Ross5eChap26sm - Chapter 26: Derivatives and Hedging Risk...

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Chapter 26: Derivatives and Hedging Risk 26.1 1. Futures contracts are standardized and traded on exchanges, while forward contracts are tailor–made to suit the specific needs of two counterparties. The standardization of contracts increases the liquidity of futures markets in comparison to forward markets and also allows traders to enter into their positions with a certain degree of anonymity. 2. The holder of a futures contract is insulated from default risk due to clearing corporations and margin requirements. The owner of a forward contract has no guarantee that his counterparty will not default, and therefore forward holders must carefully evaluate each others’ credit risk before entering into a contract. 3. Since futures positions are marked–to–market at the close of trading, gains and losses on futures positions are realized daily, while gains or losses on a forward contract are not realized until the delivery of the asset. 26.2 a. 1. Since the futures price of wheat is $3.09 per bushel at the end of trading on March 18, the delivery price on that date is $3.09 per bushel. 2. On the delivery date, the long and short positions in a futures contract transact with the clearing corporation at the current futures price. Therefore, you will pay the current futures price of $3.09 per barrel in order to receive the wheat. The difference between the price that you pay at delivery and the price at which you entered into the contract is reconciled by daily marked–to–market gains and losses. 3. On March 15, you entered into a long futures position in wheat at a price of $3.00 per bushel. Since the closing futures price is $3.06 per bushel, your account receives a cash inflow of $0.06 at the end of the day. Your position in wheat futures increases to $3.06 per bushel (= $3.00 + $0.06). On March 16, your opening long position in wheat futures is $3.06 per bushel. Since the closing futures price is $3.11 per bushel, your account receives a cash inflow of $0.05 at the end of the day. Your position in wheat futures increases to $3.11 per bushel (= $3.00 + $0.06+ $0.05). On March 17, your opening long position in wheat futures is $3.11 per bushel. Since the closing futures price is $3.16 per bushel, your account receives a cash inflow of $0.05 at the end of the day. Your position in wheat futures increases to $3.16 per bushel (= $3.00 + $0.06 + $0.05 + $0.05). On March 18, your opening long position in wheat futures is $3.16 per bushel. Since the closing futures price is $3.09 per bushel, your account experiences a cash outflow of $0.07 at the end of the day. Your position in wheat futures decreases to $3.09 per bushel (=$3.00 + $0.06 + $0.05 + $0.05– $0.07). Since you receive a notice of delivery on this date, you will pay the $3.09 futures price and receive 1 bushel of wheat. 4. The following is a summary of your futures position: Answers to End–of–Chapter Problems B– 126
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Therefore, the net amount that you pay for one bushel of wheat is $3.00 per bushel.
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This note was uploaded on 07/18/2010 for the course ECONMICS ECM359 taught by Professor Matazi during the Summer '10 term at University of Toronto- Toronto.

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Ross5eChap26sm - Chapter 26: Derivatives and Hedging Risk...

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