Cours 5

Question 1

What is the process of a short sale?

Answer 1

1) A short sell order is sent to the broker.
2) The broker borrows an asset from a client.
3) The broker proceeds to the sale of the asset on the market.
4) It then purchases the asset at a future date and we give back the borrowed asset to the broker.

Question 2

How does the margin account collateral work for a short sale?

Answer 2

1) You add $$ depending on price movements.
2) The client to whom the asset belongs can ask for compensation.

Question 3

Describe the cash and carry arbitrage strategy.

Answer 3

-At t0, there’s a borrowing of money and a purchase of an asset.
-At t1, the price of the money borrowed will adjust to supply and demand and there is a delivery of the asset.
- The profits are then the sale of the asset - the price of money borrowed.

Question 4

Describe the reverse cash and carry arbitrage strategy.

Answer 4

-At t0, there’s a short of an asset and a loan of the asset is deployed.
-At t1, the asset is given back and the price will adjust accordingly to supply and demand and there’s a long forward bought.
- The profits are then the loan - long forward bought.

Question 5

Give 3 characteristics about the forward price at inception.

Answer 5

• F0 is determined such that no counterparty has an advantage.
• No $ and/or asset exchanged at the inception of a forward.
• The value at inception is therefore 0.

Question 6

What happens if the underlying asset is an asset held for consumption purposes?

Answer 6

The classic price formula for forwarding is not valid for these reasons:
-> There are significant costs that are occurring while we need to store these assets.
-> Trading is not easy since assets are consumed and used.
-> There is no arbitrage policy since there is friction in the market.
->

Question 7

How are the cash flows working with a contract that its underlying security has a known yield?

Answer 7

When the contract is signed, the cash flows are certain.

Question 8

What happens when the price of the underlying is not correlated with risk-free interest rates on forward and futures prices?

Answer 8

forward prices = futures prices

Question 9

What happens when the price of the underlying is correlated with risk-free interest rates on forward and futures prices?

Answer 9

forward prices != Futures prices

Question 10

What happens when there is a positive correlation and a long position on the margin accounts?

Answer 10

• An increase in the spot price increases the margin
• A decrease in spot increases the amount of money to put in the margin

Question 11

Why is it more advantageous to hold a futures contract than a forward contract?

Answer 11

Because of the interest income impact on the margin account.

Question 12

What does a positive correlation imply between futures prices and forward prices?

Answer 12

Futures prices >forward price

Question 13

What does a positive correlation imply between futures prices and forward prices?

Answer 13

Futures prices <forward price

Question 14

What happens if the return of the underlying is uncorrelated with the return of a diversified portfolio?

Answer 14

There are zero systematic risks and k=r. The forward price is a good predictor of the spot price in T years.

Question 15

What happens if the return of the underlying is correlated with the return of a diversified portfolio?

Answer 15

There is a risk where k>r and the forward price is not a good predictor of the spot price in T years.