Baber Makayla

We discuss that the most I’m willing to pay for this assignment is $50.00. I need this assignment as soon as possible, but 24 hours is what we discussed.

Directions: Answer the following questions and submit your answers to the Dropbox
by midnight Sunday CT.

Part I. Short Questions: please organize your answer so that it is short but to the
point. Organization will count!

1. Identify or define each of the following terms (each is worth 10 points, 50 points

total).
a) The difference between futures price and expected spot price in the future
b) The contract size of ethanol futures traded on Chicago Mercantile Exchange=?
c) Swap bank
d) Long position in put
e) The minimum value (lower bound) of American call, assuming no dividend=?

2. If a contract’s open interest declines during an actively traded day, what does it

suggest about the number of traders (increase or decrease)? Do you expect this
to happen near expiration of a contract? (20 points)

3. Discuss factors influencing the value of call options and the relationship between

each of the factors and option value; you do not need to specify the relationship
with an equation; it is sufficient to state a positive or negative relationship and
briefly explain why (20 points).

Part II. Numerical Problems: you are required to show steps/formulas/solutions to
obtain credit. That is, I need to be able to follow how you get the answer; you
cannot simply tell me that the answer is generated by computer.

4. Answer the following questions based on the following quotation, which is

October 1 price quotation on light sweet crude oil (source: New York Mercantile
Exchange). (Each part is worth 10 points, 50 points total)

Last Open

High
Open
Low High Low

Most
Recent Change

Nov 2007 80.25 81.55 81.45 82.02 79.45 80.24s 0.01
Dec 2007 79.28 80.35 80.3 80.8 78.5 79.28s 0.00
Jan 2008 78.44 n/a 79.58 79.9 77.75 78.50s -0.06
Feb 2008 77.68 n/a 78.85 78.86 77.22 77.87s -0.19
Mar 2008 77.32 n/a 78.25 78.62 76.75 77.34s -0.02
April 2008 76.83 n/a 77.61 77.61 76.28 76.86s -0.03

(a) Here the futures price is lower the greater the time to expiration; what does

this imply about the convenience yield of oil? Specifically, is it greater than
the cost of carrying oil? (Hint: carry cost model).

(b) The trading price of Nov 07 $80.25 is close to the spot price and thus we will
use this as measure of spot price. Assuming a risk-free rate of 5% and
storage cost of 1%, what is the implied convenience yield for Dec 07 futures,
based on the carry cost model? There is approximately one month till
expiration.

(c) The delivery of the underlying oil can be made any day during the delivery
month. If you are in a short position and you are scheduled to deliver the oil,
should you deliver as early as possible or as late as possible? Briefly explain.

(d) Suppose that you are a manager of a utility firm and you are very concerned
about oil price increase before January. What position (short or long) should
you take in oil futures to hedge this risk?

(e) Suppose again you are the manager described in (d), how would you use call
options on oil as insurance for potential price increase? Be sure to mention
whether you should take long or short position.

5. Assume that the following interest rates at which firms A and B can borrow:

Fixed rate Floating rate
Firm A 8% LIBOR + 1%
Firm B 9% LIBOR + 1.4%

Premium paid by B over A 1% 0.4%

Also assume that A ultimately wants a floating rate loan while B wants a fixed
rate loan. Design an interest rate swap so that both can benefit, assuming that
no swap bank is involved. I recommend you use the graph in the swap example
document available under docsharing in eCompanion (20 points).

6. Answer the following questions based on the following quotation. On October 1,

2007, S&P 500 closed at 1547 where the quotation of CALL options on S&P 500
was as follows. Those contracts expire in October 2007. (Each part is worth 10
points, 40 points total).

Strike Price Open High Low Last sett
1540 — — — — 31.70
1600 1.70 3.60 1.70 3.00 3.35

(a) Which option is in the money?
(b) Decompose the value of 1540 call, $31.7, into intrinsic value and time value.
(c) Again using the call with exercise price of 1540, what would be your cash

proceeds if you exercise the option on October 1 (index options are settled by
cash)? Assume that both dividends and transaction costs are small enough to be
ignored. Based on this answer and answer on (b), does it make sense to
exercise an American call before expiration? Explain.

(d) Assume that put-call parity holds for these options (it does not exactly hold
since the above options are all American). What should be the value of a PUT on

S&P 500 with exercise price of 1600? Assume that the annual risk-free rate is
5%.

Premium paid by B over A 1% 0.4%