HKUST FINA3203 Spring 2020
School of Business Yan Ji
Midterm Exam
Monday, Apr 6, 2020
1 (20 points) Short Questions
(Please briefly explain your answers.)
(i) (5 points) The 1 year forward on a stock trades at $102, while the spot price of the
stock is $100. The continuously compounded annual interest rate is 4%. What is the
annual dividend yield consistent with these prices? You need to show clearly how to
calculate the dividend yield.
(ii) (5 points) True or False? In a foreign exchange forward contract, the value of the
forward contract is always non-negative. Write down the formula for the value of a
foreign exchange forward contract and explain clearly how you get the answer.
(iii) (5 points) Suppose you expect to receive $100 in one year and want to use FRA to
hedge the interest rate risk between year 1 and year 2. Should you take a long position
or short position? Why?
(iv) (5 points) Consider an at-the-money European call option and an at-the-money Eu-
ropean put option on the same non-dividend-paying stock. Which one should have a
higher market value? Explain clearly why this is the case.
2 (20 points) Forwards
A stock trades at S0 = $50. It pays a continuous annualized dividend rate of 2%. The
continuously compounded risk-free rate is 5% per year. The 1-year forward price on this
stock is $52.
(i) (6 points) What should be the no-arbitrage price of 1-year forward? Is the market
currently over or under pricing the forward?
(ii) (14 points) Lay out your arbitrage strategy and the cash flows at all relevant times.
Make it clear what you are long/short and the quantities. What is your arbitrage
profits?
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3 (30 points) Futures
The current stock price of IBM is S0 = 100 per share. The futures price of IBM futures that
mature 2 days from today is F0,2 = 100.05. Suppose IBM does not pay any dividend. The
risk-free rate is constant.
(i) (10 points) What is the annual continuously-compounded risk-free rate implied by the
futures price F0,2 ?
(ii) (12 points) Suppose the futures prices at t = 1 and t = 2 are F1,2 = 99 and F2,2 = 102,
respectively. What are the implied stock prices S1 and S2 at t = 1 and t = 2? Calculate
the profits and losses on day 1 and day 2 for buying (long position) one futures contract.
(iii) (8 points) An investor Bob holds $1,000,500 IBM stock at t = 0. Bob wants to hedge
his stock position for two days using the above futures contract. What position should
Bob take (short or long)? How many futures contracts should Bob long/short? Show
clearly why this is a perfect hedge.
For this question, let us ignore the interest earnings on your margin account so that
you do not need to change your futures position over time.
4 (30 points) Swaps
The 1, 2, 3 year oil forward trade at F0,1 = $115; F0,2 = $110; F0,3 = $105 per barrel. The
1, 2, 3 year zero-coupon bonds trade at (face value $1000) P0,1 = 980.39; P0,2 = 951.84;
P0,3 = 915.23.
(i) (5 points) Calculate the 1-year, 2-year, and 3-year annual continuously-compounded
risk-free rates implied by zero-coupon bonds?
(ii) (10 points) Calculate the swap curve, i.e., the swap prices for all three maturities.
(iii) (15 points) Oily Lilies Inc. enters a 2-year swap to buy 100K barrels of oil at the end
of years 1 and 2. The next day, the oil forward prices are: F0,1 = $110; F0,2 = $112.
Interest rates have not changed. Ignore the one-day maturity effect. Tell Oily Lilies
how much it would cost (or yield) now to “get out” of the swap. What is this amount
called? Give the answer as a present value and clearly write down your derivation.
This study source was downloaded by 100000776863669 from [Link] on 02-07-2024 [Link] GMT -06:00
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