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  • Derivatives: Forward Contracts

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    SAITEJA DASARI
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    This document contains information about derivatives, including forwards and options. [1] A short forward contract has unlimited loss potential. [2] On expiration, a futures contract price equals the underlying asset price. [3] Margin requirements for financial futures involve daily mark-to-market adjustments to margin accounts to reflect changes in the contract price.

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    1QuizAdditional_sol

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    This document contains information about derivatives, including forwards and options. [1] A short forward contract has unlimited loss potential. [2] On expiration, a futures contract price equals the underlying asset price. [3] Margin requirements for financial futures involve daily mark-to-market adjustments to margin accounts to reflect changes in the contract price.

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    59 views4 pages

    Derivatives: Forward Contracts

    Uploaded by

    SAITEJA DASARI
    This document contains information about derivatives, including forwards and options. [1] A short forward contract has unlimited loss potential. [2] On expiration, a futures contract price equals the underlying asset price. [3] Margin requirements for financial futures involve daily mark-to-market adjustments to margin accounts to reflect changes in the contract price.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Flag for inappropriate content
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    of 4

    Derivatives: Forward contracts

    1. A short forward contract has an unlimited loss potential. True or False


    TRUE

    2. On the expiration date of a futures contract, the price of the contract

    (A) always equals the purchase price of the contract


    (B) always equals the average price over the life of the contract.
    (C) always equals the price of the underlying asset
    TRUE
    (D) always equals the average of the purchase price and the price of underlying
    asset
    (E) cannot be determined

    3. Explain the margin requirement for financial futures and how marking to market
    affects the margin account.

    (A) Each contract requires a margin deposit of a specified amount. Each day
    futures contracts are marked to market. This means that each day the
    margin account is changed by the gain or loss of value of the contract.
    Assuming a contract of 110, if the settlement (closing) price falls to 109,
    the $1000 loss is subtracted from the account and an additional $1000 must
    be added to the margin account. Conversely, a rise in the contract price to
    111 means the $1000 profit is added to the account, increasing the value of
    the account above the required minimum.

    1
    Derivatives: Options
    1. An agent is only allowed to write options on an underlying asset if he/she already
    owns units of the underlying. True or false?
    FALSE: The so-called naked option writing is a legal and common practice.

    2. A covered call is a portfolio consisting of a written call option and the short
    underlying. True or false?
    FALSE:

    3. Today’s price of a non-dividend-paying stock is $1000 and the annual discretely


    compounded risk-free rate is given to be 5%. You write a one-year, $1,050-
    strike Eureopan call option for a premium of $10 while you simultaneously buy
    the stock (assume you finance the stock purchase by borrowing at the risk-free
    rate). What is your profit if the stock’s spot price in one year equals $1,200?

    ST − 1000 × 1.05 − (ST − K)+ + 10 × 1.5 = 1050 − 990 × 1.05 = 10.50

    2
    4. For what values of the final asset price is the profit of a long forward contract
    with the forward price F = 100 and delivery date T in one year smaller than the
    profit of a long call on the same underlying asset with the strike price K = 100
    and the exercise date T. Assume that the call’s premium equals $10 and that the
    annual effective interest rate equals 10%. Express your answer as an interval.

    (A) 0 ≤ ST < 100


    (B) 0 ≤ ST < 89
    The profit function of the forward contract is

    ST − 100

    The profit function of the call is

    (ST − 100)+ − 10 × 1.10


    For ST ≥ 100 the call’s profit is smaller than the forward contract’s profit.
    So, we focus on s < 100 Here we have to solve for S ∗ in

    S ∗ − 100 = −11 ⇒ S ∗ = 89

    (C) ST ≥ 89
    (D) ST ≥ 100
    (E) Never

    3
    5. The following one-period binomial stock price model was used to calculate the
    price of a one-year 10-strike call option on the stock.

    12
    %
    10
    &
    8

    You are given:

    • The period is one year.


    • The true probability of an up-move is 0.75.
    • The stock pays no dividends.
    • The price of the one-year 10-strike call is $1.13.

    Upon review, the analyst realizes that there was an error in the model construc-
    tion and that Sd, the value of the stock on a down-move, should have been 6
    rather than 8. The true probability of an up-move does not change in the new
    model, and all other assumptions were correct.
    Recalculate the price of the call option.

    (A) $1.13
    (B) $1.20
    (C) $1.33
    (D) $1.40
    TRUE: The time t = 0 price of the call option is
    1 − 0.8e−r
     r 
    −r −r e − 0.8
    C0 = e [q × Cu + (1 − q) × Cd ] = e × 2 + (1 − q) × 0 =
    1.2 − 0.8 0.2
    −r
    Setting 1−0.8e
    0.2
    = 1.13 we get e−r = 0.9675 (or a c.c. rate r = 3.3%)
    If Sd = 6,then d = 0.6, and
     r 
    −r e − 0.6 1 − 0.6 × 0.9675
    C0 = e × 2 + (1 − q) × 0 = = 1.398
    1.2 − 0.6 0.3
    (E) $1.53.

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