FIN532M: Financial Derivatives
Problem Set 2
DUE DATE: Feb. 12, 2015
1. How can you differentiate the forward price from the value of a forward contract?
(2 points)
2. Explain why an FRA can be viewed as an exchange of a floating rate of interest for a fixed rate of interest payments and how you can use FRA in mitigating risks.
(4 points)
3. The standard deviation of monthly changes in the spot price of live cattle is 1.2 cents per pound. The standard deviation of monthly changes in the futures price of live cattle for the closest contract is 1.4.
The correlation between the futures price and the spot price changes is 0.7. It is now Feb 5 and a beef producer is committed to purchase 200,000 pounds of live cattle on April 10. The producer
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(Portfolio) Mismatched
(Portfolio) Matching using FRA
(FRA)
Investment earning at RK
Investment earning at RK
Paying the principal at RK
Loan paying interest at RM
Loan paying interest at RM
Investing the principal at RM
3. Given:
Standard deviation (delta spot prices) = 1.2 cents/pound
Standard deviation (delta futures prices) = 1.4 cents/pound
Correlation between delta spot and delta futures prices = 0.7
1 futures contract = 40,000lbs
Purchasing requirement = 200,000 lbs
a. Optimal hedge ratio: h* = 0.7 x (1.2/1.4) = 0.6
b. Optimal number of contract:
N = 0.6 x (200,000/40,000) = 3 contracts
Since you are the one who needs to purchase the live cattle, then you should long 3 May live cattle futures contract and close out the position in April by shorting 3 contracts.
4. Given:
Current Index : 1,200
6-month Risk-free rate: 3.5% p.a. continuous compounding
Dividend yield: 1% p.a. continuous compounding
6-month Futures Price = 1,200 x e[(3.5% – 1%) x 0.5] = 1,215.09
5. Given:
R4 = 4.2%
R5 = 4.5%
RF =?
T4 = 4
T5 = 5
T5 – T4 = 1
5th year Forward Rate (Forward rate for the periods year 4 to year 5)
RF = (R5T5 – R4T4)/(T5 – T4) = [(4.5% x 5) – (4.2% x 4)]/(5 – 4) = 5.70%
6. Given:
L = $1 million
RK = 6% p.a compounded annually
RF = 5.6% p.a. continuously compounded
R2 = 5% p.a. continuously compounded
T2 = 5
T1 = 3
You are the borrower, thus
VFRA = [L x (RF – RK) x (T2 –
The beef industry is an important asset to United States agriculture as a whole. Over a million agricultural entities benefited from the sales of cattle and calves in the year 2000. Gross totals from sales of cattle and calves in 2000 totaled $40.76 billion accounting of 21% of all agricultural receipts making the beef sector the largest single agricultural enterprise. Direct and indirect employment in or related to the production and processing of beef supports over 1.4 million full-time-equivalent jobs in the US as well. Cattle are produced in all 50 states and their economic impact contributes to nearly every county in the nation and they are a significant economic driver (Lawerance and Otto, 2000).
2) Compute the standard deviation for each of the four samples. Does the assumption of .21 for the population standard deviation appear reasonable?
We know that +/- 1.96 standard deviations from the mean will contain 95% of the values. So, we can get the standard deviation by:
5. Give the standard deviation for the mean and median column. Compare these and be sure to identify which has the least variability?
The mean birth weight of infants born at a certain hospital in the month of April was 128 oz. with a standard deviation of 10.2 oz. Which of the following is a correct interpretation of standard deviation?
Standard Deviation for the mean column is 0.476Standard Deviation for the median column is 0.754Standard deviation for the mean column has least variability
σA = 0.3 × (0.07)2 + 0.4 × (0.06)2 + 0.3 × (0.08)2 − (0.021)2 = 0.004389,
5. Find the sample variance s2 for the following sample data. Round your answer to the nearest hundredth.
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The following Histogram shows that the distribution is approximately symmetrical about the mean, or bell-shaped. Therefore, using the Empirical Rule, I concluded that 47.5% of the lbs. of milk produced per month fell between 2270.5 lbs. and 964.10 lbs. This accounts for a very large portion of the total milk produced; as 68% fell within 1 standard deviation of 653.20 of the mean, and 95% fell within 2 standard deviations of the mean.
Rounded to the closest hundreth, the standard deviation for the set is approximately 19.52. Juxtaposed
Organic ranchers and dairy farmers in California also feel the effects of the drought. They rely on green pasture to feed their animals a healthy diet. Due to the lack of rain, the pasture are drying up and the ranchers have to purchase supplemental organic hay from other states. In an attempt to fund the purchasing of this out of state hay, the organic farmers are selling herds to businesses for hamburger meat and the small
The Old Mule Farms is a cow-calf operation that provides calves for feedlots to fatten up before being sent to packing houses and eventually sold as meet for consumers. The current owners have been experiencing a problem with losses in revenue. The expenses that Old Mule Farms incurred are veterinary bills, labor, nutritional supplements and minerals, and a variety of forage. The forage is primarily grazed grasses but is supplemented with hay.
Fry Brothers heating and Air Conditioning, Inc. employs Larry Clark and George Murnen to make service calls to repair furnaces and air conditioning units in homes. Tom Fry, the owner, would like to know whether there is a difference in the mean number of service calls they make per day. Assume the population standard deviation for Larry Clark is 1.05 calls per day and 1.23 calls per day for George Murnen. A random sample of 40 days last year showed that Larry Clark made an average of
These represent the range of the sale price. Lastly, I used the formula to get the standard deviation 48,945.28, which measures the variability.