MGMT 41150 – Futures and Options

Professor Boquist

Midterm Practice Questions

** Note: these practice questions meant to be representative of midterm exam questions.
Everything from my class notes, homework assignments, the textbook chapters and supplemental
readings is fair game for the exam. DO NOT assume the problems below are the only type of
problems that will be on the exam.

Question 1
The current dollar/pound spot rate is 1.281 USD/GBP. The 6-month forward exchange rate is
1.006 USD/GBP (reminder: British pound futures contracts are 62,500 GBP each). The 6-month
T-bill yield in the USA is 0.51% (assume this is the continuously compounded annualized yield)
and the 6-month risk-free rate in the UK is 1.09% (also continuously compounded and
annualized). What is the arbitrage trade, and what is your profit per futures contract?

I covered the details of this one in class, but you long the contract, borrow GBP, and invest
USD at the risk free rate. The arbitrage trade earned us 16,955 USD per contract.

Question 2
You have a short position on a Treasury bond futures contract. The most recent settlement price
is 98-28, and the accrued interest is $1.75. The bond you have chosen to deliver is an 11%
coupon bond with 21 years and 11 months left until maturity. What will you receive at delivery?

I covered the details of this one in class, but after computing the conversion factor, the
short seller received $160,217 per contract. The key for the similar homework question
should help with this as well.
MGMT 41150 – Futures and Options
Professor Boquist

Question 3
Suppose that the risk-free interest rate is 10% per annum with continuous compounding and the
dividend yield on a stock index is 4% per annum. The index is currently trading at 400 and the
futures price for a contract deliverable in four months is 405. What arbitrage opportunities does
this create?

𝟒
(𝟏𝟎%−𝟒%)∗( )
The Futures price should be: 𝑭 = 𝟒𝟎𝟎 ∗ 𝒆 𝟏𝟐 = 𝟒𝟎𝟖. 𝟎𝟖

The price of 405 is too low, so you should take a long position in the contract.

Transaction CF Now CF in 6 months

Long Futures 0 ST - 405
Short Index +400 - ST
Invest in risk-free -400 +413.56
Pay Dividend -5.37
Total 0 +3.19

𝟒
(𝟏𝟎%)∗( )
Note: the Risk-free investment is = 𝟒𝟎𝟎 ∗ 𝒆 𝟏𝟐 = 𝟒𝟏𝟑. 𝟓𝟔

𝟒
(𝟒%)∗( )
And the Dividend is calculated= [𝒆 𝟏𝟐 − 𝟏] ∗ 𝟒𝟎𝟎 = 𝟓. 𝟑𝟕
MGMT 41150 – Futures and Options
Professor Boquist

Question 4
The current spot price of wheat is $4.46 per bushel. CME wheat futures contracts are 5,000
bushels each. The risk-free rate is 0.8%. The May 2018 contract (T=15 months) is currently
$5.25. Storage costs are $0.51 per bushel for 15 months (paid at the end of the 15 months). What
is the theoretical futures price? If the futures price is $5.51, what is the arbitrage trade, and what
is the profit per contract?

First, find the PV of the storage costs (the variable U in the notes and text):
𝟏𝟓
(−𝟎.𝟖%)∗( )
𝑼 = 𝟎. 𝟓𝟏 ∗ 𝒆 𝟏𝟐 = 𝟎. 𝟓𝟎𝟒𝟗
𝟏𝟓
(𝟎.𝟖%)∗( )
So the futures price should be: 𝑭 = (𝟒. 𝟒𝟔 + 𝟎. 𝟓𝟎𝟒𝟗) ∗ 𝒆 𝟏𝟐 = 𝟓. 𝟎𝟏𝟓

Since 5.51 is too high, we should short the contract.

At time t=0

Short Futures: CF = 0

Buy wheat: CF = (-5000)*$4.46 = -$22,300

Borrow the money: CF = +$22,300

Total: CF = 0

At time t=15 months

Sell wheat through contract: CF = +5000*$5.51 = +$27,550

Pay storage costs: CF = - ($0.51*5000) = -2,550

𝟏𝟓
(𝟎.𝟖%)∗( )
Pay back loan: 𝑪𝑭 = −𝟐𝟐, 𝟑𝟎𝟎 ∗ 𝒆 𝟏𝟐 = $ − 𝟐𝟐, 𝟓𝟐𝟒. 𝟏𝟐

Total CF = +$2476
MGMT 41150 – Futures and Options
Professor Boquist

Question 5
If you take a long position in 14 Eurodollar futures contracts on day 1, and hold them for the next
5 days, as shown below, what is the gain/loss each day, and what is your total gain/loss?

Note: the equation to calculate the price per contract is:

Price = 10,000 * [100 – 0.25*(100 – Q)]

Where Q is the quoted price in the table below:

Day Quote Price per Gain/Loss Total Cumulative

contract per contract Gain/Loss Gain/Loss
1 98.33 995,825
2 98.01 995,025 -800 -11,200 -11,200
3 97.68 994,200 -825 -11,550 -22,750
4 98.15 995,375 +1175 +16,450 -6,300
5 98.39 995,975 +600 +8,400 +2,100
6 98.59 996,475 +500 +7,000 +9,100

Question 6
You own 12 call option contracts with a strike price of $60. If the stock does a 5-to-1 split, what
happens to your options? What about a 20% stock dividend?

5:1 split: (n=5, m=1)

New Strike price = 1*60/5 = $12.00
New number of options = (1200)*(5/1) = 6,000

20% stock dividend (equivalent to a 6:5 split: n=6, m=5)

New strike price = (5*60)/6 = $50.00
New number of options = (1200)*(6/5) = 1,440
MGMT 41150 – Futures and Options
Professor Boquist

Question 7
Use the commission table below to answer the following questions:

If you buy 100 call option contracts that cost $0.50 per option, what is the commission? What if
the option costs $5.00 each?

Option price = $0.50

Total dollar amount = ($0.50)*(100 contracts)*(100 options/contract) = $5,000
Commission = $45+(1%)*($5,000) = $95

Compare this to the minimum and maximum commission:

Minimum = $30*1 + $2*99 = $228
Maximum = $30*5+$20*95 = $2,050

Therefore the commission will be $228 (since $95 is below the minimum)

Option price = $5.00

Total dollar amount = ($5.00)*100*100 = $50,000
Commission = $120 + 0.25%*($50,000) = $245

Therefore the commission will be $245.

(Note: since this is still 100 contracts, the max and min are the same as in the first part)