(Introduction to Derivatives and Risk Management, 10e Don Chance, Robert Brooks)
(Solution Manual all Chapters)
CHAPTER 1: INTRODUCTION
END-OF-CHAPTER QUESTIONS AND PROBLEMS
1. (Presuppositions for Financial Markets) There are at least three presuppositions for well-functioning
financial markets: clear rule of law, clean property rights, and a culture of trust.
2. (Market Efficiency and Theoretical Fair Value) An efficient market is one in which prices reflect the
true economic values of the assets trading therein. In efficient markets, no one can earn returns that are
more than commensurate with the level of risk. Efficient markets are characterized by low transaction costs
and by the rapid rate at which new information is incorporated into prices.
3. (Arbitrage and the Law of One Price) Arbitrage is a type of investment transaction that seeks to profit
when identical goods are priced differently. Buying an item at one price and immediately selling it at
another is a type of arbitrage. Because of the combined activities of arbitrageurs, identical goods, primarily
financial assets, cannot sell for different prices for long. This is the law of one price. Arbitrage helps make
our markets efficient by assuring that prices are in line with what they are supposed to be. In short, we
cannot get something for nothing. A situation involving two identical goods or portfolios that are not priced
equivalently would be exploited by arbitrageurs until their prices were equal. The "one price" that an asset
must be is called the “theoretical fair value.”
4. (Arbitrage and the Law of One Price) The law of one price is violated if the same good is selling at
different prices. On the surface it may appear as if that is the case; however, it is important to look beneath
the surface to determine if the goods are identical. Part of the cost of the good is convenience and customer
service. Some consumers might be willing to pay more because the dealer is located in a more desirable
section of town. Also, the higher priced dealer may have a better reputation for service and customer
satisfaction. Buyers may be willing to pay more if they feel that the premium they pay helps assure them
that they are getting a fair deal. It is important to note that many goods are indeed identical and, if so, they
should sell at the same price, but the Law of One Price is not violated if the price differential accounts for
some economic value.
5. (The Storage Mechanism) Storage is simply holding the asset. Some assets, like commodities, require
considerable storage space and entail significant storage costs. Others, like stocks and bonds, do not
consume much space but, as we shall see later, do incur costs. Storage enables us to more adequately meet
our consumption needs and, thus, provides for a more efficient alteration of our consumption patterns
across time. For example, we can store grains for the winter. In the case of stocks and bonds, we can store
them and sell them later. The proceeds from the sale of the securities can be used to meet consumption
needs at the later time. Likewise, storage enables speculators to hold goods and securities in the hope of
selling them later at a profit. In addition, storage plays an important role in defining the relationship
between spot instruments and derivatives.
6. (Delivery and Settlement) In futures markets, delivery seldom occurs. Since delivery is always possible,
however, an expiring futures contract will be priced like the spot instrument. The knowledge that futures
prices will eventually converge to spot prices is important to the pricing of futures contracts.
7. (Role of Derivative Markets) Derivative markets provide a means of adjusting the risk of spot market
investments to a more acceptable level and identifying the consensus market beliefs. They make trading
easier and less costly and spot markets more efficient. These markets also provide a means of speculating.
8. (Criticisms of Derivatives Markets) On the surface, it may be difficult to distinguish speculation from
gambling. Both entail high risk with the expectation of high gain. The major difference that makes
speculation somewhat more socially acceptable is that it offers benefits to society not conveyed by
gambling. For example, speculators are necessary to assume the risk not wanted by others. In gambling,
10th Edition: Chapter 1 1 End-of-Chapter Solutions
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole
or in part.
, there is no risk being hedged. Gamblers simply accept risk without there being a concomitant reduction in
someone else's risk.
9. (Misuses of Derivatives) Derivatives can be misused by speculating when one should be hedging, by not
having acquired the requisite knowledge to use them properly by acting irresponsibly when using
derivatives such as by being overly confident of one’s ability to forecast the direction of the market.
