Capicy Washing Case Study

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

        [pic 1]

Buying a put option involves buying an option from someone else. It gives a payoff of

        [pic 2]

In both cases the potential payoff is[pic 3]. 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? 

1. The investor is obligated to sell pounds for 1.5000 when they are worth 1.4900. The gain is (1.5000−1.4900) ×100,000 = $1,000.

1. The investor is obligated to sell pounds for 1.5000 when they are worth 1.5200. The loss 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 cents per pound?

1. The trader sells for 50 cents per pound something that is worth 48.20 cents per pound. Gain[pic 4].
2. The trader sells for 50 cents per pound something that is worth 51.30 cents per pound. Loss[pic 5].

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 a market 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.

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