Research School of Finance, Actuarial Studies and Statistics
Test 1
Semester 1, 2020
FINM2002 DERIVATIVES / FINM7041 APPLIED DERIVATIVES
Writing Time:
90 minutes
Exam Conditions:
Wattle-based
Permitted Materials:
Any
Instructions to Students:
1. It is not permitted to disclose, disseminate, reproduce, or publish any portion of this final exam in any
manner.
2. This exam consists of a total of THREE questions with subparts. Questions are of unequal value, with marks
indicated for each question. Please answer all questions.
3. All answers must be typed and provided within the Wattle exam interface. Only answers submitted and
typed within the answer space will be read and graded.
4. Incorrect choices for multiple-choice questions will be penalized.
5. Please show all working for marks. A number without intermediate steps and explanations will be awarded
a mark of zero.
6. Emailed answers will not be accepted.
7. Unless stated otherwise in a question, please keep all decimal places for interim numerical answers, final
answers should be rounded up to 4 decimal places. Failure to do so will result in penalties.
8. Please remember to save your answers often by clicking either “next page” or “previous page” as per the
discussion on how to prepare for Test 1 in Lecture 4, including how to work with Wattle quiz interface.
Total Marks = 52 (for 2002), 55 (for 7041)
This test is redeemable and counts towards 20% of your final grade for the course.
QUESTION 1. This question has 4 subparts, please answer all subparts.
I. A forward/futures contract is an agreement to buy or sell an asset at a certain time in the future for
_________. Select all that apply. (2 mark)
a. The spot price today for the asset.
b. The spot price for the asset when the contract expires.
c. The spot price when the contract expires discounted at today’s risk-free rate.
d. A certain price agreed by the buyer and seller.
e. A price to be agreed by the buyer and seller when they meet up at the time the contract expires.
Comment:
Lecture 1
II. What is a repo and what is the repo rate Select all that apply. (2 marks)
a. A repo is short for a repurchase agreement.
b. A repo involves an entity providing a loan to the investment dealer / financial institution and uses
securities as collateral.
c. The repo rate is calculated using the difference between the price at which the securities are sold and
the price at which they are repurchased.
d. The repo rate is the rate an investment dealer / financial institution agrees to receive when they sell
securities to other companies to make a profit.
e. A repo involves selling and buying back securities at different prices.
Comment:
Lecture 3
III. Which of the following is(are) wrong Select all that apply. (2 marks)
a. A short position in options means I have a put option.
b. An in-the-money option is more expensive than an out-the money option for the same underlying with
the same expiry.
c. An American option can be exercised at any time before the expiry, but a European option should only
be exercised at the expiry.
d. A callable convertible bond gives the seller/issuer the right but not obligation to call for an earlier
conversion.
Comment:
Lecture 4
IV. Which of the following statements is(are) correct in this course Select all that apply. (2 marks)
a. Every post on the course forum is important and each should be read carefully even if you might not
have a question.
b. Listening to class and tutorial recordings are the best ways to study and understand course material.
c. It is important to follow instructions for every question and the overall test to ensure our answers are
providing what a question asks for.
d. If we become comfortable with all material available on Wattle and have studied the material as they
come out every week, it will be difficult to fail this course.
e. Every student should be completing all assessments on their own and by themselves, proudly upholding
ANU’s Academic Integrity policies.
Comment:
All of these are correct and have been discussed since Lecture 1.
QUESTION 2. This question has 3 subparts, please answer all subparts.
I. Suppose you want to borrow $250,000 in 2 years for a period of 36 months. The term structure is as
follows (all rates are p.a., continuously compounded):
1 year 2 year 3 year 4 year 5 year
1% 1.50% 3% 5% 9%
Calculate the forward rate for the required loan. (3 marks)
Comment:
Lecture 3
F_{2,5} (start at year 2 for a period of 36/12=3 years) (1.5 marks)
= (RxTx-RyTy)/(Tx-Ty) = (RyTy-RxTx)/(Ty-Tx) = (5*0.09 – 2*0.015) / (5 – 2) = 0.14 = 14%. (1.5 marks)
II. It is March 2021, assume you can borrow at the risk-free rate at 0.1% p.a. continuously compounded, and
the S&P/ASX 200 is trading at 6800 points, the dividend yield is 4% p.a. continuously compounded. Suppose
the December ASX SPI 200 contract is trading at 6650 points. Is there an opportunity to make a riskless
profit Clearly explain your reasoning. And explain how this opportunity might be set up in general and how
does this potentially impact on prices. (5 marks)
Comment:
Lecture 2
The theoretical no-arbitrage price for ASX SPI 200 should be:
Se^(r-d)T = 6800*e^[(0.001-0.04)(9/12)] = 6603.9808 (1 mark)
Futures market price of 6650 > 6603.9808 => the futures is relatively overpriced in the market.
Arbitrage strategy:
Buy stocks underlying the index (1 mark) and short the ASX SPI 200 (1 mark).
Since the short position doesn’t generate immediate payoff, finance purchase of the stocks by borrowing at
the risk-free rate.
Price impact: As arbitrageurs buy the stocks and short the futures:
upward pressure on the stocks’ prices (1 mark) + downward pressure on the futures price (1 mark), until the
futures price returns to its no-arbitrage level.
III. Airlines usually use WTI crude oil futures contracts to hedge against jet fuel price fluctuation. In January
2020, FINMair entered into May WTI futures at $58 per barrel, while jet fuel was trading at $75 per barrel.
Three months later, May WTI futures collapsed to below zero one day prior to the last trading day, and jet
fuel was trading around $15 per barrel. FINMair managed to close out all of its futures positions with an
average price of -$25 per barrel one day prior to the last trading day.
(Both 2002 & 7041 (a)) Explain FINMair’s hedging strategy. Discuss whether the strategy was effective; make
sure to include all relevant discussions and calculations. (6 marks)
Comment:
Lecture 2 + Workshop 2
FINMair employed a long hedge, used to hedge jet fuel purchase in the future so it is concerned about
increasing prices (1 mark). The is also a cross hedge, since FINMair wished to hedge jet fuel price, but used
futures contract on WTI crude oil (1 mark).
Imperfect hedge => basis risk is an issue. Basis at T: $15 – (-$25) = $40 (1 mark).
FINMair’s effective purchase price:
1) Loss/gain on hedge: close out long futures with short futures @ average of -$25/bbl.
=> F2-F1 = -25-58 = -83/bbl, loss on hedge is 83/bbl. (1 mark)
2) Buy jet fuel at spot market is $15/bbl, gain 43/bbl (1 mark)
Loss greater than gain by 40 (the basis) => Effective purchase price: S2-(F2-F1) = 15+83 = $98/bbl
(or, F1+b2=F1+(S2-F2)=58+(15-(-25))=$98/bbl
Positive basis at T => FINMair’s effective cost of purchase is greater than it anticipated. FINMair’s hedge was
not effective due to an unexpected plummet in energy prices and a large basis at T resulting from the
imperfect hedge. (1 mark)
7041 (b) Could you think of a derivative that could have provided a better hedge for the scenario described
in (a), why, and what could be a drawback with this alternative (3 marks)
Comment:
This relies on understanding the differences between futures/forwards and options (L1-L4).
