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Equivalent Strategy For Interest Rate Futures
S1: Buy a t-bill maturing at time T. FV= $1mil, Price = S. S2: i) buy a futures contract maturing at t1 to deliver a t-bill maturing at T with FV=$1mil. Price = F. ii) Buy a t-bill maturing at t1 with FV=F.
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Formula for interest rate future
F = S(1+r0-t1)
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Equivalent Strategies for Stock Index Futures
S1: i) buy index basket of stock with amount equal to FV of one index futures contract (S). ii) Invest all interim dividends at risk-free rate to receive FV(Div). S2: i) buy one index futures contract valued at F. ii) invest amount S in t-bill
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Pricing equation for Index Future
F = S( 1+ r(0-T) - d(0-T) )
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Main Assumptions with Index Futures Pricing
i) marking to market CF ignored. ii) no TC iii) dividends and coupons know til maturity. iv) no tax effects v) interest rates known til maturity vi) margin requirements met with t-bills vii) no arbitrage
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Equivalent Strategies for Currency Futures
S1: i)convert £ to $ and investn in risk-less US bonds. ii)buy forward contract to deliver pounds equivalent to known end of period value. S2: invest in risk-less bonds in the UK
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Pricing Equation for Currency Futures
F = S ((1+r$)/(1+r£))
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Main Assumptions in Currency Futures Pricing
i)marking to market ignored. ii)no TC. iii)no exchange controls iv)no differential tax effects v)futures contract valued as forward contract.
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What would be the general arbitrage action if the futures contract is overpriced?
Sell entire strategy containing forward and buy entire equivalent strategy simultaneously.
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What would be the general arbitrage action if the futures contract is underpriced?
Buy entire strategy containing forward and sell entire equivalent strategy simultaneously.
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What is the basis?
The basis is the difference between the spot price and forward price, it encorporates all expected changes in the variables that may affect the price of the underlying asset from now to the delivery date.
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What is the quoted discount?
QD = (FV - Price)/FV
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How do you calculate the yield?
Yield = (FV - Price)/Price
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What is the intrinsic value of a call/put?
Call = max{0,S-E} Put = max{0,E-S}
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What is the time value of an option?
TV is the value attached to the possibility of the option becoming deeper in the money at some point in the future. Difference between the intrinsic value and the premium.
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What are the assumptions of the B-S model?
i)only European options ii)exercise only at maturity iii)no TC iv)ST interest rates are known and constant during period. v)no dividends vi)asset prices behave as random walk vii)variance of asset return is constant over time and known
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What are the biases of the B-S formula?
Theoretical values are on average: less than market prices if option is ITM, greater than market prices if option is OTM and mis-pricing will increase the deeper and option is ITM/OTM.
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Card 2

Front

Formula for interest rate future

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F = S(1+r0-t1)

Card 3

Front

Equivalent Strategies for Stock Index Futures

Back

Preview of the front of card 3

Card 4

Front

Pricing equation for Index Future

Back

Preview of the front of card 4

Card 5

Front

Main Assumptions with Index Futures Pricing

Back

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