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N. Sheflin INVESTMENT GAME ROUND 5 DERIVATIVES – QUESTIONS AND ANSWERS Time to get risky (or not) with derivatives. Highly leveraged, used for hedging, arbitrage and speculation, best used by professionals. We’ll just look at simple futures and options, and mention the infamous CDOs and Credit Default Swaps. READ about derivatives at and Futures at (skip pricing section) sections 1-4, 6, 7,9, 12, 17 and Options at sections 1,2 3.1, 5.3, 6. 7 and a bit more on Black-Scholes In VIRTUAL STOCK EXCHANGE nothing to do – doesn’t support options or future trading. HOW IS YOUR PORTFOLIO DOING? Determine your paper gain/loss and explain the causes. Compare with the performance of the S&P 500. End is almost here. PROBLEMS? If VSE is behaving oddly (or even if not), it’s a good idea to keep a paper record of all transactions (purchases/sales). At worst, you can hand in a corrected version of your actions at the end of the game. APPLICATIONS 1. Look up IBM options prices at What does a July 12 option, with a strike price equal to the current price of IBM sell for? How will you make money if you buy this? How much can you lose? (as of 12/6/2011) close 192
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2. Use the Black-Scholes calculator at and price IBM Calls of July 2012 with a strike price of equal to the current closing share price. Use a volatility of 25 and a risk free rate of 2% QUESTIONS FOR FINAL hide answers, try explaining to your cat ; look up in invest-faq, investor words, etc; ask in class; 1. What is a derivative? A financial asset whose value derives from another, underlying asset A Futures Contract? A contract which requires the purchase or sale of a standardized commodity, currency, interest rate or index bundle at a specified date in the future (expiration date) at a price set today. A Call Option? Option to buy in the future, up to an expiration date, at a price set today A Put Option? Option to sell 2. What is primary economic role of derivatives? Hedging (offsetting) of risk; farmer can short pork bellies (buy a futures contract requiring them to sell pork bellies at a price set today) guaranteeing a price when his pigs come to market; restaurant can go long in pork bellies(buy a futures contract requiring them to buy pork bellies at a price fixed today) , guaranteeing their cost in the future 3. Why are Futures and Options used? Hedging (offsetting risk), speculating, arbitrage (the simultaneous purchase
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