1. (4 points) Explain why derivatives are better described as financial instruments and not as financial securities.

2. (6 points) The futures market exchange in the UAE introduced two exotic futures contracts: Heating degree-day1 and cooling degree-day2 futures contracts. These contracts make payments based on whether the temperature is unusually very hot or very cold. Explain why the following businesses might be interested in such a contract:

   1. Soft-drink manufacturer

   2. Amusement park operator

3. (4 points) SABIC knows it will receive 50 million Japanese Yen (JPY) in six months. The current exchange rate is 0.0345 SAR per JPY. Discuss how forward and options contracts can be used by SABIC to hedge its exposure.

4. (9 points) Your friend saved 12,000 SAR during his studies in KSU. He wants to invest and he wants your help to choose one of the following two alternative investment opportunities. The first is buying 10 ounces of gold or buying 1,200 call options. The current price of gold is 1200 SAR, and the 6- month European call option with a strike price 1185 SAR is 12 SAR. He strongly feels that the price of gold will increase.

   1. What is your advice to your friend (explain your advice)?

   2. At what price both strategies will provide the same profit?

   3. What is the risk associated with each type of investment?

5. (12 points) You have a financial consultation company and a farmer from Egypt needs your help to design a strategy that help him hedge his wheat production. He expects this years harvest will produce approximately 15,000 bushels of wheat, which he will collect in September 2020. He needs your help to completely hedge his production using CME futures contracts. The following are the prices for different futures contracts:

   Month	Last price
   Aug 2020	508 cent
   Oct 2020	524 cent
   Dec 2020	545 cent

   a. What position should he take? If each wheat includes 5,000 bushels, how many futures contracts he should enter to hedge his harvest? B. Which futures contract should he choose? C.The initial margin is $4,000 and the maintenance margin is $2,500. What price would lead to a margin call? d. When he could withdraw $1,500 from the margin account?

6. 6. (8 points) The table above is a snapshot of the gold futures market activity. One of the variables you see in the table above is open interest (OPEN INT). A.Explain what does it means. Why do you think the open interest usually decrease during the month preceding the delivery month? B.Assume on Tuesday, Oct 2, there were 4,500 trades in a particular futures contract. This means there were 4,500 traders took a long position and 4,500 took a short position. Of the 4,500 buyers, 3,150 were closing out positions and 1350 were entering new positions. Of the 4,500 sellers, 2700 were closing out positions and 1800 were entering into new positions. How this days trading activity will affect the open interest?

7. (17 points) A trader owns 2,500 ounces of Rhodium (a precious metal) and plans to sell them after three months. The price of Rhodium reached an unusually high level, the trader believes the price is likely to go down. Hence, he decided to hedge the value of Rhodium he owns. Since no futures contract exists for Rhodium, he chooses to hedge with a futures contract on Palladium. Each futures contract is on 100 ounces. The daily spot prices of Rhodium and the daily futures prices of Palladium are available in the accompanying Excel file. Using the available data, help the trader design an optimal hedge strategy: A.Should the hedger take a long or short futures position? B.What is the minimum variance hedge ratio? C.What is the optimal number of futures contracts when adjustments for daily settlement are not considered? D.How can daily settlement be taken into account?

   (8 points) It is July 16. A company has a portfolio of stocks worth $150 million. Beta of the portfolio is 1.6. The company would like to use the December futures contract on a stock index to change beta of the portfolio to 0.5 during the period July 16 to November 16. The index is currently 2,100, and each contract is on $250 times the index.

   (a) What position should the company take and how many contracts?

   (b) Suppose that the company changes its mind and decides to increase the beta of the portfolio from 1.75 to 2.5. What position in futures contracts should it take and how many contracts?

   9. (10 points) You observe in the oil market the following prices:

8. Date	WTI Oil Spot Price	WTI Oil futures Prices
   13/09/2019	54.76	54.59
   16/09/2019	63.1	62.02

   If the futures contract expires after 3 months (on 22/12/2019) and the continuously compounded risk- free rate is 1.5682%, estimate what will be the convenience yield for oil on each date. What do you observe and how do you explain this observed difference?

   10. (12 points) A stock is expected to pay a dividend of $3 per share in four months and in ten months. The stock price is $90, and the risk-free rate of interest is 5% per annum with continuous compounding for all maturities. An investor has just taken a short position in a twelve-month forward contract on the stock.

   (a) What are the forward price and the initial value of the forward contract?

   (b) Six months later, the price of the stock is $76 and the risk-free rate of interest changed to 4% per annum. What are the forward price and the value of the short position in the forward contract?11. (10 points) Your cousin trades actively in a stock that does not pay dividends and as part of a long-term investment portfolio. Your cousin can buy the stock for $1,100 per share and sell it for $1099 per share. He can borrow funds at 4.5% per year and invest funds at 4% per year. (Both interest rates are expressed with annual compounding.) For what range of one-year forward prices does your cousin has no arbitrage opportunities and why? Assume the bid and offer for a forward price are the same.