2 Question 2 ·A stock trades today (to = 0) at a price of S,-100.0. ·A futures c

Question

2 Question 2 ·A stock trades today (to = 0) at a price of S,-100.0. ·A futures contract on the stock trades today at a price Fo = 100.25. . The futures contract expiration date is 5 days from today . Every day for ti = i, i = 1, 2, 3, 4, 5, the stock price is S1,S2, St, St, S. The futures price every day is Fi, F2, Fs, F4, F ·On the expiration day, Fs = SS (the futures price converges to the stock price). The stock pays a dividend of 0.1 on day 3 . Here is a list of the stock and futures prices, for i = 1,2,3,4,5. 100.75 104.25 3 S30.1 F4 Fs . The values of S2.. Ss are arbitrary, but satisfy the following inequalities: . The values of F2.., Fs are arbitrary, but satisfy the following inequalities: 104.25> F2>Fs >F>FsSs) (2.2)

Explanation / Answer

2.3) 1) C buys future on day 0 at 103.25. He sell the same contract at 104.25 at day 1

So, Day 1) Profit 104.25-103.25 = 1

Now he is short on futures and gradually the price decreases everyday as per situation given. So,

Day 2) Profit = 104.25-F2

Day 3) Profit = 104.25-F3+0.1 (stock dividend)

Day 4) Profit = 104.25-F4

Day 5) Profit = 104.25-F5

2) So total profit made by shorting futures is (104.25-F5)+0.1+1

3) He makes the profit every day in mark to market settlement but should close his position on expiration day to book maximum profit.

2.4) Investor D goes long on forward contract on day 0

There is hardly any chance of investor D making profits but instead he is going to face sure shot losses as both spot price of share and future price have gone down in next five days and forward price are directly affected in a similar way as spot price and future price. To make a profit he should have gone short on forwards instead of being long.The calculation will be similar to above but instead there are going to be losses. So he should close out position early to cut short his losses as early as possible instead of holding till expiry.

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