May Examination Period 2020

ECN358 FUTURES AND OPTIONS

Duration: 3 hours

Answer ALL questions.

If you answer more questions than specified, only the first answers (up to the
specified number) will be marked. Delete any answers that you do not wish to be
marked. The final submission on QMplus is the version that will be marked.

This examination paper MUST NOT be shared with anyone else. Doing so will be considered a
very serious assessment offence under the Queen Mary Academic Misconduct Policy.

This examination is an individual assessment and must be entirely your own work. All work will be
run through the plagiarism software, Turnitin. The software will also compare your script against all
other student submissions. Any evidence of plagiarism or collusion will be taken forward as
acacemic misconduct.

Calculators are permitted in this examination.

Please ensure that your working is clearly shown with all steps of your calculation included in your
answer document, including any formula used.

When writing formulas, please note the following:

• It is acceptable to use the standard alphabet rather than greek letters. The following are
recommended: m for µ, s for σ, w for ω, r for ρ, d for Δ, b for β

• For mathematical operators: add +, subtract -, multiply *, and divide /

• Where appropriate, use an underscore to indicate a subscript, Eg r_f for rf

• Use the ^ character for power, eg x^2 for x2, x^0.5 for √x

• As an alternative to x^.5 you may type sqrt(x).

• Use brackets as necessary. To make your answer clearer use different brackets where appropriate, eg
[] {} ()

Examiner: Sarah Mouabbi

© Queen Mary, University of London, 2020

Page 2 ECN358 (2020)

Question 1

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

[10 marks]

Question 2

A Forward Rate Agreement (FRA) entered into some time ago ensures that a company
will receive 4% per annum on $100 million for six months starting in 1 year. The Forward
LIBOR for the period is 5% per annum. The 1.5 year rate is 4.5% per annum with
continuous compounding. What is the value of the FRA (in $ millions)?

[10 marks]

Question 3

Define what an interest-rate swap is and explain how the concept of comparative
advantage is used in the context of transforming a liability.

[12 marks]

Question 4

How can a trader change the Delta, Gamma and Vega of their portfolio, respectively?

[12 marks]
ECN358 (2020) Page 3

Question 5

Suppose that put options on a stock with strike prices $30 and $35 cost $4 and $7,
respectively.

a) Detail the portfolio an investor would need to hold to construct: (i) a bull spread and (ii)
a bear spread. How much would these two portfolios cost, respectively?

[8 marks]

b) Under which economic conditions would an investor choose to construct (i) a bull
spread and (ii) a bear spread.
[8 marks]

Question 6

Provide the intuition behind option pricing using binomial trees.

[20 marks]

Question 7

What is securitisation and what was its role in the build-up of the credit crisis of 2007?

[20 marks]

End of Paper