...You are expecting IBM stock price to go up in next 8 months, however you are not completely sure. So you decide to use just one option, either European call or European put on IBM stock maturing in 8 months to bet on your view about IBM’s stock price prospects. Suppose that the current stock price and the strike price for both call and put on the IBM stock is $50. (a) What option will you invest in? Explain. Call. Call price will go up if the stock price goes up. The losses are limited by the option premium paid. (b) At what price will you breakeven if both put and call options are sold for the same premium of $5 Breakeven stock price $50+$5 = $55 (c) Assume that the risk free rate is 3% per annum. Also assume that the standard deviation of IBM’s stock return is 30% per year. What is the Black-Scholes value of the option you have identified in part a? Step 1: find d1 and d2 d_1=(ln(50/50)+(0.03+〖0.30〗^2/2)×8/12)/(0.30×√(8/12))=0.2041 d_2=0.2041-0.30×√(8/12)=-0.0408 Step 2: find N(d1) and N(d2) Using the cumulative normal table obtain N(d1) = N(0.20) = 0.5793 and N(d2) = N(-0.04) = 0.4841 Step 3: calculate the call option value c=$50×0.5793-$50×e^(-0.03×(8/12) )×0.4841=$5.2393 (d) What is the time value of the option you have identified in part a? Because the stock price equals the strike price ($50) the total value of the option would consist of time value only, therefore the time value of this option is $5.2393 Problem 2 You anticipate that the volatility...
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...FNCE90011 Derivative Securities Topic 1 Fundamentals Topic Outline Basic Concepts Option Payoff and Profit Diagrams Miscellaneous Complicated Payoffs Appendix: Market Structure References Hull (8th edition) Chapters 1, 4.2, 5.2, 9, 11 Hull (7th edition) Chapters 1, 4.2, 5.2, 9, 11 Hull (6th edition) Chapters 1, 4.2, 5.2, 8, 10 Copyright © John C. Handley 2012. 1. BASIC CONCEPTS What is a derivative ? A derivative is an asset/security whose value is completely determined by the values of one or more other ("underlying" or "state") variables. In many cases the underlying variable is the price of a traded asset such as … stocks / shares stock index bonds / interest rates currencies commodities other derivatives And sometimes the underlying variable appears to be a bit “crazy” … such as in the case of weather derivatives 2 The derivatives market is the market where derivative securities are traded The four “big” classes of derivatives are: (i) forwards and futures Users Of Derivatives hedger already has an exposure to future movements in the price of the underlying asset and is interested in reducing risk eg: you own a share and you think the stock price will fall but you do not want to sell the share … what can you do ? (ii) options (iii) swaps (iv) credit derivatives 3 speculator wishes to take a position in the market i.e. to take on risk with a view to making a profit. Either he is betting that the asset price will go up or that it will go down eg: you think...
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...1 Table 2 Table 3 Table 4 Table 5 Table 6 Table 7 Table 8 Table 9 Table 10 Table 11 Table 12 Table 13 Table 14 Table 15 Table 16 Table 17 Table 18 Table 19 Table 20 Table 21 Table 22 Table 23 Table 24 Content DCF Analysis Variables Regression Analysis WACC Calculations Payback Period Depreciation Call Option - NYSE Call Option - S&P 500 Put Option - NYSE Put Option - S&P 500 Sell A Call - NYSE Sell A Call - S&P 500 Sell A Put - NYSE Sell A Put - S&P 500 Covered Call - NYSE Covered Call - S&P 500 Protective Put - NYSE Protective Put - S&P 500 Protective Collar - NYSE Protective Collar - S&P 500 Long Straddle - NYSE Long Straddle - S&P 500 Short Straddle - NYSE Short Straddle - S&P 500 Table of Exhibits List of exhibits Exhibit A Exhibit B Exhibit C Exhibit D Exhibit E Exhibit F Exhibit G Exhibit H Exhibit I Exhibit J Exhibit K Exhibit L Exhibit M Exhibit N Exhibit O @ RISK Sensitivity analysis Change in Stock Price - NYSE Payback Period - NYSE Change in Stock Price – S&P 500 Payback Period – S&P 500 Call Option - 2034 Put Option - 2034 Long straddle - 2034 Short straddle - 2034 Input Results Output Results Detailed Statistics Sensitivity Analysis Scenario Analysis Model Inputs...
