Series 3 — National Commodity Futures Exam — All Questions
31 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 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.
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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.
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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.
A self-regulatory organization, in the CFTC's usage, is best described as:
- a.A bank that holds segregated funds
- b.A federal agency that writes futures laws
- c.A customer committee that reviews complaints
- d.An exchange or registered futures association✓
The CFTC defines self-regulatory organizations as exchanges and registered futures associations that enforce financial and sales practice requirements for their members. The federal agency that administers the Commodity Exchange Act is the CFTC itself.
Which statement describes a warehouse receipt?
- a.A receipt for margin paid to an FCM
- b.Proof of commodity held in an approved warehouse✓
- c.A notice that a delivery month has begun
- d.A confirmation of a futures trade
A warehouse receipt is a document certifying possession of a commodity in a licensed warehouse that is recognized for delivery purposes by an exchange. It is one of the instruments used to settle a futures contract by delivery.
The futures contract that matures and becomes deliverable during the present month is called the:
- a.Deferred month
- b.Calendar month
- c.Back month
- d.Spot month✓
The spot month is the futures contract that matures and becomes deliverable during the present month. Back or deferred months are the months other than the spot or front month.
On an account statement, "equity" means:
- a.The customer's net worth reported under Rule 2-30
- b.The initial margin required for open positions
- c.The account's value if liquidated now✓
- d.Total commissions paid year to date
As used on a trading account statement, equity is the residual dollar value of the account assuming it was liquidated at current prices. Initial margin is the amount required to open positions.
The price the clearing organization uses each day to settle accounts between clearing members and to determine margin calls is the:
- a.Settlement price✓
- b.Opening price
- c.High of the day
- d.Average price
The settlement price is the daily price at which the clearing organization clears all trades and settles all accounts between clearing members; it is used to determine margin calls and delivery invoice prices.
A buyer of a cash commodity and a seller agree to exchange their futures hedges as part of the cash deal. This is also called:
- a.Against actuals✓
- b.A market-on-close trade
- c.A retender
- d.A calendar spread
An exchange for physicals is also called exchange of futures for cash, AA (against actuals), or ex-pit transactions; the opposite hedges of both parties are closed out simultaneously.