1.What are conversion factors? Why were conversion factors developed? How do they impact on which bond is cheapest to deliver? Under what conditions would there be no cheapest to deliver? Explain in detail. The conversion factor, for any particular bond deliverable into a futures contract is a number by which the bond future delivery settlement price is multiplied, to arrive at the delivery price for that bond. Conversion factor relates all outstanding deliverable government bonds and notes in terms of the nominal 6% bond specified in the contract. The formula to find conversion factor is as follows:

Conversion factors were developed by the CBOT in 1970's and was intended to compensate for the coupon and timing differences of …show more content…

6. Discuss the advantages and disadvantages of using futures options to hedge as compared to futures contracts. Explain in detail. (see commodity price risk management)
Advantage:
• Options give the buyers the right, but not the obligation, to exercise the option. So it is more flexible than futures contract
• Options buyer has no margin requirements; he or she just needs to pay the premium.
• Option buyer has limited loss unlike futures contract where the loss can be unlimited. The most an option buyer can lose is the premium
Disadvantage:
• Option buyer has to pay premium
• Option seller is still the possibility of facing unlimited loss and has to post margin requirements

7. What is a long only commodity fund, describe its main features. Long only commodity fund have generated returns similar to diversified equity funds. What are the components of the returns from a long only commodity fund? Are commodities a separate asset class? Discuss.

Long-Only Commodity Funds invest in a variety of futures contracts, creating a basket of commodities. By investing in futures contracts and rolling them over, the funds replicate the price performance of the underlying commodities. Long only commodity funds have historically performed with low correlation with the stock market, and hence they have gained significant attention from investors. Components of the return include:
 Physical commodity price movement –