FINAL EXAM

FIN 4002- Fundamentals of Valuation II

Instructor: Emmanuel ZAMBLE BI, MBA

Student’s name:

Time: 1h30 mn

Date: December 16th, 2020.

Instructions: Answer all four questions.

Q 1: (55 marks)

A. The process of marking a futures contract to market means that:

a. the profitability of the contract is locked in from the onset of the contract.
b. the amount of commodity to be delivered changes as prices change.
c. contracts are closed out as soon as they become unprofitable.
d. profits or losses are posted to the contract daily.

B. With futures market contracts, _________________ guarantee(s) all trades, so that default risk
is minimized.
a. position traders
b. an organized exchange
c. day traders
d. the CFTC
e. a floor broker

C. How can companies use swaps to change the risk of securities that they have issued?

a. Swaps allow firms to exchange one series of future payments for another.

b. For example, the firm might agree to make a series of regular payments in one currency in
return for receiving a series of payments in another currency.

I. a.

II. b.

III. both a and b are correct.

IV. neither a nor b is correct.

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D. How can options, futures, and forward contracts be used to devise simple hedging strategies?

a. Options are often used by firms to limit their downside risk. For example, if you own an
asset and have the option to sell it at the current price, then you have effectively insured
yourself against loss.

b. Futures contracts are agreements made today to buy or sell an asset in the future. The
price is fixed today, but the final payment does not occur until the delivery date. Futures
contracts are highly standardized and are traded on organized exchanges. Commodity
futures allow firms to fix the future price that they pay for a wide range of agricultural
commodities, metals, and oil. Financial futures help firms to protect themselves against
unforeseen movements in interest rates, exchange rates, and stock prices.

c. Forward contracts are equivalent to tailor-made futures contracts. For example, firms
often enter into forward agreements with a bank to buy or sell foreign exchange or to fix the
interest rate on a loan to be made in the future.

I. a.

II. b.

III c.

IV. all of the three statements are correct.

E. The process of protecting oneself against future price changes by shifting some or all of the risk to
someone else is called:

a. speculating
b. investing
c. hedging
d. gambling

F. Mark entered into a "forward contract," to buy 100 shares of Way-Low Corp. stock, at a price of $5
per share—in exactly 6 months. Now, the six month period has passed. Way-Low Corp.'s stock is
trading at $7 per share. What are the consequences for Mark?

a. He has lost $500

b. He has gained $700
c. He has lost $200
d. He has gained $200
e. He has gained $500

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G. Suppose an investor buys an option for a $1000 premium on a $100,000 August T-bill futures
contract with a strike price of 120. On the expiration date, the T-bill futures contract has a price
of 115. (Recall that arbitrage will result in the spot price equalling the futures contract price.)
What is the individual likely to do?
a. He will buy the asset and make a profit of $5,000.
b. He will not buy the asset and thus suffer no loss.
c. He will buy the option but suffer a loss of $5,000.
d. He will not buy the option but he will suffer a loss of $1,000.

H. When two borrowers engage in a currency swap, they agree to:

a. trade one currency for another, thus avoiding the foreign exchange market.
b. make payments on each other's borrowings in a different currency.
c. pay to each other any depreciation or appreciation of the currency.
d. exchange fixed-rate interest payments for variable-rate interest payments.

I. Consider the buying of put option, the probability that a buyer would have negative payoff
increases with the

a. increase in stock price

b. decrease in stock price

c. increase in maturity duration

d. decrease in maturity duration

J. Two months ago, Mary bought a call option on ABC Corp. stock, having an exercise price of $30.
Mary paid $1 for this call. Today, ABC stock is trading at $25 per share. Which of the following is
true?

a. Mary has now realized a $5 profit.

b. Mary has now realized a $5 loss.
c. Mary's option is out of the money.
d. Mary's option is in the money.
e. Mary has now realized a $4 loss.

K. When the price of underlying asset increases then the best option is

a. buy the call option

b. sell the call option

c. buy the put option

d. sell the put option

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Q 2: (10 marks)

Suppose you observed that high-level managers make superior returns on investments in their
company’s stock.

a. Would this be a violation of weak-form market efficiency?

A high level managers might have private information on the firm so his or her ability to make return
on it might not be surprising. In that sense, it does not violate the weak-form market efficiency.

b. Would it be a violation of strong-form market efficiency?

Abdnormal profits are not derived from an analysis of past price and trading data so in that sense we
can say that it violates the strong-form market efficiency.

c. If the weak form of the efficient market hypothesis is valid, must the strong form also
hold?

If the weak form is efficient for the market, in that sense semi strong and strong forms are efficient
which implies that the inverse is not possible.

d. Conversely, does strong-form efficiency imply weak-form efficiency?

No the strong-form efficient does not imply weak form efficiency

Q 3: (15 marks)

Suppose that in 3 months the cost of a pound of Colombian coffee will be either $1.25 or $2.25. The
current price is $1.75 per pound.

a. What are the risks faced by a hotel chain who is a large purchaser of coffee?

The hotel chain faces the risk of seeing the rise in price of coffee. The solution to that will be to pass
that extra cost to its clients of coffee, so it is not clear to what extent the hotel chain will be affected
by an increase in coffee prices.

b. What are the risks faced by a Colombian coffee farmer?

The coffee farmer may not have no natural hedge so there is a risk if the price of coffee falls. The
solution for the coffee farmer may be to sell forward coffee.

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 c. If the delivery price of coffee turns out to be $2.25, should the farmer have forgone entering
into a futures contract? Why or why not?

When entering into contract, the coffee farmer presumably understood the risk that a hedge may
lock in a lower selling price if coffee prices rise above the futures price. The fact that the farmer lost
the upside while protecting the downside does not indicate that there were losses.

Q 4: (20 marks)

You write a call option with $50 and buy a call with strike $60. The options are on the same stock and
have the same maturity date. One of the calls sells for $3; the other sells for $9. (Assume zero
interest rate.)

a. Draw the payoff graph for this strategy at the option maturity date.

Buy call with K=$60 0 0 ST-60

Write call with K =$50 0 -(ST-50) -(ST-50)

Final payoff 0 -(ST-50) -10

Initial proceeds $6 $6 $6

Total $6 $56-ST -$4

S T≤50 50<ST<60 ST≥60

b. Draw the profit graph for this strategy for this strategy.

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 c. What is the break-even point for this strategy?

The break-even point for this strategy is when S T= $56, at that point the initial proceeds of $6 offsets
the payoffs.

d. Are you bullish or bearish on the stock?

This strategy is a bearish on the stock.

Good Luck!