Chapter 5: Q6B (page 589)
Why might individuals purchase futures contracts rather than the underlying asset?
Answer
Lower transaction cost, ease to alter holding and ability to buy on margin
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Rich McDonald, CFA, is evaluating his investment alternatives in Ytel Incorporated by analyzing a Ytel convertible bond and Ytel common equity. Characteristics of the two securities are given in the following exhibit:
a. Calculate, based on the exhibit, the
i. Current market conversion price for the Ytel convertible bond.
ii. Expected one-year rate of return for the Ytel convertible bond.
iii. Expected one-year rate of return for the Ytel common equity.
One year has passed and Ytel’s common equity price has increased to $51 per share. Also, over the year, the yield to maturity on Ytel’s nonconvertible bonds of the same maturity increased, while credit spreads remained unchanged.
b. Name the two components of the convertible bond’s value. Indicate whether the value of each component should decrease, stay the same, or increase in response to the:
i. Increase in Ytel’s common equity price.
ii. Increase in bond yield.
All else being equal, is a call option on a stock with a lot of firm-specific risk worth more than one on a stock with little firm-specific risk? The betas of the stocks are equal.
Maria VanHusen, CFA, suggests that forward contracts on fixed-income securities can beused to protect the value of the Star Hospital Pension Plan’s bond portfolio against thepossibility of rising interest rates. VanHusen prepares the following example to illustratehow such protection would work:
a. Should the investor buy or sell the forward contract to protect the value of the bondagainst rising interest rates during the holding period?
b. Calculate the value of the forward contract for the investor at the maturity of theforward contract if VanHusen’s bond price forecast turns out to be accurate.
c. Calculate the change in value of the combined portfolio (the underlying bond and theappropriate forward contract position) six months after contract initiation.
Show that Black-Scholes call option hedge ratios increase as the stock price increases. Consider a one-year option with exercise price \(50 on a stock with annual standard deviation 20%. The T-bill rate is 3% per year. Find N (d1) for stock prices \)45, \(50, and \)55.
You purchase a Treasury-bond futures contract with an initial margin requirement of 15% and a futures price of \(115,098. The contract is traded on a \)100,000 underlying par value bond. If the futures price falls to $108,000, what will be the percentage loss on your position?
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