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03-PS4-FF_sol - MIT Sloan School of Management J Wang...

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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. In terms of the contract, forwards and futures are very similar. Both of the require a transaction to be executed at a specified future date at a specified price. However, there are a few differences: Forward is trader over-the-counter (OTC), which means two party comes together and write a contract. Therefore, forward is very flexible and customized. However, as the buyers and sellers have different needs, the contracts are not homogenous and liquidity is low. There is also no third-party involved to protect either side from a default risk. Unless otherwise stated in the contract, there is no cash changing hand until the maturity date. Futures is traded in an exchange. Contracts are standardized, with just a few maturities date available for each good. Because of this, liquidity is higher and it is easier to trade in and out of the market. Moreover, there is a clearing house which guarantees each side of the trade, therefore there is no default risk to anyone who trades in futures. To protect the clearing house, however, you are required to make a margin deposit, and your position is marked-to-market. Therefore you may be required to pay your loss before the maturity date. 2. (a) Magnoosium: [(2800(1.03 - 0.02)] =$2,828 per ton Oat Bran: [0.44*(1.03 - 0.025)] =$0.4422 per bushel Biotech: 1.03*140.2 = $144.4 Allen Wrench 1.03*[58.00 - (1.2/1.03)] = $58.54 5-year T-Note: 1.03*[108.93 - (4/1.03)] = $108.20 Ruple: X = 3 . 1 * 1 . 06 1 . 03 = 3 . 19 (b) The magnoosium producer would sell 1,000 tons of six-month magnoosium futures (c) Because magnoosium prices have fallen, the magnoosium producer will receive pay- ment from the exchange. It is not necessary for the producer to undertake addi- tional futures market trades to restore its hedge position.
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