MFIN6003ABCD Derivative Securities Dr.

Huiyan Qiu

Notes on individual assignments:

• Assignments must be completed individually.

• Students must submit a PDF version of their work using the submission link in the
course Moodle page.
o The due time is 11:59 pm on the due date
o 20% penalty applies to submission being 0 to 24 hours late
o 50% penalty applies to submission being 24 to 48 hours late
o No submission being 48 hours late will be accepted
• Any identification of plagiarism problem will get severe penalty.

Individual Assignment #1

Due: Session Five

1. Suppose you desire to short-sell 1,000 shares of JKI stock, which has a bid price of
$14.74 and an ask price of $14.96, per share. You cover the short position 6 months later
when the bid price is $13.02 and the ask price is $13.20, per share.
(a) Considering only the bid and ask prices (ignoring commissions and interest), what
profit do you earn?
(b) Suppose that there is a 0.4% commission to engage in the short-sale (this is the
commission to sell the stock) and a 0.4% commission to close the short-sale (this is
the commission to buy the stock back). How do these commissions change the profit
in the previous answer?
(c) Suppose the effective 6-month interest rate is 2% and that you are paid nothing on
the short-sale proceeds. How much interest do you lose during the 6 months in
which you have the short position? Consider both cases, without commissions or
with commissions.

2. Suppose XYZ stock pays no dividends and has a current price of $50. The forward price
for delivery in 1 year is $55. Suppose the 1-year effective annual interest rate is 10%.
(a) What is the payoff in 1 year for stock prices of $40, $45, $50, $55, $60, and $65?
(b) Graph the payoff diagrams for the one-year forward contract.
(c) Is there any advantage to investing in the stock or the forward contract? Why?
(d) Suppose XYZ pays a dividend of $2 per year and everything else stays the same. Now
is there any advantage to investing in the stock or the forward contract? Why?

3. The S&R index spot price is 1100, the continuously compounding risk-free rate is 5%, and
the continuous dividend yield on the index is 2%.

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MFIN6003ABCD Derivative Securities Dr. Huiyan Qiu

(a) Suppose you observe a 6-month forward price of 1120. What arbitrage would you
undertake?
(b) Suppose you observe a 6-month forward price of 1110. What arbitrage would you
undertake?

4. Suppose the S&P 500 currently has a level of 4200. The continuously compounding
return on a 1-year T-bill is 4.25%. (Treasury bill rate is one of the benchmark interest
rates.) You wish to hedge a $3,000,000 stock portfolio that has a beta of 1.2 and a
correlation of 1.0 with the S&P 500.
(a) What is the 1-year futures price for the S&P 500 assuming no dividends?
(b) How many S&P 500 futures contracts should you short to hedge your portfolio?
What return do you expect on the hedged portfolio?

Individual Assignment #2

Due: Session Eight

1. The euro exchange rate is $1.15/euro. The continuously compounding dollar interest rate
is 3% and the continuously compounding euro interest rate is 2%. Suppose that you
borrow euros and lend dollars for 1 year, without using futures to hedge, and your initial
cash flow is zero.
(a) At what exchange rate in 1 year will you break even on this position?
(b) If the exchange rate in 1 year is $1.20, what is your profit in dollars (per 1000 euros
borrowed at time 0)?
(c) If the exchange rate in 1 year is $1.12, what is your profit in dollars (per 1000 euros
borrowed at time 0)?

2. A lender plans to invest $100m for 150 days, 60 days from today. (That is, if today is day
0, the loan will be initiated on day 60 and will mature on day 210.) The implied forward
rate over 150 days, and hence the rate on 150-day FRA, is 2.5%, effective over the
period. The actual interest rate over that period could be either 2.2% or 2.8%. The lender
enters the 150-day FRA.
(a) If the 150-day interest rate on day 60 is 2.8%, how much will the lender have to pay
to the FRA counterparty if the FRA is settled on day 60? How much if it is settled on
day 210?
(b) If the 150-day interest rate on day 60 is 2.2%, how much will the lender have to pay
to the FRA counterparty if the FRA is settled on day 60? How much if it is settled on
day 210?

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MFIN6003ABCD Derivative Securities Dr. Huiyan Qiu

3. Suppose that oil forward prices for 1 year, 2 years, and 3 years are $40, $41, and $42,
respectively. The 1-year, 2-year, and 3-year effective annual interest rates are 2.0%, 2.5%,
and 3.0%, respectively.
(a) What is the 3-year swap price?
(b) What is the price of a 2-year swap beginning in 1 year? (That is, the first swap
settlement will be in 2 years and the second in 3 years.)

4. Assume the effective 6-month interest rate is 2% and the S&R 6-month forward price is
$1020. The premiums for S&R options with 6 months to expiration are as follows:
Strike Call Put
$950 $120.405 $51.777
1000 93.809 74.201
Construct payoff and profit diagrams for the purchase of a 950-strike S&R call and sale
of a 1000-strike S&R call (call spread). Verify that you obtain exactly the same profit
diagram for the purchase of a 950-strike S&R put and sale of a 1000-strike S&R put (put
spread). What is the difference in the payoff diagrams for the call and put spreads? Why
is there a difference?

Individual Assignment #3

Due: October 14, 2023

1. Suppose the S&R index is 4,200, the continuously compounding risk-free rate is 5%, and
the dividend yield is 0%. A 1-year 4,250-strike European call costs $275 and a 1-year
4,250-strike European put costs $110. Consider the strategy of buying the index, selling
the 4,250-strike call, and buying the 4,250-strike put.
(a) What is the rate of return on this position held until the expiration of options?
(b) What is the arbitrage implied by your answer to part (a)?
(c) What difference between the call and put prices would eliminate arbitrage?

2. Suppose call and put prices are given by:

Strike 80 100 105

Call Premium 22 9 5
Put Premium 4 21 24.80

Find the convexity violations by computing the change in premium per dollar change in
the strike price. What spread would you use to effect arbitrage? (Hint: 1:5:4)
Demonstrate that the spread position is an arbitrage.

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MFIN6003ABCD Derivative Securities Dr. Huiyan Qiu

3. Let S = $100, K = $95, r = 8%, T = 1, and δ = 0. Let u = 1.3, d = 0.8, and n = 2 (n refers to
the number of binomial periods). Construct the binomial tree for an American put
option. At each node provide the premium, Δ, and B.

4. Suppose XYZ stock is currently trading at $100 per share. The volatility and dividend yield
rate of the stock are 40% and 2%, respectively. The continuous compounding risk-free
interest rate is 6%. Consider the 1-year 105-strike put option on the stock.
(a) What is the price of the put option?
(b) What is the delta of the put option?
(c) As a market-maker, you have short 200 put option on the stock. What positions do
you take to hedge?

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