Derivatives attendance questions
$0.10 (notional value = $1.60 * 15,000 pounds =$24,000 1 contract Margin call at -$1500 per contract = -X* 15,000 pounds = -$0.10* 15,000 pounds = -$1500. because you are long you experience losses as price decreases. End of day price of $1.60-0.10 = $1.50 = -$1,500 on your margin account. If we consider long 2 contracts with $12,000 initial margin with $9,000 maintenance, we can still only afford to lose $3,000 before margin call -$0.10*15,000 pounds*2 contracts = -$3,000)
A trader buys two July futures contracts on orange juice. Each contract is for the delivery of 15,000 pounds. The current futures price is 160 cents per pound, the initial margin is $6,000 per contract, and the maintenance margin is $4,500 per contract. What price change would lead to a margin call?
(a) +50c-48.20c = +1.8c (b) +50c-51.30c = -1.30c (short positions are selling so they are +cashflow and -underlying. short positions have positive payoff ST < K)
A trader enters into a short cotton futures contract when the futures price is K=50 cents per pound. The contract is for the delivery of 50,000 pounds. How much does the trader gain or lose if the cotton price at the end of the contract, ST, is (a) 48.20 cents per pound (+50c-48.20c = +1.8c, -50c+48.20c = -1.8c) (b) 51.30 cents per pound (-50c+51.30c = +1.30c, +50c-51.30c = -1.30c)
60.91, 62.76 (fT = $60e0.01+0.02-0.015 =$60.91 fT = $60e0.01+0.02+0.015 =$62.76)
Assume a spot price of $60, interest rates are 1%, storage costs are 2%, there is no q income and the convenience yield is 1.5%. T=1 year. Find the cost of carry price for this commodity. fT = $ (60.00, 60.91, 62.76) Find the cost of carry price for this commodity if instead our y = -1.5% . fT = $ (62.76, 60.00, 60.91)
40.50, go short, go long, borrowing, profit, $2.50 (40e0.05*(3/12) = 40.50 Today, an arbitrageur will short the futures contract and buy the stock by borrowing $40 at 5% for the next 3 months. This will result in a profit of 43-40.50 = $2.50.)
Assume the current stock price is $40 and the 3-month risk-free interest rate is 5% per annum. The current futures contract for 1 share for delivery in 3 months is trading at $43.00 What is the no arbitrage f3 months = (40.50, 43.00, 42.50) Today, an arbitrageur will (go short, go long) the futures contract and (go long, go short) the stock by (lending, borrowing) $40 at 5% for the next 3 months. This will result in a profit of ($3.00, $2.50, $1.50) .
$88.41, $84.10, buy, sell, do nothing, sell (CA fT = $80e(0.04+0.06)*1 = $88.41 US fT =$80e(0.04+0.01)*1 = $84.10 A speculator/arbitrageur strategy would buy futures contracts in the US market and simultaneously sell futures contracts in the Canadian market. An Oil producing hedger strategy would do nothing in futures contracts in the US market and sell futures contracts in the Canadian market.)
Canadian Parliament wishes to discourage the buying and selling of crude oil within it's borders in the name of climate change. To do this they keep interest rates and oil storage costs at 4% and 6% respectively. What is the future price of crude oil given S=$80, q= 0, y= 0 and T= 1 year, fT =($82.14, $84.10, $88.41) Ignore fx rates. The US takes a different approach to climate change, the US sets interest rates to 4% but keeps storage costs of crude oil to 1%. What is the future price of crude oil given S=$80, q= 0, y= 0 and T= 1 year, fT = ($82.14, $84.10, $88.41) . A speculator/arbitrageur strategy would (sell, do nothing, buy) futures contracts in the US market and simultaneously (sell, do nothing, buy) futures contracts in the Canadian market. An Oil producing hedger strategy would (buy, sell, do nothing) in futures contracts in the US market and (sell, buy, do nothing) futures contracts in the Canadian market.
Uncorrelated with market returns (Uncorrelated with market returns are very attractive investment vehicles for hedge funds because their specialty is to create alpha, excess returns, from unique investment strategies that do not bear same risk/return profile as typical market instruments.)
Catastrophe futures, aka Insurance derivatives, are popular investment vehicles for hedge funds because they are ____ -uncorrelated with market returns -SPV with guaranteed payoffs -low risk high reward
Yes, $4 profit (Yes, borrow $60 at 5% (you will owe $60*1.05 in 1 year) buy ABC stock, sell it at $67 and repay your loan $63. You walk away with $4 in profit. But be careful, this assumes we know for sure we can sell our stock for greater than $60 + borrow rate.)
