UNIVERSITY OF CAPE TOWN

SCHOOL OF ECONOMICS
ECO400W / ECO401W

HONOURS
FINANCIAL ECONOMICS
EXAMINATION SEPTEMBER 2004
Futures, options, Derivatives

Date: 13 September, 2004

Time: 2 hours
Answer all questions
All questions carry equal weight

1.
(a) On 1st March the price of gold is $300 and the December futures price
is $315. On 1st November the price of gold is $280 and the December
futures price is $281. A gold producer entered into a December futures
contracts on 1st March to hedge the sale of gold on 1 st November. It
closed out its position on 1st November.
What is the effective price received by the producer for the gold?
(b) A short forward contract that was negotiated some time ago will expire
in 3 months and has a delivery price of R40. The current forward price
for a 3-month forward contract is R42. The 3-month risk-free interest
rate (with continuous compounding) is 8%.
What is the value of the short forward contract?
(c) A hedger takes a long position in an oil futures contract on 1 st
November, 1999 to hedge an exposure on 1st March, 2000. The initial
futures price is $20. On 31st December, 1999 the futures price is $21.
On 1st March, 2000 it is $24. The contract is closed out on 1 st March,
2000. Each contract is on 1000 barrels of oil.
What gain is recognized in the accounting year 1st January to 31st
December, 2000?

2. An option pays off max[(S T K ),0] 2 at time T where S T is the stock price
at time T and K is the strike price. Consider the situation where K=R26 and T
is 1 year. The stock price is currently R24 and at the end of 1 year it will be
either R30 or R18. The risk-free interest rate is 5%.
(a) What is the risk-neutral probability of the stock rising to R30?
(b) What position in the stock is necessary to hedge a short position in 1
option?
(c) What is the value of the option?
3. Portfolio A consists of a 1-year zero-coupon bond with a face value of R2000
and a 10-year zero-coupon bond with a face value of R6000. Portfolio B
consists of a 5.95-year zero-coupon bond with a face value of R5000. The
current yield on all bonds is 10% per annum.
(a) Show that both portfolios have the same duration
(b) Show that the percentage changes in the values of the two portfolios
for a 0.1% per annum increase in yields are the same.
4. A currency swap has a remaining life of 15 months. It involves exchanging
interest at 14% on 20 million for interest at 10% on $30 million once a year.
The term structure of interest rates in both the UK and the USA is currently
flat, and if the swap were negotiated today the interest rates exchanged would
be 8% in dollars and 11% in sterling. All interest rates are quoted with annual
compounding. The current exchange rate (dollars per sterling) is 1.6500.
Decompose the swap into forward contracts and find its value to the party
paying dollars.
5.
(a) Three put options on a stock have the same expiration date and strike
prices of R55, R60 and R65. The market prices of the options are R3, R5
and R8, respectively.
Create a butterfly spread and construct a table showing the profit from the
strategy.
(b) A European call option and a put option on a stock both have a strike price
of R20 and an expiration date in 3 months. Both sell for R3. The risk-free
interest rate is 10% per annum, the current stock price is R19 and a R1
dividend is expected in 1 month.
Identify the arbitrage opportunity open to a trader.