Lecture 4: Derivatives

Practice Questions

Positions and Investor can take

Questions
1. You have bought a share for R65. You are required to deposit an initial margin of
25% and your maintenance margin is 1.5 times your initial margin. Calculate the
price at which you will receive a margin call?
A. R54.17
B. R57.35
*C. R78.00

2. You have decided to purchase 100 shares in ABC Corporation which is currently
trading at R50 per share. You have decided that you will borrow R2500 to fund your
purchase. What is your leverage ratio?
A. 0.50
B. 1.00
*C. 2.00

3. An investor buys an $82 stock with a 50% initial margin and a maintenance margin
(minimum) of 30%. Calculate the price for a margin call?

= Price for a margin call =P0((1-initial)/(1 -maintenance)) =30%

= 82 x ((1-0.5)/(1-0.3))
= $58.57

4. The current price of a stock is $25 per share. You have $10 000 to invest. You borrow
an additional $10 000 from your broker and invest the $20 000 in the stock. If the
maintenance margin is 30%, at what price will a margin call first occur?
a. $9.62
b. $17.86*
c. $19.71

= Price for a margin call =P0((1-initial)/(1 -maintenance))

= 25 x ((1-0.5)/(1-0.3))
= $17.86

5. Assume you sell short 1000 shares of common stock at $35 per share, with initial
margin at 50%. What would be your rate of return if you repurchase the stock at
 $25/share? The stock paid no dividends during the period, and you did not remove
any money from the account before making the offsetting transaction.
A. 57.14%*
B. – 57.14%
C. 28.57%
D. – 28.57%

Profit on stock = ($35 - $25)(1,000) = $10,000;

initial investment = ($35)(1,000)(.5) = $17,500;
return =$10,000/$17,500 = 57.14%.

Futures and Forwards

1. You purchased one silver future contract at $3 per ounce. What would be your profit (loss)
at maturity if the silver spot price at that time is $4.10 per ounce? Assume the contract size
is 5,000 ounces and there are no transactions costs.
A. $5.50 profit
B. $5,500 profit
C. $5.50 loss
D. $5,500 loss
E. None of these is correct.
$4.10 - $3.00 = $1.10 X 5,000 = $5,500.

2. You sold one silver future contract at $3 per ounce. What would be your profit (loss) at
maturity if the silver spot price at that time is $4.10 per ounce? Assume the contract size is
5,000 ounces and there are no transactions costs.
A. $5.50 profit
B. $5,500 profit
C. $5.50 loss
D. $5,500 loss
E. None of these is correct.
$3.00 - $4.10 = -$1.10 X 5,000 = -$5,500.

3. You sold one wheat future contract at $3.04 per bushel. What would be your profit (loss) at
maturity if the wheat spot price at that time were $2.98 per bushel? Assume the contract
size is 5,000 ounces and there are no transactions costs.
A. $30 profit
B. $300 profit
C. $300 loss
D. $30 loss
E. None of these is correct.
$3.04 - $2.98 = $0.06 X 5,000 = $300.
 4. You purchased one wheat future contract at $3.04 per bushel. What would be your profit
(loss) at maturity if the wheat spot price at that time were $2.98 per bushel? Assume the
contract size is 5,000 ounces and there are no transactions costs.
A. $30 profit
B. $300 profit
C. $300 loss
D. $30 loss
E. None of these is correct.
$2.98 - $3.04 = -$0.06 X 5,000 = -$300.

5. Given a stock index with a value of $1,000, an anticipated dividend of $30 and a risk-free rate
of 6%, what should be the value of one futures contract on the index?
A. $943.40
B. $970.00
C. $1030.00
D. $915.09
E. $1000.00
F = 1000*(1.06) - 30; F = 1030.00.

6. You purchased the following futures contract today at the settlement price listed in the Wall
Street Journal. Answer the questions below regarding the contract.

- What is the total value of the futures contract?

- If there is a 10% margin requirement how much do you have to deposit?
- Suppose the price of the futures contract changes as shown in the following table.
- Enter the relevant information into the table. Show your calculations.
The answers are shown below.

The total value of the contract is $9,174, as shown in the table. If there is a 10% margin requirement,
you will have to deposit $917.40 in cash or securities.

The contract is marked to market daily and profits or losses are posted in the account. The contract
keeps pace with market activity and doesn't change value all at once at the maturity date. The
marking-to-market process protects the clearinghouse because the margin percentage is calculated
daily and if it falls below the maintenance margin a margin call can be issued. If the investor doesn't
meet the call the clearinghouse can close out enough of the trader's position to restore the margin.

USE THE FOLLOWING INFORMATION FOR THE NEXT THREE PROBLEMS

December futures on the S&P 500 stock index trade at 250 times the index value of 1187.70. Your
broker requires an initial margin of 10% percent on futures contracts. The current value of the S&P
500 stock index is 1178.

