Series 3 — National Commodity Futures Exam — All Questions

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.Restore equity 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.Exchange for physicals
• 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 that magnifies gains and 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.Cash price minus 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 month and selling another of one 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✓

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 derivatives industry's self-regulatory organization✓
• 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.

A report of drought in a major growing region reaches the market, and corn futures rise within minutes as traders buy and sell on the news. This illustrates:

• a.Convergence
• b.Arbitrage
• c.Marking to market
• d.Price discovery✓

Price discovery is the process of determining a commodity's price level through the interaction of buyers and sellers, based on supply and demand conditions; a drought report changes expected supply. Marking to market calculates each position's gain or loss at the end of each trading session; it records price changes after they happen rather than forming the price.

A trader who is long 10 June hog futures sells 10 August hog futures. The trader now has:

• a.A spread: long June, short August✓
• b.No open position
• c.A short position of 10 June contracts
• d.A long position of 20 contracts

Offset requires selling an equal number of contracts of the same delivery month. Selling a different month leaves the June longs open and adds an August short — a spread between two delivery months.

Closing out a long futures position by selling is commonly called:

• a.Assignment
• b.Delivery
• c.Liquidation✓
• d.Covering

The CFTC defines liquidation as the closing out of a long position and notes that closing out a short position is more often called covering.

In futures markets, the clearing organization protects traders mainly by:

• a.Choosing which trades may be offset
• b.Lending customers their margin
• c.Guaranteeing performance on cleared contracts✓
• d.Setting the price of every trade

Futures contracts executed on a designated contract market are guaranteed against default by the clearing organization, while forward contracts leave each party exposed to the other's default. Prices come from buyers and sellers, and margin is not a loan.

A non-clearing FCM's customer trades must be settled through:

• a.NFA
• b.The customer's bank
• c.The exchange's floor brokers
• d.A clearing member✓

All trades of a non-clearing member must be processed and eventually settled through a clearing member of the clearing organization.

The grade of a commodity that serves as the standard for a futures contract is called the:

• a.Premium grade
• b.Invoice grade
• c.Spot grade
• d.Basis grade✓

The basis grade is the grade of a commodity used as the standard or par grade of a futures contract. Better or worse grades may be deliverable at a premium or discount to it.

A contract permits delivery of a lower grade than par at a stated discount. If the short delivers that lower grade, the long pays:

• a.The settlement price minus the discount✓
• b.Nothing, because lower grades cannot be delivered
• c.The settlement price plus the discount
• d.The settlement price with no adjustment

A discount is the amount a price is reduced to purchase a commodity of lesser grade, and par is the benchmark for such adjustments. Adding the adjustment is the rule for a better grade, which carries a premium.

Which cost is NOT part of carrying charges as the CFTC defines them?

• a.Insurance
• b.Interest
• c.Commissions✓
• d.Storage

Carrying charges are the costs of storing a commodity or holding an instrument over time — insurance, storage and interest, plus incidental costs. A commission is the FCM's charge for buying and selling futures, not a cost of carrying the commodity.

A futures market in which prices in each more distant month are progressively lower is in:

• a.Contango
• b.Backwardation✓
• c.A normal market
• d.Full carry

Backwardation is a market situation in which futures prices are progressively lower in the distant delivery months; contango is the opposite.

What is the main economic function that speculators serve in futures markets?

• a.They guarantee contract performance
• b.They set daily price limits
• c.They assume price risk that hedgers transfer✓
• d.They store the physical commodity

A speculator trades to profit from anticipating price movements and does not hedge, while a hedger offsets cash-market price risk; futures are used to assume or shift price risk. Guaranteeing performance is the clearing organization's role.

A trader opens and closes all positions within the same trading session. The trader is a:

• a.Hedger
• b.Position trader
• c.Day trader✓
• d.Floor broker

A day trader takes positions and offsets them during the same trading session, before the close. A position trader holds for an extended period.

A market in which large orders can be executed with minimal effect on price is described as:

• a.Locked
• b.Inverted
• c.Liquid✓
• d.Volatile

A liquid market is one in which buying and selling can be accomplished with minimal effect on price. Volatility measures the rate of price change, a different idea.

The market for immediate delivery of and payment for a commodity is the:

• a.Spot market✓
• b.Deferred market
• c.Futures market
• d.Forward market

The CFTC defines spot as the market of immediate delivery of and payment for the product. Forward and futures markets set terms for later delivery.

Which statement about the mandatory futures risk disclosure is correct?

• a.It is required only for options accounts
• b.It may be given after the first trade
• c.It warns that losses can exceed the funds deposited✓
• d.It promises that losses cannot exceed the margin deposit

The risk disclosure warns that a customer may sustain a total loss of funds deposited and may incur losses beyond these amounts, and it must be furnished before the account is opened.

A futures contract is 1,000 barrels and a trader's initial margin is $6,000. The contract price is $80 per barrel. The margin is what percentage of the contract value?

• a.75 percent
• b.12.5 percent
• c.0.75 percent
• d.7.5 percent✓

The contract value is $80 × 1,000 = $80,000, and $6,000 ÷ $80,000 = 7.5 percent. Controlling a large dollar amount with comparatively little capital is leverage.

Which person is an associated person (AP)?

• a.A clerk who only files order tickets
• b.An exchange employee who maintains the trading system
• c.A customer who trades her own account
• d.A salesperson soliciting customer orders for an FCM✓

An AP is an individual who solicits or accepts orders, other than in a clerical capacity, or supervises anyone who does, on behalf of an FCM, IB, CTA or CPO. Purely clerical work does not make someone an AP.

A firm that operates an investment fund that trades futures for many participants who share profits and losses pro rata is a:

• a.Futures commission merchant
• b.Introducing broker
• c.Commodity trading advisor
• d.Commodity pool operator✓

A commodity pool operator solicits or accepts funds for the purpose of trading futures or commodity options, and a commodity pool is an enterprise in which participants typically share profits and losses pro rata.

A newsletter writer who, for a subscription fee, regularly recommends specific futures trades is acting as a:

• a.Commodity pool operator
• b.Commodity trading advisor✓
• c.Futures commission merchant
• d.Floor trader

A CTA is a person who, for pay, regularly advises others on the value or advisability of trading futures or options, or issues analyses or reports about them. The subscription fee is the pay.