BaaaBEseetoeN BUS 337 FINANCIAL INSTRUMENTS Solutions to Suggested Homework Problems frm Hull th ed) Problems 121,128 210,211,227 33,311, 3 61,67, 6.10 75,7, 712,717, 722,728,725 83,84, 88, 811,814,815, 816,819,820 317,319 122, 125, 12.6, 127, 12.15, 12.16, 12.26, 12.42, 12.44 138, 13:19, 1320, 13.26, 13.25 165, 166, 168, 1613, 173,175,197, 1710, 19.11, 17.13 219CHAPTER 1 1.21. The arbitrageur could borrow money to buy 100 ounces of gold today and short futures contracts on 100 ounces ounces of gold for delivery in one year, This means that gold is purchased for $500 per ounce and sold for $700 per ounce. The return (40% per annum) is far greater than the 10% cost ofthe borrowed funds. This is such ‘ profitable opportunity that the erbitrageur should buy as many ounces of gold as possible and short futures contracts on the same number of ounces. Unfortunately arbitrage opportunities as profitable as this rarely arise in practice 41.28. (a) The trader buys 1 180-day call option and takes a short position in a 180 day forward contract. If Sr isthe terminal spot rate, the profit from the call option is max (Sr ~1.57, 0)~ 0.02 ‘The profit from the short forward contract is 1.6018 ~ Sp ‘The profit from the strategy is therefore ‘max (Sz ~1.87, 0) — 0.02 +1.6018 - Sp smax Sr ~ 187, 0)+1.8818 ~ Sy ee 1S818—Sp when Sp < 187 OO” when Sr > 1.57 ‘This shows chat the prot is always postive, The time value of money has been ignored in thwe calculation. However, when iti taken into account the strategy Stl Hey to be profitable inal circumstances, (We would require an extremely high interest rte for S0.0118 interest to be required on en outlay of $0.02 over a 180-day period.) (@) The trader buys S0-day put options and takes along poston in 890 day forward contrct. If Sp isthe terminal spot rate, the prof from the put option is ‘max (1.64 ~ Sr, 0) ~ 0.020 ‘The profit from the long forward contract is Sr ~ 1.6056, ‘The profit from this strategy i therefore max (1.64 ~ Sp, 0) = 0.020-+ Sy ~ 1.6056 ‘max (1.64 ~ Sy, 0) + Sp ~ 1.6256 This is Sp—16256 when Sp > 1.66 001s when Sp <1.64 ‘The profit is therefore always positive. Again, the time value of money has been ‘ignored but is unlikely to affect the overall profitability of the strategy. (We would require interest rates to be extremely high for 80.0144 interest to be required on an outlay of $0.02 over a 90-day period.)2.10. 2.11. 2.27. CHAPTER 2 There will be a margin call when $1,000 has been lost from the margin account, This will occur when the price of silver increases by 1000/5000 = $0.20. The price of silver ‘must therefore rise to $5.40 per ounce for there to be a margin call. Ifthe margin call is not met, the position is closed out. ‘These options make the contract less attractive to the party with the long position and more attractive to the party with the short position. They therefore tend to reduce the futures price. The mining company can estimate its production on a month-by-month basi. Tt ean then short futures contracts to lock in the price received for the gold. For example, if ‘8000 ounces are expected to be produced in November 1999 and December 1999, the price received for this production can be hedged by shorting a total of 30 December 1999 contracts.