BFC5915 - Mid Semester Test

(You operate a business in Australia that frequently trades with partners in China. As a result, you often receive payments denominated in Renminbi (RMB), and occasionally you pay bills in RMB. This exposes you to foreign exchange risk, therefore you make use of forward contracts to manage this risk. The spot exchange rate between AUD and RMB is RMB1.0000 = AUD0.2004. The riskfree rates of interest in Australia and China are 2% and 4% respectively (continuously compounded). 1. The 6-month forward rate for the delivery of RMB six months' from today is RMB1.0000=AUD (how much??) 2. Suppose that the forward exchange rate you observe is RMB1 = AUD0.1900. Then to make arbitrage profit you should (select one) : a. Borrow AUD, convert it to RMB at the spot rate, invest the resulting RMB in China for 6 months, and enter a six-month forward contract to sell the accumulated RMB b. Borrow RMB and convert to AUD at the forward rate to make a profit c. Borrow AUD and convert it to RMB at the forward rate to make a profit d. Borrow RMB, convert it to AUD at the spot rate, invest the accumulated AUD in Australia for 6 months, and enter a six-month forward contract to sell the accumulated AUD

1. The 6 month forward rate is F=0.1989exp((0.02-0.04)*0.5)= 0.19692=0.1969 to four decimal places. 2. The forward rate is too low. Buy the forward (buy RMB under the 6 month forward contract) and sell the spot (sell RMB spot). The strategy therefore is to borrow RMB for 6 months, sell the RMB immediately in the spot market (exchange RMB for AUD), invest the resulting AUD for 6 months, and then sell the accumulated AUD under the 6 month forward contract (that is, buy RMB forward). This will result in a riskless profit.

Today the spot rate between US dollars (USD) and Australian dollars (AUD) is AUD1=USD0.6900, and the current spot price of gold is USD1,750 per ounce. You are a large Australian jewellery maker and you have ordered 1,000 ounces of gold for delivery in 3 months time. You decide to hedge your exposure to movements in the gold price using a forward contract on gold. When you are ready to buy the gold in 3 months, the spot price of gold is USD1,800 per ounce, and the spot exchange rate is AUD1 = USD0.7500. 1. If the jewellery maker had remained unhedged, the Australian jewellery maker would be exposed to the risk of the gold price (rising/ falling??) 2. The Australian jewellery maker is exposed to the risk of the AUD (depreciating/appreciating??) 3. To hedge exposure to fluctuations in the gold price, assume the jewellery maker originally entered a forward contract on (1,000 ounces of) gold with a forward price of USD1,700 per ounce. The jewellery maker entered a (long/short) forward contract 4. With the forward gold hedge in place, in three months time, when the Australian jewellery maker buys the 1,000 ounces of gold, the cost in AUD will be AUD (how much??). Give your answer in millions to two decimal places or your answer will be incorrect

1. The jeweller is exposed to the price of gold rising from where it is today in the 3 months before it needs to be bought. (appreciating) 2. The jeweller buys the gold and must pay in USD. Therefore the gold miner is exposed to the USD appreciating (AUD depreciating) because then it will cost more in AUD. 3. The jeweller wants to buy gold - so the contract is a long forward. 4. Cost in AUD? Cost in USD is 1000×1700. Convert to AUD = 1000×1700 /0.75= 2,266,666.7=2.27 million written in millions to two decimal places

A long call bull spread consists of a long call with strike price K1 and a short call with strike price K2, where K2 > K1. Which of the following statements is true? Choose one. a. A short call bull spread consists of a short call option with strike price K1 and a short call option with strike price K2. b. A short call bull spread consists of a short call option with strike price K1 and a long call option with strike price K2. c. A short call bull spread is actually a bearish strategy that pays off when share prices drop. d. A short call bull spread is actually a bullish strategy that pays off when share prices rise. e. Both statements b and c are correct f. Both statements a and d are correct.

