{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

Ch15Sols

# Ch15Sols - CHAPTER 15 ADVANCED DERIVATIVES AND STRATEGIES...

This preview shows pages 1–2. Sign up to view the full content.

15-1 CHAPTER 15: ADVANCED DERIVATIVES AND STRATEGIES END-OF-CHAPTER QUESTIONS AND PROBLEMS 1. In both types of swaps there are two parties who make payments to each other at specific dates according to different formulas. In an interest rate swap the payments made by one party are based on a particular interest rate. The other payments can be fixed or based on another type of interest rate. In an equity swap the payments of at least one party are based on the performance of a stock or index. The payments of the other party can be based on the performance of a different stock or index or can be based on a fixed or floating interest rate. Thus, any swap in which one party's payments are based on a stock or index is called an equity swap even though it might really be only part-equity and part-interest rate. 2. Most structured notes are tailored, i.e., structured, to the specific needs of an investor. A portfolio manager whose portfolio is exposed to loss from falling interest rates over the holding period might purchase an inverse floating rate note as a type of hedge. If interest rates decrease, the inverse floater will gain, thereby offsetting some or all of the loss on the rest of the portfolio. Of course, the inverse floater will lose if rates rise thereby offsetting some or all of the gain on the rest of the portfolio. 3. The payoffs at expiration from the chooser are as follows: Payoff of Chooser at Expiration Choice made at t S T E S T > E designate chooser as a call 0 S T - E designate chooser as put E - S T 0 The holder of the chooser option will designate it as a call at time t if C(S t ,T-t,E) > P(S t ,T-t,E). From put- call parity, the put price can be expressed as C(S t ,T-t,E) - S t + E(1 + r) -(T-t) . Thus, C(S t ,T-t,E) > P(S t ,T- t,E) implies that C(S t ,T-t,E) > C(S t ,T-t,E) - S t + E(1 + r) -(T-t) , which implies that S t > E(1 + r) -(T-t) . We are told that to replicate the chooser we hold a call expiring at T with exercise price E and a put expiring at t with exercise price E(1 + r) -(T-t) . Now suppose we are at t and the following occurs: S t > E(1 + r) -(T-t) The call is still alive but the put expires out-of-the-money. At the call’s expiration at T, it will pay off S T - E if S T > E and zero otherwise, which is exactly like the chooser. S t E(1 + r) -(T-t) The call is still alive and the put expires and pays off E(1 + r) -(T-t) - S T . Take the amount E(1 + r) - (T-t) and invest it in risk-free bonds. At T, it will be worth E. Short the stock at t and buy it back at T. Thus, the overall value at T if S T > E is S T - E (from the call) + E (from the risk-free bond) - S T (from buying back the stock), for a total of 0. If at T S T E then you will have zero (from the call), E (from the risk-free bond) and - S T (from buying back the stock), for a total of E - S T . These match the payoffs of the chooser option.

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

### Page1 / 12

Ch15Sols - CHAPTER 15 ADVANCED DERIVATIVES AND STRATEGIES...

This preview shows document pages 1 - 2. Sign up to view the full document.

View Full Document
Ask a homework question - tutors are online