FINA 3080 Practice Problems
Derivatives Markets
1. True or False
If the riskfree rate is higher it is more costly to borrow and the cost oflarry
,
is larger Since the
.
current spot and future prices differ by the cost of carry the ,
difference increases in riskfree rate That
. is , Fo-Soclof + C-d) of , where the cost
(a) The higher the riskfree rate, the larger the difference between current spot and futures prices carry isretc-d .
T (holding other parameters unchanged). spot and futures prices differ by more if the riskfree rate
If is higher .
(b) A call option writer will exercise the option if the spot price at maturity is higher than the
F strike price. The option to exercise is with the option holder As a call option writer you cannot .
choose to exercise the call option
(c) Call options and put options holders have limited loss.
T
Option holders can choose not to exercise their call or put options. In that case the options
&
,
&
(d) The shape of the payoff structure of a bearish collar (short stock + short put + long call) is expire worthless
&
T the same as that of the bearish money spread (long put + short put).
and the holders
I
lose the premium
(e) Buying on margin is similar to buying a naked call option. Both are bets that asset prices they paid when the
will go up. options were bought.
2. Spot-Futures Parity Theorem
On the last trading day of December 2020, you observe the following gold prices:
Spot price = $1,000/ounce
1-year futures price = $1,050/ounce
Suppose storage costs are 1% per year and income is 0%.
1050 =
1000 (1 + rf-070 + 1 %)
(a) What is the riskfree rate, rf?
Uf =
4%
(b) What is the no-arbitrage futures price for a contract that matures at the end of June 2021?
Fo 1000 (1+ 4% 0 %+ 19005 1024 69507
g
=
= -
(c) Construct a trading strategy if the contract in (b) has a futures price of $1,010. The strategy
should have zero cashflow now but a positive cashflow in June 2021.
3. Futures Contracts and Spot-Futures Parity Theorem
&
You are asked by the Hong Kong Exchanges and Clearing Limited (HKEx, a clearinghouse for
futures in Hong Kong) to design new futures contracts on residential properties.
(Futures contracts are actively traded in the secondary market. Like stocks, a futures contract
on an underlying asset is the same as another futures contract on the same underlying asset. In
other words, they are “standardized” and we require the assets to be available in a large
quantity.) Co CF0 5
Buy Jane 2011 futures
.
8 SV-1010
sell gold 5
1000 Su + (4 05)0 1) x 1000 1
-
Lend - Su + 4
- -
=
99
.
4000 5
1000 (1 04)0 1019 80
.
= .
Total ⑧
$14 79 .
(a) Briefly explain to the HKEx why you think it is difficult to have a market for such futures
contracts.
(b) List one source of income you can get if you own a residential property.
(c) Despite the difficulty in (a), the HKEx has established the futures market for residential
properties. Suppose the spot price is HK$3 million, the riskfree rate is 3% per year, the income
payout is 2% per year, and the storage cost is zero. What is the futures price for a futures
contract that matures in a year?
(d) If the actual futures price is HK$10,000 lower than your answer in (c), how would you carry
out an arbitrage strategy? Outline the transactions in your strategy, and calculate the cashflow
today and the cashflow in a year (show your calculations). Do you expect that the arbitrage
profit will be enough to cover your transaction costs? Why or why not? payoff (in dollars)
1
100
50
O > Asset
4. Options as Building Blocks: Long two puts price
at T
, Si
O
An investor is holding two puts on the same underlying asset (each put is on one unit of the
asset). Both puts have an identical strike price of $50 and identical maturity. Each put costs $6.
&
(a) Draw the payoff diagram for this strategy. The vertical axis is payoff in dollars (ignore the
price of the options) and the horizontal axis is the asset price at maturity, ST.
(b) Calculate the range of values of the underlying asset at maturity for which the investor will
earn a profit. (Include the price of the options in calculating the profit/loss.)
The strategy earns a profit when Spayoff) 12
2(50- SD712 - SVC44
5. Options as Building Blocks: Long one call and short one call
Consider the following strategy: you long a call option with strike price X = $40, and short a
call option with strike price X = $45 at the same time. (This is called a bullish money spread.)
The price of the call option with X = $40 is $8 and the price of the call option with X = $45 is
$5. Both options are on the same underlying asset (each call is on one unit of the asset) and
have the same maturity date, T.
Draw the profit diagram for this strategy. The vertical axis is profit/loss in dollars (include the
price of the options in calculating the profit/loss) and the horizontal axis is the asset price at
maturity, ST.
6. Options as Building Blocks: Short one call and short one put
a D
Consider the following strategy: you short a call option with strike price X = $110, and short a
put option with strike price X = $105 at the same time.
2
The price of the call option is $2.85 and the price of the put option is $4.40. Both options are
on the same underlying asset (each option is on one unit of the asset) and have the same
maturity date, T.
(a) Draw the payoff diagram for this strategy. The vertical axis is payoff in dollars (ignore the
price of the options) and the horizontal axis is the asset price at maturity, ST.
(b) What will be the profit/loss for your strategy if the asset is selling at $107 at T? What if the
asset is selling at $120? (Include the price of the options in calculating the profit/loss.)
(c) For which two asset prices at T are you just breaking even on this strategy? (Include the
price of the options in calculating the profit/loss.)
(d) What does an investor undertaking this strategy expect the asset price to behave?
(a)$pff
105 110
sell
2 Asset
OS Call
at
Maturity Si
(b)
Selling at $107 both the
:
put and call are not [Link], the profit is
2
.
85 + 4 40 $7
.
=
. 25
selling at $120 : The
put is not exercised by the call is exercised. Therefore ,
the
profit is 2 .
85 + 4 40
.
-
(120-110)= -$2 75 .
(c) The strategy
This
is
breaking even
happens when the asset is
when $payoff :
$-7 25
.
or when the asset
selling at7 25 + 105= $97 75
.
selling
.
is at 7 25+ 110
-
$117 25
= .
(d) The investor
expects that the
volatility of the asset price will
below (so that the asset
price at T stays in the
range .
3
$payoff
A
> Sr
O do is
$payoff
A
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