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options futures and other derivatives

Questions and Answers of Options Futures And Other Derivatives

How is the conversion factor of a bond calculated by the Chicago Board of Trade? How is it used?AppendixLO1
A Eurodollar futures price changes from 96.76 to 96.82. What is the gain or loss to an investor who is long two contracts?AppendixLO1
What is the purpose of the convexity adjustment made to Eurodollar futures rates? Why is the convexity adjustment necessary?AppendixLO1
The 350-day LIBOR rate is 3% with continuous compounding and the forward rate calculated from a Eurodollar futures contract that matures in 350 days is 3.2% with continuous compounding. Estimate the
It is January 30. You are managing a bond portfolio worth $6 million. The duration of the portfolio in 6 months will be 8.2 years. The September Treasury bond futures price is currently 108-15, and
The price of a 90-day Treasury bill is quoted as 10.00. What continuously compounded return (on an actual/365 basis) does an investor earn on the Treasury bill for the 90-day period?AppendixLO1
It is May 5, 2005. The quoted price of a government bond with a 12% coupon that matures on July 27, 2011, is 110-17. What is the cash price?AppendixLO1
Suppose that the Treasury bond futures price is 101-12. Which of the following four bonds is cheapest to deliver? Conversion factor Bond Price 1 125-05 2 142-15 3. 115-31 4 144-02 1.2131 1.3792
It is July 30, 2005. The cheapest-to-deliver bond in a September 2005 Treasury bond futures contract is a 13% coupon bond, and delivery is expected to be made on September 30, 2005. Coupon payments
An investor is looking for arbitrage opportunities in the Treasury bond futures market. What complications are created by the fact that the party with a short position can choose to deliver any bond
Suppose that the 9-month LIBOR interest rate is 8% per annum and the 6-month LIBOR interest rate is 7.5% per annum (both with actual/365 and continuous compounding). Estimate the 3-month Eurodollar
Suppose that the 300-day LIBOR zero rate is 4% and Eurodollar quotes for contracts maturing in 300, 398, and 489 days are 95.83, 95.62, and 95.48. Calculate 398-day and 489-day LIBOR zero rates.
Suppose that a bond portfolio with a duration of 12 years is hedged using a futures contract in which the underlying asset has a duration of 4 years. What is likely to be the impact on the hedge of
Suppose that it is February 20 and a treasurer realizes that on July 17 the company will have to issue $5 million of commercial paper with a maturity of 180 days. If the paper were issued today, the
On August 1, a portfolio manager has a bond portfolio worth $10 million. The duration of the portfolio in October will be 7.1 years. The December Treasury bond futures price is currently 91-12 and
How can the portfolio manager change the duration of the portfolio to 3.0 years in Problem 6.17?AppendixLO1
Between October 30, 2006, and November 1, 2006, you have a choice between owning a US government bond paying a 12% coupon and a US corporate bond paying a 12% coupon. Consider carefully the day count
Suppose that a Eurodollar futures quote is 88 for a contract maturing in 60 days. What is the LIBOR forward rate for the 60- to 150-day period? Ignore the difference between futures and forwards for
The 3-month Eurodollar futures price for a contract maturing in 6 years is quoted as 95.20. The standard deviation of the change in the short-term interest rate in 1 year is 1.1%. Estimate the
Explain why the forward interest rate is less than the corresponding futures interest rate calculated from a Eurodollar futures contract.AppendixLO1
Assume that a bank can borrow or lend money at the same interest rate in the LIBOR market. The 90-day rate is 10% per annum, and the 180-day rate is 10.2% per annum, both expressed with continuous
A Canadian company wishes to create a Canadian LIBOR futures contract from a US Eurodollar futures contract and forward contracts on foreign exchange. Using an example, explain how the company should
The futures price for the June 2005 CBOT bond futures contract is 118-23. (a) Calculate the conversion factor for a bond maturing on January 1, 2021, paying a coupon of 10%. (b) Calculate the
A portfolio manager plans to use a Treasury bond futures contract to hedge a bond portfolio over the next 3 months. The portfolio is worth $100 million and will have a duration of 4.0 years in 3
Companies A and B have been offered the following rates per annum on a $20 million 5-year loan: Fixed rate Floating rate Company A: Company B: 12.0% 13.4% LIBOR + 0.1% LIBOR + 0.6% Company A requires
Company X wishes to borrow US dollars at a fixed rate of interest. Company Y wishes to borrow Japanese yen at a fixed rate of interest. The amounts required by the two companies are roughly the same
A $100 million interest rate swap has a remaining life of 10 months. Under the terms of the swap, 6-month LIBOR is exchanged for 12% per annum (compounded semiannually). The average of the bid-offer
Explain what a swap rate is. What is the relationship between swap rates and par yields?AppendixLO1
A currency swap has a remaining life of 15 months. It involves exchanging interest at 14% on 20 million for interest at 10% on $30 million once a year. The term structure of interest rates in both
Explain the difference between the credit risk and the market risk in a financial contract.AppendixLO1
A corporate treasurer tells you that he has just negotiated a 5-year loan at a competitive fixed rate of interest of 5.2%. The treasurer explains that he achieved the 5.2% rate by borrowing at
Explain why a bank is subject to credit risk when it enters into two offsetting swap contracts.AppendixLO1
Companies X and Y have been offered the following rates per annum on a $5 million 10-year investment: Fixed rate Floating rate Company X: 8.0% LIBOR Company Y: 8.8% LIBOR Company X requires a
A financial institution has entered into an interest rate swap with company X. Under the terms of the swap, it receives 10% per annum and pays 6-month LIBOR on a principal of $10 million for 5 years.
