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principles of finance

Questions and Answers of Principles Of Finance

12.6. For the situation considered in Problem 12.5, what is the value of a one-year European put option with a strike price of $100? Verify that the European call and European put prices satisfy
12.5. A stock price is currently $100. Over each of the next two six-month periods it is expected to go up by 10% or down by 10%. The risk-free interest rate is 8% per annum with continuous
12.4. A stock price is currently $50. It is known that at the end of six months it will be either$45 or $55. The risk-free interest rate is 10% per annum with continuous compounding.What is the value
12.3. What is meant by the delta of a stock option?
12.2. Explain the no-arbitrage and risk-neutral valuation approaches to valuing a European option using a one-step binomial tree.
12.1. A stock price is currently $40. It is known that at the end of one month it will be either$42 or $38. The risk-free interest rate is 8% per annum with continuous compounding.What is the value
11.28. A bank decides to create a five-year principal-protected note on a non-dividend-paying stock by offering investors a zero-coupon bond plus a bull spread created from calls. The risk-free rate
11.27. Describe the trading position created in which a call option is bought with strike price K2 and a put option is sold with strike price K1 when both have the same time to maturity and K2 > K1.
11.26. What trading position is created from a long strangle and a short straddle when both have the same time to maturity? Assume that the strike price in the straddle is halfway between the two
11.25. Suppose that the price of a non-dividend-paying stock is $32, its volatility is 30%, and the risk-free rate for all maturities is 5% per annum. Use DerivaGem to calculate the cost of setting
11.24. Draw a diagram showing the variation of an investor’s profit and loss with the terminal stock price for a portfolio consisting of:(a) One share and a short position in one call option(b) Two
11.23. A diagonal spread is created by buying a call with strike price K2 and exercise date T2 and selling a call with strike price K1 and exercise date T1 (T2 > T1). Draw a diagram showing the
11.22. Three put options on a stock have the same expiration date and strike prices of $55, $60, and $65. The market prices are $3, $5, and $8, respectively. Explain how a butterfly spread can be
11.21. A trader sells a strangle by selling a European call option with a strike price of $50 for$3 and selling a European put option with a strike price of $40 for $4. For what range of prices of
11.20. A trader creates a bear spread by selling a six-month put option with a $25 strike price for $2.15 and buying a six-month put option with a $29 strike price for $4.75. What is the initial
11.19. An index provides a dividend yield of 1% and has a volatility of 20%. The risk-free interest rate is 4%. How long does a principal-protected note, created as in Example 11.1, have to last for
11.18. A foreign currency is currently worth $0.64. A one-year butterfly spread is set up using European call options with strike prices of $0.60, $0.65, and $0.70. The risk-free interest rates in
11.17. What is the result if the strike price of the put is higher than the strike price of the call in a strangle?
11.16. “A box spread comprises four options. Two can be combined to create a long forward position and two can be combined to create a short forward position.” Explain this statement.
11.15. How can a forward contract on a stock with a particular delivery price and delivery date be created from options?
11.14. An investor believes that there will be a big jump in a stock price, but is uncertain as to the direction. Identify six different strategies the investor can follow and explain the differences
11.13. Construct a table showing the payoff from a bull spread when puts with strike prices K1 and K2 are used (K2 > K1).
11.12. A call with a strike price of $60 costs $6. A put with the same strike price and expiration date costs $4. Construct a table that shows the profit from a straddle. For what range of stock
11.11. Use put–call parity to show that the cost of a butterfly spread created from European puts is identical to the cost of a butterfly spread created from European calls.
11.10. Suppose that put options on a stock with strike prices $30 and $35 cost $4 and $7, respectively.How can the options be used to create (a) a bull spread and (b) a bear spread?Construct a table
11.9. Explain how an aggressive bear spread can be created using put options.
11.8. Use put–call parity to relate the initial investment for a bull spread created using calls to the initial investment for a bull spread created using puts.
11.7. A call option with a strike price of $50 costs $2. A put option with a strike price of $45 costs $3. Explain how a strangle can be created from these two options. What is the pattern of profits
11.6. What is the difference between a strangle and a straddle?
11.5. What trading strategy creates a reverse calendar spread?
11.4. Call options on a stock are available with strike prices of $15, 1 2 $17 , and $20 and expiration dates in three months. Their prices are $4, $2, and 1 2 $ , respectively. Explain how the
11.3. When is it appropriate for an investor to purchase a butterfly spread?
11.2. Explain two ways in which a bear spread can be created.
11.1. What is meant by a protective put? What position in call options is equivalent to a protective put?
“If a company does not do better than its competitors but the stock market goes up, executives do very well from their stock options. This makes no sense.” Discuss this viewpoint. Can you think
A trader has a put option contract to sell 100 shares of a stock for a strike price of $60.What is the effect on the terms of the contract of:(a) A $2 dividend being declared(b) A $2 dividend being
Calculate the intrinsic value and time value from the mid-market (average of bid and offer)prices for the September 2015 call options in Table 1.2. Do the same for the September 2015 put options in
A U.S. investor writes five naked call option contracts. The option price is $3.50, the strike price is $60.00, and the stock price is $57.00. What is the initial margin requirement?
