Unit 16 Assessment — Derivatives & Risk Management

📞 Options: Calls & Puts

📈 Options Payoffs & Strategies

📦 Futures & Forwards

🔁 Swaps & Risk Management

Calls & Puts — Basics

Call OptionRight (not obligation) to BUY the underlying asset at the strike price (K) before expiration

Put OptionRight (not obligation) to SELL the underlying asset at the strike price (K) before expiration

Option PremiumPrice paid for the option = Intrinsic Value + Time Value

In-the-Money (ITM)Call ITM: S > K · Put ITM: S < K

Black-Scholes InputsS (stock price), K (strike), T (time), r (risk-free rate), σ (volatility)

Payoffs at Expiration

Call Buyer PayoffMax(S − K, 0) − Premium paid

Call Seller PayoffPremium received − Max(S − K, 0)

Put Buyer PayoffMax(K − S, 0) − Premium paid

Put Seller PayoffPremium received − Max(K − S, 0)

Protective PutOwn stock + buy put = insurance floor; limits downside while preserving upside

Futures & Forward Contracts

Forward ContractPrivate agreement to buy/sell at a set price on a future date — no exchange, counterparty risk

Futures ContractStandardized exchange-traded forward; marked to market daily; minimal counterparty risk

Long FuturesAgree to BUY — profits if price rises · Hedges future purchase price risk

Short FuturesAgree to SELL — profits if price falls · Hedges future sale price risk

Hedging with FuturesShort hedge: own asset, short futures · Long hedge: need asset in future, long futures

Swaps & Risk Types

Interest Rate SwapExchange fixed-rate payments for floating-rate (or vice versa) on a notional principal

Currency SwapExchange principal and interest in different currencies — manages exchange-rate risk

Swap SettlementOnly the NET difference in payments is exchanged (not full principal)

Market RiskRisk from price movements (interest rates, equity, FX, commodities)

Credit RiskRisk counterparty defaults — reduced with exchange-traded derivatives & central clearing

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out of 100 points

—

Section 1

—/40

Multiple Choice

Section 2

—/20

True / False

Section 3

—/20

Short Answer

Section 4

—/20

Extended Response

⚠ Sections 3 & 4 are teacher-graded. Use the rubric selectors below to finalize the score.

Multiple Choice

Select the best answer · Option payoffs, futures hedging, swaps & risk management calculations

2 pts each · 40 pts

Click the best answer. Use the formula reference panel and payoff strip above. Each question is worth 2 points.

True or False

Click TRUE or FALSE for each statement

2 pts each · 20 pts

Select TRUE or FALSE for each statement. Each is worth 2 points.

Short Answer

Show all calculations + explain in 2–4 sentences · Teacher-graded

5 pts each · 20 pts

Answer in 2–4 complete sentences. Show every calculation step clearly. Rubric selectors appear after grading.

Extended Response — Bessemer Steel Supply: Commodity & Interest Rate Risk Management

Futures hedge · Interest rate swap · Options protection · Risk strategy memo · Teacher-graded

20 pts

Read the scenario carefully. Write a well-organized risk management memo of at least 8 sentences. Show all calculations with labeled steps. Use and underline at least four unit vocabulary terms.

📋 Scenario — Bessemer Steel Supply Co.: Hedging Commodity & Rate Risk

Bessemer Steel Supply Co. (BSS) is a Black-owned metal distributor supplying contractors across Alabama. BSS faces two major financial risks: (1) the price of steel it must purchase in 90 days could spike, and (2) its $1,000,000 floating-rate bank loan exposes it to rising interest rates. The CFO has asked you to design a risk management plan using derivatives.

