MSc.

ACCOUNTING AND FINANCE

MFA 561: FINANCIAL DERIVATIVES

ATTEMPT ALL QUESTIONS

BY

YOUR NAME

STUDENT NUMBER

EXAMINER: DR. EBENEZER BUGRI ANARFO

SECTION A

For the next 3 questions. An investor enters into a SHORT forward contract to sell 100,000
British pound sterling (£) for Ghanaian cedis (₵) at an exchange rate of₵2.33 per pound sterling.

1. (A) Pound sterling will depreciate against the cedi

 2. (c) ₵33,000

3. (e) -₵5,095.238

Workings below for question 1, 2 & 3:

For the next 2 questions. A trader enters into a SHORT cotton futures contract when the futures
price is 50 U.S. cents per pound (weight measure). The contract is for the delivery of 50,000
pounds of cotton.

1 $ =100 cents

50 Us cents mean $ 0.5 per pound of cotton.

A trader enters into short cotton future contract that means he has an obligation to sell 50000
pounds of cotton for $0.5 per pound of cotton.

4. At the end of the contract, price is $0.4530 per pound of cotton.

Profit=50000*(0.50-0.4530)

Answer: (b) $2,350

5. At the end of the contract, price is $0.5280 per pound of cotton.

Loss=50000*(0.5280-0.50)

Answer: (b) -$1,400

6. Answer: (d) About 264 contracts,

Total number of contracts = 12,000,000 / (1000 barrels * future price)

= 12,000,000 / (1,000 * 45.50)

= 263.7

It is around 264 contracts to hedge the above value.

 7. Hedging means buying and selling any asset such as the potential abnormal loss or gain
can be avoided. Meaning any abnormality and uncertainty is avoided using the buying or
selling of different financial instruments. This is done in order to reduce as much risk as
possible.

Here, the asset is already hedged by buying it at $70 and selling a future contact at $72,
avoiding the risk of uncertainty. So, there would only be a gain of $72-$70 = $2

Answer: b) $2

For the next 5 questions. Suppose the beta of your international stock portfolio, currently
valued at $50 million, is 1.3. You decide to hedge the downside risk of this portfolio with a
SHORT position in S&P 500 futures contract, currently priced at 1,300 (note that the dollar price
of this contract = 1,300 x $250 = $325,000).

8. Hedge Ratio or number of futures contracts to sell = (Value of portfolio * Beta of

portfolio) / value of 1 futures contract

=>Hedge Ratio or number of futures contracts to sell =($50,000,000 * 1.30) / $325,000

=>Hedge Ratio or number of futures contracts to sell = 200

Correct Option (b) 200

9. Beta of the stock portfolio is 1.3

It means if the market will rise/falll by 1% then the stock portfolio will rise/fall by 1.3%

As we have taken sell or short position in Futures contract, hence decline in market will
cause gain in Futures Position.

Answer :( d) Loss in the stock portfolio but a gain in the futures position

10. Total Futures position = 200 contracts * $325,000 per contract = $ 65,000,000

If market declines then there will be gain in sell futures position.

 Hence Gain in futures position = Total Futures position * 10%

=> Gain in futures position = $ 65,000,000 *10%

=> Gain in futures position = $ 6,500,000

Correct Answer: (a) Gain of $6,500,000

11. Beta of the stock portfolio is 1.3

It means if the market will rise/falll by 1% then the stock portfolio will rise/fall by 1.3%

If the market declines by 10% , then the stock portfolio will fall by = 1.3 *10% = 13%

Hence Loss on stock Portfolio = value of portfolio * % fall

=>Loss on stock Portfolio =$50,000,000 * 13%

=>Loss on stock Portfolio =$ 6,500,000

Correct Answer: (b) Loss of $6,500,000

12. If market declines by 10%, then there is Gain of $ 6,500,000 in futures position and loss
of $ 6,500,000 in stock Portfolio.

Hence Gain/loss on overall position = Gain of $ 6,500,000 - loss of $ 6,500,000

=>Gain/loss on overall position = $0

As the nest gain/loss is $0, hence it is a perfect hedge.

Correct Answer :( c) $0; a perfect hedge

For the next 7 questions. A PUT and a CALL option are written on a stock with a strike

price of $60. The options are held until expiration.

13. given,

k = 60

s= 75

Intrinsic value of put = max( k - s, 0)

Intrinsic value of put = max( 60-75, 0)

Intrinsic value of put = 0

Answer: (A) $0

14.  Answer is Option (b): (57,3)

Breakeven Price = Strike Price - Premium = 60 - 3 = 57

Time value of option = Option Premium = 3

15. Answer is Option (b): 3

Premium is the profit, Since Stock price > Strike Price Put option is not exercisable.

16. Answer is Option (b): 15

Intrinsic value = 75 - 60 = 15

17. C) 76 , 16
Breakeven point = strike price + premium = 60 +16 = 76
Time value of option = option price = 16

18. e) NONE OF THE ABOVE

Profit on expiration = premium received - value of option at expiration
= 16 - (75-60)
= 16-15
=1

19. a) Be exercised; in-the-money; not be exercised; out-of-the-money; zero

Loss on call at expiration = premium paid - expiration value
 = 16 - (75-60)
=1
Loss on put option = whole premium in case of out of money
=3

20. As Share is bought for $165, if there is increase in price, we are in profit. So, the threat is
of price fall.

Therefore First Two options are wrong

A call option is the option in which buyer of call option has the option to buy the stock.
As there is threat of price fall, call option will not help in this case.

