Question 1

Explain the impact transaction costs have on the ability to make arbitrage profits in forward and futures markets.

Accepted Answer

The existence of bid-ask spreads,commissions,and taxes take away from profits.The existence of security mispricing and implementation of arbitrage strategies,therefore,may not produce profits if these costs exceed the potential profit.

Question 2

Throughout the chapter the topic of arbitrage is mentioned.Ask the class to explain arbitrage.Follow-up the answers by asking what role arbitrage plays in futures and forward markets.Finish up the Q & A with a group discussion of why arbitrage exists,given the limited opportunity for arbitrage profits.Guide students towards an understanding of the necessity of the arbitrage function,despite the limited opportunity for profit.

Accepted Answer

Arbitrage is the practice of taking advantage of price differences in different markets to make a profit. In the context of futures and forward markets, arbitrage plays a crucial role in ensuring that prices remain consistent across different markets.

In futures and forward markets, arbitrageurs play a key role in keeping prices in line with each other by buying in the cheaper market and selling in the more expensive market, thereby narrowing the price gap. This helps to prevent price discrepancies and ensures that the market remains efficient.

Despite the limited opportunity for arbitrage profits, arbitrage exists because it is necessary for maintaining market efficiency. The presence of arbitrageurs helps to keep prices in check and prevents the market from becoming inefficient. Without arbitrage, there would be greater price discrepancies and market inefficiencies, which could ultimately harm market participants and the overall functioning of the market. Therefore, even though the opportunity for profit may be limited, the arbitrage function is essential for the smooth operation of futures and forward markets.

Question 3

Explain the steps necessary to take advantage of an arbitrage opportunity,which may exist between the dollar and yen,when a future yen payment is required.

Accepted Answer

Rather than lock in the cost of a future yen payment with a forward or futures contract,calculate the PV of the yen payment using yen rates.Convert this figure to dollars at the spot rate.Borrow at the dollar rate,thus locking in your dollar cost.Exchange those funds and place in a yen time deposit account until needed.

Question 4

The manager of a blue chip growth stock mutual fund is trying to fully hedge the $650 million portfolio position during the last two months of the calendar year.The current price of the S&P 500 Index futures contract is 1200.If the mutual fund has a beta of 1.24,how many contracts will be needed to hedge the fund?

Accepted Answer

A)  1,083 
B)  3,033 
C)  242,963 
D)  541,666 
A)  1,083 
B)  3,033 
C)  242,963 
D)  541,666

Question 5

Name some advantages that futures contracts have over forward contracts.

Accepted Answer

Futures are more liquid and po

Question 6

The S&P 500 Index is priced at $950.46.The annualized dividend yield on the index is 1.40%.The continuously compounded annual interest rate is 8.40%.What is the price of a forward contract that expires 9 months from today?

Accepted Answer

A)  $937.48 
B)  $942.66 
C)  $984.36 
D)  $1001.69 
A)  $937.48 
B)  $942.66 
C)  $984.36 
D)  $1001.69

Question 7

The current currency spot rate is $1.31 per euro.If dollar denominated interest rates are 3.0% and euro denominated interest rates are 4.0%,what is the likely dollar per euro exchange rate for a 2-year forward contract?

Accepted Answer

A)  $1.28 
B)  $1.30 
C)  $1.31 
D)  $1.33 
A)  $1.28 
B)  $1.30 
C)  $1.31 
D)  $1.33

Question 8

HAW,Inc.plans to pay a $1.10 dividend per share in 3 months and a $1.15 dividend in 6 months.HAW's share price today is $45.60 and the continuously compounded quarterly interest rate is 2.1%.What is the price of a forward contract,which expires immediately after the second dividend?

Accepted Answer

A)  $45.28 
B)  $45.96 
C)  $45.60 
D)  $46.24 
A)  $45.28 
B)  $45.96 
C)  $45.60 
D)  $46.24

Question 9

Interest rates on the U.S.dollar are 5.4% and euro rates are 4.6%.Given a dollar per euro spot rate of 0.918,what is the 6-month forward rate ($/E)?

