FINA0301 Tutorial

Tutorial 1 Answer – Chapter 1 & 2
Question 1

Short sale entails borrowing shares and then selling them, receiving cash. Therefore, initially, we will receive the proceeds from the sale of the asset, less the proportional commission charge:
300  ($30.19)  300  ($30.19)  0.005  $9,057  0.995
 $9,011.72

When we close out the position, we will again incur the commission charge, which is added to the purchasing cost:
300  ($29.87)  300  ($29.87)  0.005  $8,961  1.005
 $9,005.81

Finally, we subtract the cost of covering the short position from our initial proceeds to receive total profits: $9,011.72  $9,005.81  $5.91. We can see that the commission charge that we have to pay twice significantly reduces the profits we can make.

Question 2

RHS of the Forward pricing formula: S0 e rT  1100e5%6 /12  1127.85
(a)

If F0T  1120 we would buy low and sell high (i.e. Long Forward; Short-sell stock and lend out the short-selling proceed).
Arbitrage Strategy

T=0

Short-sell Stock

1100

Lend

-1100

T = 6 months

-ST
5%×6/12

1100e

= 1127.85

Long Forward

0

ST – 1120

Total

0

7.85

1

(b)

If F0T  1130 we would buy low and sell high (i.e. Short Forward; Long stock and borrow to finance our long stock position).
Arbitrage Strategy

T=0

T = 6 months

Borrow

1100

-1100e5%×6/12 = -1127.85

Long Stock

-1100

ST

Short Forward

0

1130 – ST

Total

0

2.15

Question 3
(a)

The payoff to a short forward at expiration is equal to:
Payoff to short forward = Forward price – Spot price at expiration

Therefore, we can construct the following table:
Price of Asset in 6

Agreed Forward Price

months

Payoff to Short
Forward

40

10

45

50

5

50

50

0

55

50

-5

60

(b) The payoff

50

50

-10

to a purchased put option at expiration is:

Payoff to long put option = max [0, Strike price - Spot price at expiration]