Practice

Finance 4720 Class Homework #5 Solution Professor Joel Rentzler

1. (a) The elevator does not hedge.

(b) ( (tot) = (Sell - (Buy = 2.11 – 2.07 = 0.04

2. (a) Short hedges from Sept. 1 to Nov. 1

(b)

| | |SM |FM | |BASIS |

|Sept. 1 |Inventory |2.10 |2.34 |Sell |- 0.24 |

|Nov. 1 |Sell |2.11 |2.38 |Buy |- 0.27 |

| | |(2.21 - .10) | | | |

| |( (SM/FM) |+ 0.01 |-0.04 | |(B = - 0.03 |

(SH (TOT) = (SH (SM) + (SH (FM) = (St+1 - St) + (t FT – t+1 FT) = (S - (F

= + 0.01 - 0.04 = - 0.03

BASIS ( Bt = St – tFT and the Change is Basis ( (B = Bt+1 – Bt Thus:

(B = (St+1 - t+1 FT) – (St - t FT) = (St+1 - St) + (t FT – t+1 FT) = (S - (F

= (SH (tot)

SH loses $ when basis ( - Weakens – (i.e. when (B < 0)

SH makes $ when basis (- Strengthens – (i.e. when (B > 0)

Here the basis weakens & so SH loses money since (SH (tot) = (B = -0.03

3. (a) Long hedges from Sept. 1 to Nov 1

(b)

| | |SM |FM | |BASIS |

|Sept. 1 |Forward commit |2.12 |2.34 |Long |- 0.22 |

|Nov. 1 |Buys |2.13 |2.38 |Short |- 0.25 |

| |( (SM/FM) |- 0.01 |+ 0.04 | |(B = -...