Accepted Answer

A)  0.912 
B)  0.917 
C)  0.922 
D)  0.934 
A)  0.912 
B)  0.917 
C)  0.922 
D)  0.934

Question 10

Which of the following statements does NOT accurately reflect the relationship between securities and synthetic forward contracts?

Accepted Answer

A)  Forward = stock - zero coupon bond 
B)  Zero coupon bond = stock - forward 
C)  Prepaid forward = forward - zero coupon bond 
D)  Stock = forward + zero coupon bond 
A)  Forward = stock - zero coupon bond 
B)  Zero coupon bond = stock - forward 
C)  Prepaid forward = forward - zero coupon bond 
D)  Stock = forward + zero coupon bond

Question 11

What are some uses for index futures contracts?

Accepted Answer

In no particular order,the most common u

Question 12

The annualized dividend yield on the S&P 500 Index is 1.40%.The continuously compounded interest rate is 6.4%.If the 9-month forward price is $925.28 and the index is priced at $950.46,what is the profit/loss from a cash-and-carry strategy?

Accepted Answer

A)  $25.18 loss 
B)  $25.18 gain 
C)  $61.50 loss 
D)  $61.50 gain 
A)  $25.18 loss 
B)  $25.18 gain 
C)  $61.50 loss 
D)  $61.50 gain

Question 13

Interest rates on the U.S.dollar are 6.5% and euro rates are 5.5%.The dollar per euro spot rate is 0.950.What is the arbitrage profit on a required 1 million euro payment if the forward rate is 0.980 dollars per euro and the exchange occurs in one year?

Accepted Answer

A)  $10,000 
B)  $21,000 
C)  $28,000 
D)  $34,000 
A)  $10,000 
B)  $21,000 
C)  $28,000 
D)  $34,000

Question 14

The S&P 500 Index is priced at $950.46.The annualized dividend yield on the index is 1.40%.What is the price of a 6-month prepaid forward contract on the S&P 500 Index?

Accepted Answer

A)  $943.83 
B)  $950.00 
C)  $964.26 
D)  $984.21 
A)  $943.83 
B)  $950.00 
C)  $964.26 
D)  $984.21

Question 15

Consider an investment in five S&P 500 Index futures contracts at a price of $924.80.The initial margin requirement is 15.0% and the maintenance margin is 10.0%.If the continuously compounded interest rate is 5.0% what will the futures price need to be for a margin call to occur 10 days from now? Assume no settlement within the 10 days.

Accepted Answer

A)  $852.64 
B)  $872.79 
C)  $898.63 
D)  $905.25 
A)  $852.64 
B)  $872.79 
C)  $898.63 
D)  $905.25

Question 16

What is the process involved in creating a cash-and-carry strategy?

Accepted Answer

Buy a tailed position in a security and

Question 17

The price of an S&P 500 Index futures contract is $988.26 when you decide to enter a long position.When the position is closed the futures price is $930.32.If there are no settlement requirements,what is your dollar gain or loss? (Ignore opportunity costs.)

Accepted Answer

A)  $14,485 loss 
B)  $14,485 gain 
C)  $57.94 loss 
D)  $57.94 gain 
A)  $14,485 loss 
B)  $14,485 gain 
C)  $57.94 loss 
D)  $57.94 gain

Question 18

An investor wants to hold 200 euro two years from today.The spot exchange rate is $1.31 per euro.If the euro denominated annual interest rate is 3.0% what is the price of a currency prepaid forward?

Accepted Answer

A)  $200 
B)  $206 
C)  $231 
D)  $247 
A)  $200 
B)  $206 
C)  $231 
D)  $247

Question 19

The price of an S&P 500 Index futures contract is $988.26 when you decide to enter a long position.When the position is closed the futures price is $930.32.If there are no settlement requirements,what is your percentage gain or loss under a 15.0% margin requirement? (Ignore opportunity costs.)

Accepted Answer

A)  39% gain 
B)  39% loss 
C)  43% gain 
D)  43% loss 
A)  39% gain 
B)  39% loss 
C)  43% gain 
D)  43% loss

Question 20

KMW,Inc.plans to pay a dividend of $0.50 per share both 3 and 6 months from today.KMW's share price today is $36.00 and the continuously compounded quarterly interest rate is 1.5%.What is the price of a 6-month prepaid forward contract,which expires immediately after the second dividend?

