'Solution of Week6\r'

' chore 1. 7. deem that you write a entrap adopt with a strike toll of $40 and an expiration date in triad months. The current stock expenditure is $41 and the puzzle is on deoxycytidine monophosphate make dos. What scram you committed yourself to? How much could you pass or lose? You have lot a put pick. You have agree to steal 100 sh bes for $40 per share if the party on the other status of the contract chooses to exercise the right to sell for this cost. The excerption entrust be exercised un slight when the outlay of stock is be confused $40. Suppose, for example, that the option is exercised when the cost is $30.You have to buy at $40 shares that are worth $30; you lose $10 per share, or $1,000 in impart. If the option is exercised when the hurt is $20, you lose $20 per share, or $2,000 in total. The worst that raft turn over is that the charge of the stock declines to or so zero during the three-month period. This highly supposed(prenominal) shell would cost you $4,000. In return for the practical future terminationes, you receive the determine of the option from the grease ones palmsr. trouble 1. 21. â€Å"Options and futures are zero- integrality games. ” What do you re procure is meant by this statement?The statement marrow that the gain (loss) to the party with the compendious strength is equal to the loss (gain) to the party with the yearn position. In aggregate, the net gain to all(prenominal) parties is zero. chore 1. 30 The price of funds is currently $1,000 per ounce. The turn up front price for auction pitch in one year is $1,200. An arb basin borrow cash at 10% per annum. What should the arbitrageur do? subject on that the cost of storing metallic is zero and that currency provides no income. The arbitrageur should borrow money to buy a certain heel of ounces of gold today and curt frontwards contracts on the same number of ounces of gold for delivery in one year.This mean that g old is purchased for $1000 per ounce and sell for $1200 per ounce. Assuming the cost of borrowed funds is less than 20% per annum this generates a fortuneless derive. Problem 2. 3. Suppose that you enter into a go around futures contract to sell July silver for $17. 20 per ounce. The size of the contract is 5,000 ounces. The initial allowance is $4,000, and the sustenance gross profit is $3,000. What shift in the futures price leave behind draw to a bank augur? What passs if you do non see to it the circumference call? in that location go away be a shore call when $1,000 has been woolly-headed from the brink chronicle.This will occur when the price of silver increases by 1,000/5,000 ? $0. 20. The price of silver must so rise to $17. 40 per ounce for at that place to be a margin call. If the margin call is non met, your broker closes out your position. Problem 2. 10. let off how margins protect investors against the mishap of inattention. A margin is a sum of money deposited by an investor with his or her broker. It acts as a guarantee that the investor domiciliate top side any losses on the futures contract. The sense of equilibrium in the margin account is familiarised daily to reflect gains and losses on the futures contract.If losses are above a certain level, the investor is required to deposit a further margin. This system makes it un presumable that the investor will default. A similar system of margins makes it un promising that the investor’s broker will default on the contract it has with the change category member and unlikely that the clearing kinsperson member will default with the clearing house. Problem 2. 11. A trader buys twain July futures contracts on frozen orange tree juice. individually contract is for the delivery of 15,000 pounds. The current futures price is 160 cents per pound, the initial margin is $6,000 per contract, and the maintenance margin is $4,500 per contract.What price change would learn to a margin call? on a lower floor what circumstances could $2,000 be withdrawn from the margin account? There is a margin call if to a greater extent than $1,500 is lost on one contract. This happens if the futures price of frozen orange juice travel by more than 10 cents to below 150 cents per pound. $2,000 give the axe be withdrawn from the margin account if there is a gain on one contract of $1,000. This will happen if the futures price rises by 6. 67 cents to 166. 67 cents per pound. Problem 2. 21. What do you think would happen if an qualify started trading a contract in which the feel of the rudimentary plus was incompletely specified?The contract would non be a success. Parties with laconic positions would triumph their contracts until delivery and indeed deliver the cheapest random variable of the summation. This baron well be viewed by the party with the keen-sighted position as garbage! Once news of the quality problem became widely known no one woul d be prepared to buy the contract. This shows that futures contracts are feasible only when there are rigorous standards within an constancy for delimit the quality of the asset. Many futures contracts have in practice failed because of the problem of defining quality. Problem 2. 6 dealer A enters into futures contracts to buy 1 million euros for 1. 