FIN 4021 Homework 1 fall 2015

| December 9, 2017

1. (4pt)An investor enters into a short forward contract to sell 150,000 British pounds for US dollars at an exchange rate of 1.4000 US dollars per pound. How much does the investor gain or lose if the exchange rate at the end of the contract is (a) 1.3700 and (b) 1.4200? (c)Draw the investor’s payoff diagram on this forward. Make sure that you distinguish your payoff chart from that of your counterparty’s if you are drawing both within the same chart.2. (4pt)A trader enters into a short cotton futures contract when the futures price is 50 cents per pound. The contract is for the delivery of 55,000 pounds. How much does the trader gain or lose if the cotton price at the end of the contract is (a) 48.20 cents per pound and (b) 51.45 cents per pound? (c)Draw the trader’s payoff diagram on this futures contract. Make sure that you distinguish your payoff chart from that of your counterparty’s if you are drawing both within the same chart.3. (10pt)Suppose that you write a put contract with a strike price of $40 and an expiration date in 3 months. The current stock price is $42 and the contract is on 100 shares. (a)Draw profit diagram for yourself and your counterparty, assuming that the put contract you wrote was sold for $3.5. Make sure that you distinguish your payoff chart from that of your counterparty’s if you are drawing both within the same chart. (b) Are you in long or short position on the underlying asset? (c)Are you in long or short position on the option?4. (8pt)Suppose that a March call option to buy a share for $70 costs $2.50 and is held until March. Draw profit diagram for both parties of the transaction. Make sure that you distinguish your payoff chart from that of your counterparty’s if you are drawing both within the same chart.5. (14pt)A stock’s price is $29. An investor buys one call option contract on the stock with a strike price of $32 and sells a call option contract on the stock with a strike price of $32.50. The market prices of the options are $2.75 and $1.50, respectively. The options have the same maturity date. Draw a chart that describes all the followinga) investor’s profit/loss from the call option he/she boughtb) investor’s profit/loss from the call option he/she soldc) investor’s total profit/loss from his position.In your chart, mark and write the spot prices where the slope of the profit/loss changes.Challenge(5pt)Companies A and B have been offered the following rates per annum on a $20 million5-year loan:Company A requires a floating-rate loan; company B requires a fixed-rate loan. Design a swap that will net a bank, acting as intermediary, 0.1% per annum and that will appear equally attractive to both companies.Hint:Company A should end up borrowing at a Floating rate of LIBOR-0.3% and Company B should end up borrow at a Fixed Rate of 6.0%.

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