MGTC71 -Test1sample

MGTC71-Test1sample - UNIVERSITY OF TORONTO AT SCARBOROUGH DEPARTMENT OF MANAGEMENT MGTC71 Introduction to Derivatives Markets Sample Test-1

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UNIVERSITY OF TORONTO AT SCARBOROUGH DEPARTMENT OF MANAGEMENT MGTC71: Introduction to Derivatives Markets Sample Test-1 Instructions : This is a closed book examination. You are allowed One side of one 8½’’ × 11’’ page with handwritten notes and/or formulae. Show all your work otherwise you will not get full credit . Make sure you allocate time appropriately . You have 2 hours. Good Luck! NAME: _____________________________________________ ID#: _____________________________________________ Answer all the following 5 short questions: Q-1 _______________ (15 Points) Q-2 ________________ (15 Points, Not for Test-1) Q-3 _______________ (18 points) Q-4 ________________ (12 points) Q-5 _______________ (20 points) Total _____________ (80 points)

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2 Question-1 (15 Points) Short questions a) [5 Points] There must be an arbitrage if the 3-month futures price of corn is less than the spot price. TRUE/FALSE. Clearly explain your answer using formulas when required. Solution: This is called backwardation which means: the convenience yield has exceeded the cost of carry. b) [5 Points] “The recent growth of market in financial Futures contracts provides a great source of information about how people think stock and bond prices will move in the future. For instance, if the futures price on S&P 500 is well below the current price then this implies that the market increasingly pessimistic about the future prospect of the stock market.” Evaluate this statement. Solution: Not true: The relation between the futures and expected futures depends on the risk premium of the underlying. Depending on the premium, the futures may under-estimate, or overestimate the expected spot. The futures price is expected spot only if the underlying carries no risk premium. The S&P has a positive premium therefore it always under-estimate the expected spot.
3 c) [5 points] Using an example explain why conversion factors are used in the treasury bond futures. Solution: To allow the futures price to reflect the full range of issues eligible for delivery, the CBOT has developed a conversion factor system. This system was created to facilitate the T-bond and T-note delivery mechanism and adjust for the coupons eligible for delivery into the futures contract. In other words , the use of the conversion factor in calculating the invoice price more or less equates the cost of delivering different available bonds. This makes the market more liquid and efficient. See Q-5 for an example.

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4 Question-2 [15 points] A Corp. wishes to be a floating-rate dollar borrower, which it can be at LIBOR +
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This note was uploaded on 07/20/2011 for the course MGMT 71 taught by Professor Mazaheri during the Spring '11 term at University of Toronto- Toronto.

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MGTC71-Test1sample - UNIVERSITY OF TORONTO AT SCARBOROUGH DEPARTMENT OF MANAGEMENT MGTC71 Introduction to Derivatives Markets Sample Test-1

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