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Unformatted text preview: Answers to Quiz Questions CHAPTER 1 1.1 A trader who enters into a long futures position is agreeing to buy the underlying asset for a certain price at a certain time in the future. A trader who enters into a short futures position is agreeing to sell the underlying asset for a certain price at a certain time in the future. 1.2 A company is hedging when it has an exposure to the price of an asset and takes a position in futures or options markets to offset the exposure. In a speculation the company has no exposure to offset. It is betting on the future movements in the price of the asset. Arbitrage involves taking a position in two or more different markets to lock in a profit. 1.3 In (a) the investor is obligated to buy the asset for $50. (The investor does not have a choice.) In (b) the investor has the option to buy the asset for $50. (The investor does not have to exercise the option.) 1.4 a. The investor is obligated to sell pounds for 1.5000 when they are worth 1.4900. The gain is (1.5000 - 1.4900) x 100,000 = $1,000. b. The investor is obligated to sell pounds for 1.5000 when they are worth 1.5200. The loss is (1.5200 - 1.5000) x 100,000 = $2,000. 1.5 You have sold a put option. You have agreed to buy 100 America Online shares for $40 per share if the party on the other side of the contract chooses to exercise the right to sell for this price. The option will be exercised only when the price of America Online is below $40. Suppose, for example, that the option is exercised when the price is $30. You have to buy at $40 shares that are worth $30; you lose $10 per share, or $1,000 in total. If the option is exercised when the price is $20, you lose $20 per share, or $2,000 in total. The worst that can happen is that the price of America Online declines to almost zero during the three-month period. This highly unlikely event would cost you $4,000. In return for the possible future losses, you receive the price of the option from the purchaser. 1.6 One strategy is to buy 200 shares. Another is to buy 2,000 options (20 contracts). If the share price does well, the second strategy will give rise to greater gains. For example, if the share price goes up to $40, you gain [2,000 x ($40 - $30)] - $5,800 = $14,200 from the second strategy and only 200 x ($40 - $29) = $2,200 from the first strategy. However, if the share price does badly, the second strategy yields greater losses. For example, if the share price goes down to $25, the first strategy leads to a loss of 200 x ($29 - $25) = $800, whereas the second strategy leads to a loss of the entire $5,800 investment. 1.7 You should buy 50 put option contracts with a strike price of $25 and an expiration date in four months. If at the end of four months the stock price proves to be worth less than $25, you can exercise the options and sell the shares for $25 each....
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This note was uploaded on 02/18/2012 for the course FIN 101 taught by Professor Write during the Spring '12 term at PWSZ w Gorzowie Wielkopolskim.
- Spring '12