payments or withdrawals to Jacks

account?
Q1. We have a futures contract for the e) What will be final net profit/loss
purchase of 10,000 bushels of wheat at
position of Jacks account?
$3.00 per bushel. If the price of wheat f)
On what days, Jack will receive
were to increase to $3.50, explain what
margin call and of which amount. Show
happens to the parties involved in the
calculation.
contract in terms of marking to market. Be
FOFM - Tutorial 12
sure to identify who is long and short and
Q1. We have a futures contract for the
specifically how much is transferred.
purchase of 10,000 bushels of wheat at
Q2. Consider a call option; in terms of the
$3.00 per bushel. If the price of wheat
option writer and option holder, who is the
were to increase to $3.50, explain what
buyer? Who is the seller? Finally, who has
happens to the parties involved in the
the option? Explain.
contract in terms of marking to market. Be
Q3. With a put option, what specifically
sure to identify who is long and short and
does the option holder receive for the
specifically how much is transferred.
price paid for the option?
Q2. Consider a call option; in terms of the
Q4. Imagine a baker who has the
option writer and option holder, who is the
opportunity to bid on a contract to supply
buyer? Who is the seller? Finally, who has
a local military base with bread for an
the option? Explain.
entire year. The problem is the baker must
Q3. With a put option, what specifically
commit to a price today and hold to that
does the option holder receive for the
price for the entire year. Identify the risk
price paid for the option?
faced by the baker, and explain how the
Q4. Imagine a baker who has the
use of a futures contract could transfer the
opportunity to bid on a contract to supply
risk.
a local military base with bread for an
Q5. Explain why for speculation, the
entire year. The problem is the baker must
purchase of an option may be more
commit to a price today and hold to that
attractive than a futures contract or the
price for the entire year. Identify the risk
outright purchase of the underlying asset.
faced by the baker, and explain how the
Q6. Mr. Jack buys a Futures contract of
use of a futures contract could transfer the
Reliance shares at a price of 1000 on April
risk.
5th 2016. The Lot Size is 300 shares.
Q5. Explain why for speculation, the
Suppose the initial margin is 10% and
purchase of an option may be more
maintenance margin is 7.5%. Answer the
attractive than a futures contract or the
following:
outright purchase of the underlying asset.
a) If the price rises to 1010 on next day,
Q6. Mr. Jack buys a Futures contract of
what will be marking to market
Reliance shares at a price of 1000 on April
payments or withdrawals to Jacks
5th 2016. The Lot Size is 300 shares.
account?
Suppose the initial margin is 10% and
b) If the price declines to 985 on third
maintenance margin is 7.5%. Answer the
day, what will be marking to market
following:
payments or withdrawals to Jacks
a)
If the price rises to 1010 on next day,
account?
c) If the price again declines on fourth
what will be marking to market
day to 970, what will be marking to
payments or withdrawals to Jacks
market payments or withdrawals to
account?
b) If the price declines to 985 on third day,
Jacks account?
d) If the price rises on fifth day to 975,
what will be marking to market
and Jack squares-off his position, what
payments or withdrawals to Jacks
will be final marking to market
account?

FOFM - Tutorial 12

c) If the price again declines on fourth day e)

to 970, what will be marking to market
payments or withdrawals to Jacks f)
account?
d) If the price rises on fifth day to 975, and
Jack squares-off his position, what will
be final marking to market payments or
withdrawals to Jacks account?

What will be final net profit/loss position

of Jacks account?
On what days, Jack will receive margin
call and of which amount. Show
calculation.

Solution
Q1. The buyer of the contract, the long position, will pay $30,000 for 10,000 bushels of
wheat. The seller of the contract, the short position, delivers 10,000 bushels of wheat and
receives $30,000. If before expiration the market price of wheat increases to $3.50 the seller,
(short) will have to give the buyer, (long) $5000 so that the buyer will still only have to pay
$30,000 for the wheat. So the buyer's margin account will be marked to market (credited)
with $5,000, which comes from the seller's margin account which is marked to market
(debited) for the $5,000.
Q2. In the case of a call option, the option writer is the seller. Here the option writer is stating
the underlying asset, strike price, and expiration or delivery date. The option holder is the
buyer of the option. The option holder buys the right to have the option of actually purchasing
the underlying asset on or before the expiration date for the strike price. The option holder
has the option, because she could let the option expire and not "call away" the underlying
asset, just foregoing the price paid for the option.
Q3. The option holder (buyer) receives the right but not the obligation, to sell the underlying
asset at a specific (strike) price on or before the expiration date of the option. If the strike
price is above the spot or current market price the option holder will profit from exercising the
option. If the strike price is below the spot price of the underlying asset, the option holder will
let the option simply expire.
Q4. The baker faces the problem of not knowing what the future price of flour (wheat) will be.
He may feel quite comfortable developing a price for the bread based on the current prices of
wheat, but if the price of wheat should increase the bread making profits will fall and may turn
into significant losses. Without the ability to transfer this risk the baker would probably have
to pass on this opportunity. Fortunately the baker could purchase a wheat futures contract
that would expire in a year, giving him the right to purchase some quantity of wheat at a price
reflecting today's market price. If the market price of wheat increases he will lose on the
baking operation but the value of his futures contract will increase. If the price of wheat falls,
his futures contract loses value but his baking profits will increase.
Q5. Let's say an investor believes that interest rates are going to fall over the next few
months. There are three ways to bet on this possibility. One is to purchase a bond and if the
investor guesses correctly, the bond price will rise as the interest rate falls. This is expensive
since it requires the purchase of the bond. Another strategy is to purchase a futures contract,
meaning take the long position. If the market price of the bond increases with falling interest
rates, the investor will reap the profits. This approach requires a small investment, but this
approach is also very risky since the investment is highly leveraged since the market price
can move against the investor. A third strategy involves the use of an option. The investor
could purchase a call option on a Treasury bond. If he or she is right and interest rates fall, the
value of the call option will rise, which is the upside. On the other hand, if the investor bets
wrong and interest rates rise, the option will expire worthless and the investor just loses the
fee paid for the option. The bet is both highly leveraged and limited in its potential losses.
Q6.