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...because their values are derived from underlying assets, are a powerful tool used in business today. These instruments can be used for two very distinct management objectives: Speculation – use of derivative instruments to take a position in the expectation of a profit Hedging – use of derivative instruments to reduce the risks associated with the everyday management of corporate cash flow 3 1 Foreign Currency Derivatives Derivatives are used by firms to achieve one of more of the following individual benefits: Permit firms to achieve payoffs that they would not be able to achieve without derivatives, or could achieve only at greater cost Hedge risks that otherwise would not be possible to hedge Make underlying markets more efficient Reduce volatility of stock returns Minimize earnings volatility Reduce tax liabilities Motivate management (agency theory effect) 4 Foreign Currency Derivatives What are they? Forward contracts Futures contracts Options Swaps 5 Foreign Currency Futures A foreign currency (FX) futures contract is an alternative to a forward contract that calls for future delivery of a standard amount of foreign exchange at a fixed time, place and price. It is similar to futures contracts that exist for commodities such as cattle, lumber, interest-bearing deposits, gold, etc. In the US, the most important market for foreign currency futures is the International Monetary Market (IMM), a division of the Chicago Mercantile...
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...financial results. There are three main types of foreign exchange exposures are (1) transaction (short-term), (2) economic (medium to long term) and (3) translation exposures. For a company like Tiffany which has sales in numerous countries, there are a continuing series of foreign currency receivables and payables. Thus, Tiffany should have a foreign currency hedging program to cover these foreign exchange exposures. The objective of hedging would be to stabilize product costs, over the short-term, despite exchange rate fluctuations. In the long-term, if exchange rate differences have significantly changed, it is possible to adjust retail prices when necessary to maintain its gross margin. To reduce exchange rate risk on its yen cash flow, Tiffany had two basic...
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...(A.) Introduction This paper provides an overview of how the various component of the Black Scholes model impact the option price and to what degree. The 6 determinants of the BS model namely stock price, strike price, time to expired, volatility, risk free interest rate and dividend are explained as well as their relative impacts of Call and Put prices. This is followed by discussions of a case study on a company UWA which has decided to change its performance rewards policy from bonus payout to an options offer and whether the management would actually benefit from such a program. Finally another case study covering the financial relationship between Macdonalds Corporation and its subsidiary in UK and the various arrangements between the firms. The paper analyses the benefit of hedge policies using cross currency swaps and whether Macdonalds should recognize its profit and loss for Cross currency swaps as OCI (Other Comprehensive Income) in its Revennue statements and the potential impacts. This submission is part of the Main Assignment for the Advanced Treasury Management – Financial Engineering module as part of MSC 25 course. (1a.) is the cumulative distribution function of the standard normal distributionS is the spot price of the underlying assetT − t is the time to maturityK is the strike pricer is the risk free rateN(d1) and N(d2) represent log normal distribution values. | Options are derivative instruments that give investors the right to buy or sell...
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...Classnote Prof. Gordon Bodnar Techniques for Managing Exchange Rate Exposure A firm's economic exposure to the exchange rate is the impact on net cash flow effects of a change in the exchange rate. It consists of the combination of transaction exposure and operating exposure. Having determined whether the firm should hedge its exposure, this note will discuss the various things that a firm can do to reduce its economic exposure. Our discussion will consider two different approaches to handling these exposures: real operating hedges and financial hedges. Transaction Exposure Financial Techniques of Managing Transaction Exposure Transaction exposure hedging should have been discussed in some detail in the previous international finance course; however, we will briefly go over the standard financial methods available for hedging this exposure. The main distinction between transaction exposure and operating exposure is the ease with which one can identify the size of a transaction exposure. This, combined with the fact that it has a well-defined time interval associated with it makes it extremely suitable for hedging with financial instruments. Among the more standard methods for hedging transaction exposure are: i) Forward Contracts - When a firm has an agreement to pay (receive) a fixed amount of foreign currency at some date in the future, in most currencies it can obtain a contract today that specifies a price at which it can buy (sell) the foreign currency at the specified...
