Solution Manual-
Options, Futures, And Other Derivatives
11th Edition -John Hull
,CHAPTER 1
Introduction
Practice Questions
Problem 1.1.
What Is The Difference Between A Long Forward Position And A Short Forward Position?
When A Trader Enters Into A Long Forward Contract, She Is Agreeing To Buy The
Underlying AssetFor A Certain Price At A Certain Time In The Future. When A Trader
Enters Into A Short Forward Contract, She Is Agreeing To Sell The Underlying Asset For A
Certain Price At A Certain Time In
The Future.
Problem 1.2.
Explain Carefully The Difference Between Hedging, Speculation, And Arbitrage.
A Trader Is Hedging When She Has An Exposure To The Price Of An Asset And Takes A
Position In ADerivative To Offset The Exposure. In A Speculation The Trader Has No
Exposure To Offset. She Is Betting On The Future Movements In The Price Of The Asset.
Arbitrage Involves Taking A PositionIn Two Or More Different Markets To Lock In A
Profit.
Problem 1.3.
What Is The Difference Between Entering Into A Long Forward Contract When The
Forward PriceIs $50 And Taking A Long Position In A Call Option With A Strike Price Of
$50?
In The First Case The Trader Is Obligated To Buy The Asset For $50. (The Trader Does Not
Have A Choice.) In The Second Case The Trader Has An Option To Buy The Asset For $50.
(The Trader DoesNot Have To Exercise The Option.)
Problem 1.4.
Explain Carefully The Difference Between Selling A Call Option And Buying A Put Option.
Selling A Call Option Involves Giving Someone Else The Right To Buy An Asset From You.
It GivesYou A Payoff Of
Max(ST K 0) Min(K ST 0)
Buying A Put Option Involves Buying An Option From Someone Else. It Gives A Payoff Of
Max(K ST 0)
In Both Cases The Potential Payoff Is K ST . When You Write A Call Option, The Payoff Is
Negative Or Zero. (This Is Because The Counterparty Chooses Whether To Exercise.) When
YouBuy A Put Option, The Payoff Is Zero Or Positive. (This Is Because You Choose
Whether To Exercise.)
Problem 1.5.
An Investor Enters Into A Short Forward Contract To Sell 100,000 British Pounds For
US Dollars At An Exchange Rate Of 1.5000 US Dollars Per Pound. How Much Does
The InvestorGain Or Lose If The Exchange Rate At The End Of The Contract Is (A)
1.4900 And (B) 1.5200?
, (a) The Investor Is Obligated To Sell Pounds For 1.5000 When They Are Worth
1.4900. TheGain Is (1.5000−1.4900) ×100,000 = $1,000.
(b) The Investor Is Obligated To Sell Pounds For 1.5000 When They Are Worth
1.5200. TheLoss Is (1.5200−1.5000)×100,000 = $2,000
Problem 1.6.
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 50,000 Pounds. How Much Does The
Trader Gain Or Lose If The Cotton Price At The End Of The Contract Is (A) 48.20 Cents Per
Pound; (B) 51.30 CentsPer Pound?
(a) The Trader Sells For 50 Cents Per Pound Something That Is Worth 48.20 Cents Per
Pound.
Gain ($05000 $04820)50 000 $900 .
(b) The Trader Sells For 50 Cents Per Pound Something That Is Worth 51.30 Cents Per
Pound.Loss ($05130 $05000)50 000 $650 .
Problem 1.7.
Suppose That You Write A Put Contract With A Strike Price Of $40 And An Expiration
Date In Three Months. The Current Stock Price Is $41 And The Contract Is On 100
Shares. What HaveYou Committed Yourself To? How Much Could You Gain Or Lose?
You Have Sold A Put Option. You Have Agreed To Buy 100 Shares For $40 Per Share If
The Party On The Other Side Of The Contract Chooses To Exercise The Right To Sell For
This Price. The Option Will Be Exercised Only When The Price Of Stock Is Below $40.
Suppose, For Example, That The Option Is Exercised When The Price Is $30. You Have To
Buy At $40 Shares That Are Worth $30; You Lose $10 Per Share, Or $1,000 In Total. If The
Option Is Exercised When The Price Is $20, YouLose $20 Per Share, Or $2,000 In Total. The
Worst That Can Happen Is That The Price Of The Stock Declines To Almost Zero During
The Three-Month Period. This Highly Unlikely Event Would Cost You $4,000. In Return
For The Possible Future Losses, You Receive The Price Of The Option From The Purchaser.
