John C. Hull, University of Toronto. If You're an Educator Download instructor resources Additional order info. Overview Order Downloadable Resources Overview. Download Resources. Previous editions. Fundamentals of Futures and Options Markets, 8th Edition. Relevant Courses. Options Finance. Sign In We're sorry!
Username Password Forgot your username or password? Sign Up Already have an access code? Figure S1. Draw a diagram showing how the profit on a short position in the option depends on the stock price at the maturity of the option.
Under what circumstances does the investor make a gain? The Chicago Board of Trade offers a futures contract on long-term Treasury bonds. Characterize the investors likely to use this contract. Most investors will use the contract because they want to do one of the following: a Hedge an exposure to long-term interest rates.
There is just as much chance that the price of oil in the future will be less than the futures price as there is that it will be greater than this price. It may well be true that there is just as much chance that the price of oil in the future will be above the futures price as that it will be below the futures price. This means that the use of a futures contract for speculation would be like betting on whether a coin comes up heads or tails. But it might make sense for the airline to use futures for hedging rather than speculation.
The futures contract then has the effect of reducing risks. It can be argued that an airline should not expose its shareholders to risks associated with the future price of oil when there are contracts available to hedge the risks.
The statement means that the gain loss to the party with the short position is equal to the loss gain to the party with the long position. In total, the gain to all parties is zero. A trader enters into a short forward contract on million yen. A trader enters into a short cotton futures contract when the futures price is 50 cents per pound.
The contract is for the delivery of 50, pounds. How much does the trader gain or lose if the cotton price at the end of the contract is a A company knows that it is due to receive a certain amount of a foreign currency in four months. What type of option contract is appropriate for hedging? A long position in a four-month put option can provide insurance against the exchange rate falling below the strike price.
It ensures that the foreign currency can be sold for at least the strike price. A United States company expects to have to pay 1 million Canadian dollars in six months. Explain how the exchange rate risk can be hedged using a a forward contract; b an option. The company could enter into a long forward contract to buy 1 million Canadian dollars in six months. This would have the effect of locking in an exchange rate equal to the current forward exchange rate. Alternatively the company could buy a call option giving it the right but not the obligation to purchase 1 million Canadian dollar at a certain exchange rate in six months.
This would provide insurance against a strong Canadian dollar in six months while still allowing the company to benefit from a weak Canadian dollar at that time. Further Questions Problem 1. What is the difference between the positions of the traders?
Show the profit per ounce as a function of the price of gold in one year for the two traders. Explain what the investor has agreed to. Under what circumstances will the trade prove to be profitable? What are the risks?
The risk to the investor is that the stock price plunges to a low level. The current exchange rate is 1. Discuss how forward and options contracts can be used by the company to hedge its exposure. The company could enter into a forward contract obligating it to buy 3 million euros in three months for a fixed price the forward price. The forward price will be close to but not exactly the same as the current spot price of 1.
An alternative would be to buy a call option giving the company the right but not the obligation to buy 3 million euros for a a particular exchange rate the strike price in three months. The use of a forward contract locks in, at no cost, the exchange rate that will apply in three months.
The use of a call option provides, at a cost, insurance against the exchange rate being higher than the strike price. The options have the same maturity date. Describe the investor's position. This is known as a bull spread and will be discussed in Chapter The profit is shown in Figure S1. What should the arbitrageur do? Assume that the cost of storing gold is zero and that gold provides no income. The arbitrageur should borrow money to buy a certain number of ounces of gold today and short forward contracts on the same number of ounces of gold for delivery in one year.
Discuss how foreign currency options can be used for hedging in the situation described in Example 1. This will ensure that the price received for the sterling will be above 1. An investor who feels that the price of the stock will increase is trying to decide between buying shares and buying 2, call options 20 contracts. What advice would you give? How high does the stock price have to rise for the option strategy to be more profitable?
The investment in call options entails higher risks but can lead to higher returns. On July 17, , an investor owns Google shares. As indicated in Table 1. The investor is comparing two alternatives to limit downside risk. Discuss the advantages and disadvantages of the two strategies. The second alternative involves what is known as a stop or stop-loss order.
There are some circumstances where the put option alternative leads to a better outcome and some circumstances where the stop-loss order leads to a better outcome.
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