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...faster rate in near future. The emergence of the market for derivatives products, most notably futures and options, can be tracked back to the willingness of risk-averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices. By their very nature, the financial markets are marked by a very high degree of volatility. Through the use of derivative products, it is possible to partially or fully transfer price risks by locking-in asset prices. As instruments of risk management, these generally do not influence the fluctuations in the underlying asset prices. However, by locking-in asset prices, derivative product minimizes the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-averse investors. However, the use of F&O has grown into other segments like leveraged trading and arbitrage. 2.0 OBJECTIVES OF THE REPORT: To get a basic understanding of what these instruments are and how are these instruments used in the financial market. 3.0 WHAT AREDERIVATIVES: Derivatives are financial instruments, which derive their value from an underlying asset. The underlying asset can be bullion, index, share, bonds, currency, interest etc. For example, equity futures and options are derived from equities in the...
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...Question .1 You as an investor had purchased a 4month call option on the equity shares of X ltd of 10, of which the current market price is Rs. 132 and the exercise price is Rs. 150. You expect the price to range between Rs. 120 to 190. The expected share price of X ltd and related probability is given below. Expected price | 120 | 140 | 160 | 180 | 190 | probability | .05 | .20 | .50 | .10 | .15 | Compute following 1. Expected share price at the end of 4months 2. Value of the ex call at the end of 4 months, if the exercise price prevails 3. In case the option is held to maturity, what will be the expected value of the call option? Question 2 Yes limited wants to aquire No ltd and the cash flows of Yes ltd and the merged entity are given below Rs in lakhs | Year | 1 | 2 | 3 | 4 | 5 | Yes ltd | 175 | 200 | 320 | 340 | 350 | Merged entity | 400 | 450 | 525 | 590 | 620 | Earnigs would have witnessed 5% constant growth rate without merger and 6% with merger on account of economies of operations after 5 years in each case. The cost of capital is 15%. The number of shares outstading In both the compaines before the merger is the same and the companies agree to an exchange ratio of 0.5 shares of Yes Ltd for each share of No Ltd. Pv factor at 15% for t years 1-5 are 0.870, 0.756, 0.658, 0.572, 0.497 respectively. You are required to 1. Compare the value of Yes Ltd before...
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...Class, This is a set of information comparing IP Contact Call Centers in side-by-side analysis that was created by Faulkner’s FACCTs several years ago. You can see that they do cover information on each company, the features that are in each product, and even some basic pricing information. You are going to use this as if it is the compiled responses from a real RFP. This information will help you assign vendor scores in your table, and help you decide which vendor to use. IP Contact Call Centers: Side-by-Side |The right IP contact call center can make potential new customers go away happy. A conventional “Your call is important to us…” call | |center—in today’s age of Internet gratification—will likely just make them go away. | | | |Take a conventional call center, put it over an IP-telephony infrastructure, plug in a multimedia server or two and upgrade the agent PC | |client software, and presto—you’ve got all the makings of an IP contact center. It’s not quite that easy, of course. Contact centers—so | |called because they add customer-interaction channels beyond just voice—represent considerable added complexity, and cost, over voice-only | |call centers. ...
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...Overview................................................................................................................................1 20.1 Financial Options...........................................................................................................2 Call Options ......................................................................................................................2 Put Options......................................................................................................................5 American, European, and Bermudan Options.................................................................6 More on the Shapes of Option Payoff Functions.............................................................7 20.2 Option Valuation............................................................................................................8 Limits on Option Values...................................................................................................8 Variables That Affect Option Values..............................................................................10 The Binomial Option Pricing Model ...............................................................................12 . Put-Call...
