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Unformatted text preview: EFN412 Advanced Managerial Finance School of Economics and Finance, QUT Topic 11 Topic: 11. Risk Management Reading: PBEHP 10 th edition, Chapters 17 and 18 or PBEHP 9 th edition, Chapters 18 and 19 Background Reading: RTCWJ 4 th edition Chapter 20 o r RTCWJ 3 rd edition Chapter 21 Optional Reading: Optional Reading on Option strategies: John C. Hull, Options, Futures and Other Derivatives, 5 th Edition, 2003 Prentice-Hall. Optional Reading on Value at Risk (VaR): Philippe Jorion, Value at Risk, 2 nd Edition, 2001, McGraw-Hill. Learning Objectives: Understand how to use options to hedge price risk. Understand how to construct synthetic positions with options, futures and physical cash positions. Understand how to use options for speculation. Understand how to use put-call parity to construct synthetic positions. Understand convertible securities. Understand Value-at-Risk (VaR). Other Information: Many of the graphs that appear in the solutions are based on charts produced in Excel. The Excel file is available on the units online site. You might like to have a look at how the graphs were drawn. Risk Management Excel Charts.xls Visit the ASX website http://www.asx.com.au Read the ASX PDF File on Option Strategies. Have some fun, get the movie Trading Places; it will make a lot more sense now that you know what some of the terms mean. This is optional . Risk Management 1 Self-Study Questions Question 1 It is February and the ABC Biscuit Co is in the middle of a hostile takeover bid. The bidder has made what it thinks is a fair and reasonable offer to ABC shareholders. However, there is much public opposition to the takeover: how could we ever stomach Scotch Finger Cookies ? As a result, there is speculation that the bidder will have to lift its offer price. A new higher bid depends on whether the bidder still considers ABC to be a desirable investment at a higher price. ABC shares are currently trading at around the initial bid price of $5.00. Call options are available on ABC with a $6 exercise price and April maturity for a premium of 60c. $6 April put options are also available for ABC at a premium of $1.20. (a) You suspect the bidder will lift its offer price and this will generate a jump in ABC stock. You take up a long call position. Draw the Profit diagram for this long call position. Clearly show where the breakeven point is. What is the net profit from this strategy if: (i) the offer is raised causing share price to rise to $6.20 (ii) the offer is raised causing share price to rise to $7.00 (iii) the takeover bid is withdrawn and share price slumps to $4.50. (b) You suspect that the takeover bid will be withdrawn. You enter a long put position. Draw the Profit diagram for this long put position. Clearly show where the breakeven point is. What is the net profit from this strategy if: (i) the offer is raised causing share price to rise to $6.20 (ii) the bid is withdrawn and share price drops to $4.90the bid is withdrawn and share price drops to $4....
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