Derivatives Markets, 3e (McDonald)

Chapter 2 An Introduction to Forwards and Options

2.1 Multiple Choice
1) The spot price of the market index is $900. A 3month for!ard contract on this index is priced
at $930. "hat is the profit or loss to a short position if the spot price of the market index rises to
$920 #$ the expiration date%
A) $20 &ain
') $20 loss
C) $10 &ain
() $10 loss
Ans!er) C
2) The spot price of the market index is $900. A 3month for!ard contract on this index is priced
at $930. The market index rises to $920 #$ the expiration date. The annual rate of interest on
treasuries is 2.*+ ,0.2+ per month). "hat is the difference in the pa$offs #et!een a lon& index
in-estment and a lon& for!ard contract in-estment% ,Assume monthl$ compoundin&.)
A) $10..*
') $2*./9
C) $20.*0
() $*3.20
Ans!er) '
3) The spot price of the market index is $900. A 3month for!ard contract on this index is priced
at $930. The annual rate of interest on treasuries is 2.*+ ,0.2+ per month). "hat annuali1ed rate
of interest makes the net pa$off 1ero% ,Assume monthl$ compoundin&.)
A) *..+
') ../+
C) 11.2+
() 13.2+
Ans!er) (
*) The spot price of the market index is $900. After 3 months2 the market index is priced at $920.
An in-estor has a lon& call option on the index at a strike price of $930. After 3 months2 !hat is
the in-estor3s profit or loss%
A) $10 loss
') $0
C) $10 &ain
() $20 &ain
Ans!er) '
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/) The spot price of the market index is $900. After 3 months the market index is priced at $920.
The annual rate of interest on treasuries is 2.*+ ,0.2+ per month). The premium on the lon& put2
!ith an exercise price of $9302 is $..00. "hat is the profit or loss at expiration for the lon& put%
A) $2.00 &ain
') $2.00 loss
C) $1.9/ &ain
() $1.9/ loss
Ans!er) C
0) The spot price of the market index is $900. After 3 months the market index is priced at $920.
The annual rate of interest on treasuries is 2.*+ ,0.2+ per month). The premium on the lon& put2
!ith an exercise price of $9302 is $..00. At !hat index price does a lon& put in-estor ha-e the
same pa$off as a short index in-estor% Assume the short position has a #reake-en price of $930.
A) $921.90
') $930.00
C) $93..0/
() $9*0.00
Ans!er) C
8) All of the positions listed !ill #enefit from a price decline2 except)
A) 9hort put
') :on& put
C) 9hort call
() 9hort stock
Ans!er) A
.) The spot price of the market index is $900. The annual rate of interest on treasuries is 2.*+
,0.2+ per month). After 3 months the market index is priced at $920. An in-estor has a lon& call
option on the index at a strike price of $930. "hat profit or loss !ill the !riter of the call option
earn if the option premium is $2.00%
A) $2.00 &ain
') $2.00 loss
C) $2.01 &ain
() $2.01 loss
Ans!er) C
9) The spot price of the market index is $900. After 3 months the market index is priced at $91/.
The annual rate of interest on treasuries is 2.*+ ,0.2+ per month). The premium on the lon& put2
!ith an exercise price of $9302 is $..00. Calculate the profit or loss to the short put position if the
final index price is $91/.
A) $1/.00 &ain
') $1/.00 loss
C) $0.9/ &ain
() $0.9/ loss
Ans!er) (
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10) 7f $our homeo!ner3s insurance premium is $12000 and $our deducti#le is $20002 !hat could
#e considered the strike price of the polic$ if the home has a -alue of $1202000%
A) $11.2000
') $1202000
C) $1182000
() $1222000
Ans!er) A
11) A put option is purchased and held for 1 $ear. The 6xercise price on the underl$in& asset is
$*0. 7f the current price of the asset is $30.*/ and the future -alue of the ori&inal option premium
is ,$1.02)2 !hat is the put profit2 if an$2 at the end of the $ear%
A) $1.02
') $1.93
C) $3.//
() $/.18
Ans!er) '
12) The premium on a lon& term call option on the market index !ith an exercise price of 9/0 is
$12.00 !hen ori&inall$ purchased. After 0 months the position is closed2 and the index spot price
is 90/. 7f interest rates are 0./+ per month2 !hat is the Call 5a$off%
A) $2.0*
') $12.00
C) $12.30
() $1/.00
Ans!er) (
13) The premium on a call option on the market index !ith an exercise price of 10/0 is $9.30
!hen ori&inall$ purchased. After 2 months the position is closed2 and the index spot price is
1082. 7f interest rates are 0./+ per month2 !hat is the Call 5rofit%
A) $9.30
') $9.39
C) $12.01
() $22.00
Ans!er) C
2.2 9hort Ans!er 6ssa$ ;uestions
1) The spot price of the market index is $900. A 3month for!ard contract on this index is priced
at $930. (ra! the pa$off &raph for the short position in the for!ard contract.
Ans!er)
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2) An in-estor has a lon& call option on the market index at a strike price of $930. At expiration
the index price is $920. 6xplain the profit and loss.
Ans!er) The lon& call in-estor has the ri&ht2 not the o#li&ation2 to exercise. Thus2 she !ill elect
to let the option expire unexercised and reali1e no profit or loss.
3) The spot price of the market index is $900. After 3 months the market index is priced at $920.
The annual rate of interest on treasuries is *..+ ,0.*+ per month). The premium on the lon& put2
!ith an exercise price of $9302 is $..00. (ra! the pa$off &raph for the lon& put position at
expiration. 7nclude strike price2 #reake-en price2 and max loss.
Ans!er)
*) (e-elop the pa$off ta#le for the pre-ious <uestion2 usin& at least fi-e different possi#le index
prices2 in addition to the strike price and #reake-en price.
Ans!er)
/) As !ith Chr$sler Corp. man$ $ears a&o2 the &o-ernment occasionall$ &uarantees loans. "hat
option is the &o-ernment &rantin& and to !hom in a loan &uarantee%
Ans!er) The &o-ernment is &i-in& the #anks ,or lenders) a put option. 7f the #orro!er defaults
,thus the price of the loan drops) the #anks ma$ exercise their put options and sell the loans to
the &o-ernment.
2.3 Class (iscussion ;uestion
1) 6n&a&e the class in a con-ersation a#out auto insurance. "h$ do people feel their premium is
!asted if the$ do not file a claim% 9teer the class to!ards an understandin& of put options and
potential &ain should a loss occur. 7t ma$ also #e #eneficial to ask students to relate insurers3
poolin& of losses !ith the concept of risk mana&ement.
*
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