15.407 Finance Theory - Fall 2003
Jiang Wang

Questions:

A: Think of the short rate as the "instantaneous forward rate". More detailed discussion: Assume that by entering a forward contract at time t (of principal $1), you will be promised a price of p(t,T). Then the continuous forward rate, denoted by f(t,T), is equal to log[p(t,T)]/T. Take the limit as T goes to t, we get the value f(t,t), and it is called the short rate r(t).

A: Book value of a company is the value of all its equity, that is, net asset subtract net liabilities. You can also think about it as culmulated retained earnings (and cash raised from selling stocks). Book value per share, then, is just dividing BV by number of shares outstanding. You can also think about it as how much cash is associated with each share of stock right now

3: Why does the future prices on oil is lower, although it is costly to store?

A: Crude oil has a very high demand at any point of time. As a result, the convenience yield on holding a barrel of oil is much higher than the storage cost. Therefore you see backwardation in oil futures

4: How does option prices change with maturity?
A: In most cases, it increases. The only reasonable except is for put options that are very deep in the money. But you can more or less assume that all option prices increase with maturity