Binomial model
input
output
Inputs
Number of periods (n)
1 (dt=T/n)
risk-free rate, time to maturity, stock volatility, stock price, exercise price
call option value
Time to maturity (T)
Riskless rate (r)
Volatility ()
Exercise price
0.6667
0.0150
0.3523

LANCASTER UNIVERSITY
JANUARY 2016 EXAMINATIONS
EXAMINATIONS FOR THE MSC IN FINANCE, MSC IN ACCOUNTING AND FINANCIAL
MANAGEMENT, MSC IN FINANCIAL ANALYSIS, MSC MONEY, BANKING & FINANCE
AND QUANTITATIVE FINANCE
ACF 504
FINANCIAL MARKETS
Time: 2 hours
(+ 15

Introduction to Financial Markets (ACF 404)
Margin trading and short selling
Margin trading and short selling
Introduction to Financial Markets (ACF 404): Pre-arrival notes part 3
Simon Smith
Lancaster University Management School
Michaelmas Term
ACF 404

Exam Questions
Callable bonds
Beta plc has decided to borrow money by issuing perpetual
bonds. The face value of the bonds is 1,000 and the
coupon is 8% payable annually. The interest rate for the first
year is 8%. It is known that next year there is 65%

The operation of margins
Short position
Day
Price
1
2
3
4
5
6
1620
1630
1639
1650
1641
1630
Daily
gain
Cumulative gain Margin
Margin
call/with
-drawal
5500
Contract size: 100; initial/resetting margin: $5500; maintenance margin: $4000
The operation of mar

Duration: Example
Consider a 1-year zero-coupon bond with face
value F
Assume (for the moment) annual
compounding, with yield given by y
The price of the bond is given by
B = F/(1 + y)
The duration of the bond is therefore
D = 1/B * [1 * F/(1 + y)] =

The cost of financial distress
No hedging
Firm value, V
Proportional cost
of financial
distress: 1 -
V=
V =
Region of financial distress
Profit,
The cost of financial distress
No hedging
Firm value, V
Realized profit can
take with equal
probabilities o

Chapter 4
Interest Rates
Options, Futures, and Other Derivatives 8th Edition,
Copyright John C. Hull 2012
1
Types of Rates
Treasury rates
LIBOR rates
Repo rates
Options, Futures, and Other Derivatives 8th Edition,
Copyright John C. Hull 2012
2
Treasury Ra

Hedging in a nutshell
QA: quantity of the hedged asset (tons, # shares, gallons)
S1: (known) spot price of 1 unit of the hedged asset at T = 1
S2: (uncertain) spot price of 1 unit of the hedged asset at T
=2
QF : size of the hedging instrument (# ounc

Tailing the hedge: The general idea
We want (our 1-day* return to be certain):
hF = S
We know
F = SerT
We therefore have
hSerT = S
h erT = 1
h = e-rT = S/F
In general, the length of the time interval relevant for marking to market
*
Forward contract
C

Covered interest rate parity
You have
600 now
You would earn r = 10%
interest (in )
S(t) = 0.6/$
You can have $
now
You would have
. in 1 year
F(t,T) = ?
You would earn rf = 5%
interest (in $)
NOTE: Rates of interested are annually
compounded
You will
ha

Chapter 7
Swaps
Options, Futures, and Other Derivatives, 8th Edition,
Copyright John C. Hull 2012
1
Nature of Swaps
A swap is an agreement to exchange
cash flows at specified future times
according to certain specified rules
Options, Futures, and Other De

Chapter 10
Properties of Stock Options
Options, Futures, and Other Derivatives, 8th Edition,
Copyright John C. Hull 2012
1
Notation
c:
European call
option price
C:
American call
option price
p:
European put
option price
P:
American put
option price
S0:
S