CONFIDENTIAL BMIJUN 2014/FING45/541/651/630 UNIVERSITI TEKNOLOGI MARA FINAL EXAMINATION COURSE : FUTURES AND OPTIONS / MALAYSIAN FUTURES AND OPTIONS COURSE CODE 1 FING45/541/651/630 EXAMINATION : JUNE 2014 TIME : 3HOURS INSTRUCTIONS TO CANDIDATES 1 This question paper consists of five (5) questions. 2. ‘Answer ALL questions in the Answer Booklet. Start each answer on a new page. 3. Do not bring any material into the examination room unless permission is given by the invigilator. 4, Please check to make sure that this examination pack consists of i) the Question Paper ji) an Answer Booket — provided by the Faculty DO NOT TURN THIS PAGE UNTIL YOU ARE TOLD TO DO SO This examination paper consists of 6 printed pages (© Hak Cipta Universiti Teknologi MARA, CONFIDENTIALCONFIDENTIAL 2 BMIJUN 2014/FING45/541/651/630 QUESTION 1 a) Explain two (2) circumstances in which crude palm oil futures price moves away from its fair value. (4 marks) A refiner receives an order for a large volume of refined palm oil for which he will need 5,000 metric tons of crude palm oil (CPO) as raw material in the production process. It is now August and the order is to be filled by November. The cash price is RM3,270, while futures quotes are as follows: ae ] August September October November | Price (RM per metric ton) | 3,268 3,277 3,275 3,274 However, the refiner does not have the cash to purchase the crude palm oil in the cash market at this time. The refiner decides to hedge 80% of his position to lock in the buying price in anticipation of rising crude palm oil prices in the cash market In November, the refiner has to purchase the crude palm oil he needs. The cash Price and November futures have risen to RM3,280 and RM3,290 respectively. i) Explain the strategy that the refiner has to take in order to protect himself against price risks. (4 marks) ii) Determine the effective price per metric ton of the crude palm oil (10 marks) iii) Comment on the outcome of the strategy. (2 marks) QUESTION 2 a) The common stock of ABC Company is currently trading at RM42. Both put and call options are available for ABC stock, each having an exercise price of RM40 and an expiration date in six months. The premium for both put and call is RM4, Based on the closing stock prices below, prepare a payoff table for the following positions: es RM25 | RM30 | RM35 | RM40 | Rs | oll RMS55 | RM60 Price a (© Hak Cipta Universiti Teknologi MARA CONFIDENTIAL,CONFIDENTIAL, 3 BMIJUN 2014/FIN645/541/651/630 i) Buy one ABC call option (4 marks) ii) Short one ABC call option. (4 marks) ili) ‘Sketch and label the expiry profit diagram for the positions taken above. (4 marks) b) There are six common factors that affect the value of options on stocks. Three of these factors include (1) the current price of the underlying stock, (2) the time to maturity for the option contract, and (3) the dividend on the stock. Identify and explain two of the remaining factors. (4 marks) ©) Atrader goes long on March KCI call option at 1850 index points for 25 points and short March KLCI option at 1900 index points for 15 points. i) Name a possible strategy for the option. (1 mark) ii) Determine the pay-off profile for the strategy. (3 marks) QUESTION 3 a) _Itis now March 2014 and FKB3 at BMDB are trading as follows: Contract Price _| Mac 2014 FKB3 — 94.02 Jun 2014 FKB3 a 94.18 Sep 2014 FKB3. - 94.29 Dec 2015 FKB3 94.38 By looking at the prices above, the yield curve is inversed. A trader believes the yield curve will normalize and he wants to create a spread trade for June and ‘September 2014 contracts, which later close at 94.31 and 94.18, respectively. i) Describe how he could create a profitable spread trade for 10 June and 10 September FKB3 contracts (4 marks) il) Calculate his profit or loss for June contract. s (3 marks) ii) Calculate is his net profit or loss from doing the spread trade. (3 marks) (© Hak Cipta Universiti Teknologi MARA CONFIDENTIAL,CONFIDENTIAL, 4 BM/JUN 2014/FING45/541/651/630 b) A speculator feels that there will be a deciine in interest rates. On the morning of January 20, 2014 he goes long on 10 Jan KLIBOR futures contracts at 94.52 and he is required to pay a margin of RM8,000 per contract. The maintenance margin is RM6, 500 per contract. The daily settlement prices are given as follows: [Date _| Settlement Price ‘January 20, 2014 [94.43 — January 21, 2014 94.56 = January 22, 2014 94.45 - January 23, 2014 94.39 [January 24, 2014 94.35 : i) Show the daily variation margins from January 20". to January 24”. (7 marks) ii) Determine the net profit or loss when he closes-out his position on 24". January. (3 marks) QUESTION 4 a) Identify the potential users of MGS futures and the primary use of this instrument. (4 marks) b) Briefly explain the role of clearing house in the provision of guarantee in the derivative market. (4 marks) ¢) It is now February 2014 and ABC Bank intends to purchase RM200 million 5-year MGS when these instruments are issued in one month’s time. The current interest rate is 8 percent. The bank is concerned about a fall in interest rate between now and the next month and decides to hedge its position today to lock in the purchase price of the bond. Currently, March FMGS is trading at 114. In March, the interest rate falls to 7 percent and March FMGS trades at 116. i) Describe the bank's strategy and indicate whether it makes a profit or loss if the above occurs. (8 marks) ii) Calculate and comment bank's effective price. (4marks) (© Hak Cipta Universiti Teknologi MARA CONFIDENTIALCONFIDENTIAL, 5 BM/JUN 2014/FIN645/541/651/630 QUESTION 5 a) tis now 1%, June 2014 and the FBM KLCI is at 1846, The average dividend yield of the FBM KLCI is 2.3% and the risk-free interest rate is 5% per annum. A trader has RM10 million which he can fund at the risk-free rate. Meanwhile, September 2014 FKLI is trading at 1892.5. The trader believes that there is an arbitrage opportunity. i) Find the fair value for September 2014 FKL (6 marks) ii) Determine the number of contracts he can trade and outline the strategy he can partake, (6 marks) iii) Show the profit or loss of the arbitrage if both cash and September FKL! converged at 1876 on the last day of September. (6 marks) b) _Explain the importance of speculators in the futures market and why speculating is considered risky. (4 marks) END OF QUESTION PAPER (© Hak Cipta Universiti Teknologi MARA CONFIDENTIAL