Philipp Illeditsch Fall 2009 Financial Derivatives (206/717) Sections 401, 402, 403 The Wharton School, University of Pennsylvania First Midterm Exam Y ou hav e one hour and 20 min utes to comple te this exam. Please show you r work and clearly state any assump tions you are makin g. I cannot give part ial credi t unless y ou explain what you are doing. If you get stuck at one step, explain as clearly as possibl e what you w ould do, and move on to the next step. If you are in any doubt about what I am asking in a question, tell me what you are assuming in answering the question. Watch the ti me. Att empt all questio ns. Ther e are FIVE questi ons in total . Question 1 (20 points) The current yield curve for risk free rates (both borrowing and lending) is: 1 month 1% 2 months 1.5% 3 months 2% 4 months 2.5% 5 months 3% 6 months 4% 7 months 4.5% (All rates are con tin uously compoun ded. F or exampl e, the 5 mon th rate means that if you invest $100 today, you will have 100 e 5 12 ×0.03 in 5 months.) The current stock price of ABC is $80 and ABC pays a $5 dividend each quarter (the next dividend payment is due in one month). There are no transaction cost. (a) What is the 6-month forward price? (b) Suppose the 2-month forward price is $75 .5. You work for an arbitrage desk that just shorted one million of these 2 -month forward contracts. Y ou are asked to lock in an arbitrage profit. Describe in detail the arbitrage strategy and determine the total arbitrage profit. 1
