Assignment 1

Assignment -1
Due date: 28th Oct, 2023
1. You would like to speculate on the rise of certain stock; you have Rs. 7000 to invest.
The current price of the stock is Rs.40. A 3-month call with a strike price of Rs. 45
costs Rs.7. Identify two alternative investment strategies, one in the stock and the
other in an option on the stock listing out the potential gains and losses from each?
2. Suppose that a March call option to buy a share for $50 costs $2.50 and is held until
March. Under what circumstances will the holder of the option make a profit? Under what
circumstances will the option be exercised? Draw a diagram illustrating how the profit
from a long position in the option depends on the stock price at maturity of the option.
3. A trader enters into a short forward contract on 100 million yen . The forward exchange
rate is $0.0090 per yen. How much does the trader gain or lose if the exchange rate at the
end of the contract is (a) $0.0084 per yen and (b) $0.0101 per yen?
4. Describe the profit from the following portfolio: a long forward contract on an asset and a
long European put option on the asset with the same maturity as the forward contract and
a strike price that is equal to the forward price of the asset at the time the portfolio is set up. Does
this resemble some other instrument?
5. On July 1, 2021, a company enters into a forward contract to buy 10 million Japanese yen
on January 1, 2022. On September 1, 2021, it enters into a forward contract to sell
10 million Japanese yen on January 1, 2022. Describe the payoff from this strategy.
6. Suppose that USD/sterling spot and forward exchange rates are as follows:
Spot 1.5580
90-day forward 1.5556
180-day forward 1.5518
What opportunities are open to an arbitrageur in the following situations?
(a) A 180-day European call option to buy £1 for $1.52 costs 2 cents.
(b) A 90-day European put option to sell £1 for $1.59 costs 2 cents.
7. A trader buys a call option with a strike price of $30 for $3. Does the trader ever exercise
the option and lose money on the trade? Explain your answer.
8. On May 3, 2016, the spot price of Google stock is $696.25

and the price of a call option with a strike price of $700 and a maturity date of
September is $39.20. A trader is considering two alternatives: buy 100 shares of the stock
and buy 100 September call options. For each alternative, what is (a) the upfront cost,
(b) the total gain if the stock price in September is $800, and (c) the total loss if the stock
price in September is $600. Assume that the option is not exercised before September and
if the stock is purchased it is sold in September.
9. Trader A enters into a forward contract to buy an asset for $1,000 in one year . Trader B
buys a call option to buy the asset for $1,000 in one year . The cost of the option is $100.
What is the difference between the positions of the traders? Show the profit as a function
of the price of the asset in one year for the two traders.
10. The price of gold is currently $1,200 per ounce. The forward price for delivery in 1 year is
$1,300 per ounce. An arbitrageur can borrow money at 3% per annum. What should the
arbitrageur do? Assume that the cost of storing gold is zero and that gold provides no
income.
11. A bond issued by Standard Oil some time ago worked as follows . The holder received no
interest. At the bond’s maturity the company promised to pay $1,000 plus an additional
amount based on the price of oil at that time . The additional amount was equal to the
product of 170 and the excess (if any) of the price of a barrel of oil at maturity over $25 .
The maximum additional amount paid was $2,550 (which corresponds to a price of $40
per barrel). Show that the bond is a combination of a regular bond, a long position in call
options on oil with a strike price of $25, and a short position in call options on oil with a
strike price of $40. What is the name for this options strategy?
12. A corporate treasurer said: ‘‘I will have £1 million to sell in 6 months. If the exchange rate is less
than 1.42, I want you to give me 1.42. If it is greater than 1.48, I will accept 1.48. If the exchange
rate is between 1.42 and 1.48, I will sell the sterling for the exchange rate.’’ How could you use
options to satisfy the treasurer? What is the name for such contracts?
13. A trader buys a European call option and sells a European put option. The options have
the same underlying asset, strike price, and maturity. Describe the trader’s position.
Under what circumstances does the price of the call equal the price of the put?
14. What does a stop order to sell at $2 mean? When might it be used? What does a limit
order to sell at $2 mean? When might it be used?
15. A trader buys two July futures contracts on frozen orange juice concentrate. Each
contract is for the delivery of 15,000 pounds. The current futures price is 160 cents per
pound, the initial margin is $6,000 per contract, and the maintenance margin is $4,500 per
contract. What price change would lead to a margin call? Under what circumstances
could $2,000 be withdrawn from the margin account?
16. A cattle farmer expects to have 120,000 pounds of live cattle to sell in 3 months. The live
cattle futures contract traded by the CME Group is for the delivery of 40,000 pounds of
cattle. How can the farmer use the contract for hedging? From the farmer’s viewpoint,
what are the pros and cons of hedging?
17. Trader A enters into futures contracts to buy 1 million euros for 1.1 million dollars in
three months. Trader B enters in a forward contract to do the same thing. The exchange
rate (dollars per euro) declines sharply during the first two months and then increases for
the third month to close at 1.1300. Ignoring daily settlement, what is the total profit of
each trader? When the impact of daily settlement is taken into account, which trader has
done better?
18. Explain what is meant by open interest. On a particular day, there were 2,000 trades in a
particular futures contract. This means that there were 2,000 buyers (going long) and 2,000
sellers (going short). Of the 2,000 buyers, 1,400 were closing out positions and 600 were entering
into new positions. Of the 2,000 sellers, 1,200 were closing out positions and 800
were entering into new positions. What is the impact of the day’s trading on open interest?
(To understand the concept of open interest, refer to Zerodha Varsity’s article Open Interest –
Varsity by Zerodha)
19. Suppose that there are no storage costs for crude oil and the interest rate for borrowing or
lending is 4% per annum. How could you make money if the June and December futures
contracts for a particular year trade at $50 and $56, respectively?
20. What position is equivalent to a long forward contract to buy an asset at K on a certain
date and a put option to sell it for K on that date? Show the payoff / profit diagrams.

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Assignment -1

Due date: 28th Oct, 2023

8. On May 3, 2016, the spot price of Google stock is $696.25

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