7. How much must you deposit in a margin account if you wish to purchase one contract?
a) $267,232.5
b) $29,450
c) $29,692.50*
d) $30,000
e) $265,050

Margin = 0.10 x 250 x 1187.70 = $29,692.50

8. Suppose at expiration the futures contract price is 250 times the index value of 1170. Disregarding
transaction costs, what is your percentage return?
a) 1.87%
b) -0.68%
c) -14.90%*
d) 10.36%
e) None of the above

Purchase December contract

250 x 1187.7 = $296,925

Sell December contract

250 x 1170 = $292,500
Loss in futures = $292,500 - $296,925 = -$4425

Rate of return = -$4425/29,692.50 = -.1490 or -14.9%

9. Calculate the return on a cash investment in the S&P 500 stock index over the same time period
a) 1.87%
b) -0.68%*
c) -14.90%
d) 10.36%
e) None of the above

Return on cash investment in the index = (1170 – 1178)/1178 = -0.0068 or 0.68%

10. Today’s settlement price on a Chicago Mercantile Exchange (CME) Yen futures contract is
$0.8011/¥100. Your margin account currently has a balance of $2,000. The next three days’
settlement prices are $0.8057/¥100, $0.7996/¥100, and $0.7985/¥100. (The contractual size of one
CME Yen contract is ¥12,500,000). If you have a short position in one futures contract, the changes in
the margin account from daily marking-to-market will result in the balance of the margin account after
the third day to be:
a. $1,425
b. $2,000
c. $2,325
d. $3,425

11. Mr Stinson entered into a futures contract yesterday to buy $2,500 at R6.80 per $. Suppose that
the futures price closes today at R6.65. How much have you made/lost?
a. You have lost R375.00
b. You have made R375.00
c. You have made $375.00
d. You have lost $375.00.

Rationale: You have lost R0.15, 2,500 times for a total loss of R375 = R0.15/$ × $2,500

12. Yesterday, Mr Stinson entered into a futures contract to buy $2,500 at R6.80 per $. The bank asked
him to deposit an initial margin of R400 and gave him a maintenance level of R150. At what price will
Mr Stinson receive a margin call and be asked to post additional fund into his account?
a. $6.70 per R.
b. When the account drops to R250
c. R6.70 per $
d. R6.74 per $

Rationale: To get a margin call, you have to lose R250. That will happen when the price FALLS (since
you’re buying dollars) to R6.70 per $:
[R6.80/ $ – R6.70 per $] × $2,500 = R250.
13. Miss Fortune is expecting to receive a bonus in 5 months time and has decided to use her money
to buy Aztec shares. At present the shares are worth R57.50 but Miss Fortune is worried that the share
will increase in value and become too expensive for her to buy. She then decides to buy a forward,
that will allow her to buy the shares in 5 months time at R59.00. If after 5 months, the shares are
worth R56.00, did Miss Fortune benefit from the forward?
a. Yes Miss Fortune will benefit from the forward agreement as she will have to pay R59.00 for
each share whereas in the market they are only worth R56.00
b. No Miss Fortune will not benefit as the she will have to sell the shares at R56.00 whereas in
the market she could have sold them for R59.00
c. Yes Miss Fortune will benefit as the she can sell the shares at R59.00 whereas in the market
she would have had to ssold them for R59.00
d. No Miss Fortune will not benefit as the she will have to pay R59.00 for each share whereas in
the market she could have bought them for R56.00.

14. If the initial margin is $5,000, the maintenance margin is $3,500 and your balance is $4,000, how
much must you deposit?
a. $6,000
b. $1,500
c. $9,000
d. nothing

15. December futures on the S&P 500 stock index trade at 250 times the index value of 1187.70.
Your broker requires an initial margin of 10% percent on futures contracts. The current value of the
S&P 500 stock index is 1178. How much must you deposit in a margin account if you wish to
purchase one contract?
a. $267,232.5
b. $267,232.5
c. $29,692.50
d. $267,232.5

Margin = 0.10 x 250 x 1187.70 = $29,692.50

Use the following information to answer the next three questions

You, a farmer, anticipate taking 80,000 bushels of soybeans to the market in three months. The current
cash price for soybeans is $5.85. The size of the futures contract is 5,000 bushels per contract and the
current three-month futures price is $5.88.

16. If you wanted to hedge one-half of your exposure to a drop in the value of soybeans, how many
futures contracts would you buy or sell?
a. Sell eight futures contracts.
b. Sell sixteen futures contracts.
c. Buy sixteen futures contracts.
d. Sell four futures contracts.
17. Assume that in three months, when you take the soybeans to market, you close out the futures
contracts and the price has fallen to $5.80. What is the total loss in value over the three months on
the actual soybeans you produced and took to market?
a. $2,400
b. $3,200
c. $4,000
d. $6,400

Loss = ($5.85 - $5.80) x 80,000 = $4000

18. Assume that in three months, when you take the soybeans to market, you close out the futures
contracts and the price has fallen to $5.80. How much did this hedge in the futures market generate
in gains?
a. $2,400
b. $3,200
c. $4,000
d. $6,400

Gain = ($5.85 - $5.80) x (8 x 5,000) = $3,200

19. You have heard that there may be arbitrage opportunities in the futures market. You conduct some
research and find that the price on a 1 year oil future contract is $130 per barrel. Currently the spot
price of oil is at $112 per barrel, and the 1 year US interest rate is at 4.50%. Ignoring the costs, is there
an arbitrage opportunity?
a. No there is not an arbitrage opportunity because the forward price of oil is less than the
futures price
b. Yes there is an arbitrage opportunity because the forward price of oil is more than the futures
price
c. No there is not an arbitrage opportunity because the forward price of oil is more than the
futures price.
d. Yes there is an arbitrage opportunity because the forward price of oil is less than the futures
price

F = S(1 +r)T
F = 112(1+0.045) = 117.05
Therefore yes there is an arbitrage opportunity

20. Based on question 34 above, what would be the profit or loss gained from this arbitrage
opportunity, if you take it?
a. $5.85 profit
b. $12.95 profit
c. $5.85 loss
d. $12.95 loss