Question 1

(a)Suppose that an investor holds a share of Sophia stock, currently valued at $50. She is concerned that over the next few months the value of her holding might decline, and she would like to hedge that risk by supplementing her holding with the following choices of derivative positions:

(i)A long position in a put option with an exercise price of $50 and a front-end premium expense of $3.23

(ii) A short position in a call option with an exercise price of $50 and a front-end premium receipt of $5.20

Complete the following table for the above positions in your answer book and the net value of the portfolio refers to the holding of the stock and related option position:

Expiration Date Expiration DateInitialNet Value of

Sophia Stock Price($)Derivative PayoffDerivative Premiumthe Portfolio

25

30

35

40

45

50

55

60

65

70

75

(b) Discuss the financial risks of investing in the AUD/USD accumulators in the case of "CITIC Pacific: When Hedging Turned Sour, a Lesson in Structured Products in Hong Kong. Did the company demonstrate effective risk management in handling structured financial product? Explain how options could be used to hedge the risk.

Question 2:

(a)TheHong Kong government became an active market participant which bought about US$15 billionshares of companies trading on theHang Seng Index in August 1998 in the face of the Asian economic crisis. Discuss the pros and cons of its actions.

(b)Discuss the major risks of buying Exchange Traded Funds (ETF).

(c)What are the major challenges in developing ETF products in Hong Kong?