Concept explainers
A
To explain: Calculate the total cash flow in strategy at different time intervals and as per the given information.
Introduction: An arbitrage strategy is given, first future contract price
A
Answer to Problem 19PS
Thus the final cash after
Explanation of Solution
Given information: Future contract price
There are two future prices with definite time period, initially the cash was zero, after one year it will be
B
To explain: If arbitrage opportunity is none then why profit will be zero at time
Introduction: An arbitrage strategy is given, first future contract price
B
Answer to Problem 19PS
Thus investment at this period is zero and also it is risk free. Hence the total profit also is null when there is no arbitrage opportunity.
Explanation of Solution
Given information: Future contract price
In the absence of the arbitrage opportunity the profit will be zero because investment in time
C
To explain: Establish the relation between
Introduction: An arbitrage strategy is given, first future contract price
C
Answer to Problem 19PS
Hence relation between
Explanation of Solution
Given information: Future contract price
At last stage for profit should be zero at time
Want to see more full solutions like this?
- Consider a stock that pays no dividends on which a futures contract, a call option, and a put option trade. The maturity date for all three contracts is T, the exercise price of both the put and the call is X, and the futures price is F. Show that if X = F, then the call price equals the put price. Use parity conditions to guide your demonstration.arrow_forwardThe premium on a put option is primarily a function of the difference in spot price S relative to the strike price X, the time until maturity T, and the volatility of the currency o. P = f(S-X, T, o) For each characteristic of a put option, use the table to indicate whether that would lead to a higher put option premium or a lower put option premium (all else equal). Characteristic A lower spot price relative to the strike price A shorter time before expiration A higher level of volatility for the currency Higher Put Option Premium Lower Put Option Premium When using a put option to hedge receivables in an international currency, a U.S. based MNC can lock in the receive. minimum maximum amount of dollars it willarrow_forwardThe premium on a call option is primarily a function of the difference in spot price S relative to the strike price X, the length of time until expiration T, and the volatility of the currency o. C = f(S-X, T, o) For each characteristic of a call option, use the table to indicate whether that would lead to a higher call option premium or a low call option premium (all else equal). Characteristic A lower spot price relative to the strike price A shorter time before expiration A higher level of volatility for the currency Higher Call Option Premium O Lower Call Option Premium When using a call option to hedge payables in an international currency, a U.S. based MNC can lock in the to obtain the needed foreign currency. maximum minimum amount of dollars neededarrow_forward
- Consider a stock that pays no dividends on which a futurescontract, a call option, and a put option trade. The maturity date for all three contracts is T, the strikeprice of both the put and the call is K, and the futures price is F. Prove that if K = F, then the price ofthe call option equals the price of the put option.arrow_forwardAt time t = 0, a trader takes a long position in a futures contract on stock i that willexpire at time T. the present value of this contract to the long is given by: See Image. Assume no-arbitrage price, briefly descthat if the return from stock i is positively correlated with the overall return on the stock market, then the futures market must be in backwardation at time t = 0.arrow_forwardMatch the vocabulary below with the following statements. • organized market,• maintenance margin,• standardized contract,• margin call• standardized expiration,• variation margin,• clearing corporation,• open interest,• daily recontracting• interest rate risk• marking to market• cross-hedge• convergence• delta-hedge• settlement price• delta-cross-hedge• default risk of a future• ruin risk• initial margin(a) Daily payment of the change in a forward or futures price.(b) The collateral deposited as a guarantee when a futures position is opened.(c) Daily payment of the discounted change in a forward price.(d) The minimum level of collateral on deposit as a guarantee for a futures position.(e) A hedge on a currency for which no futures contracts exist and for an expiration otherthan what the buyer or seller of the contract desires.(f) An additional deposit of collateral for a margin account that has fallen below itsmaintenance level.(g) A contract for a standardized number of units of a…arrow_forward
- Consider two binomial trees, one for the spot price of an asset and the other for the futures price on the same asset. Let the up factor, u, and the down factor, d, be the same for both trees. The difference in the risk-neutral probabilities for the up movement on spot tree and on the futures tree is: Oa (1-d)/e Ob. (u-1)/et Oc ert /u Od (e".1)/ (u-d) Oo (u-et)/ (u-d)arrow_forwarda)define and explain convenience yield, and describe how it is incorporated into the futures pricing model. b)discuss the debate on whether risk premium should be included in the pricing of futures and forward contracts. c) define backwardation, normal backwardation, contango, and normal contango. d) discuss the relationship between the prices of puts, calls, and forward/futures contracts on the same underlying asset using the put-call-forward/futures parity. e) discuss the boundary conditions on the prices of American and European call option contracts on futures.arrow_forwardSuppose you observe the following situation on two securities:Security Beta Expected Return Pete Corp. 0.8 0.12 Repete Corp. 1.1 0.16 Assume these two securities are correctly priced. Based on the CAPM, what is the return on the market?arrow_forward
- This question is about futures risk premia. Consider a two period economy.You can buy stocksin period 0, and then sell them in period 1. You can also enter into futures contracts in period 0, whichexpire in period 1. Since buying single-stock futures appears to be a fairly profitable trade, you decide toinvest in a futures strategy. You enter a long futures contract position. You also invest cash in period 0 at the risk-free rate, so you have just enough topay for the futures contract at expiration. You plan to sell the stock just after expiration. What is theexpected return on this trading strategy (in terms of expected period-1 dollars you get, per period-0dollar invested)?arrow_forwardQuestion 1. Let St be the current price of a stock that pays no dividends. a)Let rbid be the interest rate at which one can invest/lend money, and roff be theinterest rate at which one can borrow money, rbid≤roff. Both rates are continuously compounded. Using arbitrage arguments, find upper and lower bounds for the forwardprice of the stock for a forward contract with maturity T > t. b)How does your answer change if the stock itself has bid price St,bid and offer price St,off?arrow_forwardT/F a. According to Expectation theory, long-term rates are geometric average of current and expected short-term rates. b. The swap curve usès on-the-run prices at plot points. C. When a bond is traded, the seller owes the buyer accrued interest. d. Higher inflation rates lead to higher required interest rates. e. If prices increase, then velocity and/or quantities decrease. f. Quantitative easing adds liquidity when the federal funds rate is negative. g. Bonds may trade in advance of Treasury auction. h. Off the run bonds are the most recently auctioned off for a given initial maturity. i. The yield curve never uses the on-the-run Treasuries. j. If the yield curve in upward sloping, investors expect lower inflation or real rates.arrow_forward
- Essentials Of InvestmentsFinanceISBN:9781260013924Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.Publisher:Mcgraw-hill Education,
- Foundations Of FinanceFinanceISBN:9780134897264Author:KEOWN, Arthur J., Martin, John D., PETTY, J. WilliamPublisher:Pearson,Fundamentals of Financial Management (MindTap Cou...FinanceISBN:9781337395250Author:Eugene F. Brigham, Joel F. HoustonPublisher:Cengage LearningCorporate Finance (The Mcgraw-hill/Irwin Series i...FinanceISBN:9780077861759Author:Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan ProfessorPublisher:McGraw-Hill Education