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Options, Futures and Derivatives Problem

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Options, Futures and Derivatives Problem
Below is your study guide.

Understanding the Scenario
Before making any specific discussion geared towards the 4 requirements, let me guide you through the entire scenario first.

First, the portfolio manager actually holds a position on 3 underlying assets - US Treasury note, corporate bond, and Schatz - rather than being long or short on derivatives designed around these underlying. This is important to note since hedging derivative and underlying positions are two different strategies.

Second, when we say elevated risk of extreme volatility we mean that the risk of the values of the above underlying assets spread out over a very large range of values is very high with individual security type prices changing very dramatically over a short period of time in either direction.

Third, a restriction as to how the 3 positions are to be hedged is identified - inability to sell the securities.

Fourth, the portfolio manager believes that the currency markets will move to their benefit and would ...

Solution Summary

The options, futures and derivative problems are examined.

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Trading Issues and Basics of Forward and Futures Contracts

5 Paragraphs:
Because of new information that has been gathered on derivatives, it has become apparent that these instruments are capable of providing a good hedge mechanism for various currency transactions in which the firm will engage. Because of the potential importance of derivatives, the treasurer would like more information on futures contracts. He needs you to provide explanations for the following questions:

* What is the difference between a contango market and a backwardation market
* What exactly is meant by a basis?
* Are there any ethical concerns that need to be addressed when using derivative instruments?
8-10 slides:
Chief Executive Officer (CEO) Barbara Kline has requested that you create a PowerPoint presentation detailing the differences between using forward contracts and options contracts to reduce risk. She wants to know if there are any advantages to using one of the instruments over the other. Is one of these more effective than the other? Are the costs of each different? Calculate how many call options contracts would be needed if you were trying to hedge a portfolio of 1,000 shares of stock. The answers to these questions will have an effect on the bottom line of the firm. Provide concrete explanations of each and create examples where it would be more appropriate to utilize an options contract over a forward contract and vice versa. Your presentation should be between 8-10 slides.

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