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Fall 2013 FIN 327 Name: ___________________________________

Take Home Test 1 Due Date: September 23, 2013

I will not discuss answers with my classmates: _______________________________

1. Which of the following features distinguish futures markets from forwards

markets?

(a) Standardization of contracts.

(b) The use of margin accounts to manage risk.

(c) Ease in reversing positions.

(d) All of the above.

2. A replicating portfolio for a derivative security is

(a) A portfolio consisting of long and short positions in the derivative.

(b) A portfolio that has the same payoffs as the derivative.

(c) A portfolio that has payoffs at least as great as, and in some states greater than,

the payoffs from the derivative.

(d) A portfolio that combines the derivative with another derivative on the same

underlying so as to make the portfolio riskless.

3. Complete the following table.

Date Buyer Seller Contracts Open Interest

Aug 6 A B 20

Aug 8 C B 10

Aug 8 D E 5

Aug 8 A E 4

Aug 9 B C 5

Aug 10 E A 9

Aug 10 B A 10

4. You observe the following prices. Assume perfect market conditions.

Spot price of silver 7.50 dollars per ounce

1-year silver futures are trading at $10.00 per ounce

Current market interest rate is 9% per annum.

(a) Of the following two arbitrage strategies, which one will you use

i. Cash and carry arbitrage

ii. Reverse cash and carry arbitrage

(b) Depending on the strategy, you choose in (a), you will buy _____________

and sell _______________.

(c) If one futures contract is for 5000 ounces of silver, how much money will you

need to borrow? ____________________

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(d) How much money will you have to repay? __________________

(e) What will your profit be? __________________

(f) If futures silver price fell below 6 dollars you will continue use the same

strategy as you selected in (a).

i. True

ii. False

5. Copper is trading at 6.00 dollars per pound in the spot market, while a 1-year

futures contract is trading at 6.25 dollars per pound. The transaction cost on the

spot market is 2%, while the 1-year borrowing rate is 8%. Using this information

answer the following questions:

(a) The standard contract size of copper futures is: ___________________

(b) The per pounds basis is: __________________________

(c) The per contract basis is: _________________________

(d) At the maturity of the futures contract the basis will be: _______________

(e) Given the spot and futures prices, we are observing a (normal/inverted)

__________________

(f) Explain your response to the previous question

(g) Given the data, can be conclude about the prices being in contango or

backwardation? ____________________

(h) What is the difference between a market in contango and a market in

backwardation?

6. If the stock market index is at a level of 1,120 and the one-year forward on the

index is 1,210, what is the implied repo rate in continuously-compounded terms

(assuming zero dividends on the index)?

(a) 5.72%

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(b) 6.52%

(c) 7.72%

(d) 8.62%

7. Which of the following is not true (circle one)

(a) When a CBOE call option on IBM is exercised, IBM issues more stock

(b) An American option can be exercised at any time during its life

(c) An call option will always be exercised at maturity if the underlying asset

price is greater than the strike price

(d) A put option will always be exercised at maturity if the strike price is

greater than the underlying asset price.

8. A trader buys 100 European call options (i.e., one contract) with a strike price of

$20 and a time to maturity of one year. The cost of each option is $2. The price of

the underlying asset proves to be $25 in one year. What is the trader’s gain or

loss? Show a dollar amount and indicate whether it is a gain or a loss.

9. A forward contract is struck at a forward price of $40. At maturity the spot price

of the asset is $45. The short forward position earns the following payoff:

(a) $5

(b) –$5

(c) $45

(d) –$45

10. A US-based exporter anticipated receiving €100 million in six months, and took a

short forward position, locking-in an exchange rate of $1.38/€. If after six months,

at maturity, the exporter calculates that she has made a profit of $2 million from

the hedging strategy, the spot exchange rate at maturity must be

(a) $ 0.50/€.

(b) $ 1.36/€

(c) $1.40/€

(d) $ 2.00/€

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11. On June 1, you observe that an index futures contract that tracks three stocks is

trading at 100. The futures contract matures on October 15, and the three stocks

are priced as follows: Stock A = 85, Stock B = 92 and Stock C = 63. The index is

a price weighted index and the divisor is 3. You can borrow or invest at 7%

simple interest. The three stocks are scheduled to pay dividends as follows:

Stock A will pay 1.52 dollars per share on July 15

Stock B will pay 1.68 dollars per share on August 25

Stock C will pay 1.05 dollars per share on September 3.

On Oct 15, the three stocks are trading at 72, 85 and 65 respectively. Assume

360days in a year.

a. What is the value of the index on June 1? __________________

b. If you were to employ a cash and carry arbitrage what would you do on

June 1? (just explain the strategy without any calculations)

c. If you were to employ a reverse cash and carry arbitrage what would you

do on June 1? (just explain the strategy without any calculations)

d. Suppose you want to use the cash and carry arbitrage.

i. The amount you will borrow to buy the stocks is: ______________

ii. The amount you have to return to lender is: _________________

iii. The interest earned on the dividends between the time you receive

and the maturity of the futures is:

1. Stock A: ________________

2. Stock B: _______________

3. Stock C: ______________

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iv. You can use the dividends and the interest earned thereon to pay

off part of your liability. What is your net liability?

_______________

v. On October 15, you sell the three stocks.

1. What are the total sales proceeds? ____________

2. What is the profit or loss on the sale? __________

vi. What is the gain on your futures contract? ____________

vii. What is your net overall gain or loss? ______________

12. Which of the following is true (circle one)

(a) Principals are not usually exchanged in a currency swap

(b) The principal amounts usually flow in the opposite direction to interest

payments at the beginning of a currency swap and in the same direction as

interest payments at the end of the swap.

(c) The principal amounts usually flow in the same direction as interest payments

at the beginning of a currency swap and in the opposite direction to interest

payments at the end of the swap.

(d) Principals are not usually specified in a currency swap

13. Which of the following is a consumption asset (circle one)

(a) The S&P 500 index

(b) The Canadian dollar

(c) Copper

(d) IBM shares

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14. The one-year Canadian dollar forward exchange rate is quoted as 1.0500. What is

the corresponding futures quote? Give four decimal places _ _ _ _ _ _

15. Which of the following is true (circle one)

(a) Both forward and futures contracts are traded on exchanges.

(b) Forward contracts are traded on exchanges, but futures contracts are not.

(c) Futures contracts are traded on exchanges, but forward contracts are not.

16. Neither futures contracts nor forward contracts are traded on exchanges.

Which of the following is not true (circle one)

(a) Futures contracts nearly always last longer than forward contracts

(b) Futures contracts are standardized; forward contracts are not.

(c) Delivery or final cash settlement usually takes place with forward

contracts; the same is not true of futures contracts.

(d) Forward contract usually have one specified delivery date; futures contract

often have a range of delivery dates.

I did not discuss answers with my classmates: ________________________________

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