SOLUTION MANUAL FUNDAMENTALS OF
FUTURES AND OPTIONS MARKETS 9TH
EDITION QUESTIONS & ANSWERS WITH
RATIONALES (CHAPTER 1-24)
, 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 asset
for 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 a
derivative 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 position
in 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 price
is $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 does
not 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 gives
you 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 you
buy 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 investor
gain or lose if the exchange rate at the end of the contract is (a) 1.4900 and (b) 1.5200?
FUTURES AND OPTIONS MARKETS 9TH
EDITION QUESTIONS & ANSWERS WITH
RATIONALES (CHAPTER 1-24)
, 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 asset
for 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 a
derivative 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 position
in 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 price
is $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 does
not 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 gives
you 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 you
buy 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 investor
gain or lose if the exchange rate at the end of the contract is (a) 1.4900 and (b) 1.5200?