Options on General Motors stock are on a March, June, September, and December cycle.What options trade on (a) March 1, (b) June 30, and (c) August 5?
Consider an exchange-traded call option contract to buy 500 shares with a strike price of$40 and maturity in four months. Explain how the terms of the option contract change when there is: (a) a 10%
Explain carefully the difference between (a) hedging, (b) speculation, and (c) arbitrage.
What is the difference between (a) entering into a long futures contract when the futures price is $50 and (b) taking a long position in a call option with a strike price of $50?
Suppose that you write a put contract with a strike price of $40 and an expiration date in three months. The current stock price is $41 and one put option contract is on 100 shares.What have you
What is the difference between the over-the-counter and the exchange-traded market?What are the bid and offer quotes of a market maker in the over-the-counter market?
It is May and a trader writes a September call option with a strike price of $20. The stock price is $18 and the option price is $2. Describe the trader’s cash flows if the option is held until
An investor writes a December put option with a strike price of $30. The price of the option is $4. Under what circumstances does the investor make a gain?
The CME Group offers a futures contract on long-term Treasury bonds. Characterize the traders likely to use this contract.
A company in the United States expects to have to pay 1 million Canadian dollars in six months. Explain how the exchange rate risk can be hedged using (a) a forward contract;(b) an option.
Trader A enters into a forward contract to buy an asset for $1,000 in one year. Trader B buys a call option to buy the asset for $1,000 in one year. The cost of the option is $100.What is the
On May 13, 2015, as indicated in Table 1.2, the spot offer price of Google stock is $532.34 and the offer price of a call option with a strike price of $525 and a maturity date of September is
Discuss how foreign currency options can be used for hedging in the situation described in Example 1.1 so that (a) ImportCo is guaranteed that its exchange rate will be less than 1.5900, and (b)
On May 13, 2015, an investor owns 100 Google shares. As indicated in Table 1.3, the bid share price is $532.20 and a December put option with a strike price of $500 costs $22.10.The investor is
The author’s website (www-2.rotman.utoronto.ca/~hull/data) contains daily closing prices for the crude oil futures contract and the gold futures contract. You are required to download the data for
3.28. The following table gives data on monthly changes in the spot price of a commodity and the futures price of a contract used to hedge it. Use the data to calculate a minimum variance hedge
3.29. It is now October 2016. A company anticipates that it will purchase 1 million pounds of copper in each of February 2017, August 2017, February 2018, and August 2018. The company has decided to
Suppose that risk-free zero interest rates with continuous compounding are as follows:Calculate forward interest rates for the second, third, fourth, fifth, and sixth quarters. Maturity (months) Rate
Suppose that 6-month, 12-month, 18-month, 24-month, and 30-month zero rates continuously compounded are 4%, 4.2%, 4.4%, 4.6%, and 4.8% per annum, respectively. Estimate the cash price of a bond with
Suppose that risk-free zero interest rates with continuous compounding are as follows:Calculate forward interest rates for the second, third, fourth, and fifth years. Maturity (years) Rate (% per
Use the risk-free rates in Problem 4.14 to value an FRA where you will pay 5% (compounded annually) and receive LIBOR for the third year on $1 million. The forward LIBOR rate (annually compounded)
A 10-year 8% coupon Treasury bond currently sells for $90. A 10-year 4% coupon-Treasury bond currently sells for $80. What is the 10-year zero rate? (Hint: Consider taking a long position in two of
Suppose that 3-month, 6-month, 12-month, 2-year, and 3-year OIS rates are 2.0%, 2.5%, 3.2%, 4.5%, and 5%, respectively. The 3-month, 6-month, and 12-month OISs involve a single exchange at maturity;
Suppose that risk-free rates are as in Problem 4.28. What is the value of an FRA where the holder pays LIBOR and receives 7% (semiannually compounded) for a six-month period beginning in 18 months?
The following table gives the prices of Treasury bonds:(a) Calculate zero rates for maturities of 6 months, 12 months, 18 months, and 24 months.(b) What are the forward rates for the periods: 6
What is the difference between the forward price and the value of a forward contract?
A stock index currently stands at 350. The risk-free interest rate is 8% per annum (with continuous compounding) and the dividend yield on the index is 4% per annum. What should the futures price for
Estimate the difference between short-term interest rates in Japan and the United States on May 13, 2015, from the information in Table 5.4.
