A company runs a number of slaughterhouses which supply hamburger meat to McDonalds. The company is afraid that live cattle prices will increase over the next year, even though there is widespread belief in the market that they will be stable. What can the company do to hedge against the risk of increasing live cattle prices? Which statement(s) are correct?

(i) buy call options on live cattle.

(ii) buy put options on live cattle.

(iii) sell call options on live cattle.

Select the most correct response:

You're considering making an investment in a particular company. They have preference shares, ordinary shares, senior debt and junior debt.

Which is the safest investment? Which will give the highest returns?

A firm wishes to raise $10 million now. They will issue 6% pa semi-annual coupon bonds that will mature in 8 years and have a face value of $1,000 each. Bond yields are 10% pa, given as an APR compounding every 6 months, and the yield curve is flat.

How many bonds should the firm issue?

**Question 235** SML, NPV, CAPM, risk

The security market line (SML) shows the relationship between beta and expected return.

Investment projects that plot * on* the SML would have:

You're trying to save enough money for a deposit to buy a house. You want to buy a house worth $400,000 and the bank requires a 20% deposit ($80,000) before it will give you a loan for the other $320,000 that you need.

You currently have no savings, but you just started working and can save $2,000 per month, with the first payment in one month from now. Bank interest rates on savings accounts are 4.8% pa with interest paid monthly and interest rates are not expected to change.

How long will it take to save the $80,000 deposit? Round your answer up to the nearest month.

**Question 383** Merton model of corporate debt, real option, option

In the Merton model of corporate debt, buying a levered company's debt is equivalent to buying the company's assets and:

The market's expected total return is **10**% pa and the risk free rate is **5**% pa, both given as effective annual rates.

A stock has a beta of **0.5**.

In the last 5 minutes, the federal government unexpectedly raised taxes. Over this time the share market fell by **3**%. The risk free rate was unchanged.

What do you think was the stock's historical return over the last 5 minutes, given as an effective 5 minute rate?

**Question 825** future, hedging, tailing the hedge, speculation, no explanation

An equity index fund manager controls a USD**500** million diversified equity portfolio with a beta of **0.9**. The equity manager expects a significant rally in equity prices next year. The market does not think that this will happen. If the fund manager wishes to increase his portfolio beta to **1.5**, how many S&P500 futures should he buy?

The US market equity index is the S&P500. One year CME futures on the S&P500 currently trade at **2,155** points and the spot price is **2,180** points. Each point is worth $**250**.

The number of one year S&P500 futures contracts that the fund manager should buy is:

**Question 890** foreign exchange rate, monetary policy, no explanation

The market expects the Reserve Bank of Australia (RBA) to **increase** the policy rate by **25** basis points at their next meeting. The current exchange rate is **0.8** USD per AUD.

Then unexpectedly, the RBA announce that they will increase the policy rate by **50** basis points due to increased fears of inflation.

What do you expect to happen to Australia's exchange rate on the day when the surprise announcement is made? The Australian dollar is likely to suddenly:

**Question 956** option, Black-Scholes-Merton option pricing, delta hedging, hedging

A bank sells a European call option on a non-dividend paying stock and delta hedges on a daily basis. Below is the result of their hedging, with columns representing consecutive days. Assume that there are 365 days per year and interest is paid daily in arrears.

Delta Hedging a Short Call using Stocks and Debt |
|||||||

Description |
Symbol |
Days to maturity (T in days) |
|||||

60 |
59 |
58 |
57 |
56 |
55 |
||

Spot price ($) | S | 10000 | 10125 | 9800 | 9675 | 10000 | 10000 |

Strike price ($) | K | 10000 | 10000 | 10000 | 10000 | 10000 | 10000 |

Risk free cont. comp. rate (pa) | r | 0.05 | 0.05 | 0.05 | 0.05 | 0.05 | 0.05 |

Standard deviation of the stock's cont. comp. returns (pa) | σ | 0.4 | 0.4 | 0.4 | 0.4 | 0.4 | 0.4 |

Option maturity (years) | T | 0.164384 | 0.161644 | 0.158904 | 0.156164 | 0.153425 | 0.150685 |

Delta | N[d1] = dc/dS | 0.552416 | 0.582351 | 0.501138 | 0.467885 | 0.550649 | 0.550197 |

Probability that S > K at maturity in risk neutral world | N[d2] | 0.487871 | 0.51878 | 0.437781 | 0.405685 | 0.488282 | 0.488387 |

Call option price ($) | c | 685.391158 | 750.26411 | 567.990995 | 501.487157 | 660.982878 | ? |

Stock investment value ($) | N[d1]*S | 5524.164129 | 5896.301781 | 4911.152036 | 4526.788065 | 5506.488143 | ? |

Borrowing which partly funds stock investment ($) | N[d2]*K/e^(r*T) | 4838.772971 | 5146.037671 | 4343.161041 | 4025.300909 | 4845.505265 | ? |

Interest expense from borrowing paid in arrears ($) | r*N[d2]*K/e^(r*T) | 0.662891 | 0.704985 | 0.594994 | 0.551449 | ? | |

Gain on stock ($) | N[d1]*(SNew - SOld) | 69.052052 | -189.264008 | -62.642245 | 152.062648 | ? | |

Gain on short call option ($) | -1*(cNew - cOld) | -64.872952 | 182.273114 | 66.503839 | -159.495721 | ? | |

Net gain ($) | Gains - InterestExpense | 3.516209 | -7.695878 | 3.266599 | -7.984522 | ? | |

Gamma | Γ = d^2c/dS^2 | 0.000244 | 0.00024 | 0.000255 | 0.00026 | 0.000253 | 0.000255 |

Theta | θ = dc/dT | 2196.873429 | 2227.881353 | 2182.174706 | 2151.539751 | 2266.589184 | 2285.1895 |

In the last column when there are 55 days left to maturity there are missing values. Which of the following statements about those missing values is **NOT** correct?