4 s - 1 THE UNIVERSITY OF HONG KONG FACULTY OF BUSINESS AND...

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Unformatted text preview: 1 THE UNIVERSITY OF HONG KONG FACULTY OF BUSINESS AND ECONOMICS FINA0301 - DERIVATIVES Second Semester, 2008-2009 Tutorial 4 Problem Set Solution – Chapter 5,6 & 7 c Chapter 5 & 6 Question 1 (a) We plug the continuously compounded interest rate and the time to expiration in years into the valuation formula and notice that the time to expiration is 6 months, or 0.5 years. We have: (b) The annualized forward premium is calculated as: (c) For the case of continuous dividends, the forward premium is simply the difference between the risk-free rate and the dividend yield: We can solve: Question 2 (a) We plug the continuously compounded interest rate, the forward price, the initial index level and the time to expiration in years into the valuation formula and solve for the dividend yield: FINA0301 – Tutorial 4 Solution Mr. Clive Man Chung HO 2 (b) With a dividend yield of only 0.005, the fair forward price would be: Therefore, if we think the dividend yield is 0.005, we consider the observed forward price of 1,129.257 to be too cheap. We will therefore buy the forward and create a synthetic short forward, capturing a certain amount of \$8.502. We engage in a reverse cash and carry arbitrage: (c) With a dividend yield of 0.03, the fair forward price would be: Therefore, if we think the dividend yield is 0.03, we consider the observed forward price of 1,129.257 to be too expensive. We will therefore sell the forward and create a synthetic long forward, capturing a certain amount of \$12.637. We engage in a cash and carry arbitrage: FINA0301 – Tutorial 4 Solutions Mr. Clive Man Chung HO 3 Question 3 (a) The notional value of 10 contracts is 10 × \$250 × 950 = \$2 , 375 , 000, because each index point is worth \$250, we buy 10 contracts and the S&P 500 index level is 950. With an initial margin of 10% of the notional value, this results in an initial dollar margin of \$2 , 375 , 000 × 0 . 10 = \$237 , 500....
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4 s - 1 THE UNIVERSITY OF HONG KONG FACULTY OF BUSINESS AND...

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