1a. Despite the fact that forward contracts carry more credit risk than futures
ID: 2729604 • Letter: 1
Question
1a. Despite the fact that forward contracts carry more credit risk than futures contracts, forward contracts offer what primary advantage over futures contracts?
a. the over-the-counter forward market is a highly regulated market b. forward contracts prevent the writer from assuming the credit risk of the buyer c. terms and conditions are tailored to the specific needs of the two parties involved d. transaction information between the two parties involved in the forward contract is readily available to the public e. conditions of the forward contract, such as delivery date and location, cannot be altered
1b. What is the lower bound of a European call option on a futures contract where fo is the futures price and X is the exercise price? Assume fo is greater than X
a. the difference between fo and X b. zero c. the present value of the difference between fo and X. d. the ratio of fo to X e. none of the above
1c. Determine the appropriate price of a European put on a futures if the call is worth $6.55, the continuously compounded risk-free rate is 5.6 percent, the futures price is $80, the exercise price is $75, and the expiration is in three months
a. $12.56 b. $0.54 c. $11.48 d. $1.62 e. none of the above
1d. Suppose you buy a one-year forward contract at $65. At expiration, the spot price is $73. The risk-free rate is 10 percent. What is the value of the contract at expiration?
a. $8.00 b. -$8.00 c. $0.00 d. $7.27 e. none of the above
1e. Suppose you sell a three-month forward contract at $35. One month later, new forward contracts with similar terms are trading for $30. The continuously compounded risk-free rate is 10 percent. What is the value of your forward contract?
a. $4.96 b. $5.00 c. $4.92 d. $4.55 e. none of the above
1f. A deep in-the-money call option on futures is exercised early because
a. the intrinsic value is maximized b. it behaves like a futures but ties up funds c. the futures price is not likely to rise any further d. all of the above e. none of the above
1g. What would be the spot price if a stock index future price were $75, the risk-free rate were 10 percent, the continuously compounded dividend yield is 3 percent, and the futures contract expires in three months?
a. $73.70 b. $77.48 c. $72.60 d. $76.32 e. none of the above
1h. Consider a portfolio consisting of a long call with an exercise price of X, a short position in a non-dividend paying stock at an initial price of So, and the purchase of riskless bonds with a face value of X and maturing when the call expires. What should such a portfolio be worth?
a. C + P – X(1 + r)-T b. C – So c. P – X d. P + So – X(1+r)-T e. none of the above
Explanation / Answer
1a. c. terms and conditions are tailored to the specific needs of the two parties involved
1b. a.the difference between fo and X
1c. Formula: p = c + Ke-rt - S
=> $6.55 + $80e-0.056 x (3/12) - $75 = $10.4379 or $10.44
So, none of the option is correct.
1d. Value of forward contract = Spot Price at expiration - PV of forward price
=> $73 - $65(1.10)-1 = $13.90
So, none of the option is correct.
1e.
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