ECOM026 - Financial Derivatives

Question 1

A bread factory expects to purchase 210 tonnes of wheat in 3 months time. CME Wheat futures with a three-month expiration exist for delivery of 70 tonnes of wheat. How should this factory hedge its exposure?

[5 marks]

Question 2

What is a Repo agreement? Why does a loan in the Repo market involve very little credit risk?

[5 marks]

Question 3

Using Put Call Parity, being long a stock and short a call option on that stock is equivalent to what type of options combination?

[5 marks]

Question 4

What is the difference between a first order Greek and a second order Greek in the world of options?

[5 marks]

Question 5

What is the purpose of the clearinghouse in futures markets? Is there any feature of the clearing house model that could reduce market stability during times of market stress?

[10 marks]

Question 6

The Monte Carlo method for pricing options is often referred to as a method of last resort. Explain why this might be the case, and when would an analyst use the Monte Carlo Approach to price a derivative?

[10 marks]

Question 7

If you have an options position where you are long one call option with a strike price of $90 at a price of $2, long another call with a strike price of 110 at a price of $0.5, and short two call options with a strike price of 100 at a price of $1.

What is this options combination called?

What does this options combination cost?

What is the maximum gain and the maximum loss that you can take on this position?

What is the break-even price for this options combination?

Why would a trader put on a position like this?

[15 marks]

Question 8

XYZ and ABC enter a three year Plain Vanilla Interest rate Swap. XYZ is paying 5% fixed with semi-annual compounding and receiving floating. The notional is $100 million. There are semi-annual cashflows.

If the realized LIBOR rates are:

Period 1 4.2%

Period 2 4.8%

Period 3 5.3%

Period 4 5.5%

Period 5 5.6%

Period 6 5.9%

Draw a table showing the cashflows exchanged between ABC and XYZ

[15 marks]

Question 9

Use a 3 step binomial tree to value an At the Money Call option.

The option expires in 6 months. The interest rate is 10% annually continuously compounded. The spot price is 100. U = 1.2 and D = 0.8. Early exercise is possible with this option. Show and explain all of your calculations.

[15 marks]

Question 10

On April 20th 2020 West Texas Intermediate Crude Oil futures fell in price eventually trading at -$37 per barrel. Explain what futures market dynamics could explain such an event.

[15 marks]