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Hedging strategies using future(Hull's chapter 3)----2011 Practice question

quest. #152.1

David, after solving this question i realised that my solution was different from yours. i would appreciate it if you confirm whether my answer to the question is correct or wrong. i am confused if i did the right thing, although i had the orrect answer. please find my solution below;

S2 - S1 = 7.3-7.0 =0.30
F2 - F1 = 9.1-9.0=0.10
Basis = (S2-S1) - (F2 - F1)
= 0.30 - 0.10
= +0.20(strenthening of the basis)
 

David Harper CFA FRM

David Harper CFA FRM
Staff member
Subscriber
Hi barrour,

My answer is:
152.1. C. Basis strengthens by +$0.20 because -1.80 - (-2.00) = +0.20
basis T1 = $7.00 - $9.00 = -$2.00
basis T2 = $7.30 - $9.10 = -$1.80
-1.80 - (-2.00) = +0.20

Such that if:
b1 = S1 - F1,
b2 = S2 - F2

change in basis = b2 - b1 = (S2 - F2) - (S1 - F1) = S2 - F2 - S1 + F1 = (S2 - S1) - (F2 - F1)
+ change = strengthen of basis; - = weaken of basis

So, your looks fine to me, and (although not teased out like this in Hull) is somewhat natural IMO: as basis is difference between spot and forward, basis change is difference between change in spot and change in forward.

Hope that confirms, thanks, David
 
hi David,

quest. 154.1: in the solution, you stated that "a single silver future contract is for 5,000 ounces." is this always the case or the you calculated it? i visited the link you gave but it couldn't populate any information for me. is this figure going to be part of the question?

thanks
 

David Harper CFA FRM

David Harper CFA FRM
Staff member
Subscriber
Hi baffour,

Are you sure about the link? see
http://www.cmegroup.com/trading/metals/precious/silver_contract_specifications.html
see Contract Size:

The exam probably will not assume you know that; the exam will almost certainly give you the contract size
(with the possible exception of the S&P 500 contract, which i think they have historically assumed you know that's $250 * Index)

I think 5,000 ounces is the only silver contract, many of them have mini-contracts

I would have included in the question, except i thought it is more interesting to link to the CME in order to add some real life color to the question... Thanks, David
 
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