3. Derivatives Contracts (12 marks) 1) Bitcoin (BTC) is currently quoted at USD $40000 per unit. The riskless interest rate is 1.5% p.a. annually compounded. BTC can be purchased/sold in fractions (i.e. you can purchase 0.1 BTC in the spot market).

a) Ed plans to sell his current investment portfolio in a years time, after it has rebounded, and invest all the proceeds in Bitcoins. However, he is afraid Bitcoin will significantly rise in price over that period and would like to find a way to lock in its price. Which position (long or short) should he take in the futures market to hedge the price risk of BTC? (1 mark)

b) Micro Bitcoin futures traded on the CME have a contract size of 0.1 BTC. What should be the arbitrage-free futures price for the delivery of 0.1 BTC in a years time given the going price for 1BTC and the risk-free rate? (1 mark) c)

If Ed observes a 1-year futures price of Micro Bitcoin futures $3,992.00, explain how he can set up an arbitrage strategy to make a riskless profit (provide details including all the cash flows now and 1 year from now). (4 marks)

2) Current share price of ABDC Corp is $50. Given her forecasts of the future share value, Misha bought two put options on ABDC with a strike price of $50 and sold two put options one with strike price of $45, the other $55. Information on the options can be found in the table below: Option Type Exercise Price Premium Put 45 $1.84 Put 50 $3.96 Put 55 $6.99 All options are European options and have ABDC Corp as underlying; all options have identical maturities. In the table below, tabulate the profits of Mishas investment strategy (ST stands for the share price of ABDC at option maturity; the payoff and profit can be a function of ST).

a) What is the maximum profit? What about maximum loss? (5 marks) ST < 45 45 < ST < 50 50 < ST < 55 ST > 55 payoff profit

b) What is Mishas expectation of the share price of ABDC Corp, given her investment strategy? (maximum 2 sentences) (1 mark)