ECMC71-11Mid2A - UNIVERSITY OF TORONTO SCARBOROUGH...

Info iconThis preview shows pages 1–6. Sign up to view the full content.

View Full Document Right Arrow Icon
UNIVERSITY OF TORONTO SCARBOROUGH DEPARTMENT OF MANAGEMENT MGTC71: Introduction to Derivatives Markets Term Test-2 (Solutions) A. Mazaheri Instructions : This is a closed book examination. You are allowed one side of a one 4”x6" crib card and the use of a calculator. Show all your work otherwise you will not get full credit . Make sure you allocate time appropriately . You have 2 hour. Good Luck! NAME: _____________________________________________ ID#: _____________________________________________ Answer all the following 4 questions: Q-1 _______________ (18 points) Q-2 _______________ (20 points) Q-3 ________________ (12 points) Q-4 _______________ (20 points) Total _____________ (70 points)
Background image of page 1

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

View Full DocumentRight Arrow Icon
2 Question-1 (18 Points) Short questions . a) [5 Points] In the binomial model the risk neutral probability cannot be more than the unity? True/False explain why? Answer: False, the risk neutral probability is not a real probability. It is the probability that makes the expected return from holding the stock equal to the risk-free. Therefore it can be more than one if: u e d u d e P rT rT > => > - - = 1 b) [5 Points] Use graphs to explain why – in the absence of dividend – an American put option might be early exercised while an American call might not. Solution: Call: The lower bound is a S-PV(K) which is higher than S-K therefore the time value is always positive => It is always better to sell the American call than to exercise it. Call: PV(K) K
Background image of page 2
3 Put: The lower bound is a PV(K)-S which is lower than K-S therefore the time value can be negative => The deep in the money put options will be exercised – have negative time value. PV(K) K
Background image of page 3

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

View Full DocumentRight Arrow Icon
4 c) [8 Points] Consider the following option strategy: Long one call with $100 strike price, bought for $6 Long one call with $90 strike price, bought for $20 Short one call with $105 strike price, sold for $8 Short one call with $95 strike price, sold for $16 Show in a table the payoff and profit of the strategy and then graph the payoff. Briefly explain the bet behind the strategy. Solution: St<=90 90<St<=95 95<St<=100 100<St>105 St>105 Long 1 Call 100 0 0 0 St-100 St-100 Long 1 Call 90 0 St-90 St-90 St-90 St-90 Short 1 Call 105 0 0 0 0 -(St-105) Short 1 Call 95 0 0 -(St-95) -(St-95) -(St-95) Payoff 0 St-90 5 St-95 10 Cost 24-26=-2 Profit -2 St-92 3 St-97 8 This is a bullish bet very much like bull spread.
Background image of page 4
5 Question-2 . [20 points] Companies A and B face the following borrowing costs: Fixed rate Floating rate A 7% 6-m LIBOR B 9% 6-m LIBOR + 1% a) [5 Points] Explain any comparative advantage A and/or B may have in fixed rate and/or floating borrowing. If the two sides decide to engage in a swap what would be is maximum gain possible?
Background image of page 5

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

View Full DocumentRight Arrow Icon
Image of page 6
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 12

ECMC71-11Mid2A - UNIVERSITY OF TORONTO SCARBOROUGH...

This preview shows document pages 1 - 6. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online