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ECN603 Asset Pricing/Workshop 1

1) What are the main differences between Exchange traded markets and Over the Counter (OTC) markets for derivatives?

2) What is the main difference between hedging using options contracts and forward contracts?

3) You decide to enter into a short forward contract on 100 million yen. The forward exchange rate is $0.0080 per yen. How much does the trader gain or lose if the exchange rate at the end of the contract is (a) $0.0074 per yen, or (b) $0.0091 per yen?

4) A Norwegian company knows it will have to pay 3 million euros in three months. The current exchange rate is 0.11 NOK per euro. Discuss how forward and options contracts can be used by the company to hedge its exposure.

5) The price of gold is currently $1,000 per ounce. The forward price for delivery in   one year is $1,200. An arbitrageur can borrow money at 10% per annum. What should the arbitrageur do? Assume that the cost of storing gold is zero and that gold provides no income.

6) Define hedgers, speculators, and arbitrageurs in the derivatives market.

7) Explain how margins work in futures contracts. Why are margins important?

8) You are working as the CFO of an orange company and you want to hedge your  current orange position. You expect to sell 10 tons of oranges on June 15. There are currently two orange futures contracts you can choose between. The first expires on May 15. The second expires on July 15. Your CEO advised you to use the May contract. i) Advise your CEO on why this is a bad choice. ii) If your CEO is persistent

on using the May contract, how can you fix the situation?