10. (Role of Derivative Markets) The existence of derivative markets in the United States economy and
indeed throughout most modern countries of the world undoubtedly leads to a much higher degree of
market efficiency. Derivatives facilitate the activities of individual arbitrageurs so that unequal prices of
identical goods are arbitraged until they are equal. Because of the large number of arbitrageurs, this is a
quick and efficient process. Arbitrage on this large a scale makes markets less capable of being
manipulated, less costly to trade in, and therefore more attractive to investors. (The opportunity to hedge
also makes the markets more attractive to investors in managing risk.) This is not to say that an economy
without derivative markets would be inefficient, but it would not have the advantage of this arbitrage on a
large scale.
It is important to note that the derivative markets do not necessarily make the U.S. or world economy any
larger or wealthier. The basic wealth, expected returns, and risks of the economy would be about the same
without these markets. Derivatives simply create lower cost opportunities for investors to align their risks at
more satisfactory levels. This may not necessarily make them wealthier, but to the extent that it makes them
more satisfied with their positions, it serves a valuable purpose.
11. (Return and Risk) Return is the numerical measure of investment performance. There are two main
measures of return, dollar return and percentage return. Dollar return measures investment performance as
total dollar profit or loss. For example, the dollar return for stocks is the dollar profit from the change in
stock price plus any cash dividends paid. It represents the absolute performance. Percentage return
measures investment performance per dollar invested. It represents the percentage increase in the investor’s
wealth that results from making the investment. In the case of stocks, the return is the percentage change in
price plus the dividend yield. The concept of return also applies to options, but, as we shall see later, the
definition of the return on a futures or forward contract is somewhat unclear.
12. (Repurchase Agreements) A repurchase agreement (known as repos) is a legal contract between a seller
and a buyer, the seller agrees to sell a specified asset to the buyer currently as well as buy it back usually at
a specified time in the future at an agreed future price. The seller is effectively borrowing money from the
buyer at an implied interest rate. Typically, repos involve low risk securities, such as U. S. Treasury bills.
Repos are useful because they provide a great deal of flexibility to both the borrower and lender.
Derivatives traders often need to be able to borrow and lend money in the most cost-effective manner
possible. Repos are often a very low cost way of borrowing money, particularly if the firm holds
government securities. Repos are a way to earn interest on short-term funds with minimal risk (for buyers)
and repos are a way to borrow for short-term needs at a relatively low cost (for sellers).
13. (Derivative Markets and Instruments) An option is a contract between two parties—a buyer and a
seller—that gives the buyer the right, but not the obligation, to purchase or sell something at a later date at
a price agreed upon today. The option buyer pays the seller a sum of money called the price or premium.
The option seller stands ready to sell or buy according to the contract terms if and when the buyer so
desires. An option to buy something is referred to as a call; an option to sell something is called a put.
A forward contract is a contract between two parties—a buyer and a seller—to purchase or sell something
at a later date at a price agreed upon today. A forward contract sounds a lot like an option, but an option
carries the right, not the obligation, to go through with the transaction. If the price of the underlying good
10th Edition: Chapter 1 2 End-of-Chapter Solutions
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole
or in part.
, changes, the option holder may decide to forgo buying or selling at the fixed price. On the other hand, the
two parties in a forward contract incur the obligation to ultimately buy and sell the good.
14. (The Underlying Asset) Because all derivatives are based on the random performance of something, the
word “derivative” is appropriate. The derivative derives its value from the performance of something else.
That “something else” is often referred to as the underlying asset. The term underlying asset, however, is
somewhat confusing and misleading. For instance, the underlying asset might be a stock, bond, currency, or
commodity, all of which are assets. However, the underlying “asset” might also be some other random
element such as the weather, which is not an asset. It might even be another derivative, such as a futures
contract or an option.
15. (Swaps) A swap would allow the two parties to exchange cash flows. A firm may be receiving cash from
one investment but would prefer another type of investment in which the cash flows are different. The party
contacts a swap dealer who takes the opposite side of the transaction. Thus, the firm and the dealer, in
effect, swap cash flow streams.
16. (Risk Preference) The expected outcome of this opportunity is ($10 + $0 - $1) / 3 = $3. As a risk neutral
individual (one who is indifferent to the risk inherent in the opportunity), you would be willing to pay $3 to
take the risk of playing the game. If you were instead risk averse, you would be willing only to pay some
amount less than $3. If you were risk seeking, you would be willing to pay some amount more than $3.
