining the futures price through expected demand and supply after discounting expected news, data releases and information on the product.

Explanation:

Mark-to-market (MTM) margin is calculated on each trading day by taking the difference between the closing price of a contract on that particular day and the price at which the trade was initiated (for new positions taken during the day) or is based on the previous day’s closing price (for carry forward positions from previous day).

When a new short position is initiated, it means the trader has sold the futures believing that prices will fall. If the prices rise and is higher than the transaction price at the end of day, there will be a Mark to Margin loss which the trader has to pay.

Explanation:

If the Seller gives delivery of .999 purity, he will get a proportionate premium and sale proceeds will be calculated as under:

Rate of delivery ie. Contract Rate X 999/ 995

If the quality is less than 995, it is rejected.

Explanation:

There are two types of option contracts —call options and put options. Call option contracts give the purchaser the right to buy a specified quantity of a commodity or financial asset at a particular price (the exercise price) on or before a certain future date (the expiration date).

Put option contracts give the buyer the right to sell a specified quantity of an asset at a particular price on or before a certain future date.

Explanation:

The put-call parity theorem explains the relationship between call/put prices and the underlying commodity price.

Explanation:

Selling a call option means the view is bearish (price to fall). Mr. A has sold a call option but the price has risen from Rs.40000 to Rs. 42000. This means there is a loss of Rs. 2000. He has however earned a premium of Rs.600.

So his net loss is Rs. 2000 – Rs. 600 = Rs. 1400

Rs 1400 is the loss for 10 grams.

So for 1 kg or 1000 grams (lot size) the loss is (1000 x 1400 / 10) = Rs 140000.

Explanation:

Basis is a measure of the difference between the spot and the futures prices.

Basis= Spot Price – Futures Price

Remember – Weakening of basis happens when basis becomes less positive or more negative.

In the above question, a change of basis from +70 Rupees to +60 Rupees is weakening of basis because the basis is becoming less positive.

Explanation:

There are two main types of commodities that trade in the spot and derivatives markets:

– Hard commodities: These are natural resources that are mined or processed such as the crude oil, gold, silver, etc.

– Soft commodities: These are the perishable agricultural products such as corn, wheat, coffee, cocoa, sugar, soybean, etc.

Explanation:

All the orders received are sorted on ‘best-price’ basis i.e., orders are first ranked according to their prices and similar priced orders are then sorted on a time-priority basis (i.e., the order that comes in early gets
priority over the later order).

For eg. if there are three BUY orders at Rs 100, Rs 101 and Rs 99, the buy order at Rs 101 will be ranked first and then Rs 100 and Rs 99 orders.

If there are two buy orders at Rs 101, then the order received first (time basis) will be ranked first.

Explanation:

If a gold futures contract is bought for Rs 50,000 per 10 grams of gold with a quality specification of .995 fineness and on the delivery date, if .999 fineness gold is delivered, the price is recalculated as follows:

Gold price = 50000 x 999/995 = Rs 50,201. The buyer will pay Rs 50,201 as against the original contract price of Rs 50,000 per 10 grams.

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:

If a trader is expecting a large decrease in volatility, he will try to gain from it by selling a call and a put with same expiry dates but with different strike prices. This is known as Short Strangle.

Explanation:

Algorithmic trading is defined as trading in financial instruments where a computer algorithm automatically determines individual parameters of orders such as initiation of order, timing, price or quantity, managing the order post submission with / without limited human intervention.

Any order that is generated using automated execution logic is known as algorithmic trading. Algorithmic trading permits the use of programs and computers to generate and execute orders in markets with electronic access and do not require human intervention.

Explanation:

If all other factors affecting an option’s price remain same, the time value portion of an option’s premium will decrease with the passage of time. This is also known as time decay and is valid for both call and put options.

The rate at which the time value of the option erodes (time decay) is not linear and the erosion speeds up as expiry date approaches. This means that time decay is slower in the initial days and speeds up as expiry approaches.

Explanation:

The difference between the Spot price and the Futures price is the Cost of Carry. The main components associated with cost of carry include finance cost (interest), storage cost and insurance

The cost of carry diminishes with each passing day and on the date of delivery, the cost of carry becomes zero and the spot and futures price converge. This is known also known as convergence.

Explanation:

When a person is selling a Put, he will receive the option premium.

If the prices rise, he gains on the option but loses on the actual commodity purchases

If the prices falls, he loses on the option but gains on the actual commodity purchases

So in both the cases he is not affected by the price rise or fall. But he will gain by the option premium he has received thus lowering his purchase price.

Explanation:

If the farmer didn’t want to deliver his soya bean, he could pass on his contractual obligation to another farmer. The price of the contract would increase or decrease depending on what was happening in the soya bean market.

Explanation:

The exchange traded commodity options in India devolves into their futures contracts.

Explanation:

In a Forwards commodity contract, the terms of the contract are decided by the buyer and the seller and there is no commodity exchange involved. So there is an inherent credit or default risk since the counter-parties of the forward transaction may fail either to deliver the commodity or to pay the agreed price at maturity.

(A futures contract is a legally binding agreement between the buyer and the seller, entered on an exchange. The exchange guarantees the delivery/payment even if the parties defaults)