A long call bull spread consists of a long call option with strike price K1 and a short call option with strike price K2, where K2>K1. Therefore a short call bull spread means taking the negative of the positions above. A short call bull spread consists of a short call option with strike price K1 and a long call option with strike price K2 where K2 >1. Because it is the negative of the original position it will pay off when prices fall so it is a bearish strategy. The correct answer is: Both statements b and c are correct

You have a view that the United States Dollar (USD) will weaken relative to the AUD. The spot exchange rate is USD 1.00 = AUD 1.3889 (i.e., AUD 1.00 = USD 0.7200). You will speculate on the USD weakening using a forward contract denominated in AUD. Which position will profit from a weakening USD? Select one: a. Short Forward contract to sell AUD b. Long forward contract to buy AUD

A weakening USD means that the AUD is strengthening.A long forward contract on AUD will profit when the AUD strengthens. The correct answer is: Long forward contract to buy AUD

You are situated in Zariland where the currency is denominated as ZAN. You are importing from a country called Qualand where the currency is denominated as QUA. The current risk-free interest rates (continuously compounded) are 5% in Zariland and 4% in Qualand. The current exchange rate is QUA1=ZAN0.5897. The arbitrage-free current 6-month forward exchange rate (correct to 4 decimal places) is: Select one: a. QUA1=ZAN0.5868 b. ZAN1=QUA0.5868 c. QUA1=ZAN0.5927 d. ZAN1=QUA0.5927

F = S0e(rt-rb)T The QUA is the base currency (rb=4%) and the ZAN is the terms currency (rt=5%) F = 0.5927 The forward rate is QUA1=ZAN0.5927 The correct answer is: QUA1=ZAN0.5927

The spot price of gold is $1700 per ounce. The fair (no arbitrage) forward price for the delivery of gold in two years' time is $1800 per ounce. However, you discover that the 2-year quote for gold forward contracts is $1750. What trades would an arbitrageur enter today to capture this arbitrage opportunity? Select one: a. Enter a long forward contract to buy gold two years from now at $1750, then simultaneously short sell gold today at $1700 and invest the proceeds in the bank. b. Borrow $1700 today from the bank and use it to buy gold on the spot market, then immediately enter a long forward contract on gold at the correct price of $1800. c. Enter a long forward contract to buy gold two years from now at $1750, then simultaneously borrow $1700 today from the bank and use it to purchase gold on the spot market. d. Borrow $1700 today from the bank and use it to buy gold on the spot market, then immediately enter a short forward contract on gold at the incorrect price of $1750.

Forward price is too low. Buy the underpriced and sell the overpriced. Buy gold forward, short sell spot, invest $1700 for 2 years. The correct answer is: Enter a long forward contract to buy gold two years from now at $1750, then simultaneously short sell gold today at $1700 and invest the proceeds in the bank.

XYZ share price is currently $25. You are considering two possible investment strategies to profit from a predicted increase in XYZ share price: (i) purchase 40 shares at the spot price, or (ii) enter a long call option (quoted at $0.60) which allows you to buy 100 shares at a strike price of $28. Calculate the share price at which the two strategies generate the same gross profit (ignore the outlay for each strategy). Select one: a. Impossible to determine without further information b. $30.00 c. $28.00 d. $63.33

Gross payoff on long share position = 40(ST-25.00) Gross payoff on call option = 100(ST-K)=100(ST-28.00) Equate the two expressions. 60ST=1800 or ST=30.00 The correct answer is: $30.00

A trader creates a spread by selling a 9-month put option with a $25.00 strike price for $2.19 and buying a 9-month put option with a $28.00 strike price for $4.25. The initial cost to set up the strategy is ($how much?) The breakeven share price for the strategy is ($how much??) This strategy is called a (bear/bull)- spread

Initial cost is -2.19+4.25=2.06 Breakeven is $2.06 below the higher strike. Breakeven is 28.00-2.06=25.94 This is a bear spread.

Futures contracts are written on crude oil. You enter a long futures position covering 20,000 barrels of oil, with a futures price (F) of $50 per barrel. Several weeks later, when you close that futures position, the futures price on oil is $40 per barrel. What is the profit or loss on your futures trading? Select one: a. $1,000,000 profit b. $200,000 profit c.Impossible to determine without knowing what the underlying position in oil was. d. $800,000 profit e. $200,000 loss

Outcome = 20000 X (FT-F0) for long position = 20000 X (40-50) = -$200,000 The correct answer is: $200,000 loss