Consider the borrow rate for money is 5% for 1 year and ABC stock cost $60 today. Can you borrow $60 buy a ABC stock today and sell it later at $67 for a profit? If so how much?
we hedged financial risk (We hedged financial risk because we did not use the futures to execute the trade.)
Did we use the futures to hedge physical or financial risk in the example on L5 slide 29? -we hedged financial risk -we hedged physical risk
Eurodollar futures (Eurodollar futures, these instruments directly impacted by LIBOR rates.)
If 3M LIBOR is influenced by market manipulation, this could adversely affect every investor exposed to -Eurodollar futures -SP500 futures -10 year bond futures
True (True, much more potential for international participation.)
If futures markets are traded 23 hours a day, 6 days a week, this market has much more potential for international participants than say a US stock market that is only trading between 9:30am and 4pm EST
Downwards (Contango contract will converge downwards towards spot by expiration, if spot stays constant. Use Lecture 3 slide 14 graphic.)
If the spot price for gold stays constant at 1200 for the next year, a contract that is in contango today must converge (downwards/upwards) towards the spot price by expiration.
1
If we construct a perfect hedge, this means our h* =
Both of these describe why we would not sell a put in this scenario.
If we expect the price of a stock to decline, why wouldn't we sell a put (also called writing a put or shorting a put). -Selling puts is a bullish strategy because you earn a profit if a stock's price remains high and lose money when the price falls. -Both of these describe why we would not sell a put in this scenario. -Selling puts, when you expect a decline in underlying, is expecting the buyer to exercise at strike.
Yes (Yes, you can sell your spot oil for profits that the futures trader can not. This is called convenience yield ( to hold spot).)
If you hold oil commodity today, is it an advantage? Can you make profits today if there is a short term shortage as opposed to holding a contract to buy oil 8 months from today?
go long a stock futures (Go long a stock futures, you spend $1,520 posted to your margin account to make $600. This is considered more capital efficient.)
In Lecture 2, the AAPL example we have a choice of buying stock full cash or to use a futures contract. Which is more capital efficient?
Eurodollar
In Lecture 2, we imported the $ margin for 3 futures contracts and calculated the % margin for these same contracts. Which futures has the cheapest $margin?
receive, do not receive (In a financial future, the underlying is a financial instrument like a bond. If you hold the bond spot you receive coupon cashflow and if you hold the bond futures contract you do not receive coupon cashflow.)
In a financial future, the underlying is a financial instrument like a bond. If you hold the bond spot you (receive, do not receive) coupon cashflow and if you hold the bond futures contract you (receive, do not recieve) coupon cashflow.
an interest rate increase, higher, lower (an interest rate decrease. We are making a deposit, earning interest, so we are afraid of a decline in interest rates. We have a higher interest rate set on the deposit leg but lower return on futures leg of the strategy.)
In our Eurodollar futures example in L5 slide 14-18, we used the ED futures contract because our risk was (an interest rate decrease, an interest rate increase) by June. What would happen to the interest rate if June delivery expired at 95? We have a (higher, lower) interest rate set on the deposit leg but (higher, lower) return on futures leg of the strategy.
strip (Gold Strip a package of contracts, all long, with different delivery dates)
In our Lecture 2 example with Goldman Sachs and Panasonic, GS is likely using a _____ to acquire gold.
both (Both, GS does not mine the gold for sale therefore they are not a hedger in the strictest sense. They are speculating that they can continue to deliver the gold to Panasonic for the next year by acquiring it cheaper in the futures market than the locked in forward delivery to Panasonic. We could argue they are an arbitrager too.)
In our Lecture 2 example with Goldman Sachs and Panasonic, is Goldman considered a hedge or a speculator?
sell, short
In our XOM example, XOM is trying to _____ (buy, sell) their oil, therefore they are looking to be ____ (long, short) oil in the futures market.
