# 1. You are a coffee dealer anticipating the purch…

1. You are a coffee dealer anticipating the purchase of 82,000 pounds of coffee in three months. You are concerned that the price of coffee will rise, so you take a long position in coffee futures. Each contract covers 37,500 pounds, and so, rounding to the nearest contract, you decide to go long in two contracts. The futures price at the time you initiate your hedge is 55.95 cents per pound. Three months later, the actual spot price of coffee turns out to be 58.56 cents per pound and the futures price is 59.20 cents per pound. a. Determine the effective price at which you purchased your coffee. How do you account for the difference in amounts for the spot and hedge positions? b. Describe the nature of the basis risk in this long hedge. 2. Suppose that one day in early April, you observe the following prices on futures contracts maturing in June: 93.35 for Eurodollar and 94.07 for T-bill. These prices imply three-month LIBOR and T-bill settlement yields of 6.65 percent and 5.93 percent, respectively. You think that over the next quarter the general level of interest rates will rise while the credit spread built into LIBOR will narrow. Demonstrate how you can use a TED (Treasury/Eurodollar) spread, which is a simultaneous long (short) position in a Eurodollar contract and short (long) position in the T-bill contract, to create a position that will benefit from these views. Please show calculations. 3. In Mid-May, there are two outstanding call option contracts available on the stock of ARB Co.: Call #1 : Exercise price = \$50, Expiration Date = Aug. 19, Market price = \$8.40 Call #2: Exercise price = \$60, Expiration Date = Aug 19, Market price = \$3.34 a. Assuming that you form a portfolio consisting of one Call#1 held long and two Call#2 held short, complete the following table showing your intermediate steps. In calculating net profit, be sure to include the net initial cost of the options. Price of ARB Stock at expiration: 40, 45, 50, 55, 60, 65, 70, 75 Profit on Call#1 position for each price? Profit on Call#2 position for each price? Net Profit on Total position for each price? b. Graph the net profit relationship in Part a, using stock price on the horizontal axis. What is (are) the breakeven stock price(s)? What is the point of maximum profit? c. Under what market conditions will this strategy (which is known as a call ratio spread) generally make sense? Does the holder of this position have limited or unlimited liability?

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