FIN 121 Fall 2025

HOMEWORK MODULE 1

Please submit your homework via Blackboard before 11:59 pm on Sept 7th. When you submit your
document title it: “HW 1 Fin 121_ last [Link]”. If Professor Root was submitting homework it would
be titled “HW 1 Fin 121_Root.doc”
1.
a. Assume that a trader at your firm has entered into a long put option on a stock with an exercise
(strike) price of $47 with a price of $3. Create a table in excel for spot prices from 20 to 60 and
record the profit for both the Long and Short Positions of the option then use excel to create a
graph of the two positions. Cut and paste the table and graph into your final document. (6
points combined for the table and the graph) The first three rows of your table will be:
FIN 121 Fall 2025

b. Repeat part a for a short call option with an exercise price of $40 and a price of $2 (create a new
table and graph using call options instead of put options then cut and paste them into your final
document 5 points combined for the table and the graph)
FIN 121 Fall 2025

2. On May 1 a Kansas farmer entered into a short futures contract to sell 250,000 bushels of wheat for
540 cents per bushel by entering into a futures contract that matures on October 31. (6 points each
part)

The general starting point for these problems is starting with an effective price of

Spot position ± (gain or loss on futures position)

The key is thinking about whether the spot position is a cost (negative cash flow) or revenue
(positive cash flow) then the impact of the gain of loss on the futures position. In this case we have
a short position, so we are selling the wheat in the spot market, making the sport transaction a
revenue.

When the futures price decreases there will be a gain in the future market. The spot price will have
compared to the original spot price, but the gain will increase the total amount received, increasing
the effective price to above the spot price (see answer a).

When the futures price increases there is a loss in the futures market. The spot price will have
increased compared to the original spot price, but the loss will decrease the total amount received
decreasing the effective price to below the spot rice (see answer b).

a) On September 30th the farmer closed out his contract by taking a long futures position at a price
of 480 cents per bushel and sells 250,000 bushels of wheat in the spot market for 480 cents per
bushel. Calculate the effective price received by the farmer (show the gain or loss on the
futures contract plus the amount received in the spot market and combine them to get the
effective price).

Spot Transaction
Sell 250,000 bushels at 480 cents per bushel
Total revenue = 120,000,000 cents
Futures Transaction
Short at 540 then closing out with a Long at 480
Gain on futures = (540-480) x (250,000) = 15,000,000 cents
Effective price = [(spot) + (gain or loss)]/(number of units in spot transaction)
= (120,000,000+15,000,000)/250,000
= 540 cents per bushel
FIN 121 Fall 2025

b) Repeat the question for a closing futures price of 620 cents per bushel and a spot price of 620
cents per bushel.

Spot Transaction
Sell 250,000 bushels at 620 cents per bushel
Total revenue = 620 x 250,000 = 155,000,000 cents
Futures Transaction
Short at 540 then closing out with a Long at 620
Loss on futures = (540-620) x (250,000) = -20,000,000 cents
Effective price = [(spot) + (gain or loss)]/(number of units in spot transaction)
= (155,000,000 - 20,000,000)/250,000
= 540 cents per bushel

c) Instead of the outcomes in part a) & b), assume the farmer sells her 250,000 bushels of wheat
for 480 cents per bushel on Oct 1, and closes out the futures contract at a price of 465 cents per
bushel also on Oct 1. Calculate the effective price received by the farmer. (You need to combine
the results in both the spot market and futures market to get the final effective price)
Now we need to account for the size of the different positions so the formula becomes

(𝑆𝑝𝑜𝑡 𝑝𝑟𝑖𝑐𝑒)(𝑠𝑖𝑧𝑒 𝑜𝑓𝑆𝑝𝑜𝑡 𝑝𝑜𝑠𝑖𝑡𝑖𝑜𝑛) ± (𝑔𝑎𝑖𝑛 𝑜𝑟 𝑙𝑜𝑠𝑠 𝑜𝑛 𝑓𝑢𝑡𝑢𝑟𝑒𝑠 𝑝𝑜𝑠𝑖𝑡𝑖𝑜𝑛)(𝑠𝑖𝑧𝑒 𝑜𝑓 𝐹𝑢𝑡 𝑃𝑜𝑠𝑖𝑡𝑖𝑜𝑛)
(𝑆𝑖𝑧𝑒 𝑜𝑓 𝑠𝑝𝑜𝑡 𝑝𝑜𝑠𝑖𝑡𝑖𝑜𝑛)

Spot Transaction
Sell at 250,000 bushels at 480 cents per bushel
Total revenue = 480x250,000 = 120,000,000 cents

Futures Transaction
Short at 540 then closing out with a Long at 465
Gain on futures = (540-465) x (250,000) = 18,750,000 cents

Effective price = [(spot) + (gain or loss)]/(number of units in spot transaction)

Note sine the size of the positions are all the same they cancel out so this could have been also
done as:
480 +(540-465) =555
In future problems the size of the spot and futures position may differ from each other – which
would then require the first equation.
FIN 121 Fall 2025

3. A company enters into a long futures contract to buy 75,000 bushels of wheat for 550 cents per
bushel. Each contract is for 5,000 bushels of wheat. Assume the initial margin is $2,000 per
contract and the maintenance margin is $1,250 per contract.

a) At what futures price will there be a margin call for the holder of the long position? (5 points)

There are 5,000 bushels in each contract

b) The daily price limit is 35 cents, how large would the gain or loss be if the futures price moved
an amount equal to the daily price limit. Does the maintenance margin cover the potential loss
if this occurs? (5 points)

Since they have a long contract, a loss occurs when the price drops. Given the 35 cent price
change this would result in a price of 550-35 = 515 cents

A 35 cents per bushel price change x 5,000 bushels results in a total loss of = 175,000 cents or
$1750 which decreases the margin account to 2,000-1,750 = $250, well below the maintenance
margin of $1,250. The loss of $1750 is large enough to drop the account well below the
maintenance margin of $1250. So it is possible for the loss to cause the margin account to fall to
a balance of zero if the balance was close to the maintenance margin prior to the start of trading
on a given day. There could be a loss greater than the maintenance margin – in that case there is
some counter party default risk, since the maintenance margin would not cover the entire loss.

c) Explain the purpose of having margin accounts. (Why were they established and explain how
they solve the problem they were designed to address) (5 points)

By setting aside money for potential losses in the future, prior to the loss actually occurring, the
margin account prevents participants from defaulting on the contract. Since the contract is
marked to its market value each day, losses occur in real time as opposed to just at the end of
the contract. This greatly reduces, or eliminates, the counter party default risk that exists in the
forward market.