Series 3 — National Commodity Futures Exam — All Questions
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In a standardized exchange-traded futures contract, which term is NOT set in advance by the exchange?
- a.The quantity of the commodity per contract
- b.The acceptable grade or quality of the commodity
- c.The price at which the trade is executed✓
- d.The delivery months available for trading
The exchange standardizes quantity, grade, delivery months, and delivery terms so contracts are fungible. Price is the one term left to the open auction market, negotiated between buyer and seller each time a trade occurs.
A customer's futures account equity falls below the maintenance margin level. What must the customer generally do?
- a.Deposit only enough to reach the maintenance level again
- b.Deposit funds to restore the account to the initial margin level✓
- c.Nothing, because losses are covered by the clearinghouse
- d.Liquidate the position within five business days
Once equity drops below maintenance margin, a margin call requires the customer to bring the account back up to the full initial margin level, not merely to the maintenance level. Restoring only to maintenance is a common distractor.
Futures margin is best described as:
- a.A good-faith performance bond ensuring the customer can meet obligations✓
- b.A partial down payment toward the purchase price of the commodity
- c.A loan from the broker that accrues interest
- d.A non-refundable fee paid to the exchange
Unlike securities margin, futures margin is a performance bond, not a loan or a down payment. It guarantees the trader can meet daily settlement obligations and is returned when the position is closed if no losses have consumed it.
The process by which the clearinghouse credits gains and debits losses to open futures positions each day is called:
- a.Conversion
- b.Offsetting
- c.Assignment
- d.Marking to market✓
Marking to market is the daily settlement process: every open position is revalued at the day's settlement price and the resulting gain or loss is posted to the account. This is why maintenance margin calls can occur daily.
A speculator who is long one futures contract will profit if:
- a.The futures price declines
- b.The futures price rises✓
- c.The basis weakens
- d.Volatility falls to zero
A long position agrees to buy, so it gains when the futures price rises above the entry price and loses when it falls. A short position profits from a price decline.
A customer wants to buy a futures contract but will not pay more than a specified price. The correct order to enter is a:
- a.Market order
- b.Stop order
- c.Buy limit order✓
- d.Market-if-touched sell order
A buy limit order sets a maximum acceptable price and executes only at that price or lower. A market order takes whatever price is available, and a stop order is used to trigger action once a price is reached, typically to limit a loss.
Because futures margin is only a small fraction of a contract's notional value, futures positions are characterized by:
- a.High leverage, so small price moves cause large percentage gains or losses✓
- b.Low leverage, so returns closely track the underlying cash market
- c.No leverage, because the full contract value is deposited
- d.Negative leverage in falling markets only
A small margin deposit controls a large contract value, producing high leverage. This magnifies both gains and losses as a percentage of the margin posted, which is central to the risk of futures trading.
A wheat farmer expecting to harvest and sell grain in three months is worried that prices will fall. The appropriate hedge is to:
- a.Buy wheat futures (a long hedge)
- b.Sell wheat futures (a short hedge)✓
- c.Buy wheat call options only
- d.Take no position because the farmer owns the physical wheat
A producer who owns or will own the physical commodity and fears falling prices sells futures, establishing a short hedge. A decline in the cash price is then offset by a gain on the short futures position.
Basis is defined as:
- a.The local cash (spot) price minus the futures price✓
- b.The futures price minus the strike price
- c.The initial margin minus the maintenance margin
- d.The difference between two option premiums
Basis equals the cash price minus the futures price for a given location and delivery month. Hedging converts price risk into basis risk, and cash and futures prices converge as delivery nears.
A cereal manufacturer that will need to buy corn in six months and fears rising prices should establish a:
- a.Short hedge by selling corn futures
- b.Calendar spread by selling the near month
- c.Long hedge by buying corn futures✓
- d.Naked short call position
A user or future buyer of a commodity who fears rising prices buys futures, creating a long hedge. A later rise in the cash purchase price is offset by a gain on the long futures.
An intramarket (calendar) spread in futures involves:
- a.Buying a call and selling a put on the same contract
- b.Buying the same commodity on two different exchanges
- c.Buying two unrelated commodities
- d.Buying one delivery month and selling a different delivery month of the same commodity✓
A calendar or intramarket spread buys one delivery month and sells another of the same commodity, profiting from a change in the price difference between the two months. Because the legs move together, spreads typically carry lower risk than outright positions.
