BEE3032

UNIVERSITY OF EXETER
BUSINESS SCHOOL
May 2013
FUTURES AND OPTIONS
Module Convenor: Vladislav Damjanovic
Duration: 2 HOURS
Answer THREE questions from Section A (10% each), ONE
question from Section B (35%) and ONE question from Section C
(35%)
All questions in each sections are worth equal marks. There are
5 pages of exam questions including this one.
Materials to be supplied:
Statistical table for Standard Normal Distribution
Materials to be supplied on request:
Answer booklet
Approved calculators are permitted .
This is a closed note paper.
1
SECTION A
Answer THREE of the following ve questions (30% marks)
1. What are the main dierences between futures and forwards contracts?
How would you explain the statement that the futures contract are
designed so as to minimise the credit risk? [10]
2. What is the dierence between a long forward position and a short
forward position? For each position explain the circumstances in which
gains or losses occur. [10]
3. What restrictions are imposed on price changes in a binomial tree to
prevent arbitrage? What would you do when those restrictions are
violated? [10]
4. Briey explain what happens with the Market Makers hedging port-
folio (long delta shares, short call) when the stock price moves up or
down one standard deviation. [10]
5. Dene the Value at Risk (VaR) and briey explain how it can be cal-
culated for a single stock. [10]
2
SECTION B
Answer ONE of the following two questions (35% marks)
1. Suppose you are a market-maker in XYZ index forward contracts. The
XYZ index spot price is 400, the annual continuously compounded
risk-free rate is 4%, and the dividend yield on index is 1.2%.
(a) Compute the no-arbitrage forward price for delivery of the index
in 8 months. [5]
(b) Suppose a customer wishes to enter a short index futures position.
If you take the opposite position, demonstrate how you would
hedge your resulting long position using the index and borrowing
or lending. [15]
(c) Suppose a customer wishes to enter a long index futures position.
If you take the opposite position, demonstrate how you would
hedge your resulting short position using the index and borrowing
or lending. [15]
2. Suppose the gold spot price is $310/oz, the 9 months forward price is
$320.22, and the continuously compounded annual risk-free rate is 5%.
(a) What is the lease rate for the gold? [5]
(b) What is the return on the cash-and-carry arbitrage strategy in
which gold is not loaned? How would you explain this result?
[15]
(c) What is the return on a cash-and-carry arbitrage strategy in
which gold is loaned, earning the lease rate? How would you
explain this result? [15]
3
SECTION C
Answer ONE of the following three questions (35% marks)
1. The initial price of a non dividend paying stock is o
0
= $60. the annual
continuously compounded risk free interest rate is : = 8% and the
annualised standard deviation is o = 30%.
(a) Consider a two period (: = 2) binomial tree with time span of
1 = 2 years. Construct a forward tree for the stock by indicating
the stock prices at each node of the tree. Report n and d. [10]
(b) Calculate the risk neutral probabilities. [5]
(c) Calculate the payos at each terminal node for a call option assum-
ing that the exercise price is 1 = $55 Working backward through
the tree calculate the price of European call option. [10]
(d) Working backward through the tree compute the price of Euro-
pean put option Check your result using put-call parity. [10]
2. The initial price of a non dividend paying stock is o
0
= $48. the annual
continuously compounded risk free interest rate is : = 5% and the
annualised standard deviation is o = 20%.
(a) Consider a two periods (: = 2) binomial. tree with time span of
1 = 1 year. Construct a forward tree for the stock by indicating
the stock prices at each node of the tree. Report n and d. [10]
(b) Calculate the risk neutral probabilities.[5]
(c) Calculate the payos at each terminal node for an call option
assuming that the exercise price is 1 = $50. Working backward
through the tree calculate the price of an American Call option.
[10]
(d) Working backward through the tree compute the price of an Amer-
ican Put option Why does put-call parity not hold? [10]
4
When answering following question use the Black-Scholes formula
for call option:
C = oc
T
`(d
1
) 1c
rT
`(d
2
)
d
1
=
ln(o,1) + (: o +
1
2
o
2
)1
o
p
1
d
2
= d
1
o
p
1
and put-call parity.
3. The spot price of the stock is $100, the annualised standard deviation
is o = 15%. and the annual continuously compounded risk-free rate is
: = 6%.
(a) Assuming that the stock does not pay dividends compute the
Black-Scholes call and put prices for the strike price 1 = $110
and the variety of years to maturity as indicated bellow:
Time Call Put
1
10
100
200
[10]
(b) Repeat your calculations from a) assuming that annual continu-
ously compounded dividend yield is o = 0.2%. [10]
(c) What happens with call and put prices in case a) when 1 !1?
What happens with call and put prices in case b) when 1 !1?
Explain the dierence. Are your observations consistent with put-
call parity? [15]
END OF PAPER
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