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Tutorial 1 Solutions

Your tutor will go through as many questions as possible with you in the tutorial. You should come to class with answers to these questions prepared. Solutions will be posted after the end of the week of the tutorial.

Fundamental Concept Questions

Question One
“Options and futures are zero-sum games.” What do you think is meant by this statement?

The statement means that the gain (loss) to the party with the short position is equal to the loss (gain) to the party with the long position. In total, the gain to all parties is zero.

Question Two
The Chicago Board of Trade offers a futures contract on long-term Treasury bonds. Characterize the investors likely to use this contract.

Most investors will …show more content…

This leads to a loss of $3,900 which is offset by the premium of $300 received for the options.

Question Eight
The current price of a stock is $94, and three-month call options with a strike price of $95 currently sell for $4.70. An investor who feels that the price of the stock will increase is trying to decide between buying 100 shares and buying 2,000 call options (20 contracts). Both strategies involve an investment of $9,400. What advice would you give? How high does the stock price have to rise for the option strategy to be more profitable?

The investment in call options entails higher risks but can lead to higher returns. If the stock price stays at $94, an investor who buys call options loses $9,400 whereas an investor who buys shares neither gains nor loses anything. If the stock price rises to $120, the investor who buys call options gains [pic]
An investor who buys shares gains [pic]
The strategies are equally profitable if the stock price rises to a level, S, where [pic] or [pic]
The option strategy is therefore more profitable if the stock price rises above $100.

Question Nine
A company enters into a short futures contract to sell 5,000 bushels of wheat for 250 cents per bushel. The initial margin is $3,000 and the maintenance margin is $2,000. What price change would lead to a margin call? Under what circumstances could $1,500 be withdrawn from the margin account?

There is a margin call if

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