1- Suppose the basis spread, S-F, is falling. How can you use this fundamental information to take an investment decision in options and swaps? Further, does your decision contradict the normal backwardation theory of Keynes? Why or why not? a) You use futures and/or options to hedge interest rate risk, commodity-price risk and foreign currency risk. All the time futures follow spot or options follow spot. Give one detailed example where spot follows options. b) Explain why do we engineer financial products? Is this a passing fad? Why or why not? c) Is the market fairly priced?
2- “A good trader with a bad model can beat a bad trader with a good model.” Critique MG’s failure with reference to normal backwardation model. Be very specific in pointing out what normal backwardation model entails and what MG did. Use options markets in addition to futures market to answer the question.
3- Define swaps. Give four distinct uses of swaps with examples. Make sure to illustrate the cases with graphs and numerical examples whenever necessary. How are you going to implement this in Barchart? Just give the methodology not a print output from Barchart
4- Consider the PHLX 122 Sep EUR European call option. The option has a premium of 4.41 U.S. cents per EUR. The option will expire in 98 days (T-t) in years is equal to 98/365=. 0.2685 year. We will use September futures Ft($/EUR)=$112.53. The rate r is estimated 0.5375 percent. The estimated volatility is 15.985 percent.
Use Black Scholes formula from the book to answer the following questions:
i) Find values of d1 and d2.
ii) Use N(d1=.0933)= .5372 and N (d2=.0064)=.5025 to find BS Call price.
iii) Is the market fairly priced?
5-Describe the process of investing in options using market identification and basis.