Steel Purchase Risk

BSS must buy 500 tons of steel in 90 days · Current spot price: $800/ton · Steel futures price (90-day): $820/ton · Each contract = 100 tons

Outcome Scenarios

Scenario A: Steel rises to $900/ton in 90 days · Scenario B: Steel falls to $750/ton in 90 days

Interest Rate Risk

Loan: $1,000,000 · Current floating rate: SOFR + 2% = 6% total · BSS fears SOFR will rise · Fixed-rate swap available: 7%

Options Alternative

Call options on steel: strike $820/ton · Premium: $15/ton · Available for the same 500-ton exposure

35 Write your full risk management memo covering all four parts: (a) Design the futures hedge for BSS's steel purchase risk — state whether BSS should go long or short, how many contracts, and calculate the net cost of steel under both Scenario A (price rises to $900) and Scenario B (price falls to $750), showing the futures gain/loss and net effective price per ton in each case; (b) Explain the interest rate swap BSS should enter — who pays fixed, who pays floating, and calculate the annual net swap settlement payment if SOFR rises to 5% (making the floating rate 7%) and if SOFR stays at 4% (making the floating rate 6%); explain BSS's motivation in each scenario; (c) Compare the futures hedge (Part a) to buying call options at a $15/ton premium — calculate BSS's net cost under Scenario A and Scenario B using the call option strategy, and explain ONE advantage and ONE disadvantage of using options instead of futures for this hedge; (d) Write a 2–3 sentence strategic recommendation to the BSS board on which combination of derivatives best protects the company's cash flows, and explain why risk management with derivatives is essential for small community businesses with tight margins. Use at least four underlined vocabulary terms.

📋 Teacher Scoring Rubric

Criterion	Excellent (Full)	Proficient (Partial)	Developing (Minimal)	Score
Part (a) — Futures Hedge Design & Net Costs Go LONG 5 contracts (500 tons ÷ 100 tons/contract) · Scenario A: Futures gain = (900−820)×500 = $40,000; Cash cost = 900×500 = $450,000; Net = $450K−$40K = $410K → $820/ton · Scenario B: Futures loss = (820−750)×500 = $35,000; Cash cost = 750×500 = $375,000; Net = $375K+$35K = $410K → $820/ton · Hedge locks in $820/ton in both scenarios	Long 5 contracts stated; both net costs correct at $820/ton with gain/loss shown; "locks in" interpretation	Correct direction (long) and contract count; one scenario correct; minor arithmetic	Direction correct but contract count wrong, or only one scenario attempted	/7
Part (b) — Interest Rate Swap BSS pays fixed 7%, bank pays floating (SOFR+2%) · If SOFR rises to 5%: floating = 7%; net settlement = 0 (7%−7%); BSS is protected from higher cost · If SOFR stays at 4%: floating = 6%; net: BSS pays extra 1% on $1M = $10,000/year to swap counterparty — the cost of insurance against rate rises	BSS pays fixed / counterparty pays floating clearly stated; both settlement calculations correct; motivation explained (protection vs. cost of protection)	Swap direction correct; one settlement correct; partial motivation	Swap concept misapplied; no settlement calculations	/5
Part (c) — Call Option Comparison Call option: pay $15/ton premium = $15×500 = $7,500 total · Scenario A (S=$900 > K=$820): exercise call; net cost = 820+15 = $835/ton → $417,500 total · Scenario B (S=$750 < K=$820): don't exercise; buy at spot $750; net cost = 750+15 = $765/ton → $382,500 total · Advantage: options allow benefit from price decline (Scenario B cheaper) · Disadvantage: upfront premium cost; effective floor is $835 not $820	Both option net costs correct; one advantage (asymmetric payoff — can benefit if price falls) and one disadvantage (premium paid upfront regardless) clearly stated	One net cost correct; advantage or disadvantage stated but not both	Premium calculation only; no comparison to futures	/4
Part (d) — Strategic Recommendation	Recommends futures for steel (certainty, no premium cost, $820/ton locked) + interest rate swap (converts unpredictable floating rate to fixed 7%, enabling accurate cash flow planning); argues that thin-margin community businesses cannot absorb commodity or rate spikes — derivatives convert uncertainty into planned costs; ≥4 underlined vocabulary terms used professionally	Recommendation includes both derivatives; partial reasoning; some vocabulary terms	Only one derivative addressed; no community business rationale; fewer than 2 vocabulary terms	/4

Extended Response Total: — / 20

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