Sample Risk Management and Hedging Problems (computational)

These are problems that were on Exam 4 in the Fall 2010 semester. I hope you find this useful.

25.A 6-month call option on Romer Technologies' stock has a strike price of $45 and sells in the market for $8.25. Romer's current stock price is $48. What is the exercise value of the option?

a.$3.00

b.$3.75

c.$4.69

d.$5.86

e.$7.32

26.A 6-month put option on Smith Corp.'s stock has a strike price of $45 and sells in the market for $8.90. Smith's current stock price is $41. What is the option premium?

a.$0.00

b.$4.90

c.$5.39

d.$5.93

e.$6.52

Use the following information for questions 27 – 29.

Bill is a corn farmer in the Texas Panhandle. He has a 10 year average corn production of 25,000 bushels on his farm. At no time in the past 5 years has that production dropped below 15,000 bushels. On March 5, Bill notices the December CBOT corn futures are trading at $4.178 per bushel. This is a much higher price than Bill has seen in the past and he wants to lock in his profits on his minimum production level of 15,000 bushels. Margin requirements are $1,500 per contract and a standard corn contract covers 5,000 bushels.

  1. Which of the following best describes Bill’s position on March 5 and his hedging strategy?
  2. Since Bill is short in the underlying asset, he should buy 5 futures contracts.
  3. Since Bill is short in the underlying asset, he should buy 3 futures contracts.
  4. Since Bill is long in the underlying asset, he should buy 3 futures contracts.
  5. Since Bill is long in the underlying asset, he should short 3 futures contracts.
  6. Since Bill is long in the underlying asset, he should short 5 futures contracts.
  1. How much margin must Bill deposit or receive when opening the future’s hedge?
  2. Bill must deposit $4,500 since he is short 3 contracts.
  3. Bill will receive $4,500 since he is long 3 contracts.
  4. Bill must deposit $7,500 since he is short 5 contracts.
  5. Bill will receive $7,500 since he is long 5 contracts.
  6. Bill must deposit $62,670 since this is the initial value of his hedged position.
  1. On October 10, Bill sells his entire 28,000 bushels of harvested and dried corn at the spot price of $4.785 per bushel and at the same time he closed his December futures contracts at $5.694 per bushel. How much profit or loss did Bill make on the future’s contracts?
  1. $22,740 loss
  2. $13,635 loss
  3. $9,105 profit
  4. $13,635 profit
  5. $22,740 profit

30.Bank A is AAA-rated bank in U.K., and needs to borrow $10,000,000 to finance 5-year, floating-rate (based on LIBOR), Eurodollar term loans to its commercial clients. The Bank has two sources of debt/deposits available:

Alternative A:5-YR FIXED-RATE BONDS @10%

Alternative B:5-YR FLOATING-RATE NOTES (FRNs) @ LIBOR

Bank A could arrange a swap on the above conventional loans that would result in the following for the 5 years:

Alternative C:Fixed for Floating Swap that yields LIBOR plus 0.75%

Alternative D:Floating for Fixed Swap that yields 9.5%

Alternative E:Fixed for Floating Swap that yields LIBOR minus 0.75%

Which of the above alternatives is the best for Bank A given that it desires to manage its interest margin and hedge interest rate risk on its profits?

  1. Alternative A
  2. Alternative B
  3. Alternative C
  4. Alternative D
  5. Alternative E