QUESTION ONE.

You are the dealer in one of the reputable banks and one of your roles is related to trading and monitoring of changes in the derivative markets. You are interested in one stock for Bally International hedgers; the stock under consideration is currently trading at K25 it can either go up or down by 15 percent in any given period. The risk-free rate is 10 percent.

Using a two-period binomial model,

1. Determine the six possible stock prices for the next period.
2. Determine the intrinsic values at expiration of a European call with an exercise price of 25.
3. Find the value of the option today.

QUESTION TWO.

A.

List the factors that affect call option premiums and briefly explain the relationship that exists for each. Do you think an at-the-money call option in Rand has a higher or lower premium than an at-the-money call option in Kwacha (assuming the expiration date and the total dollar value represented by each option are the same for both options)?

B.

Floro Corp purchased call options for speculative purposes. If these options are exercised, Floro Corp will immediately sell the Kwachas in the spot market. Each option was purchased for a premium of k3 per unit, with an exercise price of k81. Floro Corp plans to wait until the expiration date before deciding whether to exercise the options. Of course, Floro Corp will exercise the options at that time only if it is feasible to do so. In the following table, fill in the net profit (or loss) per unit to Floro Corp. based on the listed possible spot rates of the Kwacha on the expiration date.

C.

Provide the answers in the Net Profit (Loss) per unit to Floro Corp Column.

Possible Spot Rate of Kwacha on expiration date	Net Profit (Loss) per unit to Floro Corp.
k 76
K78
K80
K82
K85
K87