Question 1

(a) Sand is an important raw material used in the construction of buildings, roads, and the manufacture of glass. Despite its importance in the economy, there are no futures contracts for sand. Appraise the issue and briefly offer two (2) possible explanations.

(12 marks)

(b) Mr. Rossi is the CFO of Starlight Corporation which manufactures light fittings. Its

main market is the US. Mr. Rossi wanted to hedge his US dollar receipts.

(i) Discuss two (2) reasons why Mr. Rossi chose to use forward contracts instead of futures contracts.

(12 marks)

(ii) Discuss one (1) reason why Mr. Rossi did not consider using swaps instead of

futures contracts.

(6 marks)

(c) (i) Discuss what the term “open interest” means.

(3 marks)

(ii) Appraise the use of open interest by traders in the futures markets.

(6 marks)

(iii) Explain how the open interest for a futures contract can remain the same even

though there are transactions for the contract.

(6 marks)

FIN358 Tutor-Marked Assignment

SINGAPORE UNIVERSITY OF SOCIAL SCIENCES (SUSS) Page 3 of 4

(d) (i) John Tan is a commodity trader. He observed the following prices in the

commodity market. Appraise whether there is an arbitrage opportunity, how he

can execute it, and the profit that can be made.

Spot price of commodity = $50

Futures price of commodity = $52

1-year risk-free interest rate = 4%

1-year storage cost = 1%

(9 marks)

(ii) Discuss two (2) obstacles in the market that prevents Mr. Tan from realizing the

profit.

(6 marks)

Question 2

(a) Discuss whether the following options will be exercised early.

(i) Dividend-paying call

(ii) Non-dividend paying put

(10 marks)

(b) You are an options trader for a hedge fund. Your assistant prepared the following sheet

containing the prices of various options on January 31. Assume the options expire at

the end of the expiration month. The risk-free interest rate is 8% per annum.

Expiration Months

Stock Stock Std. Exercise March June September

Price Dev. Price

DDE call 50 20% 50 4.00 4.50 5.00

DDE put 50 20% 50 3.50 4.50 —

DDE call 50 20% 55 2.00 3.80 5.20

HJK call 50 30% 50 4.00 4.70 4.40

Appraise the options and identify three (3) pricing discrepancies. You may use the

Excel program to help you uncover the pricing discrepancies. Show how you would

profit from them.

Use the following format to answer this question.

• Pricing Discrepancy:
• Strategy to profit from pricing discrepancy:

(24 marks)

FIN358 Tutor-Marked Assignment

SINGAPORE UNIVERSITY OF SOCIAL SCIENCES (SUSS) Page 4 of 4

(c) List two (2) limitations of using the Black-Scholes model for valuing options.

(6 marks)