Companies A and B face the following interest rates (adjusted for the differential impact of taxes): Company A US dollars (floating rate): Canadian dollars (fixed rate): LIBOR +0.5% 5.0% Company B
After it hedges its foreign exchange risk using forward contracts, is the financial institution's average spread in Figure 7.10 likely to be greater than or less than 20 basis points? Explain your
"Companies with high credit risks are the ones that cannot access fixed-rate markets directly. They are the companies that are most likely to be paying fixed and receiving floating in an interest
Why is the expected loss from a default on a swap less than the expected loss from the default on a loan with the same principal?AppendixLO1
A bank finds that its assets are not matched with its liabilities. It is taking floating-rate deposits and making fixed-rate loans. How can swaps be used to offset the risk?AppendixLO1
Explain how you would value a swap that is the exchange of a floating rate in one currency for a fixed rate in another currency.AppendixLO1
The LIBOR zero curve is flat at 5% (continuously compounded) out to 1.5 years. Swap rates for 2- and 3-year semiannual pay swaps are 5.4% and 5.6%, respectively. Estimate the LIBOR zero rates for
The 1-year LIBOR rate is 10%. A bank trades swaps where a fixed rate of interest is exchanged for 12-month LIBOR with payments being exchanged annually. The 2- and 3-year swap rates (expressed with
Company A, a British manufacturer, wishes to borrow US dollars at a fixed rate of interest. Company B, a US multinational, wishes to borrow sterling at a fixed rate of interest. They have been quoted
Under the terms of an interest rate swap, a financial institution has agreed to pay 10% per annum and to receive 3-month LIBOR in return on a notional principal of $100 million with payments being
Suppose that the term structure of interest rates is flat in the United States and Australia. The USD interest rate is 7% per annum and the AUD rate is 9% per annum. The current value of the AUD is
Company X is based in the United Kingdom and would like to borrow $50 million at a fixed rate of interest for 5 years in US funds. Because the company is not well known in the United States, this has
An investor buys a European put on a share for $3. The stock price is $42 and the strike price is $40. Under what circumstances does the investor make a profit? Under what circumstances will the
An investor sells a European call on a share for $4. The stock price is $47 and the strike price is $50. Under what circumstances does the investor make a profit? Under what circumstances will the
An investor sells a European call option with strike price of K and maturity T and buys a put with the same strike price and maturity. Describe the investor's position.AppendixLO1
Explain why brokers require margins when clients write options but not when they buy options.AppendixLO1
A stock option is on a February, May, August, and November cycle. What options trade on (a) April 1 and (b) May 30?AppendixLO1
A company declares a 2-for-1 stock split. Explain how the terms change for a call option with a strike price of $60.AppendixLO1
How is an executive stock option different from a regular exchange-traded or over-the- counter American-style stock option?AppendixLO1
A corporate treasurer is designing a hedging program involving foreign currency options. What are the pros and cons of using (a) the Philadelphia Stock Exchange and (b) the over-the-counter market.
