| CHAPTER 1 |

Contract Settlement and Cash Flow

1.  Stock-type settlement. In stock-type settlement
the buyer must immediately pay the seller the full value of the contract, and all profits and losses are unrealized until the position is closed out.

a.   Ignoring interest considerations, describe the cash flow, realized and unrealized profit or loss, and the cumulative profit or loss resulting from the following series of trades in a stock. For purposes of realized profit or loss, the oldest trade is the basis for each calculation.

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b.   Assume that annual interest rates are 6.00% and that all trades were made at one-month intervals, where one month is exactly 1/12 of a year. What is the interest credit or debit at the end of each one-month period?

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c.   Ignoring interest compounding (interest on the interest), what is the total interest credit or debit over the entire trade sequence?

d.   Including the interest credit or debit, what is the total profit or loss resulting from the entire series of trades?

2.  Futures-type settlement. In futures-type settlement no cash changes hands between the buyer and seller when a trade is initially made. However, both parties must deposit the required margin with the exchange or clearing house. As the futures price rises or falls, there is a variation credit or debit equal to the amount of the futures price change, and all profits and losses are immediately realized.

A futures contract is currently trading at 625.80 with a point value of $200 (1.00 = $200). The margin requirement is $5,000 per contract.

a.   What is the notional value of the futures contract?

b.   Ignoring interest considerations, describe the cash flow, realized and unrealized profit or loss, and the cumulative profit or loss resulting from the following series of futures trades.

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c.   In theory, interest can be earned on a margin deposit, so there will be no interest gain or loss on a margin deposit. The cost of borrowing the required margin will be offset by the interest earned on the margin. However, as the price of the futures contract rises or falls, there will be an interest gain or loss on any variation credit or debit.

Suppose that annual interest rates are 7.80% and that all trades are made at one-week intervals, where one week is exactly 1/52 of a year. What is the interest credit or debit resulting from the variation cash flow at the end of each weekly period?

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d.   Ignoring interest compounding (interest on the interest), what is the total interest credit or debit over the entire trade sequence?

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e.   Including the interest credit or debit, what is the total profit or loss resulting from the entire series of trades?

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