QUESTION 2:

a) What is a short hedge using futures? When is it appropriate?

b) Assume that the risk-free rate is 2% per annum (continuous compounding) for all maturities. Compute the six-month forward prices of the following assets:

i) A stock index that provides a continuous dividend yield of 7% per annum. The current spot price of the index is $1840.

ii) A share that will distribute a $2 dividend in 2 months. The current spot price of the share is $23.

c) What is a lower bound for the price of a three-month European put option on a non-dividend-paying stock when the stock price is $340, the strike price is $385, and the risk-free rate is 10% per annum?

d) Describe the marking-to-market process for futures contracts.

e) Can futures prices become negative? Is your answer the same for all types of underlying assets? Try to support your answer using academic theory and empirical examples.