Suppose that a European call option to buy a share for $100.00 costs $5.00 and is held until maturity. Under what circumstances will the holder of the option make a profit? Under what circumstances
Suppose that a European put option to sell a share for $60 costs $8 and is held until maturity. Under what circumstances will the seller of the option (the party with the short position) make a
Describe the terminal value of the following portfolio: a newly entered-into long forward contract on an asset and a long position in a European put option on the asset with the same maturity as the
A trader buys a call option with a strike price of $45 and a put option with a strike price of $40. Both options have the same maturity. The call costs $3 and the put costs $4. Draw a diagram showing
Explain why an American option is always worth at least as much as a European option on the same asset with the same strike price and exercise date.AppendixLO1
Explain why an American option is always worth at least as much as its intrinsic value.AppendixLO1
Explain carefully the difference between writing a put option and buying a call option.AppendixLO1
The treasurer of a corporation is trying to choose between options and forward contracts to hedge the corporation's foreign exchange risk. Discuss the advantages and disadvantages of each.AppendixLO1
Consider an exchange-traded call option contract to buy 500 shares with a strike price of $40 and maturity in 4 months. Explain how the terms of the option contract change when there is: (a) a 10%
"If most of the call options on a stock are in the money, it is likely that the stock price has risen rapidly in the last few months." Discuss this statement.AppendixLO1
What is the effect of an unexpected cash dividend on (a) a call option price and (b) a put option price?AppendixLO1
Options on General Motors stock are on a March, June, September, and December cycle. What options trade on (a) March 1, (b) June 30, and (c) August 5?AppendixLO1
Explain why the market maker's bid-offer spread represents a real cost to options investors.AppendixLO1
A United States investor writes five naked call option contracts. The option price is $3.50, the strike price is $60.00, and the stock price is $57.00. What is the initial margin
The price of a stock is $40. The price of a 1-year European put option on the stock with a strike price of $30 is quoted as $7 and the price of a 1-year European call option on the stock with a
"If a company does not do better than its competitors but the stock market goes up, executives do very well from their stock options. This makes no sense." Discuss this viewpoint. Can you think of
Use DerivaGem to calculate the value of an American put option on a non-dividend- paying stock when the stock price is $30, the strike price is $32, the risk-free rate is 5%, the volatility is 30%,
On July 20, 2004, Microsoft surprised the market by announcing a $3 dividend. The ex- dividend date was November 17, 2004, and the payment date was December 2, 2004. Its stock price at the time was
List the six factors that affect stock option prices.AppendixLO1
What is a lower bound for the price of a 4-month call option on a non-dividend-paying stock when the stock price is $28, the strike price is $25, and the risk-free interest rate is 8% per
What is a lower bound for the price of a 1-month European put option on a non- dividend-paying stock when the stock price is $12, the strike price is $15, and the risk-free interest rate is 6% per
Give two reasons why the early exercise of an American call option on a non-dividend- paying stock is not optimal. The first reason should involve the time value of money. The second should apply
"The early exercise of an American put is a trade-off between the time value of money and the insurance value of a put." Explain this statement.AppendixLO1
Explain why an American call option on a dividend-paying stock is always worth at least as much as its intrinsic value. Is the same true of a European call option? Explain your answer.AppendixLO1
The price of a non-dividend-paying stock is $19 and the price of a 3-month European call option on the stock with a strike price of $20 is $1. The risk-free rate is 4% per annum. What is the price of
Explain why the arguments leading to put-call parity for European options cannot be used to give a similar result for American options.AppendixLO1
What is a lower bound for the price of a 6-month call option on a non-dividend-paying stock when the stock price is $80, the strike price is $75, and the risk-free interest rate is 10% per
What is a lower bound for the price of a 2-month European put option on a non- dividend-paying stock when the stock price is $58, the strike price is $65, and the risk-free interest rate is 5% per
A 4-month European call option on a dividend-paying stock is currently selling for $5. The stock price is $64, the strike price is $60, and a dividend of $0.80 is expected in 1 month. The risk-free
A 1-month European put option on a non-dividend-paying stock is currently selling for $2.50. The stock price is $47, the strike price is $50, and the risk-free interest rate is 6% per annum. What
Give an intuitive explanation of why the early exercise of an American put becomes more attractive as the risk-free rate increases and volatility decreases.AppendixLO1
The price of a European call that expires in 6 months and has a strike price of $30 is $2. The underlying stock price is $29, and a dividend of $0.50 is expected in 2 months and again in 5 months.
Explain carefully the arbitrage opportunities in Problem 9.14 if the European put price is $3.AppendixLO1
The price of an American call on a non-dividend-paying stock is $4. The stock price is $31, the strike price is $30, and the expiration date is in 3 months. The risk-free interest rate is 8%. Derive
Explain carefully the arbitrage opportunities in Problem 9.16 if the American put price is greater than the calculated upper bound.AppendixLO1
Prove the result in equation (9.4). (Hint: For the first part of the relationship, consider (a) a portfolio consisting of a European call plus an amount of cash equal to K, and (b) a portfolio
Prove the result in equation (9.8). (Hint: For the first part of the relationship, consider (a) a portfolio consisting of a European call plus an amount of cash equal to D + K, and (b) a portfolio
Regular call options on non-dividend-paying stocks should not be exercised early. How- ever, there is a tendency for executive stock options to be exercised early even when the company pays no
Use the software DerivaGem to verify that Figures 9.1 and 9.2 are correct.AppendixLO1
A European call option and put option on a stock both have a strike price of $20 and an expiration date in 3 months. Both sell for $3. The risk-free interest rate is 10% per annum, the current stock
Suppose that c1, c2, and c3 are the prices of European call options with strike prices K, K2, and K3, respectively, where K3 > K > K and K3 - K = K2 - K. All options have the same maturity. Show that
What is the result corresponding to that in Problem 9.23 for European put options?AppendixLO1
Suppose that you are the manager and sole owner of a highly leveraged company. All the debt will mature in 1 year. If at that time the value of the company is greater than the face value of the debt,
Consider an option on a stock when the stock price is $41, the strike price is $40, the risk- free rate is 6%, the volatility is 35%, and the time to maturity is 1 year. Assume that a dividend of
What is meant by a protective put? What position in call options is equivalent to a protective put?AppendixLO1
Explain two ways in which a bear spread can be created.AppendixLO1

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