Question

In: Finance

1. Suppose you buy a call option on a $100,000 Treasury bond futures contract with an...

1. Suppose you buy a call option on a $100,000 Treasury bond futures contract with an exercise price of $99,000 for a premium of $1000. If on expiration the price of the futures contract is $98,500, what is your profit or loss on the contract?

2. Suppose you buy a put option on a $100,000 Treasury bond futures contract with an exercise price of $100,000 for a premium of $1500. If on expiration the futures contract has a price of $99,000, what is your profit or loss on the contract?

3. Suppose you buy a Treasury bond futures contract for a price of 98.5 percent of the face value of $100,000. Assume that the Treasury bond futures price rises to 99.5 percent. What is your loss or gain?

4. Suppose that the pension fund you are managing is expecting an inflow of funds of $10 million next year and you want to make sure that you will earn the current interest rate of 6% when you invest the incoming funds in long-term bonds. How would you use the futures market to do this?

5. Suppose foreign investors reduce their willingness to invest in U.S. assets. Explain what would happen to the value of the dollar on average and why.

6. Suppose the European central bank greatly increases the supply of Euros it issues. Explain what would happen to the value of the Euro on average and why.

Solutions

Expert Solution

1) Excercise price - $99000

Cost of call option - $1000

Price at the time of expiry - $98500

The loss on the contract is $1000, which is the cost of the option. The option would not be excercised as it is out of the money.

2) Excercise price - $100000

Cost of put option - $1500

Futures price at expiry - $99000

The loss on the contract is $500, the details are given below:

$1500 (cost of the option) - $1000 (profit on excercising the put option - $100000-$99000)

3) The cost of Treasury bond futures contract is $98500 (98.5% of $100000)

If the future price rises to 99.5% the price of contract is $99500

The profit is $1000 ($99500-$98500)

4) For ensuring that I earn te interest rate of 6%, I will buy long term bond futures worth $10 million with 1 year expiry. If the interest rate reduces below 6% then the bond price will increase and will act as a hedge inorder to earn 6% interest on the incoming funds in long term bonds.

5) If the foreign investors reduce their willingness to invest in US assets then the value of dollar would go down as there would not be a demand of dollars to purchase US assets which can only be purchased in dollars.

6) If the European central bank greatly increase the supply of Euros then the value of Euros would depreciate on average as the supply for Euros would be greater than the demand.


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