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HW 2

This document provides the instructions and questions for Homework 2 for the finance course FINA0301/FINA2322. Students are asked to solve 5 questions related to arbitrage opportunities in index futures, hedging a portfolio with index futures, currency carry trades, and implied forward rates. The questions must be submitted in hard copy by 6PM on November 3, 2016. Students can work in groups of 4 or less and only one solution set needs to be submitted per group.

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276 views

HW 2

This document provides the instructions and questions for Homework 2 for the finance course FINA0301/FINA2322. Students are asked to solve 5 questions related to arbitrage opportunities in index futures, hedging a portfolio with index futures, currency carry trades, and implied forward rates. The questions must be submitted in hard copy by 6PM on November 3, 2016. Students can work in groups of 4 or less and only one solution set needs to be submitted per group.

Uploaded by

chrislmc
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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FINA0301/FINA2322

Fall, 2016

Homework Questions 2: Due dateThursday, Nov. 3, 2016

Name:
Instructions:
Read the questions carefully, write all your steps where necessary.
You dont have to computer-type the solution. However, the hand-written version has
to be reader-friendly.
Hard copies of the solutions must be dropped in the TAs box by 6PM on the due
date. No later submission will be accepted.
You may work in groups of four or less, and only one solution set will be turned in
by each group. The grade on the problems turned by the group will be given to each
member of the group.
Please write clearly which subclass you are from: A, B or C.
1. The S&P index spot price is 1100 and the continuously compounded risk-free
rate is 5%. You observe a 9-month forward price of 1129.257.
(a) What dividend yield is implied by this forward price?
(b) Suppose you believe the dividend yield over the next 9 months will be only
0.5%. What arbitrage would you undertake?
(c) Suppose you believe the dividend yield will be 3% over the next 9 months.
What arbitrage would you undertake?
2. Suppose the S&P 500 index is currently 950 and the initial margin is 10%. You
wish to enter into 10 S&P 500 futures contracts.
(a) What is the notional value of your position (recall each contract is 250 units)?
What is the margin?
(b) Suppose you earn a continuously compounded rate of 6% on your margin
balance, your position is marked-to-market weekly, and the maintenance
margin is 80% of the initial margin. What is the greatest S&P 500 index
futures price 1 week from today at which you will receive a margin call?
3. Suppose the S&P 500 currently has a level of 875. The continuously compounded
return on a 1-year T-bill is 4.75%. You wish to hedge an $800,000 portfolio that
has a beta of 1.1 and a correlation of 1.0 with the S&P 500.
(a) What is the 1-year futures price for the S&P 500 assuming no dividends?
(b) How many S&P 500 futures contracts should you short to hedge your portfolio? What return do you expect on the hedged portfolio?
1

FINA0301/FINA2322

Fall, 2016

4. The euro exchange rate is $1.25/euro. The continuously compounded dollar


interest rate is 5% and the continuously compounded euro interest rate is 4%.
Suppose that you borrow euros and lend dollars for 1 year, without using futures
to hedge.
(a) At what exchange rate will you break even on this position?
(b) If the exchange rate in 1 year is $1.30, what is your profit?
(c) If the exchange rate in 1 year is $1.22, what is your profit?
5. Using information in Table 7.1, complete the following:
ZeroZeroOne-year
Years to Coupon
Coupon
implied
Maturity Bond Yield Bond Price Forward Rate
1
6%
0.943396
6%
2
6.5
0.881659
7.00236
3
7.0
0.816298
8.00705

Par
Coupon
6%
6.48423
6.95485

Continuously
Compounded
Zero Yield
5.82689%
6.29748
6.76586

(a) Compute the implied forward rate from time 1 to time 3.


(b) Compute the implied coupon rate of a 2-year par coupon bond that will be
issued at time 1.

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