Yes, there is an arbitrage (FT = Se(r+s)T FT = $1250*e(0.05+0)1 = $1250*e0.05 = $1250*1.0513 = $1314.125 As per the above equation 1-year forward price should be $1314.125 but in the market it is $1350)
In some situations an arbitrage opportunity could exist between the spot price S0 and the future/forward price FT. We can detect arbitrage by calculating the (no) arbitrage fair price of the underlying using spot-futures parity or the cost of carry model and determining if the fair value differs from the currently trading value of the forward/future. Determine if there is arbitrage opportunity in the following using the continuous formula: Gold spot price is $1250 an ounce, and the 1 year forward price is currently trading $1350.The risk-free rate is r = 5% and the storage cost can be neglected c = 0.
Nothing, Cargill's FRA has fixed the borrow rate
In the Cargill FRA example in L5 slides 11-12 what would happen is LIBOR was instead quotes at 4%? -Cargill's borrow rate would decrease -Nothing, Cargill's FRA has fixed the borrow rate -Cargill's borrow rate would increase
For every 100 oz they mine they should sell a futures contract for delivery 2 months later.
It is July 2022. A mining company has just discovered a small deposit of gold. It will take 6 months to construct the mine. The gold will then be extracted on a more or less continuous basis for 1 year. Futures contracts on gold are available with delivery months every 2 months from August 2022 to December 2023. Each contract is for the delivery of 100 ounces. You work as a consultant for this mining company, how would you advise them to hedge? -For every 100 oz they mine they should buy a futures contract for delivery 2 months later. -For every 100 oz they mine they should sell a futures contract for delivery 2 months later.
Receives, buyer, exercise
It is May and a trader writes a September call option with a strike price of $20. The stock price is $18 and the option price is $2. Describe the trader's cash flows if the option is held until September and the stock price is $25 at that time. The trader (pays, receives) premium of $2. At Sep maturity the option (buyer, seller) will (exercise, not exercise) the option.
5, 2, options
Noogle current stock price is $880. A standard American call on Noogle stock with a strike of $880 is currently priced at $25, how much exposure can you get with $5,000 trading account and which is more capital efficiency. Note: a standard American call option is for 100 shares Approximately (3, 4, 5, 2) shares of Noogle for $5,000 Approximately 3 call options of Noogle $5,000 Buying (options, stock full cash) is more capital efficient.
The hedge ration decreases (the hedge ratio decreases (0.29/0.18)*0.35=0.56)
On L4 slide 26, what happens to h* if the correlation coefficient is only 0.35? -correlation coefficient has no effect on h* -the hedge ratio decreases -the hedge ratio increases
they participated in the OTC derivatives market which was high unregulated
One reason Lehman ended in bankruptcy is because -they participated in the OTC derivatives market which was high unregulated. -they were levered(leveraged) 2:1. -their credit rating increased post crisis, leading to more shot term funding. -they did not sell enough company stock on the public markets.
0.9400, exchange at spot price (The gain on the futures contract is 0.9800-0.9600=0.0200 cents per yen. The basis is 0.9200-0.9600= 0.0400 cents per yen when the contract is closed out. The effective price obtained in cents per yen is the final spot price plus the gain on the futures: 0.9200+0.0200=0.9400 50m YEN @ 1/0.9200 =54,347,826 50m YEN @ 1/0.9600 =52,083,333)
Our our example in L5 slide 29, what would have happened to our effective price if the Yen futures had settled at 0.9600 in July with spot remaining at 0.9200? Our effective price would be (0.9200, 0.9750, 0.9400) Would it have been a better strategy to exchange 50m YEN into USD at spot, 0.9200, or use the futures contract with the 0.9600 July settle price? (exchange at futures price, exchange at spot price)
5. 0.20 (notional value = $17.20 per ounce * 5,000 ounces = 86,000 initial margin rate ~5% margin call at -$1,000 = +$0.20 per ounce * -5,000 ounces = -$1,000. because you are short you experience losses as price increases. End of day price of $17.20+0.20 = $17.40 = -$1,000 on your margin account.)
Suppose that you enter into a short futures contract to sell July silver for $17.20 per ounce. The size of the contract is 5,000 ounces. The initial margin is $4,000, and the maintenance margin is $3,000. What is the initial margin rate = % (5, 7, 3) What change in the futures price will lead to a margin call $ (0.30, 0.20, 0.50)
True (True, ST > K = +payoff on a long position.)
T/F If the maturity price, ST, for your long futures position is $1,500 and your strike ( aka delivery price) is $1,450. You will have a profit, a positive payoff, on your long position.
True (The objective of its hedging strategy was to protect the profit margins in its forward delivery contracts by insulating them from increases in energy prices. They expected the futures curve to be in backwardation, acquiring the energy each month at cheaper and cheaper prices.)
