Financial Derivatives (N1559) – Spring 2024
Seminar Questions Week 1
Please work through the seminar questions BEFORE attending the seminar. Solutions to the questions will be provided on Canvas. If you would like to discuss any of the Quiz questions in the seminar, please email your tutor which details of which questions you would like to be covered. Question 1 was not discussed in class, this question covers different compounding conventions that will be used in this module (you should have seen all of these in other modules).
1. (JC 2.1-2.3)
(a) The interest rate is 5% per year. Compute the six-month zero-coupon bond price using a simple interest rate.
(b) The interest rate is 5% per year. Compute the six-month zero-coupon bond price using a compound interest rate with monthly compounding.
(c) The interest rate is 5% per year. Compute the six-month zero-coupon bond price using a continuously compounded interest rate.
2. (JC 1.6) Explain why derivatives are zero-sum games.
3. (JC 4.9) Suppose you are a trader specializing in futures on corn, wheat, oats, barley and
other agricultural commodities. From the following list, which risks do you face: credit risk, market risk, liquidity risk, settlement risk, operational risk, legal risk.
4. (JC 5.8) Explain and carefully describe the following four security positions, drawing payoff
diagrams (x-axis: price of the underlying at maturity, y-axis: payoff of the derivative at maturity) wherever necessary to support you answer:
(a) short a forward contract with a delivery price of $100
(b) short two forward contracts with a delivery price of $100
(c) short selling a stock at $100
(d) going short on an option with a strike price of $100
5. (JC 6.6) Suppose a two-year zero-coupon bond has a price of $0.90 and a three year zero- bond has a price of $0.85. A bank allows you to borrow or lend at 4 percent, compounded once a year. Show two ways that you can make arbitrage profits from these prices.