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- Fundamentals of Futures and Options Markets Edition 7 ch 12 Problem Solutions
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(a) When a CBOE option on IBM is exercised, IBM issues more stock

(b) An American option can be exercised at any time during its life

(c) An call option will always be exercised at maturity if the underlying asset price is greater than the

strike price

(d) A put option will always be exercised at maturity if the strike price is greater than the underlying

asset price.

ANS: A

2. A trader sells 100 European put options with a strike price of $50 and a time to maturity of six

months. The price received for each option is $4. The price of the underlying asset is $41 in six months.

What is the trader's gain or loss? ………

3. A company enters into a short futures contract to sell 50,000 pounds of cotton for 70 cents per

pound. The initial margin is $4,000 and the maintenance margin is $3,000. What is the futures price

above which there will be a margin call? ………..

ANS: 72 cents

4. You sell three December gold futures contracts when the futures price is $410 per ounce. Each

contract is on 100 ounces of gold and the initial margin per contract is $2,000. The maintenance margin

per contract is $1,500. During the next seven days the futures price rises slowly to $412 per ounce.

What is the balance of your margin account at the end of the seven days?

ANS: $5400

5. On March 1 the price of a commodity is $300 and the December futures price is $315. On November 1

the price is $280 and the December futures price is $281. A producer entered into a December futures

contracts on March 1 to hedge the sale of the commodity on November 1. It closed out its position on

November 1. What is the effective price received by the producer? …………

ANS: $314

6. Suppose that the standard deviation of monthly changes in the price of commodity A is $2. The

standard deviation of monthly changes in a futures price for a contract on commodity B (which is similar

to commodity A) is $3. The correlation between the futures price and the commodity price is 0.9. What

hedge ratio should be used when hedging a one month exposure to the price of commodity A? …………..

ANS: .6

7. The three-year zero rate is 7% and the four-year zero rate is 7.5% (both continuously compounded.

What is the forward rate for the fourth year? ………..

ANS: 9%

8. A short forward contract that was negotiated some time ago will expire in three months and has a

delivery price of $40. The current forward price for three-month forward contract is $42. The risk-free

interest rate (with continuous compounding) is 8%. What is the value of the short forward contract?

……….

ANS: -1.96

9. An investor shorts 100 shares when the share price is $50 and closes out the position six months later

when the share price is $43. The shares pay a dividend of $3 per share during the six months. What is

the investor's profit or loss? ………….

10. Suppose you enter into an interest rate swap where you are receiving floating and paying fixed.

Which of the following is true?

(a) Your credit risk is greater when the term structure is upward sloping than when it is downward

sloping.

(b) Your credit risk is greater when the term structure is downward sloping than when it is upward

sloping.

(c) Your credit risk exposure increases when interest rates decline unexpectedly.

(d) Your credit risk exposure increases when interest rates increase unexpectedly

ANS: A&D

(b) The principal amounts usually flow in the opposite direction to interest payments at the beginning of

a currency swap and in the same direction as interest payments at the end of the swap.

(c) The principal amounts usually flow in the same direction as interest payments at the beginning of a

currency swap and in the opposite direction to interest payments at the end of the swap.

ANS: B

12. Consider an exchange traded put option to sell 100 shares for $20.

Give (a) the strike price and (b) the number of shares that can be sold after

ANS: A B and D

14. A call and a put on a stock have the same strike price and time to maturity. At 10:00am on a certain

day, the price of the call is $3 and the price of the put is $4. At 10:01am news reaches the market that

has no affect on the stock price, but increases its volatility. As a result the price of the call changes to

$4.50. What would you expect the price of the put to change to? ………….

ANS: $5.50

15. What is the lower bound for the price of a six-month European put option on a stock when the stock

price is $40, the strike price is $46 and the risk-free interest rate is 6%?

ANS: $4.64

16. Six-month call options with strike prices of $35 and $40 cost $6 and $4, respectively.

What is the maximum gain when a bull spread is created from the calls? ………..

ANS: $3

dx=a dt+b dz

What is the mean value of the variable after three years? …………….

ANS: 16

Considering information given in Q 17, what is the standard deviation of the value of the variable after

three years? ……………..

ANS: 5.20

18. A stock price is $30, the expected return is 18% per annum and the volatility is 20% per annum.

What is the mean of the logarithm of the stock price in two years? …………….

ANS: 3.721

Considering information given in Q 18, what is the standard deviation of the logarithm of the stock price

in two years? ____________

ANS: .283

19. For a call option on a non-dividend-paying stock, the stock price is $30, the strike price is $29, the

risk-free interest rate is 6% per annum, the volatility is 20% per annum and the time to maturity is three

months. Expressed in terms of the cumulative normal function, N(x), what is the price of the call option?

…………………………………………….

ANS: 30N(0.5390)−28.57N(0.4390)

20. Considering information given in Q21, what is the price of the option (expressed in terms of the

cumulative normal function, N(x)) if the option is a put? …………………………….

ANS: 28.57N(−0.4390)−30N(−0.5390)

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