17. (Short Selling) If an individual anticipates the price of a stock falling, he can attempt to capture a profit by
selling short. He would first borrow the stock from a broker and sell that stock in the marketplace. If the
price of the stock then indeed fell, he would buy back the stock at a lower price. This would allow him to
capture a profit and repay the shares to the broker. Short selling creates a liability in that the short seller is
obligated to someday buy back the stock and return it to the broker; however, the short seller does not
know how much he will have to pay to buy back the shares.
18. (Operational Advantages) First, derivative markets entail lower transaction costs. Second, derivative
markets often have greater liquidity than spot markets. And third, derivative markets allow investors to sell
short in an easier manner.
19. (Derivatives and Ethics) Codes of ethics perform a vital role in governing the behavior of finance
professionals. Every major finance practitioner association has adopted a code of ethics as well as standards
of professional conduct. These moral principles provide essential guidance to professionals facing difficult
and complex situations that often have economic interests that conflict. Before entering a specific
profession, it is important to fully understand existing normative ethics and consider your own personal
ability to abide within the expectations engendered by these codes of ethics.
10th Edition: Chapter 1 3 End-of-Chapter Solutions
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole
or in part.
, CHAPTER 2: STRUCTURE OF OPTIONS MARKETS
END-OF-CHAPTER QUESTIONS AND PROBLEMS
1. (Types of Derivatives) a. The call holder exercises the call, buying the asset for $100. The put holder does
not exercise the put. The holder of the long forward contract must buy the asset for $100.
b. The call holder does not exercise the call. The put holder exercises the put, selling the asset for $95. The
holder of the long forward contract must buy the asset for $100.
2. (Options) You should first create an example in which the asset price is a certain number. Then create a
call and a put with a lower exercise price. The call would be in-the-money and the put would be out-of-the
money. Then create an example of a call and a put with a higher exercise price. The call would then be out-
of-the-money and the put would be in-the-money.
3. (Swaps) A forward is the obligation to pay a fixed price or rate and receive something whose value varies.
A swap is a combination of forwards in that it provides multiple obligations to pay a fixed price or rate and
receive something whose value varies. These multiple obligations have various expirations spaced over a
defined period of time.
4. (Other Types of Derivatives) A real option is one of many rights a company has in many of its capital
investment projects, such as the option to delay launching a project, extend the life of a project, or increase
or decrease the scale of a project. Traditional net present value analysis merely discounts the expected cash
inflows and outflows of an investment project but does not take into account the fact that after the project is
started there may be additional information that can affect decisions a company would make. Traditional
NPV analysis more or less makes all decisions for the life of the project at the start.
5. (Introduction and Evolution of Financial Derivatives) a. The CME and CBOE are both in Chicago but
they are not the same company. The New York Stock Exchange and LIFFE are part of the NYSE-Euronext
company of exchanges. The Chicago Board of Trade and New York Mercantile Exchange are both part of
the CME Group.
6. (Standardization of Contracts) d. The price of the derivative. The price is always negotiated between the
two parties. All other terms are established by the exchange.
7. (Standardization of Contracts) For some contracts, the clearinghouses establish maximum and minimum
prices at which a contract can trade on a given day. The purpose is to limit large price changes, which can
result in large losses for certain parties. The clearinghouse is ultimately responsible for these losses, so it
seeks to collect funds before prices move much more and further losses are incurred.
8. (Options) With each contract covering 100 options, 20 call contracts at $2.25 would ordinarily generate a
premium of $4,500. Normally the premium goes from the call buyer to the call seller, but on an exchange-
listed option, it passes from through the call buyer’s broker, the broker’s clearing firm, and into the
clearinghouse. In other words, the seller cannot get its hands on the premium until fulfilling its obligation
through exercise, or when the contract expires.
9. (Expiration and Exercise Procedures) Physical delivery literally requires that the underling be delivered
to a specific location or, for securities, transferred electronically to the opposite party. In case settlement,
one party simply pays the other the cash equivalent value. For example, if A is to pay B ¥10,000 for an
asset worth ¥12,000 , physical delivery would require that B deliver the asset to A and A pay B ¥10,000. A
has then acquired an asset that is worth ¥2,000 more than what it paid. In a cash settlement, B would
merely pay ¥2,000. If A wanted the asset, it could buy it for ¥12,000, resulting in a net cost of ¥10,000.
