5.50, but leave the beta of the equity portfolio unchanged at 1.08. She will use equity index and
bond futures to achieve these objectives. Exhibit 1 provides information on the relevant futures
contracts. The risk-free rate is 2.15%.
Exhibit 1
Futures Contracts Information
Beta of equity index futures contract 0.95
Price of equity index futures contract USD 125,000
Modified duration of bond futures contract 7.50
Price of bond futures contract USD 105,000
Note: Yield beta of the bond futures contract is 1.00.
A. Determine, to achieve Thurman’s desired asset allocation and bond portfolio modified
duration, the number of:
i. equity index futures contracts she should sell.
ii. bond futures contracts she should buy.
Show your calculations.
9 minutes (Answer 8-Ai on page 48 and 8-Aii on page 49)
Devon’s derivatives trading desk uses delta hedging to manage the risk of the firm’s option
positions. Devon is currently short the equity index call options shown in Exhibit 2. These three
options have the same expiration date, the same underlying index, and no material difference in
implied volatility.
Exhibit 2
Devon’s Short Options Positions
Call ID Exercise Price
C (120) USD 120
C (135) USD 135
C (148) USD 148
One week before the options’ expiration date, the index is at 133.
B. Determine, one week before expiration, which option’s delta hedge is the most difficult
to maintain. Justify your response.
3 minutes (Answer 8-B on page 50)
One of Devon’s clients is planning to acquire a competing firm in 109 days. The acquisition will
initially be financed by a USD 80,000,000 bridge loan with a term of 180 days and a rate of
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