*Question 1a: Open** interest tends to be low when a contract with a new expiration is first listed for trading, and it tends to be small after the contract has traded for a long time. Explain.*
When the agreement is initially listed for exchange or trading, open interest is virtually zero. As investors take positions, free interest develops. Therefore, at the end of the trading, public interest returns to zero. Each contract would have been realized by offset, provision, or an EFP. Thus, as the agreement approaches the end of the month or period, several traders would offset their locations to escape delivery. This significantly reduces or minimizes open interest. At the end of the trading, deliveries that happen further decrease open interest. Additionally, EFPs usually minimize public interest. This develops a series of each low open interest in the agreement’s initial days of doing business, followed by rises, then diminution, and lastly, contract termination.
*Question 1b: Explain** why the futures price converges to the spot price and discuss what would happen if this convergence failed.*
The description for the convergence at the extension or expiration relies on whether the market presents cash settlement or deliveries, but in every incidence, convergence relies on common arbitrage arguments. Traders consider every type of the agreement in turn; however, for a deal with real delivery, future convergence provides increase to an arbitrage chance at delivery. Nonetheless, the cash price may either be below or above the next value, if the two are not same. If the cash value is higher than the future price, the investor or business person purchase the future, leaving the delivery, and resells the product in the cash market at a slightly higher price. However, if the price is more than the cash price, the trader acquires goods on the cash market, markets futures, and provides the cash item in the realization of prospects. To isolate both kinds of cash markets together, the future price should be equal as the cash price at the end. Small differences may exist. This is because of the transaction costs and the idea that the short business person owns chances linked with starting the delivery pattern.
For the contract with cash settlement, shortfall of convergence means arbitrage. Before delivery, in case the future value becomes higher than the cash price, a business person can dispose of the future costs, wait for the end of the business period, and the future prices would be set to be same as cash price. This provides a profit, which is same as the difference between the futures and cash. On the other hand, if the cash price is more than future value, and end if imminent, the entrepreneur may purchase the future and hold on for the costs to rise to equate cash price. Therefore, regardless of whether future expenses if below or above the cash price, the profit opportunity would be accessible instantly. In summary, the cash and coming price convergence at the end of the business to exclude arbitrage, and failure of the convergence means there is arbitrage chances or opportunities.
*Question 2. Suppose that the Jewellery Company is planning to sell twenty thousand ounces of platinum at some future date. The standard deviation of changes in the futures price per ounce sd (F) is 11.86% that for changes in the spot price per ounce sd (S) is 12.38%, and the correlation coefficient between the spot and futures price changes corr(S, F) is 0.60.*
*a. **Compute the optimal hedge ratio for Jewellery Co. *