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FIN 5207, Advanced Derivative Securities Fall 2011 HW1, Forwards and Swaps Post Date: 9/17/11 Due

Date: 9/26/11 at 9AM EST

Professor Feng

Please send your homework to our course GA Dan Martin at damartin@clarku.edu .

Formalities
Every spreadsheet or word or pdf must have the first tab showing the students submitting and their e-mail addresses:

The name of the submission should be of the form: Medvedev_kapoor_koopman_assignment1.xls

1. Assume the appropriate discount rates for 3, 6, 9 and 12 months are the same as the LIBOR rates given. A hypothetical stock, XYZ, has a price of $125 on 09/10/11 and will pay dividends as shown below: Date 11/11/11 02/11/12 05/11/12 08/11/12 Dividend Amount $1.50 $2.00 $2.00 $2.00

LIBOR Interest Rates1 3mo 0.35 % 6mo 0.50 % 9mo 0.69 % 12mo 0.82 % a) Determine the price to enter a long one-year forward position in XYZ. b) Calculate the one-year forward price for delivery of XYZ, as of 9/10/11 c) Assume the traded forward price is different from the value you calculated in part b. For concreteness, lets assume the forward price is lower by $2. How would you construct an arbitrage trade around this discrepancy? Be precise about long or short position in the stock, money borrowed and/or deposited at risk-free rate, and the timing of all cash flows. You can ignore transaction costs, stock borrowing/lending fee and all other market frictions. d) Plot the payoff pattern of a long position in a one-year forward contract at maturity. e) How would the 1-year forward price of XYZ on 9/11/12 have changed if the 3 month, 6 month, 9 month and 12 month LIBOR rates all suddenly increased by 1% (increased by 100 bps) while the stock price remained unchanged at $125? f) Another hypothetical stock, PQR, had a price of $100 on 9/11/12 and pays no dividends. What is the price to enter into a 1-year asset swap that receives the total return on XYZ and pays the total return on PQR? 2. Go to the website http://finance.yahoo.com, enter Ebay symbol (EBAY) to get the close price on Friday, 9/16/11. Assume Ebay will never pay dividends. Use this spot stock price information to calculate the forward price on 09/16/11 of a one-year forward contract for Ebay, assuming the interest rates in Question 1. 3. Suppose that a stock currently selling at S0 is just about to go ex-dividend. The immediate dividend will be D0 dollars. Show that the parity value for the futures price on the stock can be written F0 = S0 (1 + r) (1 d), where d = D0/S0 and r is the risk-free interest rate for a period corresponding to the term of the futures contract. Construct an arbitrage table
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LIBOR is based on actual/360 day-count convention and simple compounding

demonstrating the riskless strategy assuming that the dividend is reinvested in the stock. Is your result consistent with the claim in class that the parity value is F0 = S0 (1 + r) FV(D)? [Hint: how many shares will you hold after reinvesting the dividend? How will this affect your hedging strategy? Also, notice that Ive defined d here slightly differently than I did in class. Here it is D0/S0; in class it was D1/S0.] 4. Prove using a no-arbitrage argument that the parity relationship for time spreads is F0(T2) = F0(T1) (1 + r) FV(D) where F0(T) is today's futures price for delivery at time T, T2 > T1, and FV(D) is the future value to which any dividends paid between T1 and T2 will grow if invested risklessly until time T2. r is the risk-free interest rate for the period from T1 to T2. [Hint: You need to maintain a continually-hedged position. Start with offsetting long and short positions in the two futures contracts. When the shorter-maturity futures expires, maintain your hedged position by replacing the contract with a position in the stock.]