Q&P_Ch8_20080505

# Q&P_Ch8_20080505 - Certain Selected Problems Chapter 8...

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Certain Selected Problems Chapter 8

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1. On Monday morning, an investor takes a long position in a pound futures contract that matures on Wednesday afternoon. The agreed‑upon price is \$1.78 for £62,500. At the close of trading on Monday, the futures price has risen to \$1.79. At Tuesday close, the price rises further to \$1.80. At Wednesday close, the price falls to \$1.785, and the contract matures. The investor takes delivery of the pounds at the prevailing price of \$1.785. Detail the daily settlement process (see Exhibit 8.3). What will be the investor's profit (loss)?
Net profit is \$1,250 - 937.50 = \$312.50.

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2. Suppose that the forward ask price for March 20 on euros is \$0.9127 at the same time that the price of IMM euro futures for delivery on March 20 is \$0.9145. How could an arbitrageur profit from this situation? What will be the arbitrageur's profit per futures contract (size is €125,000)?
Answer. Since the futures price exceeds the forward rate, the arbitrageur should sell futures contracts at \$0.9145 and buy euro forward in the same amount at \$0.9127. The arbitrageur will earn 125,000(0.9145 - 0.9127) = \$225 per euro futures contract arbitraged.

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3. Suppose that DEC buys a Swiss franc futures contract (contract size is SFr 125,000) at a price of \$0.83. If the spot rate for the Swiss franc at the date of settlement is SFr 1 = \$0.8250, what is DEC's gain or loss on this contract?
Answer. DEC has bought Swiss francs worth \$0.8250 at a price of \$0.83. Thus, it has lost \$0.005 per franc for a total loss of 125,000 x .005 = \$625.

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4. On January 10, Volkswagen agrees to import auto parts worth \$7 million from the United States. The parts will be delivered on March 4 and are payable immediately in dollars. VW decides to hedge its dollar position by entering into IMM futures contracts. The spot rate is \$0.8947/€ and the March futures price is \$0.9002/€.
a. Calculate the number of futures contracts that VW must buy to offset its dollar exchange risk on the parts contract.

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Answer. Volkswagen can lock in a euro price for its imported parts by buying dollars in the futures market at the current March futures price of €1.1109/\$1 (1/0.9002). This is equivalent to
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