Rivkah Carl 3/4/2012 HW Assignment #1

Questions: Question 1: You as a trader and enter a short forward contract on 100 million yen. The forward exchange rate is $0.0080 per yen. How much does the trader (you) gain or loss if the exchange rate at the end of the contract is (a) $0.0074 per yen, (b) 0.0091 per yen? Answer #1: When a trader enters a short position in a forward contract, they expect the price to fall. In this case, the trader will gain if the exchange rate is lower i.e. the dollar gets stronger versus the yen. a) At time t=0, when the trader shorts the contract on 100 million yen He receives 100 million* .0080= $ .80 million= $800,000 At time t=1, at the end of the contract the trader must buy 100 million yen He must pay 100 million* .0074= $ .74 million= $740,000 He gained $ 60,000 b) At time t=0, when the trader shorts the contract on 100 million yen He receives 100 million*.0080= $800,000 At time t=1, at the end of the contract the trader must buy 100 million yen He must pay $100 million*.0091= $910,000 He lost $110,000 Question 2: Assuming today is Feb. 16, 2010, you expect to purchase crude oil 10 million barrels for your airline company in 9 months, on Nov. 2010. The crude oil spot price is $70 per barrel and the future price in 9 months is $75 per barrel. To hedge your crude oil exposure, a) what hedging strategies are you going to use? b) How to hedge using your strategies? c) If the crude oil spot price on Nov. 2010 turns out to be $65 per barrel, how much do you gain/loss from your hedging strategy only? d) How much of your total cost (including hedging) purchasing those 10 million barrels of crude oil? Answer #2 a) The airline company will want to take a long position in hedging on crude oil contracts. This means that they will long a future, now for a contract that will end on Nov 2010. A contract size is 1000 barrels. Therefore they will buy 10,000 contracts. b) The hedge goes as follows : On Feb 2010, the company longs 10,000 Future contracts at F1 On Nov 2010, the company buys 10 million barrels of oil at the spot price S2

While at the same time closing out their position i.e. take the opposite position on the contract. So they will receive F2 on 10,000 contracts. c) If the spot price of oil on Nov 2010 turns out to be lower than the future price. Then the company has experienced a loss. They will lose $ 75-65= $10 per contract. The company will have to pay the price of oil for $75 per barrel instead of the market spot price of $65 a barrel. d) The total cost of the hedging operation will be: 10,000* $75 (10,000*65,000) = 100,000. Question 3: It is March 1. A U.S. company expects to receive 50 million Japanese yen at the end of July. Yen futures contracts on the Chicago Mercantile Exchange have delivery months of March, June, Sep. and Dec.. One contract is for the delivery of 12.5 million yen. The company therefore shorts four Sep. yen futures contracts on March 1. When the yen are received at the end of July, the company closes out its position. We suppose that the futures price on March 1 in cents per yen is 0.78 and that the spot and futures prices when the contract is closed out are 0.79 and 0.725, respectively. What did company received in dollars? Answer #3 The gain on the futures contract is .78-.725- .0550 cents per yen. The basis is .79-.7250= .065 cents per yen when the contract is closed out. The effective price in cents per yen is the final spot price plus the gain on the futures: .79+.0550= .845. Therefore, the company received 50 million yen and received 50* .00845 million dollars =.4225 million dollars or $ 422,500. Question 4: S&P 500 futures price is 1,000. Value of Portfolio is $5 million. Beta of portfolio is 1.5 a) What position in futures contracts on the S&P 500 is necessary to hedge the portfolio? b) What position is necessary to reduce the beta of the portfolio to 0.75? c) What position is necessary to increase the beta of the portfolio to 2.0? d) What position is necessary if the beta of the portfolio is 0.75? Answer #4 a) Because the index contract size is 250. And the Future Price is 1,000. Therefore you will short future contracts in order to hedge the portfolio. The optimal amount to hedge is based on the optimal ratio 1.5 (5,000,000/(250*1000))= 30. One should short 30 future contracts. b) In order to reduce the beta of the portfolio to .75. : Short 15 contracts c) In order to increase the beta of the portfolio to 2.0: Long 10 contracts d) In order to hedge a portfolio whose beta is .75: .75 (5,000,000/(250*1000))= 15 One should short 15 contracts Question 5:

Can you please explain the option strategies on the wsj.com that I listed below? Please explain clearly how the traders can make money or loss money on his/her strategies? Bets Put Expedia Above $20 By TENNILLE TRACY NEW YORKAs Expedia Inc. prepares to report quarterly earnings next week, some options traders are betting its stock will stay above $20. Several traders showed up Wednesday to sell puts in Expedia, collecting a premium on the options they sold and hoping the stock stays above the strike price attached to the contracts. Traders in this case showed interest in selling February $20 puts, collecting about 30 cents for positions that work best if Expedia shares stay above $20. The stock closed the day at $22.11, up four cents. It hasn't traded below $20 since late July. Put options convey the right to sell a stock at a fixed price, so a seller thinks the stock will stay above that price. If it doesn't, the investor has to be willing to buy the stock. So by selling Feb. $20 puts in Expedia, traders also signal a willingness to buy shares in the onlinetravel company for that price.The release of Expedia's fourth-quarter earnings is set for Feb. 11. Analysts polled by Thomson Reuters expect earnings of 28 cents a share.Elsewhere in options, the bulls managed to dominate a decent amount of activity despite a bit of weakness in the broader stock market. Reflecting an optimistic tone was trading in Zions Bancorp, Bed Bath & Beyond Inc. andSkechers USA Inc. signal a willingness to buy shares in the online-travel company for that price. Answer #5 Traders believe that stock prices will stay about $20. Therefore, they are shorting put options to receive the premium of the put from other traders at time t=0. If the price stays above $20, then the traders will make money. They will make a profit in the premium per contract that they sold. However, if the price of the stock will not rise above $20, then the traders will lose money and will not receive the premium as a gain. This contract was out the money because the stock closed at $ 22.11 that is $ 2.11 above the strike price. And therefore the trader with the long position in the put will not exercise his option and the trader with the short position will make the profit of the premium. | | | | ______________________ | / } This is their profit of the premiums when stock> 20 |______________/__|_______________________}__________ / strike price =$20 /