Question 4 Financial Derivatives (10 marks)

4.1To construct a hedge against price risk, futures contracts are better than forward contracts. Explain THREE reasons? (3 marks)

4.2 Explain the following:

a. A firms cash flows are risky for various reasons. Explain THREE sources of risk or volatility in firm cash flows. (3 marks)

b. How does a call option differ from a put option? (1 mark)

4.3 Currently, a call option on Minelli Enterprises Limiteds ordinary share is selling for $1.20 (option premium). The exercise price is $21.00. Assuming the stock price at expiration is $25.50, calculate the breakeven point, profit, or loss, the option holder makes at the expiration date. (3 marks)