A cattle farmer plans to buy live cattle in 3 months' time. Suppose cattle is traded in units of 100 live animals. Let the price of one cattle contract, i.e. price of 100 live animals, at time t be St, where time is measured in months. The farmer enters into a long forward contract on cattle with 3 months to delivery date and a forward price of K. You may ignore any income or expenses during the contract term. (a) Discuss the relative advantages and disadvantages of the farmer's strategy. After one month, suppose cattle prices are such that S₁ < K. At that point of time, the
A cattle farmer plans to buy live cattle in 3 months' time. Suppose cattle is traded in units of 100 live animals. Let the price of one cattle contract, i.e. price of 100 live animals, at time t be St, where time is measured in months. The farmer enters into a long forward contract on cattle with 3 months to delivery date and a forward price of K. You may ignore any income or expenses during the contract term. (a) Discuss the relative advantages and disadvantages of the farmer's strategy. After one month, suppose cattle prices are such that S₁ < K. At that point of time, the
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Please write part d also
Transcribed Image Text:A cattle farmer plans to buy live cattle in 3 months' time. Suppose cattle is traded in units
of 100 live animals. Let the price of one cattle contract, i.e. price of 100 live animals, at time
t be St, where time is measured in months.
The farmer enters into a long forward contract on cattle with 3 months to delivery date and
a forward price of K. You may ignore any income or expenses during the contract term.
(a) Discuss the relative advantages and disadvantages of the farmer's strategy.
After one month, suppose cattle prices are such that Sı < K. At that point of time, the
farmer buys a 2-month European put option contract on cattle with strike price K.
(b) Draw and label a consolidated payoff diagram for the farmer who is now holding a
combination of a 2-month European put option contract with strike price K and a long
forward contract with delivery price K and 2 months left to delivery date.
(c) Discuss the considerations behind the farmer's strategy to purchase the European put
option contract in addition to the existing long forward contract.
(d) Explain the pattern behind the consolidated payoff of the farmer's strategy using the
relationship of put-call parity.
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