1. You are a sugar dealer anticipating the purchase of 250,000 pounds of sugar in three months. You are concerned that the price of sugar will rise , so you take a long position in sugar futures. Each contract covers 112,000 pounds, and so, rounding to the nearest contract, you decide to go long in two contracts. The futures price at the time you initiate your hedge is 19.56 cents per pound. Three months later, the actual spot price of sugar turns out to be 20.65 cents per pound and the futures price is 20.85 cents per pound.
  2. Determine the effective price at which you purchased your sugar. How do you account for the difference in amounts for the spot and hedge positions?
  3. Describe the nature of the basis risk in the long hedge.
  4. Suppose that one day in early April, you observe the following prices on futures contracts maturing in June: 97.65 for Eurodollar and 98.25 for T-Bill. These prices imply three month LIBOR and T-Bill settlement yields of 2.35 percent and 1.75 percent, respectively. You think that over the next quarter the general level of interest rates will rise while the credit spread built into LIBOR will narrow. Demonstrate how you can use a TED (Treasury/Eurodollar) spread, which is a simultaneous long (short) position in a Eurodollar contract and short (long) position in the T-Bill contract, to create a position that will benefit from these views.
  1. In Mid-May, there are two outstanding call option contracts available on the stock of Hilltop, Inc.
  1. Assuming that you form a portfolio consisting of one Call #1 held long and two Calls #2 held short, complete the following table showing your intermediate steps. In calculating net profit, be sure to include the net initial cost of the options.

  1. Graph the net profit relationship in Part a, using stock price on the horizontal axis. What is (are) the breakeven stock price(s)? What is the point of maximum profit?
  2. Under what market conditions will this strategy (which is known as a ‘call ratio spread’) generally make sense? Does the holder of this position have limited or unlimited liability?
  1. Consider the following questions on the pricing of options on the stock of Hatters Yachts.
  2. A share of Hatteras Yachts sells for $65 and has a standard deviation of 20 percent. The current risk free rate is 4 percent and the stock pays two dividends: (1) $1.00 just prior to the option’s expiration date, which is 91 days from now (exactly one-quarter of a year); and (2) a $1.00 dividend 182 days from now (i.e., exactly one-half year). Calculate the Black-Scholes value for a European-style call option with an exercise price of $60.
  3. What would be the price of a 91-day European-style put option on Hatteras Yachts having the same exercise price?
  4. Calculate the change in the call option’s value that would occur if Hatteras’ management suddenly decided to suspend dividend payments and this action had no effect on the price of the company’s stock?
  5. Describe some of the ethical considerations of a financial manager selling collateralized debt obligations, such as sub-prime loans, to elderly clients.