Consider a firm in the DC that sells it output to a retailer in the FC. To hedge the FX risk the DC firm could (select all that are true): Write a call option DC to FC at today's spot FX. Exercise a call option DC to FC at today's spot rate Purchase a fututes contract for DC to FC at today's spot rate. Purchase a futures contract for FC to DC to offset lost sales Write a put option for FC to DC at today's spot rate Purchase a call option for FC to DC at today's spot rate
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- AIR, an airline company, used to deal only in derivatives of futures and swaps to hedge its jet fuel market risk. However, in the mid2003, AIR started trading in speculative derivative options and took a bullish view of the jet fuel market.The company predicted correctly but by the end of 2003, AIR revised its strategy to a bearish stance.The CEO signed contracts with several banks, buying put options and selling call options, but the prices soared above the strike priceof the call, and AIR faced a large deficit.1. Explain how AIR could have floored the losses through an adequate risk management procedureDespite mark to market losses of $30 million by mid 2004, the CEO increased AIR exposure.In addition, the trading was not disclosed in the financial statements, and AIR accounted for the options at intrinsic value, ignoringthe time value component.From March 2003, AIR started trading options on its own account.AIR was unable to meet some of the margin calls, resulting in the company…When you are long an option and you delta hedge, you want A. traders talking a lot about other asset classes and ignore your underlying B. volatility to increase and the underlying to move around a lot C. the cost of carry to narrow D. volatility to decrease and the underlying to just stop movingConsider a firm in the DC that uses inputs from a supplier in the FC. To hedge the FX risk the FC firm could (select all that are true): Purchase a futures contract for DC to FC below your expected future trajectory of the FX rate and that the supply cotract is written in the DC Purchase a call option for FC to DC, which the firm will exercise if the spot FX rate (FC/DC) at the time is higher than the contract rate and the supply contract is written in the DC. Purchase a futures contract for FC to DC that you could sell for a profit if the DC weakens, which increases your costs of exporting the input Engage in a forward contract for DC to FC at today's spot rate, given that counter-party risk is managable and that the supply contract can be written in the DC. Exercise a futures contract for DC to FC if the strike price of the contract (FC/DC) is higher than the spot market rate at that time and that the supply contrtact can be written in the DC. Purchase a call option for DC to FC,…
- In the table, suppose the equal probabilities for weak economy and strong economy. Security B pays $600 if the economy is week and $0 if the economy is strong. Cash Flow in One Year Security Market Price Today Weak Economy Strong Economy Market index 1000 750 1350 Security B 600 0 Risk-free bond 1280 1350 1350 1) The expected return of security B is %. (Round to 2 decimal places) 2) The risk premium of security B is %. (Round to 2 decimal places) 3) Suppose a new security C has a Market Price Today = 2 * Security B + Risk-free bond, the equal probabilities for weak economy and strong economy. Security C pays $2250 if the economy is week and $1350 if the economy is strong, the expected return of security C is %. (Round to 2 decimal places)As it captures the sensitivity the price of a financial asset with respect to the fluctuations of the cost of capital, duration can be thought of as a measure of risk, albeit a conditional one. Coherent risk measures should satisfy four conditions, listed on page 260 of your textbook. Show if and how duration satisfies those four conditions470 q 24 The derivative based strategy known as portfolio insurance involves a. the sale of a put option on the underlying security position b. the purchase of a put on the underlying security position c. the sale of a call on the underlying security position d. the purchase of a call on the underlying security position. e. both b and d
- Angie owns an endive farm that will be worth $90,000 or $0 with equal probability. Her Bernouilli utility function is u(w) =√w, where w is her wealth level (sum of initial wealth and the worth of the endive farm). 1. Suppose her firm is the only asset she has, that is, she has no initial wealth. What is the lowest price P at which she will agree to sell her endive farm before she knows how much it will be worth? 2. Redo part (1) assuming that she has $160,000 in her bank safe. 3. Compare and discuss your results in parts (1) and (2). What relationship can you find between Angie’s initial wealth level (zero versus $160,000) and her risk aversion?Consider an insurance contract with the premium r=$200 and payout q=$800. What is John’s expected income without this insurance contract? What is John’s expected income with this insurance contract?In equilibrium U′(Yt)qet = δEt[U′(Yt+1)(qet+1 + ˜ Yt+1)] holds. Assume the following: . Infinite periods . δ = .97 . The agent follows ln utility . There are 2 futures states where (Y 1, Y 2) = (2, .50) which evolve based on transition matrix T. . The transition matrix T is: T = [.60 .40 .40 .60] (hint: Answering this question involves solving the system of equations: U′(Yt)qet = δEt[U′( ˜ Yt+1)(˜qt+1 + ˜ Yt+1)] U′(Yt)qet = δEt[U′( ˜ Yt+1)( ˜ Yt+1)] + δEt[U′( ˜ Yt+1)(˜qt+1)] What are the 2 equilibrium conditions? What is the price of q(2) and q(.50)?
- D & R A1 6 Question 6. Foreign Currency Futures and Arbitrage Strategy Today is May 23, 2016. The spot rate for British pounds is 1.9032 CAD/£. The Canadian risk-free rate is 0.52%, and the British risk-free rate is 0.45%. Both risk-free rates are compounded continuously. The vote by the British population for U.K. exit from the European Union (commonly referred to as Brexit) will occur in exactly one month. Due to the uncertainty from this event, market volatility on the British pounds futures is quite high. As an example, the British pound futures contract, which expires on September 23, is priced below the spot rate at 1.4497CAD/£. The futures contract size is 62,500 British pounds. Is the futures contract incorrectly priced? If so, construct a risk-free arbitrage strategy to take advantage of the mispricing. Assume there are 365 days in the year, and the Canadian dollar is the domestic currency.How coronavirus will dominate African interest rate decisionsJOHANNESBURG ‐ Central bankers in five key sub‐Saharan African countries will meet on interestrates in the next ten days as the focus turns to them for measures to shore up their economies thatare expected to be hit by the novel coronavirus.“We expect the Covid‐19 outbreak and current market turmoil to be major points of discussion aspolicymakers deliberate on the rate decision, with the bias certainly downwardsfor those countrieswhich have scope to cut,” said Ridle Markus, an economist for sub‐Saharan Africa at Absa Bank Ltd.Policymakers in oil‐producing countries “will need to balance the significant downside risks togrowth, brought by the slump in oil prices, against the risksresulting from the deteriorating balanceof payments and worsening inflation outlook,” he said.Here’s what central bankers in the region may do in the next ten days:South Africa, March 18 ‐ Repurchase rate: 6.25%Inflation rate: 4.5% (January) By…Excercise: Consider the Diamond-Dybvig model of bank runs utility function is given by U(c) = √c and that the parameter values are R = 4, discount factor ß = 1/3, and π = 2/5 A) How much do type-1 agents and type-2 agents consume in periods 1 and 2 under autarky, i.e., if there are no banks, insurance companies, or markets? What is the ex-ante expected utility that they derive in this scenario? B) How much do type-1 agents and type-2 agents consume in periods 1 and 2 in the "good" banking equilibrium? What is the ex-ante expected utility that they derive in this scenario? C) How many agents are able to execute their claims in period 1 (i.e., withdraw the maximum amount they have been promised) in the bank run equilibrium?
