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1. Is a total return swap on a bond the same as a credit default swap? Why or why not? 2. “Speculators want futures contracts to be incorrectly priced; hedgers want them to be correctly priced.” Why?...

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1. Is a total return swap on a bond the same as a credit default swap? Why or why not?

2. “Speculators want futures contracts to be incorrectly priced; hedgers want them to be correctly priced.” Why?

3. Your investment bank has an investment of $100 million in the stock of the Swiss Roll Corporation and a short position in the stock of the Frankfurter Sausage Company. Here is the recent price history of the two stocks:

Month

Frankfurter Sausage

Swiss Roll

January

-10

-10

February

-10

-5

March

-10

0

April

+10

0

May

+10

+5

June

+10

+10

On the evidence of these six months, how large would your short position in Frankfurter Sausage need to be to hedge you as far as possible against movements in the price of Swiss Roll?

Answered Same Day Dec 24, 2021

Solution

Robert answered on Dec 24 2021
103 Votes
Ans1)
Ans2) If futures are underpriced, he will still be hedged by selling futures and bo
owing, but he
will make a known loss (the amount of underpricing). If, for example, he hedges by selling
seven-month futures, he not only needs to know that they are fairly priced now but also that they
will be...
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