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...20.1 Option Basics • Financial Option: A contract that gives its owner the right (but not the obligation) to purchase or sell an asset at a fixed price as some future date • Call Option: A financial option that gives its owner the right to buy an asset • Put Option: A financial option that gives its owner the right to sell an asset • Option Writer: The seller of an option contract • Exercising an Option: When a holder of an option enforces the agreement and buys or sells a share of stock at the agreed-upon price • Strike Price (Exercise Price): The price at which an option holder buys or sells a share of stock when the option is exercised • Expiration Date: The last date on which an option holder has the ri p g p ght to exercise the option Ameri can Option: Options that allow their holders to exercise the option on any date up to, and including, the expiration date • European Option: Options that allow their holders to exercise the option only on the expiration date Note: The names American and European have nothing to do with the location where the options are traded. The option buyer (holder): Holds the right to exercise the option and has a long position in the contract • The option seller (writer): Sells (or writes) the option and has a short position in the contract • Because the long side has the option to exercise, the short side has an obligation to fulfill the contract if it is exercised. The buyer pays the writer a premium. Stock options are traded...
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...2: Real Options Chapter Introduction and Objectives: Managers often overrule NPV based recommendations in capital budgeting on strategic grounds. Does it mean that the NPV approach is flawed? The standard DCF methodology assumes that managers make an investment decision and then see how the market evolves. In many situations managers can wait and then make a decision. The latter is an option - an option to defer or time the investment decision. Pharmaceutical companies, for example, frequently enter into agreements with small biotechnology companies and Universities for research and development. The traditional DCF methodology does not work well in case of such projects because of prolonged development and uncertainty in cash flows. For gaining access to research, the pharmaceutical company makes an up-front payment and a series of progress payments. These contingent payments give the pharmaceutical company the right but not the obligation to make further investments. Such investments are best evaluated as options . The chapter has the following objectives: • Highlight different types of financial options • Bring out an analogy between financial options and real options • Highlight the different types of real options • Introduce valuation of real options Consider a project that has a best outcome of $ 13 m and a worst outcome of $ 9 m. Each of these outcomes are equally likely to occur (probability is 0.5). The expected value of the project...
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...argument that traditional discounted cash flow models do a poor job of capturing the value of the options embedded in many corporate actions. They have noted that these options need to be not only considered explicitly and valued, but also that the value of these options can be substantial. In fact, many investments and acquisitions that would not be justifiable otherwise will be value enhancing, if the options embedded in them are considered. In this paper, we examine the merits of this argument. While it is certainly true that there are options embedded in many actions, we consider the conditions that have to be met for these options to have value. We also develop a series of applied examples, where we attempt to value these options and consider the effect on investment, financing and valuation decisions.3 In finance, the discounted cash flow model operates as the basic framework for most analysis. In investment analysis, for instance, the conventional view is that the net present value of a project is the measure of the value that it will add to the firm taking it. Thus, investing in a positive (negative) net present value project will increase (decrease) value. In capital structure decisions, a financing mix that minimizes the cost of capital, without impairing operating cash flows, increases firm value and is therefore viewed as the optimal mix. In valuation, the value of a firm is the present value of the expected cash flows from the assets of the firm. In recent...
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...68 days since that is the option's time to expiration. 2. (Minimum Value of a Call) This would create an arbitrage opportunity. The call would be purchased and immediately exercised. For example, suppose S0 = 44, X = 40, and the call price is $3. Then an investor would buy the call and immediately exercise it. This would cost $3 for the call and $40 for the stock. Then the stock would be immediately sold for $44, netting a risk-free profit of $1. In other words, the investor could obtain a $44 stock for $43. Since everyone would do this, it would drive the price of the call up to at least $4. If the call were European, however, immediate exercise would not be possible (unless, of course, it was the expiration day), so the European call could technically sell for less than the intrinsic value of the American call. We saw, though, that the European call has a lower bound of the stock price minus the present value of the exercise price (assuming no dividends). Since this is greater than the intrinsic value, the European call would sell for more than the intrinsic value. Then at expiration, it would sell for the intrinsic value. 3. (Lower Bound of a European Call) The call is underpriced, so buy the call, sell short the stock, and buy risk-free bonds with face value of X. The cash received from the stock is greater than the cost of the call and bonds. Thus, there is a positive cash flow up front. The payoffs from the portfolio at expiration are as follows: ...
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