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Problem 1 i. What changes in the futures price will lead to a margin call? Drop in margin before margin call =4,000 3,000=1,000 Change in future price that will lead to a margin call =1,000/5,000=0.20 The price would have to increase by $0.20 to $10.40 before the investor receives a margin call. ii. What happens if you do not meet the margin call? The position will be liquidated (the position will be closed) immediately. The broker will buy the silver at $10.40 per ounce to do so. Problem 2 i. What changes in the futures price will lead to a margin call? Drop in margin before margin call =4,000 3,000=1,000 Change in future price that will lead to a margin call =1,000/5,000=0.20 The price would have to decrease by $0.20 to $10.00 before the investor receives a margin call. ii. What happens if you do not meet the margin call? The position will be liquidated (the position will be closed) immediately. The broker will buy the silver at $10.00 per ounce to do so. Problem 3 i. What are the forward price and the initial value of the forward contract? I=e-0.08x2/12+e-0.08x5/12=1.9540 F=(50-1.9540)e0.08x6/12=50.0069 f=50-1.9540-50.0069e-0.08x6/12=0 The forward price is $50.00 and the initial value of the forward contract is approximately $0. What are the forward price and the initial value of the forward contract? I=e-0.08x2/12=0.9868 F=(48-0.9868)e0.08x3/12=47.9629
ii.
f=-(48-0.9868-50.0069e-0.08x3/12)=2.0035 The forward price is $47.96 and the initial value of the forward contract is approximately $2. Problem 4 i. What are the forward price and the initial value of the forward contract? I=e-0.08x2/12+e-0.08x5/12=1.9540 F=(50-1.9540)e0.08x6/12=50.0069 f=50-1.9540-50.0069e-0.08x6/12=0 The forward price is $50.00 and the initial value of the forward contract is approximately $0. What are the forward price and the initial value of the forward contract? I=e-0.08x2/12=0.9868 F=(52-0.9868)e0.08x3/12=52.0437 f=52-0.9868-50.0069e-0.08x3/12=1.9965 The forward price is $52.04 and the initial value of the forward contract is approximately $2. Problem 5 Problem 6 i. What is the impact of the strategy you propose on the price the company pays for the copper? In order to hedge the February 2005 purchase, the company long March 2005 contracts for 80% of 10,000,000 pounds of copper. No. of contracts required =80%x10,000,000/25,000=320 The strategy to be adapted is described below: October 2004 Long 960 contracts expiring on September 2005 (320 contracts expiring September 2005 to hedge against August 2005 purchase, 320 contracts expiring September 2005 to be rolled into March 2006 during August 2005 (for February 2006 purchase), and 320 contracts expiring September 2005 to be rolled into September 2006 during August 2005 (for August 2006 purchase).
ii.
Long 320 contracts expiring on March 2005 Close out 320 contracts expiring March 2005 Close out 960 contracts expiring September 2005 Long 320 contracts expiring on March 2006 Long 320 contracts expiring on September 2006 Close out 320 contracts expiring March 2006 Close out 320 contracts expiring September 2006
Hence, the amount paid in February 2005 = 69.00+80%(72.30-69.10)=71.56 Amount paid in August 2005 = 65+80%(72.80-64.80)=71.40 For February 2006 purchase, Gain/loss on futures expiring September 2005 =64.80-72.80=-8.00 (Loss) Gain/loss on futures expiring February 2005 =76.70-64.30=12.40 (Gain) Net price paid = 77+80%x8.00-80%x12.40=73.48 For August 2006 purchase, Gain/loss on futures expiring September 2005 =64.80-72.80=-8.00 (Loss) Gain/loss on futures expiring February 2005 =88.20-64.30=24.00 (Gain) Net price paid = 88+80%x8.00-80%x24.00=75.20 The hedging strategy causes the price paid to be within 73.48 and 75.20 ranges. ii. What is the initial margin requirement in October 2004? Is the company subject to any margin calls? Initial margin requirement in October 2004 =1,280x2,000=2,560,000 Drop in margin before margin call =2,000 1,500=500 Change in future price that will lead to a margin call =500/25,000=0.20 Hence, margin call happens during: Contracts expiring March 2005: between October 2004 and February 2005 Contracts expiring September 2005: between October 2004 and February 2005, as well as between February 2005 and August 2005 Problem 7 Amount to be paid for borrowing cash =550,000x1.11=610,500 Amount to be paid for borrowing gold=1,000x1.02=1,020
Forward price of gold=F=550e(0.0925+0.005)x1=606.33 Using forward contract, the corporate client can ensure that the amount to be repaid for borrowing gold =1,020x606.33=618,457 As 618,457>610,500, the rate of interest on the gold loan is too high. A fair interest rate r will be: 1,000 (1+r)x606.33=610,500 r=0.688% Problem 8 i. What position should the fund manager take to eliminate all exposure to the market over the next two months? Optimum number of contracts= 0.87x50,000,000/(1,259x250)=138.20=138 The manager should short 138 contracts. ii. If the market index is 1,000 in 2 months, The futures price in 2 months time =1,000x1.0025=1,002.50 The gain from the short futures position =(1,259-1,002.50)x250x138=8,849,250 Index dividend return in 2 months =3%x2/12=0.5% Index capital gain yield =-250/1250=-20% Index total return =-20%+0.5%=-19.5% Hence, expected return on portfolio r: r=1%+0.87(-19.5%-1%)=-16.835% Loss on the portfolio =-16.835%x50,000,000=-8,417,500 Total gain=8,849,250-8,417,500=431,750 If the market index is 1,300 in 2 months, The futures price in 2 months time =1,300x1.0025=1,303.25 The loss from the short futures position =(1,259-1,303.25)x250x138=-1,526,625 Index dividend return in 2 months =3%x2/12=0.5% Index capital gain yield =50/1250=4% Index total return =4%+0.5%=4.5% Hence, expected return on portfolio r:
r=1%+0.87(4.5%-1%)=4.045% Gain on the portfolio =4.045%x50,000,000=2,022,500 Total gain=2,022,500-1,526,625=495,875 If the market index is 1,400 in 2 months, The futures price in 2 months time =1,400x1.0025=1,403.50 The loss from the short futures position =(1,259-1,403.50)x250x138=-4,985,250 Index dividend return in 2 months =3%x2/12=0.5% Index capital gain yield =150/1250=120% Index total return =12%+0.5%=12.5% Hence, expected return on portfolio r: r=1%+0.87(12.5%-1%)=11.005% Gain on the portfolio =11.005%x50,000,000=5,502,500 Total gain=5,502,500-4,985,250=517,250 Bonus Question