The final exam for the course will take the form illustrated in the sample exam
following this page.
Examinable material includes everything that has been covered in either the lectures or
tutorials during the whole semester.
Many of the questions are discussed and included in the class activities and so you
should have access to most of the answers.
Sample Examination Paper
Instructions to Candidate:
1. Answer ALL questions.
2. You should answer all questions in the answer book(s). No attachments will be
considered. If you used an additional book, please incorporate it within the first
book.
3. Please allocate your time according to the percentage contribution of the
questions.
4. You should answer Section A questions (multiple-choice) on the first writing page
of the answer book and start each Section B question on a new page in the
answer book. Please label your answers appropriately and show sufficient
workings for all Section B questions.
5. Please submit this examination question paper with your answer book at the end
of the examination. Examination materials must NOT be removed from the
examination room.
Materials:
Special Instructions:
1. Unless otherwise instructed, assume continuous compounding/discounting for all
calculations
2. Unless otherwise stated, contract multipliers for options and futures are assumed
to be on a 1:1 ratio.
Long Put
Short Put
-4
76 80
Stock Price ($)
Ignoring transaction costs, which of the following statements about the value of the put
option at expiration is TRUE?
A. The value of the short position in the put is $4 if the stock price is $76.
B. The value of the long position in the put is $4 if the stock price is $76.
C. The long put has value when the stock price is below the $80 exercise price.
D. The value of the short position in the put is zero for stock prices equalling or
exceeding $76.
2. Which of the following statements about the value of a call option at expiration is FALSE?
A. The short position in the same call option can result in a loss if the stock price
exceeds the exercise price.
B. The value of the long position equals zero or the stock price minus the exercise price,
whichever is higher.
C. The value of the long position equals zero or the exercise price minus the stock price,
whichever is higher.
D. The short position in the same call option has a zero value for all stock prices equal to
or less than the exercise price.
3. Which of the following statements about short selling is TRUE?
4. The current price of an asset is 75. A three-month, at-the-money American call option on
the asset has a current value of 5. At what value of the asset will a covered call writer
break even at expiration?
A. 70.
B. 75.
C. 80.
D. 85.
5. A silver futures contract requires the seller to deliver 5,000 Troy ounces of silver. An
investor sells one July silver futures contract at a price of $8 per ounce, posting a $2,025
initial margin. If the required maintenance margin is $1,500, the price per ounce at which
the investor would first receive a maintenance margin call is closest to:
A. $5.92.
B. $7.89.
C. $8.11.
D. $10.80.
7. When puts are priced with the binomial model, which of the following is true?
A. it approaches 1.0
B. it approaches zero
C. it fluctuates without pattern
D. it converges to .5
E. none of the above
9. If the stock price is 44, the exercise price is 40, the put price is 1.54, and the Black-
Scholes price using .28 as the volatility is 1.11, the implied volatility will be
10. What would be the spot price if a stock index futures price were $75, the risk-free rate
were 10 percent, the dividend yield 3 percent, and the futures expires in three months?
A. $73.70
B. $77.48
C. $72.60
D. $76.32
E. none of the above
11. Find the profit if the investor buys a July futures at 75, sells an October futures at 78 and
then reverses the July futures at 72 and the October futures at 77.
A. -3
B. -2
C. 2
D. 1
E. none of the above
12. Find the price of an American call option on a futures if the current spot price is 30, the
exercise price is 25, the futures price is 33.70, the risk-free interest rate is 6 percent, the
spot asset can go up by 10 percent or down by 8 percent per period and the call expires in
two periods, which is also when the futures expires.
A. 9.98
B. 8.70
C. 7.73
D. 8.22
E. none of the above
13. A firm that has a sum of money denominated in a foreign currency that plans to later
convert it to dollars could hedge by which of the following methods.
14. What is the lower bound of a European call on a futures contract where f0 is the futures
price and X is the exercise price?
Answer all questions. Show your worked-out solutions in the answer booklet.
QUESTION 1 [7 MARKS]
You are a portfolio manager holding the following Australian stocks on 1st October. The
number of shares, and the betas are as follows:
The portfolio is to be liquidated on 30 November. However, you believe that the Australian
market will rally during October and November and would like to increase the beta to 1.3.
A. Construct transactions that will increase the beta of the portfolio to 1.3 using one or
more of these December futures contracts:
All prices are in Australian dollars and assume all futures contracts have a contract
multiplier of $250 per index point.
[4 marks]
B. Identify two alternative methods (other than selling securities from the portfolio or
using futures) that replicates the feature strategy in Part a. Contrast each of these
methods with the futures strategy.
[3 marks]
QUESTION 2 [7 MARKS]
The current December SPI 200 futures contract is at 3301. The ASX 200 is at 3305.4. The
current 30-day bank bill is at 4.492%.
A. If there are 45 days remaining until December 2001 futures contracts expire,
determine whether put-call parity is maintained for the December call & put options
on SPI 200 futures with the exercise price closest to the current SPI 200 price.
[4 marks]
B. If put-call parity is not maintained, explain the possible reasons why it might not be.
[3 marks]
QUESTION 3 [12 MARKS]
You are a fund manager for high net-wealth clients. One of your clients expects short-term
interest rates to remain low over the coming year and expects equities to offer a significantly
higher return. The investor wants to shift some funds from cash to equities. The investor
currently holds a portfolio of money market assets.
A. Detail 3 possible solutions available to the client to achieve her aims, along with the
advantages/disadvantages associated with each method. One of these solutions
should be a swap contract.
[4.5 marks]
B. The client decides to enter into a one-year equity swap where the counterparty
agrees to pay the investor the total return to the stock index in exchange for dollar-
denominated Libor on a quarterly basis. The Exhibit below summarizes the
mechanics of the swap assuming that on settlement date the stock index is at 640,
dividends are 3.30 index points each quarter, and current 90-day Libor is 3.25% and
the notional amount of the contract is $1,000,000. Each quarter contains 91 days.
Fill in the missing values from the cash flow schedule below:
[4 marks]
C. What is the total incremental return for the above swap? [1.5 marks]
A. The current price of gold is $300 per ounce. Carrying costs in total are 0.5% (not
including interest) of the gold value payable in 6 months time. If the interest rate is
8%, is there an arbitrage opportunity if the gold futures price for delivery in six months
is $310 per ounce?
[3 marks]
B. If an arbitrage opportunity exists, explain how you would conduct it and calculate the
arbitrage profit.
[2 marks]
C. Why is it not possible in reality to perfectly hedge a portfolio using Options and/or
futures Instruments?
[2 marks]
D. Explain the shortcomings of LTCMs financial strategy that led to its eventual
downfall.
[2 marks]