4 million dollars in three months. Trader B enters in a forward contract to do the same thing. The exchange (dollars per euro) declines sharply during the first two months and then increases for the third month to close at 1. 4300. Ignoring daily resolving power, what is the total profit of severally trader? When the impact of daily settlement is taken into account, which trader does discover? The total profit of each trader in dollars is 0. 03? 1,000,000 = 30,000. Trader B’s profit is completed at the end of the three months.Trader A’s profit is realized day-by-day during the three months. Substantial losses are mad e during the first two months and lettuce are made during the final month. It is likely that Trader B has done purify because Trader A had to finance its losses during the first two months. Problem 2. 29. A caller-out enters into a short futures contract to sell 5,000 bushels of wheat for 450 cents per bushel. The initial margin is $3,000 and the maintenance margin is $2,000. What price change would lead to a margin call? Under what circumstances could $1,500 be withdrawn from the margin account?There is a margin call if $1000 is lost on the contract. This will happen if the price of wheat futures rises by 20 cents from 450 cents to 470 cents per bushel. $1500 can be withdrawn if the futures price falls by 30 cents to 420 cents per bushel. Problem 2. 30. Suppose that there are no shop costs for crude oil and the liaison rate for borrowing or bestow is 5% per annum. How could you make money on May 26, 2010 by trading July 2010 and declination 2010 contracts on crude oil? des ign Table 2. 2. The July 2010 settlement price for oil is $71. 51 per brake drum. The declination 2010 settlement price for oil is $75. 3 per barrel. You could go long one July 2010 oil contract and short one declination 2010 contract. In July 2010 you take delivery of the oil borrowing $71. 51 per barrel at 5% to meet cash outflows. The interest accumulated in five months is about 71. 51? 0. 05? 5/12 or $1. 49. In December the oil is sold for $75. 23 per barrel which is more than the amount that has to be repaid on the loan. The strategy therefore leads to a profit. line of descent that this profit is independent of the actual price of oil in June 2010 or December 2010. It will be slightly stirred by the daily settlement procedures. Problem 3. 1.Under what circumstances are (a) a short outwit and (b) a long hem in appropriate? A short beat is appropriate when a caller-up owns an asset and expects to sell that asset in the future. It can as well be used when the follow do es not currently own the asset but expects to do so at some time in the future. A long prorogue is appropriate when a company knows it will have to purchase an asset in the future. It can also be used to offset the fortune of infection from an existing short position. Problem 3. 3. Explain what is meant by a complete(a) hedge. Does a perfect hedge always lead to a better outcome than an watery hedge?Explain your answer. A perfect hedge is one that completely eliminates the tergiversator’s risk. A perfect hedge does not always lead to a better outcome than an imperfect hedge. It alone leads to a more certain outcome. watch a company that hedges its photo to the price of an asset. Suppose the asset’s price movements prove to be favorable to the company. A perfect hedge totally neutralizes the company’s gain from these favorable price movements. An imperfect hedge, which only partially neutralizes the gains, might well give a better outcome. Problem 3. 5.Giv e three reasons why the financial officer of a company might not hedge the company’s exposure to a particular risk. Explain your answer. (a) If the company’s competitors are not hedging, the financial officer might feel that the company will experience less risk if it does not hedge. (See Table 3. 1. ) (b) The shareholders might not requirement the company to hedge because the risks are weasel-worded within their portfolios. (c) If there is a loss on the hedge and a gain from the company’s exposure to the underlying asset, the treasurer might feel that he or she will have worry justifying the hedging to other executives within the organization.Problem 3. 17. A gamboge granger argues â€Å"I do not use futures contracts for hedging. My real risk is not the price of corn. It is that my whole line up gets wiped out by the survive. ”Discuss this viewpoint. Should the farmer estimate his or her expect toil of corn and hedge to try to lace in a price for expected business? If weather creates a epochal uncertainty about the volume of corn that will be harvest-festivaled, the farmer should not enter into short forward contracts to hedge the price risk on his or her expected fruit. The reason is as follows.Suppose that the weather is bad and the farmer’s production is lower than expected. Other farmers are likely to have been affected similarly. Corn production overall will be low and as a consequence the price of corn will be comparatively high. The farmer’s problems arising from the bad harvest will be made worse by losses on the short futures position. This problem emphasizes the importance of looking at the big picture when hedging. The farmer is tame to question whether hedging price risk while ignoring other risks is a dear strategy.\r\n'