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03-PS4-FF - MIT Sloan School of Management J Wang E52-456...

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MIT Sloan School of Management J. Wang 15.407 E52-456 Fall 2003 Problem Set 4: Forward and Futures Due: October 21, 2003 1. Explain the similarities and differences between forwards and futures contract on the same asset. You may want to consider (but not limited to) the following points for the differences: (a) How trade is counducted (b) Liquidity (c) Counter-party risk (d) Flexibility 2. (BM) Current riskless rate is 6% per year and the term structure is flat. Consider the following commodities and assets: Commodity/Asset Spot price Other Information Magnoosium $2,800 per ton y = 4%/year Oat bran $0.44/bushel y = 5%/year Biotech stock index 140.2 zero dividend yield AW stock $58.00 $2.40 dividend yield/year 5-year T-note $108.93 8% coupon/year Westonian Ruble R3.10 = $1 Ruble interest rate 12%/year (a) Calculate the six-month futures price for each case. (b) Explain how a magnoosium producer would use a futures market to lock in the selling price of a planned shipment of 1,000 tons of magnoosium six months from now (c) Suppose the producer takes the actions recommended in your answer to (b), but after one month magnoosium prices have fallen to $2,200. What happens? Will the producer have to undertake additional futures market trades to restore its hedged position? (d) Does the biotech index futures provide useful information about the expected future performance of biotech stocks? (e) Suppose Allen Wrench stock falls suddenly by $10 per share. Investors are confident that the cash dividend will not be reduced. What happens to the futures price?
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