Provide brief responses to the following:

(a) For American style options, selling the option rather than exercising the option would almost always be the better choice. Briefly explain why this is the case.

(4 marks)

(b) As a general rule of thumb, a long position in futures will be profitable when prices increase. So if you were a confectioner, and you are concerned over a possible increase in the price of cocoa, you would hedge your position by taking a long position in cocoa futures. Hence, if cocoa prices were to increase, your loss in the spot market would be offset by a gain in the cocoa futures position. However, in the case of interest rate futures, if you plan to borrow money in the near future, and you are worried about a possible increase in interest rates, the appropriate hedging strategy would be to take a short position in interest rate futures. How do you explain this?

(4 marks)

(c) Briefly explain why, in the case of options, margins are only collected for the short position, and not for the long position.

(4 marks)

(d) What specific role did the Credit Default Swap (CDS) play in the 2008 (Sub-Prime) Global Financial Crisis?

(4 marks)

(e) The Islamic contract of bay al-urbun has fundamental similarities with the conventional contract of put options. Do you agree?