NUGSB MSF Investments II

Problem Set 1
Futures Markets
Deadline: Sunday 21 January 2014, 23:59.

Consider the below closing market prices for a hypothetical growth stock ABC and a futures contract
on that stock for 17 consecutive trading days in January 2013. The futures contract calls for the
delivery of 1,000 stocks ABC on the fourth Friday of the month, January 25, 2013. You bought 100 of
these futures contracts. The contracts are marked to the market. ABC company reinvests all net
earnings and does not pay dividends. The expected return to the stock is 20% per annum.

Days to Spot Futures

maturit T-bill price price
day month Year y yield (TLY) (TLY)
3 Jan 2013 16 6.05 8.68 8.71
4 Jan 2013 15 6.07 8.72 8.75
7 Jan 2013 14 6.04 8.74 8.77
8 Jan 2013 13 6.03 8.80 8.83
9 Jan 2013 12 6.08 8.76 8.79
10 Jan 2013 11 6.02 8.79 8.81
11 Jan 2013 10 6.00 8.72 8.74
14 Jan 2013 9 6.01 8.69 8.71
15 Jan 2013 8 5.95 8.71 8.73
16 Jan 2013 7 5.90 8.78 8.79
17 Jan 2013 6 5.97 8.81 8.82
18 Jan 2013 5 5.98 8.83 8.84
21 Jan 2013 4 5.95 8.81 8.82
22 Jan 2013 3 5.84 8.82 8.83
23 Jan 2013 2 5.81 8.83 8.83
24 Jan 2013 1 5.78 8.87 8.87
25 Jan 2013 0 5.77 8.85 8.85

1. According to the academic definition (which benchmarks on the expected future spot price), this
market is in _________ and according to the practioners defintion (which benchmarks on today’s spot
price), the market is in _________.
(A) Normal backwardation; contango (B) Contango; backwardation
(C) Normal backwardation; backwardation (D) Contango; contango

2. After the close of trading on January 21, a money amount of ___________ will be (A) debited from
(B) credited to your margin account. (Please fill in the amount and chose A or B.)

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3. The initial margin for bitcoin futures at the CBOE futures exchange is 44% and the
maintenance margin is 40%. One contract is for the delivery of one bitcoin. Suppose that you
bought ten contracts for delivery on January 18, 2018, on December 14. The spot price on the
purchase day was $16,423 and the futures price $17,055. If the bitcoin spot price on the next
day, December 15, falls to $13,653 and the futures price for January delivery falls to $13,762,
then your account will be debited for $______ and you will receive a margin call for adding
$______ to your account.

4. Given a stock with a value of $1,100, an anticipated dividend of $27 in three months time and a
risk-free rate of 3% per annum, what should be the stocks’ futures price for delivery in six
months time?

5. If you believe that IBM stock futures are overpriced relative to the spot price of IBM stock, then
you could make an arbitrage profit by
(A) borrowing money, buying IBM stocks and selling futures on IBM stocks
(B) lending money, selling short IBM stock and buying futures on IBM stocks
(C) lending money, buying IBM stocks and buying futures on IBM stocks
(D) borrowing money, selling short IBM stock and selling futures on IBM stocks

6. At 19:08 UTC on December 14, bitcoin was trading at $16,423. The settlement price for a bitcoin
futures contract expiring on January 18 was $17,055. These prices suggest that ____________.
(A) The storage costs of bitcoins are high
(B) The bitcoin spot price is expected to appreciate strongly in January
(C) The convenience yield of bitcoins is high
(D) Bitcoin futures are too expensive

7. Suppose you believe that crude oil prices will increase, and therefore decide to purchase crude
oil futures. Each contract calls for the delivery of 1,000 barrels of oil. Suppose that the current
spot price is $96.10 per barrel and the current futures price for delivery in April is $97.35. The
initial margin requirement for the oil contract is 15%. The oil price goes up earlier than you
expected and in March the spot price is $98.05 and the futures price for April delivery is
$98.56. You decide to close out the position in March. Your percentage gain from this
speculative position is ________%.

8. Assume that the the current exchange rate between the pound and the dollar is GBP/USD = 2. A
six-month T-bill yields 4% per annum in the US and 5% per annum in the UK. The interest rate
parity theorem predicts that the six-month forward exchange rate is ______.

9. A stock is expected to pay a dividend of $2 per share in 1 months and in 4 months. The stock
price is $74, and the risk-free rate of interest is 5% per annum with continuous compounding of
all maturities. An investor has a pre-existing forward contract to sell the stock for $71 in 5
months from now. What is the current value of the forward contract?

10. For stock index futures, is the futures price greater than or less than the expected future value
of the index? Explain your answer using the relevant formulas.

11. Identify the optimal hedge for the following problem. It is now October 15. A beef producer is
committed to purchasing 200,000 pounds of live cattle on November 15. The producer wants to
use the December live cattle futures contracts to hedge its risk. Each contract is for the delivery
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 of 40,000 pounds of cattle. The standard deviation of monthly changes in the spot price of live
cattle is (in cents per pound) 1.2. The standard deviation of monthly changes in the futures price
of live cattle for the closest contract is 1.4. The correlation between the futures price changes
and the spot price changes is 0.7.

12. Give an analytical expression for the optimal hedge ration in the following case. A US company
is interested in using the futures contracts traded by the CME Group to hedge its Australian
dollar exposure. Define r as the interest rate (all maturities) on the US dollar and r f as the
interest rate (all maturities) on the Australian dollar. Assume that r and r f are constant and that
the company uses a contract expiring at time T to hedge an exposure at time t (T > t).