The current price of the stock is $10. An option position is created by buying a call option and buying a put option at the same strike price K=$10 with the same maturity. The call premium is $1.54, and the put premium is $1.17. Choose all the statements below that are true. Select one or more: a. A trader would set up this strategy when her view is that the stock will not be volatile. b. The strategy makes money when the stock price moves below $7.29 c. The strategy costs nothing to set up because you can ignore the option premiums d. A trader would set up this strategy when her view is that the stock will be volatile. e. The strategy makes money when the stock price moves above $12.71 f. The strategy makes money when the stock price moves above $2.71 g. We need information about the volatility of the stock to determine profits and losses at maturity

S=$10, K=$10C=$1.54, P = $1.17 Cost of strategy is $2.71 So makes money when stock price moves above $12.71 (10+2.71), and below $7.29 (10-2.71) The correct answers are: - The strategy makes money when the stock price moves above $12.71 - The strategy makes money when the stock price moves below $7.29 - A trader would set up this strategy when her view is that the stock will be volatile.

A put option has a strike price of K=$12.50, a premium of $1.46 and a time to maturity of 6 months. The formula for the net payoff (in $) on a long position in one put option at maturity is given by: Select one: a. -max(1.27-ST,0)+12.50 b. max(1.27-ST,0)-12.50 c. We do not have enough information to write down the formula for the net payoff. d. -max(12.50-ST,0)+1.46 e. max(12.50-ST,0)-1.46

The correct answer is: max(12.50-ST,0)-1.46

The S&P500 market index of US stocks is currently 3400 points. The dividend yield on the S&P500 index is 4% per annum (continuously compounded) and the riskfree rate of interest in the United States is 1% per annum (continuously compounded). What is the fair price (F) for a futures contract based on the S&P500 which expires in 6 months' time? Round your answer to two decimal places.

The formula to use is F = Se(r-q)T where S is the spot price, r is the riskfree rate per annum (continuously compounded), q is the dividend yield a percentage per annum (continuously compounded) and T is the time to maturity of the forward contract. Substitute the values in. The correct answer is: 3349.38

The A&Q share price index is currently at 5495. The correctly calculated no-arbitrage price of the futures contract on the A&Q share price index for settlement in six months' time is 5578. The multiplier on the index is $100. You happen to notice that the futures price is trading at 5570. Which of the following statements is true? Choose the best one. a. Large institutions will arbitrage the mispricing by taking a short position in the futures index, and buying the stocks underlying the index. This will force the stock prices up. b. Because the futures is only slightly mispriced, once transaction costs are taken into account there would be no arbitrage profits. c. Large institutions will arbitrage the mispricing by taking a long position in the futures index, and shorting the stocks underlying the index. This will push the stock prices down. d. Large institutions will arbitrage the mispricing by taking a long position in the futures index, and shorting the stocks underlying the index. This will push the futures price up. e. Large institutions will arbitrage the mispricing by taking a short position in the futures index, and buying the stocks underlying the index. This will force the futures price down.

The futures contract is trading at a price below the no-arbitrage price. The futures price is too low. So, but the futures and sell the spot. This will push the price of the futures up until it represents a price where there are no arbitrage opportunities. Note that it is the futures price which depends on the underlying spot price, so the futures price will move. The correct answer is: Large institutions will arbitrage the mispricing by taking a long position in the futures index, and shorting the stocks underlying the index. This will push the futures price up.

An electric car manufacturer needs to buy 10,000 ounces of palladium in three months time (October) and needs to hedge it. The closest contract is gold futures traded on the CME, with October expiry, where each contract is on 100 ounces of gold. The standard deviation of changes in palladium is 0.37. The standard deviation of changes in gold futures is 0.22, and the coefficient of correlation between the two changes is 0.50. The optimal hedge ratio for a three-month contract is (what??) The electric car manufacturer should take a (long/short??) position on (how many??) contracts on gold futures on the CME for October delivery. Give your answer as a whole number of contracts.

The optimal hedge ratio is 0.50 x 0.37/0.22 = 0.8409 = 0.841 correct to three decimal places. Therefore take a long position on 10000*0.841/100=84.1 or 84 contracts.

A trader enters a option position that has the following net payoff diagram: (info on google doc) The option will be exercised only when share price is (Less/More than 45/50/65) . The trader makes a positive net profit only when share price is (Less/More than 45/50/65)

The option will be exercised only when share price is [Less than $50]. The trader makes a positive net profit only when share price is [Greater than $45].

