# Economics Assignment- A bank has sold a product that offers investors the total return (excluding dividends) on the OBX index over a one year period. The return is capped at 20%. If the index goes down the original investment of the investor is returned. What option position is equivalent to the product?

Problem 1

A bank has sold a product that offers investors the total return (excluding dividends) on the OBX index over a one year period. The return is capped at 20%. If the index goes down the original investment of the investor is returned. What option position is equivalent to the product?

# Problem 2

Suppose that a European put option to sell a share for \$60 costs \$4 and is held until maturity.

1. Underwhatcircumstanceswilltheselleroftheoption(i.e.thepartywiththeshortposition)make aprofit?
2. Under what circumstances will the option beexercised?

# Problem 3

Option traders often refer to “straddles” and “butterflies.” Here is an example of each:

Straddle Buy call with exercise price of \$100 and simultaneously buy put with exercise price of \$100. Butterfly Simultaneously buy one call with exercise price of \$100, sell two calls with exercise price of

\$110, and buy one call with exercise price of \$120. 1. Draw position diagramsfor the straddle and butterfly, showing the payoffsfrom theinvestor’s net position.

# Problem 4

A call option is at expiration with an exercise price of 105 on a stock trading for 100. What is the value of the option?

# Problem5

A stock is selling for \$31. There is a call option on the stock with an exercise price of \$27. What is an appropriate minimum value of the call option today?

# Problem 6

The standard deviation of monthly changes in the spot price of live cattle is (in cents per pound) 1.2. The standard deviation of monthly changes in the futures price of live cattle for the closest contract is 1.4. The correlation between the futures price changes and the spot price changes is 0.7. It is now October 15. A beef producer is committed to purchasing 200,000 pounds of live cattle on November 15. The producer wantstousetheDecemberlive-cattlefuturescontractstohedgeitsrisk.Eachcontractisforthedeliveryof

40,000 pounds of cattle. What strategy should the beef producer follow?

# Question 7

ItisnowJune.Acompanyknowsthatitwillsell5,000barrelsofcrudeoilinSeptember.ItusestheOctober CME Group futures contract to hedge the price it will receive. Each contract is on 1,000 barrels of ‘‘light sweetcrude.’’Whatpositionshouldittake?Whatpricerisksisitstillexposedtoaftertakingtheposition?

# Question 8

A company wishes to hedge its exposure to a new fuel whose price changes have a 0.6 correlation with gasoline futures price changes. The company will lose \$1 million for each 1 cent increase in the price per gallonofthenewfueloverthenextthreemonths.Thenewfuel’spricechangehasastandarddeviationthat is 50% greater than price changes in gasoline futures prices. If gasoline futures are used to hedge the exposure what should the hedge ratio be? What is the company’s exposure measured in gallons of the new fuel?Whatpositionmeasuredingallonsshouldthecompanytakeingasolinefutures?Howmanygasoline futures contracts should be traded? Each futures contract is on 42,000gallons.