week 2

Question 1

Answer 1

–Arbitrageurs can make a riskless profit from buying the asset and entering into a short forward contract on the asset. This strategy is financed by borrowing funds at the risk free-rate if interest.

Question 2

Answer 2

–Arbitrageurs can make a riskless profit by shorting the asset and entering into a long forward contract. The excess funds are invested at the risk-free rate of interest until they are needed to buy back the asset.

Question 3

Forward and Futures Contract Prices on Assets with Known Income

Answer 3

Question 4

when is basis risk zero

Answer 4

If the asset to be hedged and the asset underlying the futures contract are the same

Question 5

Terminal table

Answer 5

Question 6

Reasons for using index futures to hedge an equity portfolio include

Answer 6

–Desire to be out of the market for a short period of time (Hedging may be cheaper than selling the portfolio and buying it back).

–Desire to hedge systematic risk (Appropriate when you feel that you have picked stocks that will outperform the market).

Question 7

A strong positive correlation between interest rates and the asset price implies

Why?

Answer 7

–A strong positive correlation between interest rates and the asset price implies the futures price is slightly higher than the forward price.

Because

• the person in the long position in a futures contract receiving an immediate gain because of daily settlement.
• The positive correlation indicates that interest rates are also likely to have risen, therefore the gain will be invested at a higher than average interest rate.

the reverse is true