T/F In the Metallgesellschaft's Hedging Debacle the company made long term forward contracts to sell oil/energy. Their hedge was the buy short-term futures contracts and roll into new months(called a stacked hedge). One of the issues with MG hedge was that the fixed price forward delivery contracts exposed it to the risk of rising energy prices.
False (FALSE, not always. Example from L3 slide 19 both the speculator and the arbitrageur has the same profit.)
T/F Speculators and Arbitrageurs perform different strategies which means they will always have different payoffs or profits.
true (True, review L4 slide 4)
T/F. 2 assets can have the same average(mean) price but different volatilities (standard deviation)
False (False, Banks can be frequently bailed out because of the systemic risk of the financial system. This does lead to moral hazard.)
T/F. Banks can be frequently bailed out because of the systematic risk of the financial system. This leads to moral hazard.
False (Beta risk is specifically the relative risk of an asset against a market like the SP500. Volatility is the total risk of an asset. It is the deviation measurement from the mean value.)
T/F. Beta is the same as volatility when referring to asset risk.
True (True, if you have $5,000 to spend you can either buy 5 shares of a stock priced at $880 buy 2 call options on a stock with strike $880 for $25 premium. The 2 call options cost you $5,000 = $25*100 share per option contract*2 option contracts The 2 call options give you 200 shares of exposure.)
T/F. Buying an option is considered to be more capital efficient because you can buy more exposure of shares than you could at full cash value.
False (False, Equity Indexes futures have a three-level expansion: a 7%, 13% and 20% to the downside day trading a 7% limit up and down in overnight trading.)
T/F. Futures contracts are traded 23 hours a day, 6 days a week. This means overnight trading is available to all futures traders. If an Equity Index futures price declines 6% overnight, the market for this contract would limit down?
False
T/F. Hedging always results in positive payoff(s)
False (False, just because the swap has a negative payoff does not mean it fails to hedge some other operational activity.)
T/F. If a swap participant has a negative payoff from the swap, it is not worth it and they should abandon their position.
False (FALSE: If you are long a futures contract at K and the price is now greater than K you have immediate value, no margin call.)
T/F. If the futures contract price rises after you purchase and lock in strike K, then you will have a margin call
False (False, Fed Funds rate is targeted by the Federal Reserve in the US and LIBOR is based on an average of banks quotes estimating the rate of interest at which they could borrow funds just prior. These are not market based or set by the market mechanism.)
T/F. LIBOR and the Fed Funds Rate are both market based interest rates. In other words they are not set or targeted by a central banking authority, they are set by the market mechanism.
True
T/F. The OTC market is greater than the Exchange-traded market for derivatives.
True (TRUE, In a repo (or repurchase agreement), a financial institution that owns securities agrees to sell the securities for a certain price and buy them back at a later time for a slightly higher price. The financial institution is obtaining a loan and the interest it pays is the difference between the price at which the securities are sold and the price at which they are repurchased. The interest rate is referred to as the repo rate.)
T/F. The repo rate is the interest rate a financial institution pays to the lending company. It is, more specifically, the difference between the price at which the securities are sold and the price at which they are repurchased.
True (TRUE see L3 slide 16)
T/F. Under the (no) arbitrage principle and assuming continuous compounding the futures price fT should equal Spot price*erT.
Forward (We typically want to be converting from a strong currency into a weaker currency. The CHF is stronger in the forward, use a forward.)
The forward price of the Swiss franc for delivery in 45 days is quoted as 1 CHF =1.1000 USD. The futures price for a contract that will be delivered in 45 days is 1 CHF = 0.9000 USD. Which is more favorable for an investor wanting to sell Swiss francs in 45 days?
