Handout 3a
Financial Derivatives; 2016-17
Prof. Shashi Murthy
Topic 3, Chapter 5 Pricing Forwards &
Futures, Part 1. This handout covers a
subset of the issues listed in the Course
Outline under Topic 3:
Perfect Markets Assumptions; Short-Selling
Invest
Handout 5c
Financial Derivatives; 2016-17
Prof. Shashi Murthy
This is a continuation of Handout 5a (Topic 5a,
Chapter 11, No-arbitrage Restrictions on Option
Prices, Chapter 11).
Here we examine the effect of dividends on (i)
Pricing Bounds, and (ii) Put-
Handout 6b
Financial Derivatives; 2016-17
Prof. Shashi Murthy
Topic 6b, Chapter 13, The Binomial Model
This handout covers only part (b) of topic 6. It
covers:
More on (Hedge &) Replicating Portfolios, & Riskneutral valuation
American, or early-exercise
Handout 4
Financial Derivatives; 2016-17
Prof. Shashi Murthy
Topic 4, Chapter 10 Mechanics of Options Markets
Omitted: Warrants; ESOPs; Convertibles
1
1
Review of Option Types
A call is an option to buy
A put is an option to sell
A European option can
Handout 5b
Financial Derivatives; 2016-17
Prof. Shashi Murthy
Topic 5b, Chapter 12, Some Trading Strategies with
Options
Covered Calls,
Protective Puts or Portfolio Insurance,
Bull Spreads,
Butterfly Spreads,
and Straddles
1
1
There are a multiplicity of
Handout 3c
Financial Derivatives; 2016-17
Prof. Shashi Murthy
Topic 3, Chapter 5 Pricing Forwards & Futures, last part
To be read after Handout 3a, Handout 3b1, &
Handout 3b2 (the last 2 are Word files). This
handout covers the rest of Chp 5.
Currency fut
Handout 6a
Financial Derivatives; 2016-17
Prof. Shashi Murthy
Topic 6a, Chapter 13, The Binomial Model
This handout covers only part (a) of topic 6. It
covers:
Hedge & Replicating Portfolios
Risk-neutral valuation
It covers the above for the case of Singl
Markets may fail for various reasons to deliver
the socially optimal outcome:
Externalities
Imperfect competition
Asymmetric information
Externalities
Public goods
Externalities
Till now we assumed that each consumers
well-being depends only on her own
c
8/3/2016
ECONOMIC PROFIT
The concept of economic profit
Accounting profit
is equal
to total revenue
minus
explicit costs
Economic profit
is equal
to total revenue
minus
all opportunity costs.
Therefore, in economics, if we say that a firm is
earning zero
8/18/2016
Game Theory
Games
Game theory was developed to analyse situations
in which strategic decisions have to be made.
A game is a situation in which a number of
individuals make decisions, and each cares
both about her own choices and about others
cho
8/23/2016
Bertrand Model
Bertrand Model
The simplest possible oligopoly market is
one with two firms (a duopoly) that
produce identical (homogeneous)
goods
There are only two firms in the industry
(so that the industry is a duopoly).
They produce an id
Perfect competition vs. Monopoly
Perfect competition vs. Monopoly
Monopoly is inferior to perfect competition
in two respects.
(1) In perfect competition, the long run
equilibrium is when price is driven down to
the point of the minimum average cost
curv
Pricing Strategies for Monopolist
We have assumed so far that the
monopolist charges the same price to
every buyer
If the monopolist can set different prices
for different customers, it can be shown
that this enables her to increase her profit.
Price Di
Monopoly
Monopoly
A monopoly is the sole producer of a commodity
that has no close substitutes and faces many
buyers.
The existence of the downward-sloping
demand curve sets a constraint on the
monopolists actions
The monopolist can either set the price
8/1/2016
ECONOMIC PROFIT
The concept of economic profit
Accounting profit
is equal
to total revenue
minus
explicit costs
Economic profit
is equal
to total revenue
minus
all opportunity costs.
Therefore, in economics, if we say that a firm is
earning zero
INDIAN MARITIME UNIVERSITY
(A Central University under the Ministry of Shipping)
East Coast Road, Uthandi, Chennai- 600 119
Ph No: (044) 2453 0343/345, Fax: (044) 2453 0342
Website: www.imu.edu.in
Academic Brochure 2014-15
For
Undergraduate & Postgraduate
CHAPTER 10
The Fundamentals of Capital Budgeting
Learning Objectives
1. Discuss why capital budgeting decisions are the most important decisions made by a
firms management.
2. Explain the benefits of using the net present value (NPV) method to analyze cap
B.
We will need to apply the same trial-and-error method to compute the IRR.
When the IRR and NPV Methods Agree
The two methods will always agree when the projects are independent and the
projects cash flows are conventional.
After the initial investment
E. PROFITABILITY INDEX (PI)
The profitability index, or PI, method compares the present value of future cash
inflows with the initial investment on a relative basis. Therefore, the PI is the ratio
of the present value of cash flows (PVCF) to the initial i
Capital budgeting decisions are the most important investment decisions made
by management.
The goal of these decisions is to select capital projects that will increase the
value of the firm.
Capital investments are important because they involve substan
Using NPV
The marketing department of your firm is considering whether to invest in a new
product. The costs associated with introducing this new product and the expected
cash flows over the next four years are listed below. (Assume these cash flows are
1
The Payback Rule
Payback period: The length of time until the accumulated cash flows from the
investment equal or exceed the original cost. We will assume that cash flows are
generated continuously during a period.
The Payback Rule: An investment is accep
Evaluating Equipment with Different Economic Lives
Example (continued)
Like the comparison between an 8% interest rate compounded semi-annually
and an 8.25% interest rate compounded annually, to compare the costs of the
above machines we want to calculate
A. PAYBACK PERIOD
Payback period = Expected number of years
required to recover a projects cost.
2. Ignores cash flows occurring after the
payback period.
B. NET PRESENT VALUE
Year
0
1
2
3
Project L
Expected Net Cash Flow
Project L
Project S
($100)
($100)
Net Present Value (NPV)
The net present value is the difference between the market value of an investment
and its cost.
NPV = - Cost + PV(Future Flows)
T
NPV = - Cost + CF t t
t=1 (1 + r )
T
NPV = CF t t
t=0 (1 + r )
NPV is a measure of the amount of mark
Both cash inflows (CIF) and cash outflows are likely in each year of the
project. Estimate the net cash flow (NCFt) = CIFt COFt for each year of the
project.
Remember to recognize any salvage value from the project in its terminal
year.
3. Determine the
B.
Ongoing and Postaudit Reviews
Management should systematically review the status of all ongoing capital
projects and perform postaudits on all completed capital projects.
In a postaudit review, management compares the actual results of a project with
w