3. Derivatives Contracts (12 marks)

Q3 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) Sarah bought 0.5 BTC 5 years ago and has held on to the investment since. She knows she will need to convert her investment to cash a year from now as she would like to use that money for a home down payment. However, she is afraid the current plummeting in BTC price might affect her investment. Which position (long or short) should she 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 Sarah observes a 1-year futures price of Micro Bitcoin futures $4,092.00, explain how she 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)