Hull Answers

Problem 1.14. Suppose that a June put option on a stock with a strike price of $60 costs $4 and is held until June. Under what circumstances will the holder of the option make a gain? Under what circumstances will the option be exercised? Draw a diagram showing how the profit on a short position in the option depends on the stock price at the maturity of the option.

We can calculate the optimal hedge by multiplying the correlation between futures and spot with standard deviation of spot divided by the standard deviation of the future.

Spot deferred contract has some characteristics of forward sale but is more flexible since the SEC sellers have a choice when to deliver the gold. Though the threshold for this vehicle to hedge risk is very high, only for companies in good shape in terms of reserves, costs and leverage, American Barrick’s excellence qualifies it to implement this vehicle. We regard it a salutary vehicle, to the effect of which the gradually increasing use of it in American Barrick

The derivatives program was reducing risk when the firm was investing in foreign currency futures for the first four months from the implementation date (February 1991 to May 1991). This is seen by the negative correlation of (0.94226594) between the derivative (futures) cash flow and the unhedged cash flow. A purpose of a perfect hedge is to obtain a net of zero or in other words, reduce your risk to nothing not including the cost of the hedge. If a correlation is negative, as it was for the first three

Taxpayer Haig Simmons operates an in home coal heating and delivery service for consumer uses in Baltimore and Anne Arundel counties. Due to the instability of coal resources and prices, Haig Simmons enters into certain futures contract purchases in order to ensure a steady supply of coal for customers at a fixed rate. Simmons sole purpose of entering into futures contracts is to protect against price fluctuations with no profitable intentions. As a

First, Mr. Myers should explain the board his reasoning on taking short futures position on 90 day T-Bill contracts. As per table 1.1, 1.2 and 1.3 in answer no. 1, Mr. Myers can establish the need to hedge against the risk of increasing interest rates.

It is the first year of the venture’s existence and the goal is to prove there is sufficient demand for Calambra olive oil to continue business. Because it has been only three months since the venture was launched, it is impossible to know if a viable market segment actually exists. Unfortunately the decision about next year has to be made now. If Calambra is able to sell all of the 1993 oil before the 1994 shipment arrives, the 1993 test will have been a success and everything will be as planned. If the 1993 sales fail to materialize then it will be unlikely demand would increase in 1994 and Frank will be out of business and left with thousands of dollars in losses (Appendix A).

* Hedging. Hedging with the fuel market could save enough money in one year to offset the next year’s fuel supply and costs.

The solution of the second problem that Deere & John is facing about market access strategy may not work smoothly as its excesses capacity because Scott was given for 24 months to run the entire facility fully operational. Also this will be very difficult for Scott and his company because the time frame that was given is short so that

The best futures contract for hedging a cash market risk exposure is one whose price sensitivity to interest rate changes is as close as possible to the sensitivity of the cash market risk exposure to interest rate changes. The higher the correlation between the interest rate on the futures contract and the interest rate in the spot market, the higher the immunization achieved against the losses / gains from the interest rate risk. Thus, the best futures

3. Refer to the monthly sales forecasts given in the first Table. Assume that these amounts are realized and that the firm’s customers pay exactly as predicted.

But, even though the possibility of winning exists, the company is exposed to a greater risk if it does not hedge. Moreover, the policy of the company is to ensure against the risk, not to speculate on the foreign exchange market.

* If index future price is under pressure in Chicago, index futures arbitrage will lead to a massive selling in the cash market.

1. Why did Nick Leeson sell numerous short straddles for each long futures contract he bought?

From its definition it can be noticed that hedging is a strategy employed by companies in an effort to safeguard their economic position and to prevent the company from the losses which are associated with the unforeseen risks. Companies can hedge against risks which are associated with losses by taking control of their future purchases. The commodity prices vary in different markets and are caused or influenced by different economic factors. Some commodities are very scarce and with the increased depletion subject to the global demand in different foreign markets, the prices are set to be hiked in response to the established demand which positions the companies that use those particular commodities to have cash flow problems.