EFB344 Risk Management and Derivatives

Tutorial W7: Forwards and Futures 2

Readings: Hull et al. (2014) Fundamentals of Futures and Options,

Ch. 5 (not 5.10) and Ch. 6

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General Questions:
Question 1

Provide an example of index arbitrage using futures contracts.

Question 2

Compare and contrast the duration targeting formula and the beta targeting formula.

Question 3

Why might a hedge based on duration targeting not work?

Question 4

A stock index currently stands at 350. The risk-free interest rate is 8% p.a. (with continuous
compounding) and the dividend yield on the index is 4% p.a. What should the futures price for a four-
month contract be?

Question 5

It is 9 January 2013. The yield on a Treasury bond with a 12% coupon that matures in 12 October 2020
is quoted as 5.04%. Assume a face value of $100,000. What is the cash price? (Hint: There are 93 days
until the next coupon payment on 12 April 2013 which will occur 182 days after the last payment).

Question 6

A 90-day bank accepted bill futures price changes from 96.76 to 96.82. What is the gain or loss to an
investor who is long the two contracts?

Question 7
A one-year long forward contract on a non-dividend-paying stock is entered into when the stock
price is AUD 40 and the risk-free rate of interest is 10% pa with continuous compounding. (a) What
are the forward price and the initial value of the contract? (b) Six months later, the price of the stock
is AUD 45 and the risk-free interest rate is still 10%. What are the forward price and value of the
forward contract?

Question 8

Suppose that the risk free rate is 10% pa with continuous compounding and that the dividend yield
on the stock index is 4% pa. The index is standing at 400 and the futures price for a contract
deliverable in four months is 405. What arbitrage opportunities does this create?

Question 9

On 1 August, a portfolio manager has a bond portfolio worth $10million. The duration of the
portfolio in October will be 7.1 years. The December 10-year Treasury bond futures price is
currently 95.12 with duration 7.8 years. How should the portfolio manager immunise the portfolio
against changes in the interest rates (i.e. – remove market risk) over the next two months?