Accepted Answer

A)  $35.00 
B)  $35.02 
C)  $36.98 
D)  $37.00 
A)  $35.00 
B)  $35.02 
C)  $36.98 
D)  $37.00

Exam 5: Financial Forwards and Futures

Explain the impact transaction costs have on the ability to make arbitrage profits in forward and futures markets.

Explain the steps necessary to take advantage of an arbitrage opportunity,which may exist between the dollar and yen,when a future yen payment is required.

Name some advantages that futures contracts have over forward contracts.

The S&P 500 Index is priced at $950.46.The annualized dividend yield on the index is 1.40%.The continuously compounded annual interest rate is 8.40%.What is the price of a forward contract that expires 9 months from today?

The current currency spot rate is $1.31 per euro.If dollar denominated interest rates are 3.0% and euro denominated interest rates are 4.0%,what is the likely dollar per euro exchange rate for a 2-year forward contract?

HAW,Inc.plans to pay a $1.10 dividend per share in 3 months and a $1.15 dividend in 6 months.HAW's share price today is $45.60 and the continuously compounded quarterly interest rate is 2.1%.What is the price of a forward contract,which expires immediately after the second dividend?

Interest rates on the U.S.dollar are 5.4% and euro rates are 4.6%.Given a dollar per euro spot rate of 0.918,what is the 6-month forward rate ($/E)?

Which of the following statements does NOT accurately reflect the relationship between securities and synthetic forward contracts?

What are some uses for index futures contracts?

The annualized dividend yield on the S&P 500 Index is 1.40%.The continuously compounded interest rate is 6.4%.If the 9-month forward price is $925.28 and the index is priced at $950.46,what is the profit/loss from a cash-and-carry strategy?

Interest rates on the U.S.dollar are 6.5% and euro rates are 5.5%.The dollar per euro spot rate is 0.950.What is the arbitrage profit on a required 1 million euro payment if the forward rate is 0.980 dollars per euro and the exchange occurs in one year?

The S&P 500 Index is priced at $950.46.The annualized dividend yield on the index is 1.40%.What is the price of a 6-month prepaid forward contract on the S&P 500 Index?

What is the process involved in creating a cash-and-carry strategy?

The price of an S&P 500 Index futures contract is $988.26 when you decide to enter a long position.When the position is closed the futures price is $930.32.If there are no settlement requirements,what is your dollar gain or loss? (Ignore opportunity costs.)

An investor wants to hold 200 euro two years from today.The spot exchange rate is $1.31 per euro.If the euro denominated annual interest rate is 3.0% what is the price of a currency prepaid forward?

The price of an S&P 500 Index futures contract is $988.26 when you decide to enter a long position.When the position is closed the futures price is $930.32.If there are no settlement requirements,what is your percentage gain or loss under a 15.0% margin requirement? (Ignore opportunity costs.)

KMW,Inc.plans to pay a dividend of $0.50 per share both 3 and 6 months from today.KMW's share price today is $36.00 and the continuously compounded quarterly interest rate is 1.5%.What is the price of a 6-month prepaid forward contract,which expires immediately after the second dividend?

Introduction to Derivatives

An Introduction to Forwards and Options

Insurance, collars, and Other Strategies

Introduction to Risk Management

Commodity Forwards and Futures

Interest Rate Forwards and Futures

Swaps

Parity and Other Option Relationships

Binomial Option Pricing: Basic Concepts

Binomial Option Pricing: Selected Topics

The Black-Scholes Formula

Market-Making and Delta-Hedging

Exotic Options: I

Financial Engineering and Security Design

Corporate Applications

Real Options

The Lognormal Distribution

Monte Carlo Valuation

Brownian Motion and Itos Lemma

The Black-Scholes-Merton Equation

Risk-Neutral and Martingale Pricing

Exotic Options: 2

Volatility

Interest Rate and Bond Derivatives

Value at Risk

Credit Risk

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