Purchasing the put option helps the buyer.

So, Option (c) & (d) are also wrong as they are related to call option. Selling Call option
will entitle to get some premium but it will not hedge the investment.

Hence, Correct Answer is (e) None of the above

21. Profit = value of option - premium

Value of option = spot price - strike price

= 185 - 165

= 20

Premium = 7.5

Profit = 20 - 7.5

= 12.5

Gain of 12.5 per share

Hence answer option e: none of the above

22. Profit from a Covered Call = UT − U0 − max[0, UT − X] + premium

 = $185 - $160 - [max{0, (185 - 165)}] + $8

= $185 - $160 - $20 + $8

= $13

So, the correct option is (c) Loss of $13 per share

23. Answer is B - Receive LIBOR, pay fixed ate at the rate of 5.5%, for a net pay of 6.5%
per year for 3 years

24.

25. The correct Option is (a):- Party paying fixed rate

Explanation: - In this case of Interest rate swap, the fixed rate is 5.5% and the floating
rate is LIBOR plus 75 basis point
That is 4.5% + 0.75% = 5.25%.

So, the fixed rate is 5.5% and floating rate interest is 5.25%.
 So, as the fixed rate is higher than floating rate then, net interest payment will be made by
the party paying the fixed interest.

26.

Interest payment under the fixed rate =

30000000*7%*3/12 = $         525,000

Interest payment under the floating rate

= 30000000*7.2%*3/12 = $         540,000

Net payment = 540000-525000 = $ 15,000

ANSWER: (a) $15,000

For the next 3 questions. Currency swap: Consider a currency swap between Party X in the
USA and Party Y in Switzerland. The swap is for $10 million and SF15 million. Party Y pays
dollars of interest to X at a fixed interest rate of 9%. Party X in the USA pays Swiss francs (SF)
at a fixed rate of 8%. The payments are made semi-annually based on the exact day count and
360 days in a year. The current period has 181 days.

27. Since in Currency Swap, one party receives the principal in one currency and pays
interest in another currency while the other receives principal in their currency and pays
interest in another currency.

Option A: Party X has to deliver (owe) the principal amount promised to pay to Y as $10
million.

28. At time of currency swap:

SF 15 million= $10 million

SF1= $10million/15million
 SF1= $10/15

Option A: SF1= $0.67

29.  Party X has to pay in Swiss Francs at 8% interest per annum

We know the interest is paid in 181 days

This means, interest rate =8%

Principal =SF 15,000,000 (SF 15 million)

Interest paid that is, next payment paid by party X=8%* (181/360) * SF 15 million

=0.08(181/360)*SF15, 000,000

Option A =SF603, 333,333.33

30. Answer A

A forward contract ensures that the effective exchange rate will equal the current forward
exchange rate. An option provides insurance that the exchange rate will not be worse than
a certain level, but requires an upfront premium. Options sometimes give a better
outcome and sometimes give a worse outcome than forwards.

SECTION B

Question 1

Answer (a):

Minimum variance hedge ratio =

= correlation coefficient between related assets * (SD of Stock price / SD of Futures), where SD
is Standard Deviation.

= 0.9 * (0.45/0.42)

= 0.9643

Answer (b):

Since hedger own 88,000 units of asset, he has a long position in asset. Obviously he will be
worried from falling price of asset in future. As such he will try to hedge his position by taking
short futures position on related asset.

Answer (c):

Optimal number of futures contract with no tailing of hedge is:-

= Hedge Ratio * (Quantity of asset in units being hedged/ Lot size of 1 Future Contract)

= 0.9643* (88000/8000)

= 10.68or

11 contracts round off.

Answer (d):

Optimal number of futures contract with Tailing of hedge incorporates the impact of daily
settlement feature of futures. For this we use following formula which is:-
= Hedge Ratio * (Value of Asset being hedged in $ terms/ Value of One Futures Lot)

= 0.9643* (88000* $30 / 8000*29)

= 10.97or 11 contracts rounded off

Question 2
 Question 3

Using an Excel Solver:

Initial Margin = $4,950

Maintenance margin = $4,500
Workings:-

Margin account balance for 19-05-2016

= Margin account balance for 18-05-2016 - loss for 19-05-2016

= $4,550 - $600

= $3,950

$3,950 is below the maintenance margin of $4,500. Now, we need to fill in $1,000 to get the
balance to initial margin which is $4,950.

Therefore Margin account balance for 19-05-2016 = $3,950 + $1,000 (deposited)

Margin account balance for 20-05-2016

= Margin account balance for 19-05-2016 - loss for 20-05-2016

= $4,950 - $500
= $4,450

$4,450 is below the maintenance margin of $4,500. Now, we need to fill in $500 to get the
balance to initial margin which is $4,950.

Therefore Margin account balance for 20-05-2016 = $4,450 + $500 (deposited)