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)?
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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)?
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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?
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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/€.
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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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