What do you think would happen if an exchange started trading a contract in which the quality of the underlying asset was incompletely specified?Explain

► Question 1: 11Speculation in futures markets is pure gambling. It is not in the public interest to allow speculators to trade on a futures exchange11. Discuss this view point.

► Question 2: What do you think would happen if an exchange started trading a contract in which the quality of the underlying asset was incompletely specified?

► Question 3: Cattle farmer expects 120,000 lbs live cattle to sell in 3 months. CME live-cattle futures are for delivery of 40,000 lbs of cattle. How can the farmer hedge with the contract? Farmer’s hedging pros and cons?

► Question 4: Long, 1 yr forward, no dividend stock, S0 = $40,
r = 10%/yr with continuous compounding.

1. What is the forward price? Initial value of forward contract?

2. Six months later, S6 = $45, r remains 10%/yr . What is the forward price? Value of forward contract?

► Question5 : The expected return on the S&P 500 is 12% and the risk-free rate is 5%. What does the CAPM tell us if the expected return on the investment has beta equal to (a) 0.2, (b) 0.5 and (c ) 1.4?

► Question 6: Company wants to hedge exposure to a new fuel whose price changes have a 0.6 correlation (ρ) with gasoline futures price changes. Company loses $1 million for each 1 cent increase in price / gallon of a new fuel over the next three months. New fuel’s price change has a standard deviation 50% greater than that of gasoline futures prices. If gas futures are used to hedge, what is the hedge ratio? What is the company’s exposure in gallons of new fuel? What position in gallons should the company take in gas futures? How many gas futures contracts should be traded, each are 42,000 gallons?

► Question 7: A portfolio manager has an actively managed portfolio with β = 0 20. Last year the risk-free rate was 5% and equities performed very badly providing a return of -30%. The portfolio manager produced a return of -10% and claims that in the circumstances it was good. Discuss this claim.

► Question 8: On July 1 an investor holds 50, 000 shares of a stock whose price is S0 = $30. The investor wants to hedge against market movements over the next month and decides to use the September Mini S&P 500 futures contract. The index is currently at 1, 500 and one contract is for delivery of
$50 times the index. The beta of the stock is 1 3. What strategy should the investor follow? Under what circumstances will it be profitable?

► Question 9: The standard deviation of monthly changes in live cattle spot prices (in cents per pound) is σA = 1 2. The standard deviation of monthly changes in live cattle futures prices is σF = 1 4. The correlation between futures prices changes and spot prices changes if ρ = 0 7. On October 15 a beef producer committed to purchasing 200, 000 lbs of live cattle on November 15. The producer wants to use the December futures to hedge. Each contract is 40, 000 lbs cattle. What strategy should the producer follow?

► Question 10: The risk-free rate of interest is r = 7% per annum with continuous compounding, and the dividend yield on a stock index is q = 3 2% per annum. The current index value is S0 = $150. What is the 6-month futures price?

► Question 11: Suppose the risk-free rate is r = 10% per annum with continuous compounding, and the dividend yield on a stock index is q = 4% per annum. The current index value is S0 = $400 and the futures price for a contract deliverable in 4 months is $405. What arbitrage opportunities does this create?

► Question 12: A stock when first issued by IPO (initial public offering) provides funds for a company. Is the same true of an exchange-traded future? Discuss.

► Question 13: The correlation coefficient between an investment portfolio and the market is defined as
σAM
ρ = ,
σAσM

where σAM is the covariance between the portfolio and the market, and σA and σM are the standard deviation of the portfolio and of the market, respectively. Show that the minimum variance hedge ratio h when trying to “cross asset hedge” is equivalent to β.

► Question 14: An airline executive argues: 11There is no point in our using oil futures. There is just as much chance that the price of oil in the future will be less than the futures price as there is that it will be greater than this price.11 Discuss the executive’s viewpoint.

► Question 15: 11Options and futures are zero-sum games.11 What do you think it meant by this statement?

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