36 Smart/Gitman/Joehnk • Fundamentals of Investing, Thirteenth Edition
Suggested Answers to “Famous Failures in Finance” Questions
Federal regulation of derivatives businesses would probably have led to closer scrutiny and less egregious
Suggested Answers to Discussion Questions
1. Because of mergers and consolidation, the list of exchanges is constantly changing and WSJ
coverage is not as complete as it once was. To find quotes, from the WSJ home page, go to
Markets/Market Data/Commodities and Futures, then use the drop down menu from under whatever
commodity chart is showing at the time.
c. CBOT—corn, ethanol, Treasury bond; KCBT—wheat; CME—cattle, hogs, Japanese yen;
2. (Note : dates referenced in this question are not available in figures 15.3 and 15.4.
3. a. (1.0365 1.0180) 12.5 million yen 231,250 3 693,750 yen profit
Solutions to Problems
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37 Smart/Gitman/Joehnk • Fundamentals of Investing, Thirteenth Edition
Note: Some of these problems require students to search for current futures contract
terms (e.g., contract size or initial margin) online.
15.1 Josh Rink gained four cents a pound on one cotton contract (50,000 lb). Thus, his total profit is:
His return on invested capital, therefore, is:
15.2 Market value of contract Price per pound Pounds in contract
15.3 Market value of contracts 4 ($0.888 50,000) 4 44,400 $177,600
15.5 Oats trade in 5,000 bushel contracts and are priced in cents/bushel. Because this is a short sale, the
selling price will be 248 (the current quote) and the purchase price will be 240 (the expected
price); thus, the value of the contract will be
Note that we will get the same rate of return by combining the three contracts into a single
investment:
15.6 Treasuries are quoted in 32nds, so the quote is 111 and 8/32% of par value, or 111.25 percent of
15.7 A Treasury bond contract covers $100,000. If he purchases one for 92 15/32 and sells it for 98, his
return will be
15.8 To short three contracts with a margin deposit of $19,688 (each) would require an investment of
The S&P 500 Stock Index futures are valued at 250 times the index; the value of each S&P 500
contract is
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Chapter 15 Futures Markets and Securities 38
Because an investor makes money in a short sale when the price of the security drops, the profit
and return on invested capital in this transaction would be substantial:
15.9 a. Since the investor’s bond portfolio is worth $500,000, he needs to short 5 T-bond futures
b. T-bond hedge:
Profit on the T-bond short sale:
15.10 a. Because Vanessa’s portfolio consists of blue chip stocks—stocks of major, well-established
b. The value of Vanessa’s portfolio is $3,800,000. One DJIA futures contract is worth $119,600
Profit on futures hedge:
The net loss on the hedged portfolio is $800 ($499,200 total profit on the hedge minus
e. The margin deposit is only a deposit; she will get it back.
15.12 Dollars $1.1050 125,000 $138,125
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39 Smart/Gitman/Joehnk • Fundamentals of Investing, Thirteenth Edition
15.13 If the American currency speculator wants to profit on a decline in the value of the Canadian
15.14 The purchase price of the gold call option would be:
Chapter 15 Futures Markets and Securities 40
This case deals with stock index futures and demonstrates how they can be used to hedge a portfolio of
a. The reason for the hedge is to protect the capital invested in the stock portfolio—if the market
does indeed drop, then the capital value of the Pernelli portfolio is likely to decline as well. Setting
up a short hedge with stock index futures would (fully or partially) protect the capital investment
1. The Pernellis have several alternatives, including: (1) short selling all or most of the portfolio;
(2) buying puts on all or most of their stocks; or (3) using stock index options to hedge their
2. The benefits of hedging with stock index futures are the amount of protection purchased with
such low cost/investment and the ease of setting up the hedge (with a single instrument that
b. The short hedge can be set up by short selling one S&P 400 Midcap futures contract; at a quote of
769.40, the underlying value of one contract will be just above the value of the Pernellis’ $375,000
portfolio:
Value of the S&P 400 Midcap futures contract 769.40 $500 $384,700
c. 1. Profit from futures contract:
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41 Smart/Gitman/Joehnk • Fundamentals of Investing, Thirteenth Edition
2. The stock index futures hedge failed simply because the Pernelli portfolio did not behave
d. This hedge would be set up with puts. Accordingly, the put would cost:
It would have a value at the end of the investment period of:
While it takes a little less money to set up a put hedge than a futures hedge, the put hedge is not
always as effective, as this problem demonstrates. Clearly, the same type of protection is obtained,
Answers to CFA Questions (Part VI)
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Chapter 15 Futures Markets and Securities 42
12. b
Outside Project
Chapter 15 What Is the Mystery in Futures Markets?
For most investors, the futures markets are about as familiar as the Hong Kong Stock Exchange. These
markets are highly specialized and can be quite volatile. However, knowledge of the futures market can be
The active trading life of any futures contract is relatively short. This means that for this project you are
only going to need weekly trading data going back just three months. The contract that is closest to its
expiration is usually the most active and the one that you should study. Select one contract in each of the
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