Practice Questions Solutions

# Practice Questions Solutions - (withSolutions 1 An investor...

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Page 1 of 5 Practice Questions for Final Exam (with Solutions) 1. An investor enters into 2 futures contracts of frozen orange juice, each for delivery of 15,000 pounds. The current futures price is 160 cents per pound, the initial margin is \$6,000 per contract, and the maintenance margin is \$4,500 per contract. What price change would lead to a margin call? The overall initial margin balance here is 2*6000=12000. The maintenance margin is 2*4500=9000. A margin call results when the margin account balance falls below the maintenance margin. This happens when the price of one future falls by more than \$1,500, or when the per pound price drops by 10 cents. 2. You prefer to borrow at 10% annual interest, semi-annually compounded, than at 9.85% annual interest, continuously compounded. True/False? Explain. True. Since ሺ1 ൅ ଴.ଵ െ 1 ൌ 10.25% and ݁ ଴.଴ଽ଼ହ െ 1 ൌ 10.35% , as a borrower you prefer to borrow at 10% annual interest, semi-annually compounded. 3. Suppose that the LIBOR yield rate (annualized, quarterly compounded) for maturity in three months is 4%, and the LIBOR yield rate (annualized, semi- annually compounded) for maturity in six months is 3.5%. What is the 3-month forward LIBOR in three months from now (annualized, quarterly compounded)? ൬1 ൅ 0.04 4 ൰ൈ൬1൅ ܨ 4 ൰ൌ൬1൅ 0.035 2 ܨ ൌ 2.97% 4. Is the 3-month forward price on a Treasury Bond higher or lower than the 3- month futures price on the same bond? Explain the intuition in detail. Through marking to market, when the Treasury rate increases, the long futures contract loses money and, conversely, when the Treasury rate falls the long futures contract makes money. Thus, you pay when money is expensive and receive money when money is cheap. In contrast, a forward contract on the Treasury rate is not marked to market and does not make or lose any money before it expires. In order to entice someone to hold a futures contract on the Treasury Bond, the futures price must be lower than the forward price. 5.

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## This note was uploaded on 10/26/2010 for the course JOHNSON 6730 taught by Professor Georgegao during the Fall '10 term at Cornell.

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Practice Questions Solutions - (withSolutions 1 An investor...

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