Log in
HomeTextbook Notes300,000AU3,000

FINS1612 Chapter 20: Viney8e_IRM_ch20

34 views23 pages
bluebee342
22 Oct 2018
School
UNSW, UNSW Sydney
Department
Finance
Course
FINS1612
Professor
All

For unlimited access to Textbook Notes, a Class+ subscription is required.

Document Summary

Therefore, an option allows a risk manager to protect the downside of a risk exposure while at the same time leaving open the opportunity to gain from any positive price movements. 1: the writer of a call option retains the full premium so long as the current market price remains below the exercise price. If the market price goes above the exercise price, the writer begins to lose the premium. If the market price goes below the exercise price, the writer begins to lose the premium. For example, an option is covered if the writer is holding sufficient of the underlying asset, or is able to borrow the underlying asset before settlement date. Interest rates are another variable that affects the value of an option. Unlike the other variables, the relationship between interest rates and the value of the option differs between call and put options.

Get access

Grade+
$40 USD/m
Billed monthly
Grade+
Homework Help
Study Guides
Textbook Solutions
Class Notes
Textbook Notes
Booster Class
10 Verified Answers
Class+
$30 USD/m
Billed monthly
Class+
Homework Help
Study Guides
Textbook Solutions
Class Notes
Textbook Notes
Booster Class
7 Verified Answers

Related Documents

FINS1612 Chapter Notes - Chapter 11: Call Option, Option Style, Financial Instrument
tealwombat375
FINS1612
Final Exam
Study Guide
FINS1612 Study Guide - Final Guide: Interest Rate Risk, Call Option, Options Strategies
bluebee342
FINS1612 Lecture Notes - Lecture 11: Call Option, Put Option, Financial Instrument
bluebee342

Related Questions

I. Fill in the blank using a number of terms listed below (@1 point). Annuity due, Asset Mgmt ratio, Call, Comparisons, Comparative ratio analysis, Corporation, Covered, Current Ratio, DSO, Du Pont Equation , Equal, Future performance, Greater, Higher, In-the-money, Less, Liquidity, Lower, Option, Ordinary Annuity, Out-of-the-money, Percentage, Perpetuity, Put, PV, Quick, Reduced, TIE, TATO, Trend Analysis, Writer 11. The payment or receipt of equal amounts, at the end of a series of equal periods, for a specified amount of time is called a(n) _______________. 12. When a loan is amortized over a five year term, the amount of interest paid is ________________ each year. 13. You have just won a $5 million lottery to be received in twenty annual equal payments of $250,000. What will happen to the present value of your winnings if the interest rate increases? It will be worth _________________. 14. The more frequent the compounding the _________________ the effective interest rate. 15. More frequent compounding results in _______________ future values and _______________ present values than less frequent compounding at the same nominal interest rate. 16. A(n) _______________ is a financial instrument that agrees to pay an equal amount of money per period into the indefinite future (i.e. forever). 17. A(n) _________________ is a contract which gives its holder the right to buy(or sell) an asset at some predetermined price within a specified period of time. 18. The seller of an option is called the option __________________. 19. An investor who writes call options against stock held in his or her portfolio is said to be selling _______________ options. 20. When the exercise price exceeds the current stock price, a call option is said to be _____________________; however, when the exercise price is less than the current price of the underlying stock, a call option is _________________. 21. An option which gives you the right to sell a stock at a specified price within some future period is called a(n) ______________ option.

4. If you __________, then you may be forced to buy the underlying stock.

  1. Buy a Call Option
  2. Buy a Put Option
  3. Sell a Call Option
  4. Sell a Put Option

5. Lower risk free rates results in __________ Put Option prices and ______ Call Option Prices.

  1. Higher, Higher
  2. Higher, Lower
  3. Lower, Lower
  4. Lower,Higher

6. Which Statement is correct?

  1. Speculators make money by setting up transactions and are the go betweens in the derivatives market.
  2. A firm should always hedge in order to reduce risk whenever they can
  3. Hedgers do not mind losing money as long as they are reducing their risk
  4. Brokers try to find mispricings in the market where they can buy at a low price and simultaneously sell at a high price without taking on any risk.

7. Which statement regarding executive stock options is correct?

  1. They are short term and usually expire after one year.
  2. They should reduce agency costs by making managers act like shareholders
  3. They are included as compensation expense on the income statement.
  4. Managers can sell the options on an exchange

8. Which of the following statements are correct?

  1. Forward contracts are standardized and trade on an exchange
  2. Profits and Losses on Futures contracts are marked to market on a daily basis.
  3. Delivery of the assets almost never occurs in the forward market
  4. Futures contracts allow you to buy or sell individual stocks for a preset price on the expiration date.

9. You need a barrel of oil next month. You could either buy the oil today and keep it for a month, wait and buy the oil next month when you need it, you could enter into a futures contract to buy oil at the current futures price $81, or you can pay $2 for a call option that gives you the right to buy oil for $80. The current spot price is $79 and the risk free rate is 2%, and carrying costs are $2. If the price ends up being $84 next month, then you should have ______________.

  1. Waited to buy the oil
  2. Entered into a futures contract
  3. Bought a call option
  4. Buy the oil today and store it for a month.

10. Which of these should cause the dollar to appreciate?

  1. A decline in foreign demand for US goods and services
  2. An increase in US demand for foreign goods and services
  3. An increase in foreign demand for US financial assets
  4. An increase in the amount of gold held by the US central bank

The current price of a particular stock is $80. Each week the stock price goes up 15% or down 10% with some probability. a.) Find probabilities that the stock goes up or down which give that the expected return from investing in this stock is $0. These probabilities are called the “risk neutral” probabilities. b.) An American call option is a contract giving the buyer of the contract the right, but not the obligation to buy the stock at a future date (called the expiration date) from the seller for a predetermined price (called the strike price). Suppose you are interested in buying a call option which expires in three weeks with a strike price of $110. If the stock price is above $110 at the end of three weeks, then you can buy the stock for a lower price than it is worth, and you effectively earn the difference between the stock price and the strike price. If the stock price is below $110, the option expires worthless. What would a fair price for this option be (that is, how much is the expected earnings from this contract) if the probabilities that the stock goes up or down are given by your answer to part (a)? c.) Rather than using the probabilities in part (a), if banks offer an interest rate on cash holdings, it is common practice in financial modeling to find “risk neutral” probabilities so that the expected return on the stock is the same as the interest rate. Find these probabilities if the current interest rate is 5% per week. d.) What is the expected earnings from an American call option which expires in three weeks with a strike price of $110 under the probabilities from part (c)? (Note that the “present value” of $1 in three weeks is $1/(1.05)3= 0.86 since if we invest 86 cents at the interest rate, it will be worth $1 in three weeks). What is the present value of the American call option?