QUESTION ONE.

You are the dealer in one of the reputable banks and one of your roles is related to trading and monitoring of changes in the derivative markets. You are interested in one stock for Bally International hedgers; the stock under consideration is currently trading at K25 it can either go up or down by 15 percent in any given period. The risk-free rate is 10 percent. You decide to take the long position in this stock at an exercise price of 20 with the contract expiry date 6 months from now.

Required:

i. At how much are you going to purchase the rights today?

ii. What is the time value of this Option?

iii. At how much will the rights in a Put option be trading at?

iv. If the main difference between a Forward and Futures contract is that of standardization and market trading, then how are futures contracts superior to Forwards.

QUESTION TWO.

A.

Holding onto an asset can bring Monetary and non-monetary benefits. In relation to taking position in derivative contracts explain how each can be used to affect the positions you take.

B.

Floro Corp purchased call options for speculative purposes. If these options are exercised, Floro Corp will immediately sell the Kwachas in the spot market. Each option was purchased for a premium of k3 per unit, with an exercise price of k81. Floro Corp plans to wait until the expiration date before deciding whether to exercise the options. Of course, Floro Corp will exercise the options at that time only if it is feasible to do so. In the following table, fill in the net profit (or loss) per unit to Floro Corp. based on the listed possible spot rates of the Kwacha on the expiration date. Provide the answers in the Net Profit (Loss) per unit to Floro Corp Column.

Possible Spot Rate of Kwacha on expiration date	Net Profit (Loss) per unit to Floro Corp.	Remarks on exercise
k 76
K78
K80
K82
K85

C.

An assumption is made that you own a security currently worth K500. You plan to sell it in two months. To hedge against a possible decline in price during the next two months, you enter into a forward contract to sell the security in two months. The risk free is 3.5%.

a. Calculate the forward price on this contract.

b. Suppose the dealer offers to enter into forward contract at K498. Indicate how you could earn an arbitrage profit.

c. After one month, the security sells for K490. Calculate the gain or loss to your position.