CFA I Der 2(M4-5)

The calculation of derivatives values is based on an assumption that

• investors are risk neutral
• arbitrage opportunities are exploited rapidly
• arbitrage opportunities do not arise in real markets

A net benefit from holding the underlying asset of a forward contract will

• increase the value of the forward contract during its life
• decrease the no-arbitrage forward price at initiation
• decrease the value of the forward contract at expiration

Other things equal, an increase in storage costs of the underlying asset will

• not affect the no-arbitrage forward price
• decrease the no-arbitrage forward price
• increase the no-arbitrage forward price

It is possible to profit from arbitrage when there are no costs or benefits to holding the underlying asset and the forward contract price is

• equal to the future value of the spot price
• greater than the present value of the spot price
• less than the future value of the spot price

The underlying asset of a derivative is most likely to have a convenience yield when the asset

• is difficult to sell short
• pays interest or dividends
• must be stored and insured

The forward price of a commodity will most likely be equal to the current spot price if the

• convenience yield equals the storage costs as a percentage
• convenience yield is equal to the risk-free rate plus storage costs as a percentage
• risk-free rate equals the storage costs as a percentage minus the convenience yield

There are two forward contracts, contract 1 and contract 2, on the same underlying. The underlying makes no cash payments, does not yield any nonfinancial benefits, and does not incur any storage costs. Contract 1 expires in one year, and contract 2 expires in two years. It is most likely that the price of contract 1

• is less than the price of contract 2.
• is equal to the price of contract 2.
• exceeds the price of contract 2.

Over time, a forward contract most likely has variable

• value and constant price.
• price and constant value.
• value and variable price.

Baywhite Financial is a broker-dealer and wealth management firm that helps its clients manage their portfolios using stand-alone derivative strategies. A new Baywhite analyst is asked to evaluate the following client situations. A Baywhite client currently owns 5,000 common non-dividend-paying shares of Vivivyu Inc. (VIVU), a digital media company, at a spot price of USD173 per share. The client enters into a forward commitment to sell half of its VIVU position in six months at a price of USD175.58. Which of the following market events is most likely to result in the greatest gain in the VIVU forward contract MTM value from the client’s perspective?

• An increase in the risk-free rate
• An immediate decline in the VIVU spot price following contract inception
• A steady rise in the spot price of VIVU stock over time

All else being equal, if the risk-free rate increases immediately after the inception of a forward contract, the value of the contract to the forward buyer will:

• decrease
• stay the same
• increase