Hide

out of6

Exam 4 December 2019, answers

Course:

Derivative Securities (025620 )

SAMPLE MID-SEMESTER EXAM QUESTIONS PART I (10 multiple choice questions x 2 mark each = 20
marks) Question 1 Which of the following is NOT true? (a) Cross hedging refers to the situation where
the asset underlying the futures contract is not the same as the asset whose price is being hedged. (b)
When the commodity futures prices trade lower than the commodity spot prices then the convenience
yield of the commodity is relatively high. (c) When long-term interest rates increase more than short-
term interest rates then the loss on the bond portfolio is more than the gains made on the short futures
position used to hedge the bond portfolio. (d) The effective price received in a short hedge is equal to
the futures price at hedge initiation plus the basis when the hedge is closed out. (e) Hedging an equity
portfolio with index futures contracts creates a position that grows approximately at the risk-free rate.
Question 2 An investor has just entered into three short oil futures contracts traded on the NYME and
the futures price is $87.30 per barrel. The size of each contract is 1000 barrels. The initial margin is
$9,000 and the maintenance margin is $6,500 per contract. Which of the following futures prices
represents the smallest change that will lead to a margin call? (a) $79.80 (b) $84.80 (c) $87.30 (d)
$89.80 (e) $94.80 Margin call when $9,000-$6,500 = $2,500 loss per contract is made in the margin
account; Given that a short position is held this will happen when the futures price increases by
($2,500 / 1,000) $2.50 per ounce, from $87.30 to $89.80. Question 3 The three-month LIBOR interest
rate is 4.7% per annum with actual/365 and continuous compounding. The estimated three-month
Eurodollar futures price quote is approximately (accurate to 2 decimal places) (a) 95.21 (b) 95.26 (c)
95.27 (d) 95.30 (e) 95.33 If Q is the Eurodollar futures quote, then 100-Q is the three-month LIBOR
rate with quarterly compounding and an actual/360 day count convention. Thus Q = 100 – LIBOR The
LIBOR rate is 4.7 x 360/365 = 4.6356 % on an actual/360 basis continuously compounded. With quarterly
compounding will be Thus Q = 100 – LIBOR = 100 – 4.6626 ~ 95.33 Question 4 A company has a $14
million portfolio with an average estimated beta of 1.30. The S&P500 index is currently standing at 1128
and the index futures price for a contract maturing in six months is trading at 1081. Futures contracts for
$250 times the index can be traded. What trades are necessary to eliminate exposure to the general
level of the market over the next four months? (a) Take a short position in 65 six-month futures contracts
and close out the position in six months (b) Take a long position in 65 six-month futures contracts and
close out the position in four months (c) Take a short position in 67 six-month futures contracts and close
out the position in four months (d) Take a long position in 67 six-month futures contracts and close out
the position in four months (e) Take a short position in 52 six-month futures contracts and close out the
position in four months To eliminate the exposure over the next four months, a short position in
0.04635641 4 1 4.6626%CRmmR me e= −= −= 

2 14,000,0001.30 67.35 671081 $250PNFβ= = = ≈× 6-month index futures contracts is required and to
close out the position in four months. Question 5 A company has a two-month $60 million floating loan
with interest paid monthly at the one-month LIBOR plus 0.8%. The company’s treasurer wants to hedge
the company’s exposure to interest rate risk and he considers the use of Eurodollar futures. The current
one-month LIBOR is 3.45% and the Eurodollar futures price is quoted at 97.525. The treasurer should:
(a) Take a long position in 20 Eurodollar futures contracts (b) Take a short position in 20 Eurodollar
futures contracts (c) Take a long position in 40 Eurodollar futures contracts (d) Take a short position in
40 Eurodollar futures contracts (e) Take a long position in 181 Eurodollar futures contracts Value of the
Eurodollar futures contract 10,000[100 0.25(100 )] 10,000[100 0.25(100 97.525)] 993,812.50Q−−= −−=
To eliminate the exposure to the interest to be paid in the second month, a short position in
160,000,0001220.1245 203993,812.5012PFPDNFD×= = = ≈× Eurodollar futures contracts is required
Question 6 Company A can borrow at 8% fixed for five years or at a floating rate of 6-month LIBOR plus
0.4%. Company B can borrow at 9% fixed for five years or at a floating rate of six month LIBOR plus 0.6%.
Assume company A wants to borrow at floating rate and company B wants to borrow at fixed rate. What
are the effective borrowing rates for both companies under a swap which earns 30 basis points for the
arranging institution and is equally attractive for both companies? (a) LIBOR for company A and 8.6% for
company B (b) LIBOR + 0.15% for company A and 8.75% for company B (c) LIBOR + 0.15% for company A
and 8.6% for company B (d) LIBOR for company A and 8.75% for company B (e) None of the above.
Question 7 The S&P 500 index is standing at 1127 and the futures price for an index futures contract
deliverable in three months is 1131. The current risk-free rate is 5% per annum with continuous
compounding and the dividend yield on the S&P 500 index is 2% per annum with continuous
compounding. An arbitrageur could lock in arbitrage profit by (a) Short selling the index and entering a
long position in index futures (b) Short selling the index and entering a short position in index futures
(c) Borrow to buy the index and entering a long position in index futures (d) Borrow to buy the index
and entering a short position in index futures (e) Arbitrage is not available Ft = St e(r-q)(T-t) = 1127
e(0.05-0.02) 3/12 = 1135.48 > Fmarket = 1131 The index futures contract is under priced relatively to
the underlying asset thus Long the futures contract and short sell the shares underlying the index.
Question 8 The current spot price of crude oil is $81.24 per barrel and the ten-month crude oil futures
price is $74.65 per barrel. The proportional storage cost of crude oil is 1.4% per annum with continuous
compounding. The interest rate is 4.7% per annum for all maturities with continuous compounding. The
current cost of carry and the convenience yield are respectively (a) 3.30% and 0% (b) 3.30% and 13.45%
(c) 6.10% and 0%