The buyer of a call option on a futures contract has the right to:
- a.Go long the underlying futures at the strike price✓
- b.Go short the underlying futures at the strike price
- c.Require the writer to deliver the physical commodity immediately
- d.Collect the premium from the writer
A call gives its buyer the right to buy, meaning to establish a long futures position at the strike price. A put gives the right to go short. The premium flows from the buyer to the writer, not the reverse.
What is the maximum loss for the buyer of a put option on futures?
- a.Unlimited
- b.The premium paid for the option✓
- c.The strike price times the contract size
- d.The initial margin on the underlying futures
An option buyer can never lose more than the premium paid, regardless of how the market moves. This defined, limited risk is a key reason hedgers and speculators buy options instead of trading futures outright.
A call option on futures with a strike price of 50 is trading while the underlying futures price is 56. The option is:
- a.Out of the money by 6
- b.At the money
- c.In the money by 6✓
- d.Worthless because it has no time value
A call is in the money when the futures price is above the strike. Here 56 minus 50 gives 6 points of intrinsic value, so the call is in the money by 6. Any premium above 6 would be time value.
An analyst who forecasts commodity prices by studying crop weather, inventory reports, and industrial demand is primarily using:
- a.Technical analysis
- b.Fundamental analysis✓
- c.Chart pattern analysis
- d.Moving-average analysis
Fundamental analysis studies the real supply-and-demand forces behind a commodity, such as weather, stocks, and usage, to judge whether prices are too high or too low. Technical methods instead study price charts.
Which tool is characteristic of technical analysis rather than fundamental analysis?
- a.USDA crop production reports
- b.Interest-rate forecasts
- c.Industrial consumption data
- d.Support and resistance levels on a price chart✓
Support and resistance levels are drawn from past price behavior and are hallmarks of technical analysis. Crop reports, rate forecasts, and consumption data are fundamental inputs that describe supply and demand.
Which entity is the federal agency that administers the Commodity Exchange Act and oversees the U.S. futures markets?
- a.The Securities and Exchange Commission (SEC)
- b.The Commodity Futures Trading Commission (CFTC)✓
- c.The National Futures Association (NFA)
- d.The Federal Reserve Board
The CFTC is the independent federal regulator that administers the Commodity Exchange Act and polices the futures markets for fraud and manipulation. The SEC regulates securities, and the NFA is the industry self-regulatory organization.
The National Futures Association (NFA) is best described as:
- a.The industrywide self-regulatory organization for the U.S. derivatives industry✓
- b.A federal government agency created by Congress
- c.A clearinghouse that guarantees every futures trade
- d.A commodity exchange where contracts are listed
The NFA is the self-regulatory organization (SRO) whose members include FCMs, IBs, CPOs, CTAs, and their associated persons. It is not a government agency, a clearinghouse, or an exchange.
A firm that solicits and accepts customer orders and holds customer funds must register as a:
- a.Commodity Trading Advisor (CTA)
- b.Introducing Broker (IB)
- c.Futures Commission Merchant (FCM)✓
- d.Commodity Pool Operator (CPO)
An FCM carries customer accounts and holds customer money. An IB solicits business but does not hold funds, a CTA gives advice, and a CPO operates a pooled investment vehicle.
Speculative position limits set by the CFTC and exchanges are designed primarily to:
- a.Guarantee profits for bona fide hedgers
- b.Prevent excessive speculation and market manipulation✓
- c.Force all speculators to take physical delivery
- d.Eliminate basis risk for hedgers
Position limits cap the number of contracts a speculator may hold to curb excessive speculation and manipulation. Bona fide hedgers can apply for exemptions from these limits because they are offsetting real commercial risk.
Before a non-institutional customer may begin trading futures, the firm must ensure the customer has received:
- a.The standardized risk disclosure statement describing the risk of loss✓
- b.A guarantee that losses will not exceed the initial margin
- c.A prospectus filed with the SEC
- d.Written approval from the CFTC for that customer
Firms must deliver the standardized risk disclosure document, which explains that futures trading carries a substantial risk of loss, before opening the account. There is no guarantee against loss and no SEC prospectus for futures.
Under anti-money-laundering rules, a futures firm that detects a transaction with no apparent lawful purpose is generally required to file a:
- a.Form 8-K with the SEC
- b.Risk disclosure statement
- c.Registration statement with the NFA
- d.Suspicious Activity Report (SAR)✓
Under the Bank Secrecy Act and USA PATRIOT Act, firms must maintain an AML program and file Suspicious Activity Reports (SARs) for qualifying suspicious transactions, along with a customer identification program and ongoing monitoring.