Question One a) John is a farmer. In three months, his harv

Question One a) John is a farmer. In three months, his harvest will… Question Onea) John is a farmer. In three months, his harvest will be ready and he will sell a big contract of 500,000 pounds of wheat. The spot market price of wheat is now $0.50 per pound but it is likely to increase. However, John is risk averse and to protect himself against the uncertainty related to the harvest, he decides to use futures contracts as hedge. The futures contracts are worth 500,000 pounds of wheat and have a current price of $0.55 per pound and expiration date in three months. Show the cash flows of the futures contracts, of the underlying transaction and of the hedge strategy if the price of wheat at delivery date is $0.30 per pound, $0.50 per pound and $0.70 per pound.                                                                                                  (10 Marks) b) Suppose that a fund manager has a portfolio of stocks currently worth (in total) £100,000 and that on the market there are a call and a put option contracts available on the same assets of the portfolio at the price of £100 each option, with 3 months to expiration, a strike price of £100 and a premium of £1.60 for the call and £1.40 for the put.  Explain how the fund manager can hedge her position (with the call or put options) against the risk of a decline in her portfolio’s value and show a table with the portfolio value, the payoff and profit of the option, and the total profit of the hedging strategy should the value of the underlying be 60, 100, or 140 at the expiration date.                                                                                                   (10 Marks) c) Briefly explain the following statement:  “The position of a buyer of a credit default swap is similar to the position of someone who is long a risk-free bond and short a corporate bond.”  (5 marks)Total: 25 marksBusiness Finance FIN 820

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