PRACTICE QUESTIONS [FINANCIAL DERIVATIVES ]

Chapter 1: Introduction to Derivatives

1. An investor receives $1,100 in one year in return for an investment of $1,000 now. Calculate
the percentage return per annum with:
(a) Annual compounding
(b) Semiannual compounding
(c) Monthly compounding
(d) Continuous compounding.
2. Suppose that zero interest rates with continuous compounding are as follows:

Maturity Rate
(months) (% per annum)

3 6.0
6 6.2
9 6.3
12 6.5
15 6.7
18 7.0

- Calculate forward interest rates for the second, third, fourth, fifth, and sixth quarters.
- The investor intends to invest 1000 USD at the end of month 3. How much will he received
after 1 year ?
3. A deposit account pays 12% per annum with continuous compounding, but interest is
actually paid quarterly. How much interest will be paid each quarter on a $10,000 deposit ?
 PRACTICE QUESTIONS [FINANCIAL DERIVATIVES ]

4. Suppose that 6-month, 12-month, 18-month, 24-month, and 30-month zero rates are,
respectively, 4%, 4.2%, 4.4%, 4.6%, and 4.8% per annum, with continuous compounding.
Estimate the cash price of a bond with a face value of 100 that will mature in30 months and
pays a coupon of 4% per annum semiannually.
5. You would like to speculate on a rise in the price of a certain stock. The current stock price
is $29 and a 3-month call with a strike price of $30 costs $2.90. You have $5,800 to invest.
Identify two alternative investment strategies, one in the stock and the other in an option on
the stock. What are the potential gains and losses from each if the stock price increases to a)
$36 per stock and b) decreases to $27 per stock at the end of 3 months ?
6. You have $5200 to invest and you would like to speculate on a rise in the price of a certain
stock. The current stock price is $52; the futures stock price is $55, each futures contract is for
the purchase of 50 stocks, initial margin for each futures contract is $20. A 3 month call with
a strike price of $55,5 costs $4. Each option is for the purchase of 50 stocks.
1. Identify alternative investment strategies
2. What are the potential gains and losses from each strategy if the stock price at
the end of 3 months a) increases to $60 per stock and b) decreases to $52 per stock
3. Which strategies will you choose ?
7. Trung Nguyen coffee company expects to receive 2 million USD for exporting coffee to US
in the next three month. The three month forward rate is 22.000 USD/VND. A 3 month put
option to sell USD with a strike price of 23.500 costs 200.000 VND. One option is to sell 100
USD.
1. What risks is Trung Nguyen exposed to ?
2. What strategies the company could do to hedge the risks ? What are the potential
outcomes from each strategy if the 3 month exchange rate is: (a) 25.000 or (b) 20.000
3. Instruct the company what they should do to hedge the risks
 PRACTICE QUESTIONS [FINANCIAL DERIVATIVES ]

Chapter 2: Futures
1. Suppose that you enter into a 6-month forward contract on a non-dividend-paying stock
when the stock price is $30 and the risk-free interest rate (with continuous compounding) is
12% per annum. What is the forward price ?
2. A 1-year long forward contract on a dividend-paying stock is entered into when the stock
price is $40, a dividend of 2$ is expected to be paid at the end of every six month and the risk-
free rate of interest is 10% per annum with continuous compounding.
a) What is the forward price ?
b) Six months later, the price of the stock is $45 and the risk-free interest rate is still
10%. What is the 6 month forward price?
3. 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 forward price for a 4-month contract be ?
4. The risk-free rate of interest is 7% per annum with continuous compounding, and the
dividend yield on a stock index is 3.2% per annum. The current value of the index is 150. What
is the 6-month forward price ?
5. The spot price of silver is $15 per ounce. The storage costs are $0.24 per ounce per year
payable quarterly in advance. Assuming that interest rates are 10% per annum for all
maturities, calculate the forward price of silver for delivery in 9 months.
6. The 2-month interest rates in Switzerland and the United States are, respectively, 2% and
5% per annum with continuous compounding. The spot price of the Swiss franc is $0.8000.
The forward price for a contract deliverable in 2 months is $0.8100. What arbitrage
opportunities does this create ?
7. A stock is expected to pay a dividend of $1 per share in 2 months and in 5 months. The
stock price is $50, and the risk-free rate of interest is 8% per annum with continuous
compounding for all maturities.
a) What is the forward price in a 6-month forward contract ?
 PRACTICE QUESTIONS [FINANCIAL DERIVATIVES ]

b) Three months later, the price of the stock is $48 and the risk-free rate of interest is
still 8% per annum. What is the 3 month forward price ?
8. A 6-month long forward contract on $1000 is entered into when the exchange rate is 20.000
USD/VND and the risk-free rate of interest is 6% per annum in Vietnam and 3% per annum
in US with continuous compounding. Assume that the risk-free interest rate is constant.
a) What are the 6 month forward price ?
b) Three months later, the exchange rate is 22.000 USD/VND. What is the forward
price of a 6 month contract ?
9. A 9-month short forward contract on $1000 is entered into when the exchange rate is
19.000VND/USD and the risk-free rate of interest is 7% per annum in Vietnam and 4% per
annum in US with continuous compounding. Assume that the risk-free interest rates are
constant.
a) What is the 9 month forward price ?
b) Three months later, the exchange rate is 21.000VND/USD. What is the 6 month
forward price ?
10. On January 1, 20X1 a company entered into short position of a FRA contract in which the
company would receive interest at 7% per year on the principal of $10 million for a period of
6 months. The contract starts after a period of 2 years. On January 1, 20X3 the SOFR is
6%/year, compounded semiannually. Determine the cashflow exchange on the same date
11. On January 1, 20X1 a FRA contract was signed between two parties in which the seller
would receive interest at 6% p.a on the principal of $10 million for a period of 6 months. The
contract starts after a period of 1 year. On January 1, 20X2 the SOFR is 5.5%/year,
compounded semiannually. What is the payoff of FRA to the seller/buyer ?
PRACTICE QUESTIONS [FINANCIAL DERIVATIVES ]