Exam 14: Derivatives: Analysis and Valuation

Exhibit 14-5 USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S) Darden Industries has decided to borrow $25,000,000.00 for six months in two three-month issues. As the Treasurer, you are concerned that interest rates will rise over the next three months and the rate upon which the second payment will be based will be undesirable. (The amount of Darden's first payment will be known at origination.) To reduce the company's interest rate exposure, you decide to purchase a 3 ´ 6 FRA whereby you pay the dealer's quoted fixed rate of 4.5% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from McIntire Industries at its bid rate of 4%. (Assume a notional principal of $25,000,000.00 and that there are 60 days between month 3 and month 6.) -Refer to Exhibit 14-5. Assuming that 3-month LIBOR is 5.00% on the rate determination day, and the contract specified settlement in advance, describe the transaction that occurs between the dealer and Darden.

European options can only be exercised on the expiration date.

Which of the following is not a typical characteristic of a convertible preferred stock?

Exhibit 14-6 USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S) Chimichango Industries has decided to borrow $50,000,000.00 for six months in two three-month issues. As the Treasurer, you are concerned that interest rates will rise over the next three months and the rate upon which the second payment will be based will be undesirable. (The amount of Chimichango's first payment will be known at origination.) To reduce the company's interest rate exposure, you decide to purchase a 3 ´ 6 FRA whereby you pay the dealer's quoted fixed rate of 5.91% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from Megabuks Industries at its bid rate of 5.85%. (Assume a notional principal of $50,000,000.00 and that there are 60 days between month 3 and month 6.) -Refer to Exhibit 14-6. Assuming that 3-month LIBOR is 5.6% on the rate determination day, and the contract specified settlement in advance, describe the transaction that occurs between the dealer and Megabuks.

The intrinsic value of a warrant is calculated as:

Exhibit 14-1 THE FOLLOWING INFORMATION IS FOR THE NEXT PROBLEM(S) A stock currently trades for $130 per share. Options on the stock are available with a strike price of $125. The options expire in 10 days. The risk free rate is 3% over this time period, and the expected volatility is 0.35. -Refer to Exhibit 14-1. Use the Black-Scholes option pricing model to calculate the price of a call option.

The conversion parity price is equal to the par value of a convertible bond divided by the number of shares into which it can be converted.

Exhibit 14-11 USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S) An international investment firm buys an interest rate cap that pays the difference between LIBOR and 6% if LIBOR exceeds 6%. Current LIBOR is 5%. The amount of the option is $1,500,000, and the settlement is every 3 months. Assume a 360 day year. -Refer to Exhibit 14-11. Find the payoff if LIBOR closes at 4.7%.

The conversion premium for a convertible bond is calculated as:

In a forward rate agreement (FRA) two parties agree today to a future exchange of cash flows based on two different interest rates.

Which of the following is not a normal characteristic of a convertible bond?

Exhibit 14-9 USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S) BioTech Industries has debentures outstanding (par value $1,000) convertible into the company's common stock at $30. The coupon rate is 11% payable semiannually and they mature in 10 years. -Refer to Exhibit 14-9. Calculate the straight-bond value assuming that bonds of equivalent risk and maturity are yielding 14% per year compounded semiannually.

An equity call option issued directly by the company whose stock serves as the underlying asset is known as a

The exercise price of The Canadian Dairy Company is $17. You purchase the warrants for $4.00 each when Canadian Dairy's stock price is $20.00 per share. Each warrant entitles you to purchase one share of CDC stock. Calculate your percentage gain assuming the warrant premium drops by 50% and you sell your warrants when the stock reaches $30.00 per share.

It is a violation of the securities laws to combine option contracts to achieve a customized payoff.

Exhibit 14-1 THE FOLLOWING INFORMATION IS FOR THE NEXT PROBLEM(S) A stock currently trades for $130 per share. Options on the stock are available with a strike price of $125. The options expire in 10 days. The risk free rate is 3% over this time period, and the expected volatility is 0.35. -Refer to Exhibit 14-1. Calculate the price of the put option.

Which of the following is not a factor needed to calculate the value of an American call option?

Index options can only be settled in cash.

Exhibit 14-5 USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S) Darden Industries has decided to borrow $25,000,000.00 for six months in two three-month issues. As the Treasurer, you are concerned that interest rates will rise over the next three months and the rate upon which the second payment will be based will be undesirable. (The amount of Darden's first payment will be known at origination.) To reduce the company's interest rate exposure, you decide to purchase a 3 ´ 6 FRA whereby you pay the dealer's quoted fixed rate of 4.5% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from McIntire Industries at its bid rate of 4%. (Assume a notional principal of $25,000,000.00 and that there are 60 days between month 3 and month 6.) -Refer to Exhibit 14-5. How much compensation does the dealer receive for transaction costs, credit risk and other costs associated with matching the FRA's?

Options can be used to