Question 1.(This question has two parts: I and II)

You purchased 2 Soybean Oil futures contracts today at the settlement price (labeled as "Settle") listed as following.

Soybean Oil (CBT) 60,000 lbs.; cents per lb.

Lifetime

Open

High

Low

Settle

Change

High

Low

Open Interest

Oct.

15.28

15.33

15.25

15.29

-.02

20.35

15.25

7,441

Part I.

If there is a 10% initial margin requirement on total value of underlyings, how much do you have to deposit?Maintenance margin requirement is $600 for each contract. In what situation will you receive a margin call from your broker?

Part II.

Assume the volatility of Soybean Oil immediately increases 20%. How will it impact Futures price? How will it impact investor's margin account requirement? Explain your answer.

Question 2.(This question has three parts: I, II, and III)

Assume you are holding 1000 shares of XYZ stocks. You are considering using call options to hedge downside risk. The stock is selling at $45 and the following two call options are being considered for writing: an XYZ July 40 (i.e., the strike price is $40, and it expires in July); and an XYZ July 50. You are going to write 10 contracts, and each contract contains 100 options.

Part I.

Your broker provided you with the information about the prices of these two call options, one is $8 and the other is $1. But he forgot to tell you which one was for $8 and which one was for $1. Based on what you have learnt, what is the price for XYZ July 40 call? Briefly discuss, why writing a call option can provide downside protection for your stock holding.

Part II.

Compare two strategies:

Strategy A: write July 40 calls against your holding;

Strategy B: write July 50 calls against your holding.

Both strategies provide some downsize protection. Please explain which strategy offers a higher level of protection in the current case.

Part III.

Besides providing different levels of protection, these two strategies offer different profit/loss profile. Under what scenario, will strategy B outperform the strategy A? You need to show your analysis/calculation process explicitly to support your conclusion.

Question 3.(This question has two parts: I and II)

John is the CFO of company A and one of his recent tasks is to borrow $10 million for 3 years to fund the company's newly initiated project. Due to the pattern of expected cash flows generated from the to-be-funded project, John wants to have a loan with a fixed rate. He called his banks and received quotes on fixed rate 8.0% and floating rate 0.5% above the LIBOR.All rates are annualized rate in quarterly compounding.

John passes this information to his regular financial consultant Tom to seek advice. After receiving this information, Tom quickly links this case with his another customer Bob, who is the CFO of company B. Bob is looking for a $10 million 3-years floating rate loan and has received a floating rate quote 1.5% above the LIBOR and a fixed rate quote 8.5%. All rates are annualized rates in quarterly compounding.

Tom immediately realizes that he can make a decent revenue by organizing separate swap contracts with John and Bob simultaneously.

Tom decides to charge 14bps (i.e., 14 basis point, 1% = 100bps), and let John and Tom equally share the rest of benefit if there is any left.

Part I.

Design a swap contract between company A and FI which Tom works for, show your working/analysis process explicitly. Use the following table to organize key information in swap contract arrangement. With the swap contract with FI, what is the net interest rate that company A has to pay for the loan?

Part II.

Both deals went smoothly until Company B claimed bankruptcy. By that time, there were still 14 months left before the swap contract between the FI and Company B expired. As a result, Tom needs to evaluate the swap contract with Bob and immediately assess the possible loss. Let's assume that in the swap contract, Tom's company pays 7.22% per annum and receives 3-month LIBOR in return on a notional principal of $10 million with payments being exchanged every three months. One month ago, the 3-month LIBOR rate was 7.5% per annum. Assume the zero rate is 7.45% per annum for all maturities. All rates are annualized rates and compounded quarterly. What is the value of the swap on FI's book? You need to show your analysis/calculation process explicitly.

Question 4.(This question has three parts: I, II and III)

A stock price is currently $100. Over each of the next two six-month periods, it is expected to go up by 10% or down by 10%.The risk-free interest rate is 10% per year with semi-annual compounding.

Part I.

Use the two-steps binomial tree model to calculate the value of a one-year American put option with an exercise price of $101.

Part II.

Is there any early exercise premium contained in price of the above American put option? If there is, what is the early exercise premium?

Part III.

Based on no arbitrage principle and riskless portfolio we can construct along the above binomial tree, briefly discuss how we can hedge risk if we make European put option with an exercise price of $101 and 1-year maturity.

Question 5.(This question has two parts: I and II)

Part I.

Indicate whether each of the following two statements below is true, false or uncertain and justify your response.

(a)It is theoretically impossible for an out-of-money European call and an in-the-money European put to be trading at the same price. Both options are written on the same non-dividend paying stock.

(b)By simultaneously buying a call and short-selling the underlying asset, we can make synthetic short position in the put.

Part II.

A 3-month European put option on a non-dividend-paying stock is currently selling for $3.50. The stock price is $47.0, the strike price is $51, and the risk-free interest rate is 6% per annum (continuous compounding).Analyze the situation to answer the following question:

If there is no arbitrage opportunity in above case, what range of put option price will trigger an arbitrage opportunity? If there is an arbitrage opportunity in the above case, please provide one possible trading strategy to take advantage of this opportunity and show your trading results.