Chapter 2 (WEEK 3)

Problem 2.8.

- Answer: Traders use short positions to sell borrowed assets with the expectation that the
price will decline, which allows the traders to repurchase them at a lower price.
Therefore, options such as the precise asset that will be delivered, where delivery will
take place, and when delivery will take place can be used to decrease the futures price.

Problem 2.9.

- Answer: A new futures contract's design is an important procedure that takes many
factors into account to guarantee the contract's performance and effectiveness in the
financial markets. The following are the most important aspects to consider while
creating a new futures contract:
+ Specification of the underlying asset: define the underlying asset that the futures
contract represents
+ Size of the contract: determine the size of the contract, specifying the quantity of
the underlying asset that each futures contract represents
+ Delivery arrangements: the place where delivery will be made must be specified.
+ Delivery months: the precise period during the month when delivery can be made
must be specified.

Problem 2.10.

- Answer: A margin is the money that an investor deposits with their broker. It acts as an
assurance that any losses on the futures contract will be covered by the investor. Daily
adjustments are made to the margin account balance to reflect gains and losses on the
futures contract. A further margin deposit is required from the investor if losses exceed a
predetermined threshold. It is unlikely that the investor will default with this system in
place. By using the marking-to-market method, the exchange can settle the parties' daily
gains and losses, thereby reducing the credit risk.
Problem 2.11.

- Answer: From the given information (delivery price 15,000 pounds, future price 160
cents per pound, initial margin $6,000 per contract, maintenance margin $4,500 per
contract), it can be concluded that if more than $1,500 is lost on one contract, a
margin call is required.
If there is a gain on every contract of $1,000, $2,000 can be withdrawn from the
margin account. It will happen if the futures price increases from 6.67 cents to
166.67 cents per lb

Problem 2.12.

- Answer: In case the futures price is greater than the spot price during the delivery
period, an arbitrageur sells a futures contract, purchases the asset, and delivers it for a
profit right away. A comparable ideal arbitrage method does not exist if the futures price
is lower than the spot price throughout the delivery period. Although an arbitrageur can
hold a long futures position, they are unable to demand the item be delivered right away.
The party in the short position decides when the delivery will take place. However, it
will be appealing to businesses that are interested in purchasing the asset to buy a futures
contract and wait for delivery. After that, the futures price will tend to increase.

Problem 2.13.

- Answer:
Stop order: Once a bid or offer is set at that specific price or a less advantageous price,
the stop order is executed at the best available price.
Market-if-touched order: When a trade happens at a given price or at a price that is more
advantageous than the specified price, a market-if-touched order (MIT) is executed at
the best available price.
The difference between them is a stop order limits the amount of money that can be lost
in the event of negative price movements, meanwhile, a market-if-touched order is used
to guarantee that gains are realized if sufficiently favorable price fluctuations occur.
Problem 2.14.

- Answer: As soon as there is a bid at 20.30, the contract will be sold if it can be done at
20.10 or a higher price. This represents a stop-limit order to sell at 20.30 with a limit of
20.10.

Problem 2.15.

- Answer:
The initial margin required for the new contracts: 20×$2,000 = $40,000
Gain on existing contracts: (50,200 - 50,000) * 100 = $20,000
Loss on new contracts: (51,000 – 50,200) * 20 = $16,000.
Therefore, the amount of money that the clearing house member has to add to its margin
account is: 40,000 – 20,000 + 16,000 = $36,000

Problem 2.16.

- Answer: For the contracts signed on July 1, 2013, and September 1, 2013, the forward
exchange rates are F₁ and F₂, respectively. Assume further that on January 1, 2014, S
represents the spot rate. (All exchange rate is expressed in terms of yen per dollar). The
first contract's payout is (S — F₁) million yen, while the second contract's payout is (F ₂
— S) million yen. Therefore, (S — F₁) + (F ₂ — S) = (F ₂ — F ₁) million yen is the total
payout.

Problem 2.17.
- Answer: The forward quote for Swiss francs to US dollars is 1.1000. The futures price
of dollars per Swiss franc is 0.9000. When the forward price is quoted similarly to the
futures price, it is calculated as 1/1.1000 = 0.9091. For this reason, the Swiss franc is
worth more on the forward market than it is on the futures market. This makes the
forward market more alluring to an investor who wishes to sell Swiss francs.