Question 1

Answer the following 10 True or False questions by filling in your answers in the table provided at the end of this section. Each correct answer will be awarded 3 marks.

a)The seller of a European put option will benefit if the underlying asset price goes down in value.

b)The six-month forward price of 1g gold is $2255.69. If the risk free rate is 5% per annum and no other holding cost is involved, the current price of this gold should be $2000.

c)The spot price of a six-month bond is $195.00. The bond is expected to pay a coupon of $20 in 3 months and the risk free interest rate for all maturities is 10% per annum. A six-month forward price of this bond is said to be over priced if it is quoted as $184.00.

d)You plan to borrow $10 million for 3 months beginning in June. You can achieve a perfect hedge of your borrowing rate by buying FRA.

e)A stock is trading at $150. A call option on the stock with a maturity of three months is trading at $9.30 and has a delta of 0.45. If the stock price increases to $159, the new call price will be more than $13.35.

f)The spot market price of premium grade palm oil is $50 per liter. A futures contract on 100,000 liters with settlement in 1 year is currently priced at $55.50 per liter. The one-year interest rate is 8% p.a. (continuously compounded) and it costs $0.70 per liter per year (payable at the beginning of each year) to store palm oil. You can make riskless arbitrage profit of $58,000 (to the nearest dollar) by buying 100,000 liters of physical palm oil, storing it and selling one futures contract.

g)Hair Asia shares and a pair of 3month options with strike price of $50 are trading at the prices in the table below. Assuming the 3month riskfree interest rate (with continuous compounding) is 10% p.a. There is no arbitrage opportunity in this set of prices.

Share Price=$52.00

Call Premium=$4.50

Put Premium=$1.26

h)In Black-Scholes option pricing model, the stock prices follow a normal distribution while the stock returns follow a log-normal distribution.

i)The Black-Scholes option pricing formula cannot be used to price European index options.

j)By shorting corn futures, corn farmers cannot hedge against the risk of adverse weather wiping out their crop.