MAF713 Futures, Options and Other Derivatives Assignment


MAF713 Futures, Options and Other Derivatives
Trimester 2, 2019
Group Assignment
DUE DATE AND TIME: Week 9, 13/09/2019, 11:59 PM
Learning Outcome Details
Unit Learning Outcome (ULO) Graduate Learning Outcome (GLO)
ULO1: Critically analyse key factors affecting option and futures prices.
Comprehend the link between various derivative instruments.
GLO1: Discipline-specific knowledge and
GLO4: Critical thinking
ULO2: Apply appropriate pricing models to a range of derivative
GLO1: Discipline-specific knowledge and
GLO5: Problem solving
ULO3: Understand the key aspects of hedging with derivatives. Identify,
construct and analyse optimal hedging strategies.
GLO1: Discipline-specific knowledge and
GLO4: Critical thinking
GLO5: Problem solving
ULO4: Work constructively in a team to solve complex problems related
to derivative securities.
GLO1: Discipline-specific knowledge and
GLO4: Critical thinking
GLO5: Problem solving
Assessment Feedback:
Students who submit their work by the due date will receive their marks and feedback on
CloudDeakin on or before 04/10/2019, 11:59 PM.
Description / Requirements
• This assignment is marked out of 60 and will be converted to 30% of your final assessment.
• The assignment must be completed in groups of 3 to 4 students.
• There is no word limit. But please be precise in answering the questions.
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• The assignment can be either typed or handwritten, or both. Scan your handwritten work as a
PDF copy for electronic submission purposes.
Submission Instructions
An electronic pdf copy of the assignment has to be uploaded to CloudDeakin by the due date.
You must keep a backup copy of every assignment you submit, until the marked assignment has
been returned to you. In the unlikely event that one of your assignments is misplaced, you will need
to submit your backup copy.
Any work you submit may be checked by electronic or other means for the purposes of detecting
collusion and/or plagiarism.
When you are required to submit an assignment through your CloudDeakin unit site, you will receive
an email to your Deakin email address confirming that it has been submitted. You should check that
you can see your assignment in the Submissions view of the Assignment dropbox folder after
upload, and check for, and keep, the email receipt for the submission.
• Penalties for late submission: The following marking penalties will apply if you submit an
assessment task after the due date without an approved extension: 5% will be deducted from
available marks for each day up to five days, and work that is submitted more than five days
after the due date will not be marked. You will receive 0% for the task. ‘Day’ means working
day for paper submissions and calendar day for electronic submissions. The Unit Chair may
refuse to accept a late submission where it is unreasonable or impracticable to assess the task
after the due date.
• For more information about academic misconduct, special consideration, extensions, and
assessment feedback, please refer to the document Your rights and responsibilities as a
student in this Unit in the first folder next to the Unit Guide of the Resources area in the
CloudDeakin unit site.
• Building evidence of your experiences, skills and knowledge (Portfolio) – Building a portfolio
that evidences your skills, knowledge and experience will provide you with a valuable tool to
help you prepare for interviews and to showcase to potential employers. There are a number
of tools that you can use to build a portfolio. You are provided with cloud space through
OneDrive, or through the Portfolio tool in the Cloud Unit Site, but you can use any storage
repository system that you like. Remember that a Portfolio is YOUR tool. You should be able
to store your assessment work, reflections, achievements and artefacts in YOUR Portfolio.
Once you have completed this assessment piece, add it to your personal Portfolio to use and
showcase your learning later, when applying for jobs, or further studies. Curate your work by
adding meaningful tags to your artefacts that describe what the artefact represents.
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Question 1
You observe the shares on ABC trading at $61.00. Call and put options on ABC shares are also
trading. Each option contract is written over 1000 shares. A three month call option at a strike price
of $60.00 is trading at $3.00 while the put option is trading at $1.08. Show that there is an arbitrage
profit to be made, and give explicit details of how the mispricing will be arbitraged and what the
profit (in dollars) of your arbitrage strategy will be. You must show the exact strategy and present
the cashflows from the strategy in a table. Assume that the risk-free rate is 4.5% p.a. (continuously
(8 marks)
Question 2
A trader decides to protect her portfolio with a put option. The portfolio is worth $150 million and
the required put option has a strike price of $145 million with a maturity of 24 weeks. The volatility
of the portfolio is 15% and the dividend yield on the portfolio is 3% per annum. The risk-free rate is
4%. Because the option is not available on exchanges, the trader decides to create an option by
maintaining a position in the underlying portfolio with the required delta. What percentage of the
original portfolio should be sold and invested at the risk-free rate:
a. Initially at time zero?
b. After one week, when value is $145 million?
c. After two weeks when value is $148 million?
(3+4+4=11 marks)
Question 3
A financial institution has the following trading strategy using options:
Type Position Strike price Option premium
Put 1 $55 $3
Put -2 $60 $5
Put 1 $65 $8
a. Construct a table showing the payoff and profit from the strategy.
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b. For what range of stock prices would the strategy lead to a loss?
(9+2=11 marks)
Question 4
Consider a 2 year American put option on a non-dividend paying stock. The current stock price is
$200, the strike price is $210, the risk free rate of interest is 3% per annum and the stock price is
expected to either increase by 6% per annum or decrease by 4% per annum with equal probability.
a. Use a two period binomial model to calculate the current value of the option?
b. Should the option be exercised early? If so, provide full details.
(6+2=8 marks)
Question 5
Assume the spot AUD/JPY (Australian Dollar/Japanese Yen) exchange rate is 85
i.e. 1 AUD = 85 JPY, the risk free interest rate in Australia is 4% per annum, the risk free interest
rate in Japan is 1% per annum and the AUD/JPY exchange rate volatility is 25% per annum.
a. Calculate the JPY value of a one-year European call option on one AUD with a strike of 88 JPY.
b. Use your answer in part a to calculate the AUD value of a one-year European put option on 88
JPY with a strike of 1 AUD.
(3+3=6 marks)
Question 6
Suppose that the date is 1st October 2007 and Josephine Rice, who is a London based pension fund
manager, is managing a fund worth £100 million with a beta of 0.90. She is concerned about the
performance of the market in the coming months as she must liquidate the fund to cover withdrawals
on Friday February 29th 2008. She plans to hedge the value of the portfolio using the March 2008
contract on the FTSE 100 futures. She observes the March 08 FTSE futures contract trading at
6660.45 (on 1st October 2007). You will find the specifications for the FTSE futures trading on
LIFFE (now ICE Futures Europe) at:
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The contract expires on 20 March 2008. On Friday 29th February when she closes her contract out
the FTSE futures contract is trading at 6000.00 and the value of her portfolio has dropped to
£85million. The performance of the FTSE100 index over the period 1st February 2007 to 1st May
2008 is depicted in the graph below:
a. What position should Josephine take to hedge the exposure to the market over the period until
liquidation of the portfolio on 29th February 2008? You must state exactly the number of
contracts she enters, whether she is long or short. When is the position closed out?
b. Now calculate her net profit/loss (in pounds). State exactly what she gains/loses in each of the
equity market and the futures market.
c. State exactly the reasons why the hedge may not be perfect.
d. Calculate the effect of Josephine’s strategy on the fund’s returns (in percentage terms) and
explain your result. Hint: compare the fund’s returns with and without the hedge
(4+4+4+4=16 marks)

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