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IPart 1: 2.24: 1 Ignoring daily settlement, the profit of each trader will be (1.4300 - 1.

.400)*1,000,000 = $ 30,000 Two inverters A and B gain $30,000 for each. 2 When the impact of daily settlement is taken into account. Investor As gain is realized day by day over three months. Based on characteristics of futures contracts such as settled daily; contract is usually closed out prior to maturity etc. On some days investor A may realize loss, whereas on other days he will realize a gain. However, the exchange rate (dollar/ euros) declines sharply during the first two months and then increases for the third month to close at 1.4300 if A exercises at the first two month he will suffer loss . Investor Bs gain is made entirely at the end of three months As a result, based on those information we can conclude that investor B has done better than investor A. 4.25: The two month LIBOR rate is 0.28% per annum with continuous compounding and three month LIBOR rate is 0.1% per annum with continuous compounding. 1 The arbitrage opportunity: Borrow at 3 months Libor rate @ 0.1%. Invest at 2 months Libor rate @ 0.28%. At the end of 2 months, we receive money from investment; invest again in 1 month until end of three months at forward rate of the third month ( R23 ) 2 How low can the three month Libor rate become without an arbitrage opportunity being created.

5.23: 1 The futures price of the index for three-month contracts: S 0 =1,200; r free3 = 3% per annum; q3 = 1.2% per annum and T =
( 0.03 0.012 )*0.25 = 1,205.4 F3 = 1,200 * e

3 = 0.25 12

2 The futures price of the index for six-month contracts: S 0 =1,200; r free 6 = 3.5% per annum; q 6 = 1% per annum and T =
( 0.035 0.01)*0.5 = 1,215.1 F6 = 1,200 * e

6 = 0.5 12

6.26: The Eurodollar future price for a contract maturing in 90 days is quoted as 89.5, Eurodollar futures rate = 100 89.5 = 10.5 Eurodollar futures rate is 10.5% per year with quarterly compounding and actual/360 Rm = 0.105* 365/360 = 0.10646 Rc = 4ln*(1 + 0.10646/4) = 0.1051 or 10.51%. The 90-day rate is 10% per annum, and the 180-day rate is 10.2% per annum, both expressed with continuous compounding and an actual/actual day count. Forward rate based on that information: R f = Arbitrage strategy: Borrow at the 180-day rate @ 10.4%. Invest money at the 90-day rate @ 10.51%. 0.102 * 180 90 * 0.1 = 0.104 = 10.4%. 90

IIPart 2: (a) Identify your anticipated outcome of the expected volatility for your circumstances. a. Will the AUD currency appreciate or depreciate. There are two circumstances: First circumstances, AUD currency appreciate due to Australian economy is stronger and they export their products to overseas other countries will need Australian dollar to buy Australian goods. Demand for AUD increase. Second circumstances, Australian companies import inputs from China to produce they will need to sell AUD to buy Yuan RMB of China demand for Chinese currency in Australian increase, it leads to AUD depreciate compared with Yuan RMB. b. Will local interest rates increase or decrease. Due to change in demand for Australian dollar to buy inputs from China local interest rates (Australian interest rates) will increase.


Identify the risk created by this volatility for your loan and your input price.

There are some risks created by this volatility: Local interest rates (Australian interest rates) will increase cost of borrowing also increase. This volatility in input price will cause exchange rate risk (we import form China and AUD depreciate we have to pay more). (c) Identify a strategy you can use to reduce or eliminate this risk.

Hedging interest rate risk: we can use the Forward Rate Agreement. The FRA is

an agreement that a certain interest rate will apply to certain principal amount for a certain time period in the future. To reduce risk in exchange rate, we should take a short position of forward contract to sell Australian dollar and take a long position to buy Yuan RMB in the future.


Will this strategy eliminate all the risk you face? 1. This strategy can eliminate risk if AUD depreciate compared with Yuan RMB, but if AUD not depreciate e.g. AUD appreciate in comparison with Yuan RMB forward contracts will make loss for company. 2. Forward contracts: it has credit risk, the counter party may default the contracts, because the forward contracts is just private contract between two parties.

This strategy can not eliminate all the risk:


Will the choice of products introduce new risks?

The choice of new products will lead to similar risks but at a different level of risks.


Hull, J.C. (2010), Fundamentals of Futures and Options Markets, Pearson, New Jersey, 7th edition. Chapters 1-6.