7.33, buy, (97-96)*100*25*5, $167,500 (4,820,000*exp(r*0.5)=5000000; r= 7.33% ED at 96 comes with an 4% LIBOR rate. Buy 5 the Sep deliver ED futures at 96. If the LIBOR rate declines to 3% by July earn (97-96)*100*25*5 = 12,500 Companies net cost to borrow = (5000000-4,820,000)-12,500 = 167,500)
Today is February and a treasurer of the company XYZ just issued $5 million in par value commercial paper that matures in July . This issuance raised $4,820,000 in cash today. What is the interest XYZ is paying to its lenders? (7.33, 6.11, 3.60) % The September delivery Eurodollar futures price is quoted as 96.00 today. How can the treasurer hedge the company's exposure to this interest rate payment to the lenders? (sell, buy) 5 the Sep deliver ED futures at 96. If the LIBOR rate declines to 3% by July earn ((97-96)*100*20*5, (97-96)*100*25*5, (96-97)*100*20*5) Companies net cost to borrow = $ (192,500, 167,500, 180,000)
to hedge expected low energy sales, Maybe, only if the CDD increased in value
Use the weather futures example for L4 slide 31. Why did we short an HDD? (to hedge expected high energy sales, to hedge expected low energy sales) Could we have bought a CDD instead as a hedge? (Maybe, only if the CDD increased in value, No, long a CDD would not guarantee a hedge, Yes, long a CDD would guarantee a hedge)
Hedge ration (univariate Linear Regression, the beta coefficient is equal to calculating the hedge ratio. Review L4 slide 29 to show the formulas for beta coefficient = hedge ratio)
Using a univariate Linear Regression, the beta coefficient is equal to calculating the _____ -hedge ratio -optimal number of contracts -short or long position
More (100*1.1 =110.00 100e0.10*1=110.52)
We have $100 we would like to deposit in a savings account for 1 year. The bank gives us a quote of 10% per annum. If we negotiate with the bank to increase the frequency of compounding from annually to continuously, we will yield (more/less) growth of our deposit than initially quoted.
hedge ratio (hedge ratio is used to calculate the optimal number of futures contracts to construct our hedge.)
We need a _____ to calculate the optimal number of futures contracts to construct our hedge. -perfect hedge -hedge ratio -alpha ratio
our underlying exposure was small (our underlying exposure was small. Our underlying exposure was ~$200k, a full size %P500 would give us too much hedging.)
We used an e-mini contract in our Index future example on L5 slide 21-22 because -our underlying exposure was large -our underlying exposure was small
1. what is the size of your exposure and are you long or short the exposure 2. what do you fear happening 3. what position do you take in the futures to make profit if your fear does happen 4. how many contracts to use
What are the steps of constructing hedges -what do you fear happening -how many contracts to use -what position do you take in the futures to make profit if your fear does happen -what is the size of your exposure and are you long or short the exposure
q is income that is not received to the futures contract holder (q is income that is not received to the futures contract holder, therefore we must remove it from the pricing model for the futures contract.)
When looking closely at the cost of carry pricing model, the q factor comes with a negative sign. One reasoning we discussed that q has a negative sign is because -q is income that is not received to the spot contract holder -q is income that is not received to the futures contract holder -q is income that is irrelevant to both spot and futures contract holder
Higher (fT = $40e0.02*1 = $40.81 fT =$40e0.03*1= $41.22)
When the central bank increases interest rates to reduce inflation this would cause our pricing models for futures contracts to yield (lower/higher) model futures prices.
all of these could be a reason
Why did the housing developer in our example not take delivery of the copper futures contract? -He only used the futures to hedge his price risk -all of these could be a reason -He may have not needed the actual delivery amount -He may not be close to the delivery point so an extra $0.10 savings would likely be eaten up by delivery charge.
Futures, futures (We want to be sure we convert our FX back to USD at the most favorable rate. The best rate to convert back to USD is at the 3 mont futures price. We also can see that the USD is weaker in the futures market, which also means our FX (both GBP and CHF) are stronger in the futures. 1 GBP = 1.5575 USD ; 1,000,000 GBP = 1,557,500 USD 1 CHF = 1.0500 USD ; 1,000,000 GBP = 1,050,000 USD)
You are a US banker working with the FX desk to convert FX at the best rates possible. You will be receiving 1 million GBP and 1 million CHF 3 months from today. GBP CHF Spot 1.5545USD 1.0000USD 3 Mon. Futures. 1.5575USD 1.0500USD Exchange 1 million GBP at (futures, spot) Exchange 1 million CHF at (futures, spot)
95.62, 120
You are long 1 crude oil futures contract at $95.50, crude oil moves in 0.01 ticks with a tick value of $10. If the price increases 12 ticks by end of day, what is the price of the contract and your end of day account position? End of day price $ (95.52, 95.62, 96.70) End of day account position $ (120, 1,200, 12)
buy a put (Buy a put, this gives you the write but not the obligation to sell at todays price in 2 months.)
You believe that a stock will decline in value over the next 2 months, this is called being bearish. You should _______ option on that stock at a strike = todays price.