10th edition: Chapter 2 4 End-of-Chapter Solutions
(Solution Manual all Chapters)
CHAPTER 1: INTRODUCTION
END-OF-CHAPTER QUESTIONS AND PROBLEMS
1. (Presuppositions for Financial Markets) There are at least three presuppositions for well-functioning
financial markets: clear rule of law, clean property rights, and a culture of trust.
2. (Market Efficiency and Theoretical Fair Value) An efficient market is one in which prices reflect the
true economic values of the assets trading therein. In efficient markets, no one can earn returns that are
more than commensurate with the level of risk. Efficient markets are characterized by low transaction costs
and by the rapid rate at which new information is incorporated into prices.
3. (Arbitrage and the Law of One Price) Arbitrage is a type of investment transaction that seeks to profit
when identical goods are priced differently. Buying an item at one price and immediately selling it at
another is a type of arbitrage. Because of the combined activities of arbitrageurs, identical goods, primarily
financial assets, cannot sell for different prices for long. This is the law of one price. Arbitrage helps make
our markets efficient by assuring that prices are in line with what they are supposed to be. In short, we
cannot get something for nothing. A situation involving two identical goods or portfolios that are not priced
equivalently would be exploited by arbitrageurs until their prices were equal. The "one price" that an asset
must be is called the “theoretical fair value.”
4. (Arbitrage and the Law of One Price) The law of one price is violated if the same good is selling at
different prices. On the surface it may appear as if that is the case; however, it is important to look beneath
the surface to determine if the goods are identical. Part of the cost of the good is convenience and customer
service. Some consumers might be willing to pay more because the dealer is located in a more desirable
section of town. Also, the higher priced dealer may have a better reputation for service and customer
satisfaction. Buyers may be willing to pay more if they feel that the premium they pay helps assure them
that they are getting a fair deal. It is important to note that many goods are indeed identical and, if so, they
should sell at the same price, but the Law of One Price is not violated if the price differential accounts for
some economic value.
5. (The Storage Mechanism) Storage is simply holding the asset. Some assets, like commodities, require
considerable storage space and entail significant storage costs. Others, like stocks and bonds, do not
consume much space but, as we shall see later, do incur costs. Storage enables us to more adequately meet
our consumption needs and, thus, provides for a more efficient alteration of our consumption patterns
across time. For example, we can store grains for the winter. In the case of stocks and bonds, we can store
them and sell them later. The proceeds from the sale of the securities can be used to meet consumption
needs at the later time. Likewise, storage enables speculators to hold goods and securities in the hope of
selling them later at a profit. In addition, storage plays an important role in defining the relationship
between spot instruments and derivatives.
6. (Delivery and Settlement) In futures markets, delivery seldom occurs. Since delivery is always possible,
however, an expiring futures contract will be priced like the spot instrument. The knowledge that futures
prices will eventually converge to spot prices is important to the pricing of futures contracts.
7. (Role of Derivative Markets) Derivative markets provide a means of adjusting the risk of spot market
investments to a more acceptable level and identifying the consensus market beliefs. They make trading
easier and less costly and spot markets more efficient. These markets also provide a means of speculating.
8. (Criticisms of Derivatives Markets) On the surface, it may be difficult to distinguish speculation from
gambling. Both entail high risk with the expectation of high gain. The major difference that makes
speculation somewhat more socially acceptable is that it offers benefits to society not conveyed by
gambling. For example, speculators are necessary to assume the risk not wanted by others. In gambling,
10th Edition: Chapter 1 1 End-of-Chapter Solutions
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole
or in part.
, there is no risk being hedged. Gamblers simply accept risk without there being a concomitant reduction in
someone else's risk.
9. (Misuses of Derivatives) Derivatives can be misused by speculating when one should be hedging, by not
having acquired the requisite knowledge to use them properly by acting irresponsibly when using
derivatives such as by being overly confident of one’s ability to forecast the direction of the market.
10. (Role of Derivative Markets) The existence of derivative markets in the United States economy and
indeed throughout most modern countries of the world undoubtedly leads to a much higher degree of
market efficiency. Derivatives facilitate the activities of individual arbitrageurs so that unequal prices of
identical goods are arbitraged until they are equal. Because of the large number of arbitrageurs, this is a
quick and efficient process. Arbitrage on this large a scale makes markets less capable of being
manipulated, less costly to trade in, and therefore more attractive to investors. (The opportunity to hedge
also makes the markets more attractive to investors in managing risk.) This is not to say that an economy
without derivative markets would be inefficient, but it would not have the advantage of this arbitrage on a
large scale.