You will receive $650 in 9 years. If the discount rate is 8% per annum continuously compounded, what is the present value of this future cash flow? Answer with 2 decimal places

The present value is the dollar amount (A) to be received discounted back at the discount rate (B) over the number of years (T). The formula is A*exp(-B*T) where B is entered as a decimal. The correct answer is: 316.39

An investor uses a long protective put strategy. The current stock price is $35.00, strike price for the option is $32.00, and the option premium is $2.00. The investor will start making a profit on this protective put strategy as long as the stock price at maturity is Select one: a. Greater than $35.00 b. The investor will always make a profit from this strategy. c. Greater than $37.00 d. Greater than $32.00

The profit for protective put is If ST > 32, profit = ST - S0 - p = ST - 35 - 2.00 = ST - 37 If ST <= 32, profit = K - S0 - p = 32 - 35 - 2.00 = -5. The investor will start making a profit as long as stock price at maturity is greater than $37 The correct answer is: Greater than $37.00

Which of the following statements is (are) true? Select one or more: a. A trader entering a long strap buys one call option at strike price K and two put options with strike price K. The call and put options have the same maturity. b. A trader entering a long strap buys two call options at strike price K and one put option with strike price K. The call and put options have the same maturity. c. A trader entering a long strap expects the stock to be volatile but that the likelihood of the price moving up is greater than the likelihood of the price moving down. d. A trader entering a long strap expects the stock to be volatile but that the likelihood of the price moving down is greater than the likelihood of the price moving up.

The slope of the payoff to the left of X is steeper. So the trader expects it's more likely for the share price to decrease than increase, and would make more money on the decrease. It consists of one call option and two put options at strike price K. (Image on google doc) The correct answers are: A trader entering a long strap buys two call options at strike price K and one put option with strike price K. The call and put options have the same maturity. A trader entering a long strap expects the stock to be volatile but that the likelihood of the price moving up is greater than the likelihood of the price moving down.

In early April 2020 the US oil futures prices went negative for the contracts settling on 21st April. The reason for the negative futures prices is argued to be (choose the best answer). Select one: a. The storage costs for oil were very high and there was an over-supply of oil b. The convenience yield on oil was very high c. The demand for oil was low and the futures market for oil was in normal backwardation d. Physical oil was in very high demand and the futures market was in contango

There was an over-supply of oil because of the pandemic and the slow down in the economy. No-one wanted the oil, because there was no storage for the oil (and to get storage was very costly) and the sellers of oil actually had to pay someone to take it off their hands. The correct answer is: The storage costs for oil were very high and there was an over-supply of oil

Futures contracts seldom lead to delivery of the underlying asset because Select one: a. Either the buyer or the seller fail to meet margin payments b. Holders of contracts take the opposite position before the delivery date c. Sellers of contracts frequently default d. Buyers of contracts frequently default e. The clearing house charges a penalty if contracts result in physical delivery

We learned that most futures contracts are not taken through to delivery because the contracts are closed out before the delivery date, by taking the opposite position. The correct answer is: Holders of contracts take the opposite position before the delivery date

The following diagram depicts the net payoff to someone who enters a short put option position. They receive the option premium of $3 but are exposed to the potential of severe losses if share price falls sharply. (pic on google doc) Which of the following best explains why a trader would enter a short put option position like this? Select one: a. The trader is expecting share price to be above the $32 breakeven point. b. If share price falls, the trader can simply choose to not exercise the option. c. After receiving the $3 premium, they can "sell to close" and avoid the severe exposure. d. Every option trade must have two counterparties. The ASX determines which party has the long position and which party has the short position.

When you enter a short put position, you expect the share price to be above the breakeven point. The correct answer is: The trader is expecting share price to be above the $32 breakeven point.

You have a share portfolio currently worth $80 million. The beta of this portfolio is 0.8. The S&P/ASX200 market index is 6200 and SPI200 futures contracts are quoted at 6350. How many SPI200 futures contracts must be entered to fully hedge your share portfolio? Note that SPI200 futures contracts have a standard multiplier of $A25. Round your answer to the nearest whole number. Select one: a. 504 contracts b. 413 c. 10323 contracts d. 10079 contracts e. 403 contracts f. 516 contracts

Your answer is correct. The correct answer is: 403 contracts