MFIN6003 Derivative Securities Dr.

Huiyan Qiu

Extra Note for Session One: Introduction to Derivatives

Solution to the in-class exercise I on slide 1-26:

5% semi-annual compounding → (1 + 5%/2)2 – 1 = 5.06% effective
annual interest
To result in the same effective annual interest
a) Annual compounding:
1 + 𝑟 = (1 + 5%/2)2 → r = 5.06%
b) Monthly compounding:
(1 + 𝑟/12)12 = (1 + 5%/2)2 → r = 4.95%
c) Continuously compounding:
𝑒 𝑟 = (1 + 5%/2)2 → r = 4.94%

Solution to the in-class exercise II on slide 1-27:

Let x denote the amount of money your grandparents put into the
account when you were born. Then we have the following:
𝒙 × 𝟏. 𝟎𝟒𝟐𝟐 = 𝟐𝟑, 𝟔𝟗𝟗
Solving the equation, we have 𝑥 = 10,000. The amount of money
your grandparents put into the account when you were born is
$10,000.
The amount of money in the account on your 32 nd birthday:
$10,000 × 1.0432 = $𝟑𝟓, 𝟎𝟖𝟎. 𝟓𝟗
The amount of money in the account on your 32 nd birthday:
$10,000 × 1.0465 = $𝟏𝟐𝟕. 𝟗𝟖𝟕. 𝟑𝟓

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MFIN6003 Derivative Securities Dr. Huiyan Qiu

Example on basic transaction:

0 T

Case 1: – 32.50 * 100 32.50 * 100

– 32.50 * 100 * 0.5% –32.50 * 100 * 0.5%
= – 3250 * 1.005 = 3250 * 0.995

Case 2: 3200 * 0.995 – 3300 * 1.005

• Without considering the market interest rate,

Case 1: – 3250 * 1.005 + 3250 * 0.995 = – 32.50
Case 2: 3200 * 0.995 – 3300 * 1.005 = – 132.50

• With the market interest rate taken into account,

Case 1: – 3250 * 1.005 * 1.02 + 3250 * 0.995 = – 97.825
Case 2: 3200 * 0.995 * 1.02 – 3300 * 1.005 = – 68.82

Discussion Question: at what interest rate, profit/loss from short-selling or from

outright purchase is the same?

− 3250 *1.005 * x + 3250 * 0.995

= 3200 * 0.995 * x − 3300 *1.005
3250 * 0.995 + 3300 *1.005
x= = 1.0155
3250 *1.005 + 3200 * 0.995

When the market interest rate is 1.55% over the investment period, the profit/loss
from short-selling or from outright purchase is the same.