1. On July I, 2011, a company enters into a forward contract to buy 10 million Japanese yen on January I, 2012. On September I, 2011, it enters into a forward contract to sell 10 million Japanese yen on January 1, 2012. Describe the payoff from this strategy.
2. Suppose that USD/sterling spot and forward exchange rates are as follows:
Spot 1.4580
90-day forward 1.4556
180-day forward 1.4518
What opportunities are open to an arbitrageur in the following situations?
(a) A 180-day European call option to buy £1 for $1.42 costs 2 cents.
(b) A 90-day European put option to sell £1 for $1.49 costs 2 cents.
Further Questions
3. Trader A enters into a forward contract to buy gold for $1,000 an ounce in one year. Trader B buys a call option to buy gold for $1,000 an ounce in one year. The cost of the option is $100 an ounce. What is the difference between the positions of the traders? Show the profit per ounce as a function of the price of gold in one year for the two traders.
4. In March, a US investor instructs a broker to sell one July put option contract on a stock. The stock price is $42 and the strike price is $40. The option price is $3. Explain what the investor has agreed to. Under what circumstances will the trade prove to be profitable? What are the risks?
A US company knows it will have to pay 3 million euros in three months. The current exchange rate is 1.4500 dollars per euro. Discuss how forward and options contracts can be used by the company to hedge its exposure.
5. A stock price is $29. An investor buys one call option contract on the stock with a strike price of $30 and sells a call option contract on the stock with a strike price of $32.50. The market prices of the options are $2.75 and $1.50, respectively. The options have the same maturity date. Describe the investor's position.
The price of gold is currently $1,000 per ounce. The forward price for delivery in 1 year is $1,200. An arbitrageur can borrow money at 10% per annum. What should the arbitrageur do? Assume that the cost of storing gold is zero and that gold provides no income.
The current price of a stock is $94, and 3-month European call options with a strike price of $95 currently sell for $4.70. An investor who feels that the price of the stock will increase is trying to decide between buying 100 shares and buying 2,000 call options (= 20 contracts).
Both strategies involve an investment of $9,400. What advice would you give? Flow high does the stock price have to rise for the option strategy to be more profitable?
6. On July 15, 2010, an investor owns 100 Google shares. As indicated in Table 1.3, the share price is about $497 and a December put option with a strike price of $460 costs $27.30. The investor is comparing two alternatives to limit downside risk. The first involves buying one December put option contract with a strike price of $460. The second involves instructing a broker to sell the 100 shares as soon as Google's price reaches $460. Discuss the advantages and disadvantages of the two strategies.
7. What differences exist in the way prices are quoted in the foreign exchange futures market, the foreign exchange spot market, and the foreign exchange forward market?
8. The party with a short position in a futures contract sometimes has options as to the precise asset that will be delivered, where delivery will take place, when delivery will take place, and so on. Do these options increase or decrease the futures price? Explain your reasoning.
9. What are the most important aspects of the design of a new futures contract? 2.10. Explain how margins protect investors against the possibility of default.
10. A trader buys two July futures contracts on orange juice. Each contract is for the delivery of 15,000 pounds. The current futures price is 160 cents per pound, the initial margin is $6,000 per contract, and the maintenance margin is $4,500 per contract. What price change would lead to a margin call? Under what circumstances could $2,000 be with-drawn from the margin account?
11. Show that, if the futures price of a commodity is greater than the spot price during the delivery period, then there is an arbitrage opportunity. Does an arbitrage opportunity exist if the futures price is less than the spot price? Explain your answer.
12. Explain the difference between a market-if-touched order and a stop order. 2.14. Explain what a stop-limit order to sell at 20.30 with a limit of 20.10 means.
13. At the end of one day a clearing house member is long 100 contracts, and the settlement price is $50,000 per contract. The original margin is $2,000 per contract. On the following day the member becomes responsible for clearing an additional 20 long contracts, entered into at a price of $51,000 per contract. The settlement price at the end of this day is $50,200. How much does the member have to add to its margin account with the exchange clearing house?
