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lecture04post - Recap Forward pricing Future contracts...

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Unformatted text preview: Recap Forward pricing Future contracts Lecture 4 - Forwards and futures BUSI 588, Fall 2011 Diego Garc a Kenan-Flagler Business School UNC at Chapel Hill September 7th, 2011 c Diego Garc a, BUSI 588, Kenan-Flagler, Fall 2011 Lecture 4 - Forwards and futures 1 / 26 Recap Forward pricing Future contracts Outline 1 Recap Homework 1 2 Forward pricing Forward contracts Bachelier Synthetic forwards Sample prices 3 Future contracts Definitions and exchanges Marking-to-market Handouts today: Class slides. Case 4 solutions, Bachelier. Homework 1 solutions. c Diego Garc a, BUSI 588, Kenan-Flagler, Fall 2011 Lecture 4 - Forwards and futures 2 / 26 Recap Forward pricing Future contracts Puts versus calls From put-call parity we have C- P = S- K (1 + r f ) T So C P if and only if K S (1 + r f ) T = F where F is the futures (forward) price of the underlying asset. Puts and calls with a strike price equal to the forward price should have the same value. c Diego Garc a, BUSI 588, Kenan-Flagler, Fall 2011 Lecture 4 - Forwards and futures 3 / 26 Recap Forward pricing Future contracts Risk, return and options Investment returns for: (a) stock, (b) bull spread, (c) bear spread. S T a b c 22.0-10.9%-100.0% 233.3% 23.0-6.8%-100.0% 166.7% 24.0-2.8%-100.0% 33.3% 25.0 1.3%-100.0%-100.0% 26.0 5.3% 42.9%-100.0% 27.0 9.4% 185.7%-100.0% 28.0 13.5% 257.1%-100.0% Both b and c are (significantly) more risky than a (in terms of volatility of returns). But b covaries positively with the market, whereas c does not. Expected returns in CAPM world: E [ r b ] > E [ r a ] > r f > E [ r c ]. c Diego Garc a, BUSI 588, Kenan-Flagler, Fall 2011 Lecture 4 - Forwards and futures 4 / 26 Recap Forward pricing Future contracts Investment advice, calls and puts Mutual fund promises you return r m or r f , whichever is greater. What is that worth? The funds payoffs can be stated as max (1 + r f , 1 + r m ) = max 1 + r f , S T S = 1 S max((1 + r f ) S , S T ) 1 S max((1 + r f ) S , S T ) = 1 + r f + 1 S max(0 , S T- (1 + r f ) S ) So investment advice is 1 / S calls with K = (1 + r f ) S . Alternatively, the funds payoffs can be stated as 1 S max((1 + r f ) S , S T ) = S T S + 1 S max((1 + r f ) S- S T , 0) So investment advice is 1 / S puts with K = (1 + r f ) S . Calls and puts worth the same when K = F !. c Diego Garc a, BUSI 588, Kenan-Flagler, Fall 2011 Lecture 4 - Forwards and futures 5 / 26 Recap Forward pricing Future contracts Forward contracts Over-The-Counter (not exchange traded) agreements to buy or sell an asset at a certain time in the future for a price that is agreed upon today. The party undertaking a long position agrees to buy the asset and the party undertaking a short position agrees to sell the asset....
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lecture04post - Recap Forward pricing Future contracts...

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