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BM/OCT 2006/FIN651/630

UNIVERSITI TEKNOLOGI MARA FINAL EXAMINATION

COURSE COURSE CODE EXAMINATION TIME

: : : :

MALAYSIAN FUTURES & OPTIONS FIN651/630 OCTOBER 2006 3 HOURS

INSTRUCTIONS TO CANDIDATES 1. 2. 3. 4. This question paper consists of five (5) questions. Answer ALL questions in the Answer Booklet. Start each answer on a new page. Do not bring any material into the examination room unless permission is given by the invigilator. Please check to make sure that this examination pack consists of: i) ii) the Question Paper an Answer Booklet - provided by the Faculty

DO NOT TURN THIS PAGE UNTIL YOU ARE TOLD TO DO SO

This examination paper consists of 5 printed pages
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BM/OCT 2006/F IN 651/630

QUESTION 1

Suppose on August 16, 2006 you are the portfolio manager of a RM75 million stock fund. You anticipate a downturn in the market between now and September, but remain bullish for the long term. However, you also know that a declining portfolio value would look bad in the end-of-year report that your fund will provide to its investors. The following information is available: Current market data (as at August, 2006) KLSE Composite index : 984.5 Contract month August 2006 September 2006 December 2006 March 2007 Futures Prices 988.0 985.5 988.5 990.5

Current market data (as at September, 2006) KLSE Composite index : 975.5 Contract month September 2006 October 2006 December 2006 March 2007 Futures Prices 980.5 985.0 990.0 995.5

a)

Describe the strategy that you would use to minimize the expected loss in September. (3 marks)

b)

Based on the information above, calculate and comment on the results of the hedging strategy that you have taken. (15 marks)

c)

Differentiate between intracommodity spreads and intercommodity spreads. (2 marks)

Hak Cipta Universiti Teknologi MARA

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BM/OCT 2006/FIN651/630

QUESTION 2 Consider the following situations: Today, November 2006, a trader believes that due to market volatility, there may be an opportunity for arbitrage between the KLIBOR futures market and the physical KLIBOR market. Current market data are as follows: December KLIBOR futures: 3.35% (96.65) 30 day KLIBOR rate: 2.55% 120 day KLIBOR rate: In December 2006 : 3.50% December KLIBOR futures converge with physical rate at 3.45%.

Assume that you can borrow or lend RM1,000,000. a) b) Explain how the dealer is able to determine whether an arbitrage exists. (5 marks) Outline the transactions that the trade must undertake to complete the arbitrage and calculate the resulting profit or loss. (12 marks) Under what circumstances would the three-month KLIBOR futures move away from its fair value? (3 marks)

c)

QUESTION 3 Expiry September 2006 September 2006 September 2006 September 2006
Type Put Put

Call Call

Exercise Price 900 950 900 950

Premium 21.0 45.0 56.0 30.0

a)

Construct an expiry profit diagram for a short strangle in the KLSE Composite Index market using the relevant information from the table above. Show the breakeven point(s), maximum or minimum profit/loss from such strategy. (12 marks) What would be the trader's expectation of the futures prices if he were to enter into the short strangle, assuming the market is currently at 935? (3 marks)

b)

c)

Distinguish between the time value and the intrinsic value of an option. Explain when an option is in-the-money and out-of-money? (5 marks)
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Hak Cipta Universiti Teknologi MARA

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BM/OCT 2006/FIN 651/630

QUESTION 4 a) What is meant by the term basis and how does a basis differs between normal and backwardation futures markets? (5 marks) Consider the settlement prices for Crude Palm Kernel Oil Futures. Delivery Month JulO6 AugO6 Sept 06 Oct06 Nov06 Dec 06 FebO7 Open 2149 2148 2150 2157 2155 2160 2162 High 2152 2156 2157 2162 2163 2168 2169 Low 2148 2146 2146 2151 2150 2159 2160 Settlement price 2150 2154 2155 2158 2160 2162 2166

b)

On the cash market, the underlying Crude Palm Kernel Oil was at RM2146 per MT. i) Compute the basis for each of the futures contracts. (7 marks) ii) Based on your results in part b (i), is this a normal market or a backwardation market? Why? (3 marks)

c)

Spreading is less risky than taking an outright position. Comment on this statement. (5 marks)

Hak Cipta Universiti Teknologi MARA

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BM/OCT 2006/FIN651/630

QUESTION 5 a) A spread trader is bearish about the current 5-year MGS futures market and would like to make a profit from such situation. The quotations of the MGS futures on August 6, 2006 is as follows: September FMG5 contract December FMG5 contract 113.12 113.05

i)

What is the type of spread that the trader is taking? (2 marks)

ii)

Outline the strategy that the spreader would take to benefit from the current market situation. (2 marks) Determine the profit or loss that the spreader would make based on strategy (ii), if the following information is given on September 3, 2006: September FMG5 contract December FMG5 contract 112.55 112.26 (10 marks)

iii)

b)

Briefly explain three (3) market players of the Malaysian Government Securities futures. (6 marks)

END OF QUESTION PAPER

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