It is important to note that the derivative markets do not necessarily make the U.S. or world economy any
larger or wealthier. The basic wealth, expected returns, and risks of the economy would be about the same
without these markets. Derivatives simply create lower cost opportunities for investors to align their risks at
more satisfactory levels. This may not necessarily make them wealthier, but to the extent that it makes them
more satisfied with their positions, it serves a valuable purpose.
11. (Return and Risk) Return is the numerical measure of investment performance. There are two main
measures of return, dollar return and percentage return. Dollar return measures investment performance as
total dollar profit or loss. For example, the dollar return for stocks is the dollar profit from the change in
stock price plus any cash dividends paid. It represents the absolute performance. Percentage return
measures investment performance per dollar invested. It represents the percentage increase in the investor’s
wealth that results from making the investment. In the case of stocks, the return is the percentage change in
price plus the dividend yield. The concept of return also applies to options, but, as we shall see later, the
definition of the return on a futures or forward contract is somewhat unclear.
12. (Repurchase Agreements) A repurchase agreement (known as repos) is a legal contract between a seller
and a buyer, the seller agrees to sell a specified asset to the buyer currently as well as buy it back usually at
a specified time in the future at an agreed future price. The seller is effectively borrowing money from the
buyer at an implied interest rate. Typically, repos involve low risk securities, such as U. S. Treasury bills.
Repos are useful because they provide a great deal of flexibility to both the borrower and lender.
Derivatives traders often need to be able to borrow and lend money in the most cost-effective manner
possible. Repos are often a very low cost way of borrowing money, particularly if the firm holds
government securities. Repos are a way to earn interest on short-term funds with minimal risk (for buyers)
and repos are a way to borrow for short-term needs at a relatively low cost (for sellers).
13. (Derivative Markets and Instruments) An option is a contract between two parties—a buyer and a
seller—that gives the buyer the right, but not the obligation, to purchase or sell something at a later date at
a price agreed upon today. The option buyer pays the seller a sum of money called the price or premium.
The option seller stands ready to sell or buy according to the contract terms if and when the buyer so
desires. An option to buy something is referred to as a call; an option to sell something is called a put.
A forward contract is a contract between two parties—a buyer and a seller—to purchase or sell something
at a later date at a price agreed upon today. A forward contract sounds a lot like an option, but an option
carries the right, not the obligation, to go through with the transaction. If the price of the underlying good
10th Edition: Chapter 1 2 End-of-Chapter Solutions
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole
or in part.
, changes, the option holder may decide to forgo buying or selling at the fixed price. On the other hand, the
two parties in a forward contract incur the obligation to ultimately buy and sell the good.
14. (The Underlying Asset) Because all derivatives are based on the random performance of something, the
word “derivative” is appropriate. The derivative derives its value from the performance of something else.
That “something else” is often referred to as the underlying asset. The term underlying asset, however, is
somewhat confusing and misleading. For instance, the underlying asset might be a stock, bond, currency, or
commodity, all of which are assets. However, the underlying “asset” might also be some other random
element such as the weather, which is not an asset. It might even be another derivative, such as a futures
contract or an option.
15. (Swaps) A swap would allow the two parties to exchange cash flows. A firm may be receiving cash from
one investment but would prefer another type of investment in which the cash flows are different. The party
contacts a swap dealer who takes the opposite side of the transaction. Thus, the firm and the dealer, in
effect, swap cash flow streams.
16. (Risk Preference) The expected outcome of this opportunity is ($10 + $0 - $1) / 3 = $3. As a risk neutral
individual (one who is indifferent to the risk inherent in the opportunity), you would be willing to pay $3 to
take the risk of playing the game. If you were instead risk averse, you would be willing only to pay some
amount less than $3. If you were risk seeking, you would be willing to pay some amount more than $3.
