Fall 2013 FIN 327 Take Home Test 1

Name: ___________________________________ Due Date: September 23, 2013

I will not discuss answers with my classmates: _______________________________

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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 Aug 6 A Aug 8 C Aug 8 D Aug 8 A Aug 9 B Aug 10 E Aug 10 B

B B E E C A A

Contracts 20 10 5 4 5 9 10

Open Interest

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? ____________________

(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% 2

(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 traders 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/

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: ______________

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 5

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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