Problem 1.8.
What Is The Difference Between The Over-The-Counter Market And The Exchange-Traded
Market?What Are The Bid And Offer Quotes Of A Market Maker In The Over-The-Counter
Market?
The Over-The-Counter Market Is A Telephone- And Computer-Linked Network Of
Financial Institutions, Fund Managers, And Corporate Treasurers Where Two Participants
Can Enter Into Any Mutually Acceptable Contract. An Exchange-Traded Market Is A
Market Organized By An Exchange Where The Contracts That Can Be Traded Have Been
Defined By The Exchange. When AMarket Maker Quotes A Bid And An Offer, The Bid Is
The Price At Which The Market Maker Is Prepared To Buy And The Offer Is The Price At
Which The Market Maker Is Prepared To Sell.
Problem 1.9.
You Would Like To Speculate On A Rise In The Price Of A Certain Stock. The Current Stock
Price Is
$29, And A Three-Month Call With A Strike Of $30 Costs $2.90. You Have $5,800 To Invest.
, Identify Two Alternative Strategies, One Involving An Investment In The Stock And The
OtherInvolving Investment In The Option. What Are The Potential Gains And Losses
From Each?
One Strategy Would Be To Buy 200 Shares. Another Would Be To Buy 2,000 Options. If
The SharePrice Does Well The Second Strategy Will Give Rise To Greater Gains. For
Example, If The Share
Price Goes Up To $40 You Gain [2000($40 $30)] $5800 $14 200 From The Second
Strategy And Only 200($40 $29) $2 200 From The First Strategy. However, If The
Share Price Does Badly, The Second Strategy Gives Greater Losses. For Example, If The
Share Price GoesDown To $25, The First Strategy Leads To A Loss Of 200($29 $25)
$800 Whereas The Second
Strategy Leads To A Loss Of The Whole $5,800 Investment. This Example Shows That
OptionsContain Built In Leverage.
Problem 1.10.
Suppose You Own 5,000 Shares That Are Worth $25 Each. How Can Put Options Be Used
To Provide You With Insurance Against A Decline In The Value Of Your Holding Over The
Next FourMonths?
You Could Buy 50 Put Option Contracts (Each On 100 Shares) With A Strike Price Of $25
And AnExpiration Date In Four Months. If At The End Of Four Months The Stock Price
Proves To Be Less Than $25, You Can Exercise The Options And Sell The Shares For $25
Each.
Problem 1.11.
When First Issued, A Stock Provides Funds For A Company. Is The Same True Of An
Exchange-Traded Stock Option? Discuss.
An Exchange-Traded Stock Option Provides No Funds For The Company. It Is A Security
Sold ByOne Investor To Another. The Company Is Not Involved. By Contrast, A Stock
When It Is First Issued Is Sold By The Company To Investors And Does Provide Funds For
The Company.
Problem 1.12.
Explain Why A Futures Contract Can Be Used For Either Speculation Or Hedging.
If An Investor Has An Exposure To The Price Of An Asset, He Or She Can Hedge With
Futures Contracts. If The Investor Will Gain When The Price Decreases And Lose When The
Price Increases,A Long Futures Position Will Hedge The Risk. If The Investor Will Lose
When The Price Decreases And Gain When The Price Increases, A Short Futures Position
Will Hedge The Risk. Thus Either A Long Or A Short Futures Position Can Be Entered Into
For Hedging Purposes.
If The Investor Has No Exposure To The Price Of The Underlying Asset, Entering Into A
Futures Contract Is Speculation. If The Investor Takes A Long Position, He Or She Gains
When The Asset’sPrice Increases And Loses When It Decreases. If The Investor Takes A
Short Position, He Or She Loses When The Asset’s Price Increases And Gains When It
Decreases.
Problem 1.13.
Suppose That A March Call Option To Buy A Share For $50 Costs $2.50 And Is Held Until
March.Under What Circumstances Will The Holder Of The Option Make A Profit? Under
What Circumstances Will The Option Be Exercised? Draw A Diagram Showing How The
Profit On A Long Position In The Option Depends On The Stock Price At The Maturity Of