14. On July I, 2012, a Japanese company enters into a forward contract to buy $1 million with yen on January I, 2013. On September I, 2012, it enters into a forward contract to sell $1 million on January I, 2013. Describe the profit or loss the company will make in yen as a function of the forward exchange rates on July I, 2012, and September 1, 2012.
15. The forward price of the Swiss franc for delivery in 45 days is quoted as 1.1000. The futures price for a contract that will be delivered in 45 days is 0.9000. Explain these two quotes. Which is more favorable for an investor wanting to sell Swiss francs?
16. Suppose you call your broker and issue instructions to sell one July hogs contract. Describe what happens.
17. "Speculation in futures markets is pure gambling. It is not in the public interest to allow speculators to trade on a futures exchange." Discuss this viewpoint.
18. Live cattle futures trade with June, August, October, December, February, and April maturities. Why do you think the open interest for the June contract is less than that for the August contract in Table 2.2?
What do you think would happen if an exchange started trading a contract in which the quality of the underlying asset was incompletely specified?
"When a futures contract is traded on the floor of the exchange, it may be the case that the open interest increases by one, stays the same, or decreases by one." Explain this statement.
19. Suppose that, on October 24, 2012, a company sells one April 2013 live cattle futures contract. It closes out its position on January 21, 2013. The futures price (per pound) is 91.20 cents when it enters into the contract, 88.30 cents when it closes out its position, and 88.80 cents at the end of December 2012. One contract is for the delivery of 40,000 pounds of cattle. What is the total profit? How is it taxed if the company is (a) a hedger and (b) a speculator? Assume that the company has a December 31 year-end.
cattle farmcr expects to have 120,000 pounds of live cattle to sell in 3 months. The live cattle futures contract traded by the CME Group is for the delivery of 40,000 pounds of cattle. How can the farmer use the contract for hedging? From the farmer's viewpoint, what are the pros and cons of hedging?
19. It is July 2011. A mining company has just discovered a small deposit of gold. It will take 6 months to construct the mine. The gold will then be extracted on a more or less continuous basis for 1 year. Futures contracts on gold are available with delivery months every 2 months from August 2011 to December 2012. Each contract is for the delivery of 100 ounces. Discuss how the mining company might use futures markets for hedging.
20. Trader A enters into futures contracts to buy 1 million euros for 1.4 million dollars in three months. Trader B enters in a forward contract to do the same thing. The exchange rate (dollars per euro) declines sharply during the first two months and then increases for the third month to close at 1.4300. Ignoring daily settlement, what is the total profit of each trader? When the impact of daily settlement is taken into account, which trader has done better?
21. Explain what is meant by open interest. Why does the open interest usually decline during the month preceding the delivery month? On a particular day, there were 2,000 trades in a particular futures contract. This means that there were 2,000 buyers (going long) and 2,000 sellers (going short). Of the 2,000 buyers, 1,400 were closing out positions and 600 were entering into new positions. Of the 2,000 sellers, 1,200 were closing out positions and 800 were entering into new positions. What is the impact of the day's trading on open interest?
22. One orange juice futures contract is on 15,000 pounds of frozen concentrate. Suppose that in September 2011 a company sells a March 2013 orange juice futures contract for 120 cents per pound. In December 2011, the futures price is 140 cents; in December 2012, it is 110 cents; and in February 2013, it is closed out at 125 cents. The company has a December year end. What is the company's profit or loss on the contract? How is it realized? What is the accounting and tax treatment of the transaction if the company is classified as (a) a hedger and (b) a speculator?
23. A company enters into a short futures contract to sell 5,000 bushels of wheat for 450 cents per bushel. The initial margin is $3,000 and the maintenance margin is $2,000. What price change would lead to a margin call? Under what circumstances could $1,500 be with¬drawn from the margin account?
24. Suppose that there are no storage costs for crude oil and the interest rate for borrowing or lending is 5% per annum. How could you make money on May 26, 2010, by trading July 2010 and December 2010 contracts?