17. (Short Selling) If an individual anticipates the price of a stock falling, he can attempt to capture a profit by
selling short. He would first borrow the stock from a broker and sell that stock in the marketplace. If the
price of the stock then indeed fell, he would buy back the stock at a lower price. This would allow him to
capture a profit and repay the shares to the broker. Short selling creates a liability in that the short seller is
obligated to someday buy back the stock and return it to the broker; however, the short seller does not
know how much he will have to pay to buy back the shares.
18. (Operational Advantages) First, derivative markets entail lower transaction costs. Second, derivative
markets often have greater liquidity than spot markets. And third, derivative markets allow investors to sell
short in an easier manner.
19. (Derivatives and Ethics) Codes of ethics perform a vital role in governing the behavior of finance
professionals. Every major finance practitioner association has adopted a code of ethics as well as standards
of professional conduct. These moral principles provide essential guidance to professionals facing difficult
and complex situations that often have economic interests that conflict. Before entering a specific
profession, it is important to fully understand existing normative ethics and consider your own personal
ability to abide within the expectations engendered by these codes of ethics.
10th Edition: Chapter 1 3 End-of-Chapter Solutions
© 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole
or in part.
, CHAPTER 2: STRUCTURE OF OPTIONS MARKETS
END-OF-CHAPTER QUESTIONS AND PROBLEMS
1. (Types of Derivatives) a. The call holder exercises the call, buying the asset for $100. The put holder does
not exercise the put. The holder of the long forward contract must buy the asset for $100.
b. The call holder does not exercise the call. The put holder exercises the put, selling the asset for $95. The
holder of the long forward contract must buy the asset for $100.
2. (Options) You should first create an example in which the asset price is a certain number. Then create a
call and a put with a lower exercise price. The call would be in-the-money and the put would be out-of-the
money. Then create an example of a call and a put with a higher exercise price. The call would then be out-
of-the-money and the put would be in-the-money.
3. (Swaps) A forward is the obligation to pay a fixed price or rate and receive something whose value varies.
A swap is a combination of forwards in that it provides multiple obligations to pay a fixed price or rate and
receive something whose value varies. These multiple obligations have various expirations spaced over a
defined period of time.
4. (Other Types of Derivatives) A real option is one of many rights a company has in many of its capital
investment projects, such as the option to delay launching a project, extend the life of a project, or increase
or decrease the scale of a project. Traditional net present value analysis merely discounts the expected cash
inflows and outflows of an investment project but does not take into account the fact that after the project is
started there may be additional information that can affect decisions a company would make. Traditional
NPV analysis more or less makes all decisions for the life of the project at the start.
5. (Introduction and Evolution of Financial Derivatives) a. The CME and CBOE are both in Chicago but
they are not the same company. The New York Stock Exchange and LIFFE are part of the NYSE-Euronext
company of exchanges. The Chicago Board of Trade and New York Mercantile Exchange are both part of
the CME Group.
6. (Standardization of Contracts) d. The price of the derivative. The price is always negotiated between the
two parties. All other terms are established by the exchange.
7. (Standardization of Contracts) For some contracts, the clearinghouses establish maximum and minimum
prices at which a contract can trade on a given day. The purpose is to limit large price changes, which can
result in large losses for certain parties. The clearinghouse is ultimately responsible for these losses, so it
seeks to collect funds before prices move much more and further losses are incurred.
8. (Options) With each contract covering 100 options, 20 call contracts at $2.25 would ordinarily generate a
premium of $4,500. Normally the premium goes from the call buyer to the call seller, but on an exchange-
listed option, it passes from through the call buyer’s broker, the broker’s clearing firm, and into the
clearinghouse. In other words, the seller cannot get its hands on the premium until fulfilling its obligation
through exercise, or when the contract expires.
9. (Expiration and Exercise Procedures) Physical delivery literally requires that the underling be delivered
to a specific location or, for securities, transferred electronically to the opposite party. In case settlement,
one party simply pays the other the cash equivalent value. For example, if A is to pay B ¥10,000 for an
asset worth ¥12,000 , physical delivery would require that B deliver the asset to A and A pay B ¥10,000. A
has then acquired an asset that is worth ¥2,000 more than what it paid. In a cash settlement, B would
merely pay ¥2,000. If A wanted the asset, it could buy it for ¥12,000, resulting in a net cost of ¥10,000.
10th edition: Chapter 2 4 End-of-Chapter Solutions
