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Problem Set 6/FIN4110: Forwards and Futures

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Yahia Ezzat
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22 views

Problem Set 6/FIN4110: Forwards and Futures

Uploaded by

Yahia Ezzat
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Problem Set 6/FIN4110

Due: week 10
Options and Futures

CUHK(SZ)

Forwards and Futures


Problem 1. (☀) Consider a 6-month forward contract to deliver 100 shares of Txt stock. The current price
per share is $25 and Txt is expected to pay a $2 dividend per share in three months. The continuously
compounded interest rate is 10% per annum.

(a) What forward price (per share) should be stipulated in the contract.
(b) Suppose you entered a long position at an earlier time (expiring 6 months from now) stipulating a
forward price of $22. What is the marked-to-market value of your position?
(c) Suppose the quoted forward price is actually $24.73. Describe a strategy to take advantage of the
arbitrage opportunity.

Problem 2. (☀☀) Hedging with forward contracts. For this question assume that the interest rate is
constant.

(a) Lgu stock pays no dividend and its current price is $100. Its one-year fair forward price is $105.
What is the value of a long position in a forward contract on Lgu stock expiring in a year, with
forward price $100?
(b) Consider a long forward position in a non-dividend-paying stock with forward price F0 and
expiration date T . What is the value of this forward position at t ≤ T (marking-to-market value)?
What is the delta and gamma of this forward position?
(c) Your book of derivatives on the non-dividend-paying stock Lgu has a delta of 1000 and a gamma
of -2000.
• Suppose forward contracts for delivery of 100 shares are traded. How can you make your
position delta-neutral by trading in the forward market?
• In the options market, an option on 100 Lgu shares has a delta of 75 and a gamma of 20.
What position do you need to take in this option and in the forward market to make your
overall position both delta- and gamma-neutral?

Problem 3. (☀ ) In December 1999, the S&P500 index stands at 1390. You are strongly convinced that
the whole market is overpriced and are willing to take a bearish bet. The dividend yield on the index is
2% and the interest rate is constant at 6% (continuously compounded).

(a) Assuming there is no arbitrage, what is the futures price on the S&P500 index with delivery month
December 2002?
(b) You decide to go short in one S&P500 futures contract. These contracts are settled every 3 months
and each contract is for delivery of $100 times the index. The S&P500 index is at 1370 in March
2000, 1420 in June 2000, and 1520 in September 2000. What are the cash flows implied by your
position?

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(c) In September 2000, after suffering some losses on your position, you decide to close it. In December
2002, the S&P500 index stands at 930. Had you not closed your position, what would have been
your cumulative cash flow over the entire life of the contract? (Just compute the sum of cash flows,
neglecting the time value of money.)
(d) Suppose a futures price f follows a binomial process: ft+1 takes two possible values, uft or dft ,
where 0 < d < 1 < u. There is also a money market account with interest rate rt from t to t + 1.
Calculate the risk-neutral probability of an up move.

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