Derivatives Questions following, somebody, posting, receive, contract

rosewhite

Hi fellow L1 candidates,

Can somebody please clarify how the answer to the following question is option C.

22. A silver futures contract requires the seller to deliver 5,000 Troy ounces of silver. An
investor sells one July silver futures contract at a price of $8 per ounce, posting a $2,025
initial margin. If the required maintenance margin is $1,500, the price per ounce at which the
investor would first receive a maintenance margin call is closest to:
A. $5.92.
B. $7.89.
C. $8.11.
D. $10.80.



Also I do not understand how this out-of-the-money American put was worth 14 at the time of purchase (that is, option D):

The current price of an asset is 100. An out-of-the-money American put option with an
exercise price of 90 is purchased along with the asset. If the breakeven point for this hedge is
at an asset price of 114 at expiration, then the value of the American put at the time of
purchase must have been:
A. 0.
B. 4.
C. 10.
D. 14.

These problems can be found in the Sample L1 questions from the CFA website.

Wasteoftime

ADISON2000 Wrote:
-------------------------------------------------------
> Thanks to all you great guys that contributed to
> the questions but the suggestions to the second
> question are still not very convincing. First,
> like nevcfa1 earlier pointed out, the put I
> suppose is worthless as the price at expiration is
> higher than the exercise price. I tend to agree
> with nevcfa1 that the investor has profit from the
> purchase of the asset but then the next issue is
> how does the $14 profit from the asset translate
> to the price of the put?

Because it says "breakeven", which means profit from one asset = loss on the other.

> ANS rightly observed that the break even point is
> X-p but the put should be worthless given that the
> price at expiration is higher than the exercise
> price. Any further take on this?

As ANS points out, the questions says "IF".

Also ek82 is right, I missed the part about the investor being short. As for whether I am a he or a she, he is definitely right.

NC

Londonrocks

the value of the option at exipiration is not 114. 114 is just an hypothetical price at expiration. is like looking forward moving back.

if 114 is the breakeven price, what does that imply about the price of the put at the time of purchasse. this can be translate into X-St-P=0 where P is the price of the option.

Now remember the value of the put at the time of purchase is not zero because, we do not know at that time that the price at expiration would be 114. the question clearly says IF.... the price is 114. so it is just an hypothesis to find the breakeven price today based on an hypothetical price of the asset at expiration.

siavosh

Thanks to all you great guys that contributed to the questions but the suggestions to the second question are still not very convincing. First, like nevcfa1 earlier pointed out, the put I suppose is worthless as the price at expiration is higher than the exercise price. I tend to agree with nevcfa1 that the investor has profit from the purchase of the asset but then the next issue is how does the $14 profit from the asset translate to the price of the put?
ANS rightly observed that the break even point is X-p but the put should be worthless given that the price at expiration is higher than the exercise price. Any further take on this?

mnieman

change is in price is represented by (x-8), X being the higher price that will trigger the margin call.

for the margin call to be trigger this have to happen: 2025-5000(x-8)=1500 which imply that -5000(x-8)=1500-2025= -525 which imply that (x-8)= 0.11 and X=8.11

so the price at or above which the they will be a marginal call is 8.11


we know the value of an american put is (X-St) X being the exercise price and St being the price of the underlying at expiration. they is a breakeven when (X-St)=price of the option we know the value of X and the value of St

You bought the asset at 100(so you spend 100) and you bought the option at a price P
Now you can exercice the option at a price of 114.

so for you to breakeven, you have to have (114-100)= P which impy that P=14

orang3eph

I suppose the explanation for the futures contract is that since the holder is short 5000 ounces of futures contract @ $8/ounce (total of $40000). Therefore, the price will will have to increase by (2025-1500)/40000 for a margin call.

The new price becomes:
1.01313*8 = $8.11

Is this explanation right because that is the choice CFA picked as the right answer.

amqata

nevCFA's logic is the right one but I think that he/she's missed that it's a short position, not a long position.

The investor is short - he's a seller - so he loses out if the price of the future RISES. He's locked in at $8/ounce whereas new sellers are getting more than that.

So, you can rule out A and B straightaway.

If the price rises by more than the initial margin less the maintenance margin, then he will have to put up more $$$. The amount that each future has to rise by is ($2,025 - $1,500) / 5000 = 10.5c. So, if the price rises above $8.105/ounce ($8.11 - answer C) then he's up for a margin call.

Try not to use the total value as the denominator, always work back to a per-future value for these sorts of questions.

HTH

bapswarrior

The investor has deposited $2,025. This has to fall to $1,500 for there to be a margin call, that is fall by $2,025 - $1,500 = $525.
That is a fall in price per ounce of $525 / 5,000 = $0.105
Price to fall to = $8 - $0.105 = $7.895 (option B)

NC

johnnyBuz

ADISON2000 Wrote:
-------------------------------------------------------
> Hi fellow L1 candidates,
>
>
> Also I do not understand how this out-of-the-money
> American put was worth 14 at the time of purchase
> (that is, option D):
>
> The current price of an asset is 100. An
> out-of-the-money American put option with an
> exercise price of 90 is purchased along with the
> asset. If the breakeven point for this hedge is
> at an asset price of 114 at expiration, then the
> value of the American put at the time of
> purchase must have been:
> A. 0.
> B. 4.
> C. 10.
> D. 14.

Both the asset and the put is purchased. At a price of 114 the profit from the asset = 114 - 100 = 14.
For breakeven we have:
profit from asset = loss on put

Put pays nothing, and the loss on it is 14 (ignoring discounting).

Hence price of put = 14.

NC