The two-month interest rates in Switzerland and the United States are 1% and 2% per annum, respectively, with continuous compounding. The spot price of the Swiss franc is$1.0600. The futures price
Suppose that F1 and F2 are two futures contracts on the same commodity with times to maturity, t1 and t2, where t2 > t1. Prove thatwhere r is the interest rate (assumed constant) and there are no
Show that equation (5.3) is true by considering an investment in the asset combined with a short position in a futures contract. Assume that all income from the asset is reinvested in the asset. Use
What is the cost of carry for (a) a non-dividend-paying stock, (b) a stock index, (c) a commodity with storage costs, and (d) a foreign currency?
In early 2012, the spot exchange rate between the Swiss Franc and U.S. dollar was 1.0404($ per franc). Interest rates in the United States and Switzerland were 0.25% and 0% per annum, respectively,
Companies A and B have been offered the following rates per annum on a $20 million five-year loan:Company A requires a floating-rate loan; Company B requires a fixed-rate loan. Design a swap that
Company A, a British manufacturer, wishes to borrow U.S. dollars at a fixed rate of interest. Company B, a U.S. multinational, wishes to borrow sterling at a fixed rate of interest. They have been
8.15. Add rows in Table 8.1 corresponding to losses on the underlying assets of (a) 2%, (b) 6%,(c) 14%, and (d) 18%.
8.14. Explain why the end-of-year bonus is sometimes referred to as “short-term compensation.”
8.13. Explain why the AAA-rated tranche of an ABS CDO is more risky than the AAA-rated tranche of an ABS.
8.12. Explain the impact of an increase in default correlation on the risks of the senior tranche of an ABS. What is its impact on the risks of the equity tranche?
8.11. How is an ABS CDO created? What was the motivation to create ABS CDOs?
8.10. What is meant by the term “agency costs”? How did agency costs play a role in the credit crisis?
8.9. How were the risks in ABS CDOs misjudged by the market?
8.7. Why do you think the increase in house prices during the 2000 to 2007 period is referred to as a bubble?
8.6. What is a subprime mortgage?
8.5. What are the numbers in Table 8.1 for a loss rate of (a) 12% and (b) 15%?
8.4. What is the waterfall in a securitization?
8.3. What is a mezzanine tranche?
8.2. Explain what is meant by (a) an ABS and (b) an ABS CDO.
8.1. What was the role of GNMA (Ginnie Mae) in the mortgage-backed securities market of the 1970s?
The one-year LIBOR rates is 3%, and the LIBOR forward rate for the 1- to 2-year period is 3.2%, respectively. The three-year swap rate for a swap with annual payments is 3.2%.What is the LIBOR
(a) Company X has been offered the swap quotes in Table 7.3. It can invest for four years at 2.8%. What floating rate can it swap this fixed rate into? (b) Company Y has also been offered the swap
(a) Company A has been offered the swap quotes in Table 7.3. It can borrow for three years at 3.45%. What floating rate can it swap this fixed rate into? (b) Company B has also been offered the swap
Six-month LIBOR is 5%. LIBOR forward rates for the 6- to 12-month period and for the 12- to 18-month period are 5.5%. Swap rates for 2- and 3-year semiannual pay swaps are 5.4% and 5.6%,
OIS rates have been estimated as 3.4% for all maturities. The three-month LIBOR rate is 3.5%. For a six-month swap where payments are exchanged every three months the swap rate is 3.6%. All rates are
A financial institution has entered into a 10-year currency swap with company Y. Under the terms of the swap, the financial institution receives interest at 3% per annum in Swiss francs and pays
A financial institution has entered into an interest rate swap with company X. Under the terms of the swap, it receives 4% per annum and pays six-month LIBOR on a principal of$10 million for five
A bank enters into an interest rate swap with a nonfinancial counterparty using bilaterally clearing where it is paying a fixed rate of 3% and receiving LIBOR. No collateral is posted and no other
A currency swap has a remaining life of 15 months. It involves exchanging interest at 10%on £20 million for interest at 6% on $30 million once a year. The term structure of risk-free interest rates
Explain what a seven-year swap rate is.
A $100 million interest rate swap has a remaining life of 10 months. Under the terms of the swap, six-month LIBOR is exchanged for 4% per annum (compounded semiannually). Sixmonth LIBOR forward rates
It is June 25, 2017. The futures price for the June 2017 bond futures contract is 118-23.(a) Calculate the conversion factor for a bond maturing on January 1, 2033, paying acoupon of 10%.(b)
Portfolio A consists of a 1-year zero-coupon bond with a face value of $2,000 and a 10-year zero-coupon bond with a face value of $6,000. Portfolio B consists of a 5.95-year zerocoupon bond with a

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