Exam 14: Derivatives: Analysis and Valuation

Exhibit 14-7 USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S) Black Gold Industries (BGI) is an independent oil producer with production capacity of 500,000 barrels per month. Due to the cost structure of the business, BGI needs to receive $56.50 per barrel in order to remain solvent. On the other side of this situation is Petrochemicals Unlimited (PU) which uses an average of 500,000 barrels of West Texas crude oil in its normal production operations. The nature of PU's business is such that they will financially suffer if they have to pay more than an average of $57.80 per barrel for oil over the next six years. To hedge against their exposure to volatile oil prices, BI and PU contact a swap dealer to arrange the six-year oil swap described below: - $\quad$ Settlement is made monthly. - The notional principal is for 500,000 barrels per month. - The monthly WTI index value is determined as the average of the daily settlement prices for the crude oil futures contract traded on the New York Mercantile Exchange (NYMEX). - The swap dealer pays BGI $\$ 57.00$ per barrel. - BGI pays the swap dealer the average NYMEX Oil futures price per barrel. - $\quad$ PU pays the swap dealer $\$ 57.50$ per barrel. - The swap dealer pays PU dealer the average NYMEX Oi futures price per barrel. -Refer to Exhibit 14-7. Describe the transaction that occurs between PU and the swap dealer if the monthly average oil futures settlement price is $55.50.

A warrant is an option to buy a stated number of shares of common stock at a specified price at any time during the life of the warrant.

Credit risk in the options market is only a concern to the option seller.

In an interest rate swap, the fixed rate payer profits if interest rates fall.

In the Black-Scholes option pricing model, an increase in the risk free rate (RFR) will cause

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 conversion value of the bond if the stock price is $27.00 per share.

The owner of a call option on a futures contract has the obligation to buy the futures contract at a predetermined strike price during a specified time period.

Consider a pension fund manager that wishes to convert $10 million from notes paying LIBOR to stocks, using an equity swap. The equity swap should be structured so that

Exhibit 14-8 USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S) Exclusive Industries has debentures outstanding (par value $1,000.00) convertible into exclusive's common stock at $30. The coupon rate is 11% payable semiannually and they mature in 10 years. -Refer to Exhibit 14-8. Calculate the straight-bond value assuming that bonds of equivalent risk and maturity are yielding 13% per year compounded semiannually.

While LIBOR is usually used with forward rate agreements it is rarely used with other interest rate agreements.

____ has coupons denominated in a currency other than that of their principal.

Exhibit 14-7 USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S) Black Gold Industries (BGI) is an independent oil producer with production capacity of 500,000 barrels per month. Due to the cost structure of the business, BGI needs to receive $56.50 per barrel in order to remain solvent. On the other side of this situation is Petrochemicals Unlimited (PU) which uses an average of 500,000 barrels of West Texas crude oil in its normal production operations. The nature of PU's business is such that they will financially suffer if they have to pay more than an average of $57.80 per barrel for oil over the next six years. To hedge against their exposure to volatile oil prices, BI and PU contact a swap dealer to arrange the six-year oil swap described below: - $\quad$ Settlement is made monthly. - The notional principal is for 500,000 barrels per month. - The monthly WTI index value is determined as the average of the daily settlement prices for the crude oil futures contract traded on the New York Mercantile Exchange (NYMEX). - The swap dealer pays BGI $\$ 57.00$ per barrel. - BGI pays the swap dealer the average NYMEX Oil futures price per barrel. - $\quad$ PU pays the swap dealer $\$ 57.50$ per barrel. - The swap dealer pays PU dealer the average NYMEX Oi futures price per barrel. -Refer to Exhibit 14-7. Describe the transaction that occurs between PU and the swap dealer if the monthly average oil futures settlement price is $58.45.

Exhibit 14-12 USE THE FOLLOWING INFORMATION FOR THE NEXT QUESTION(S) The Skalmory Corporation has entered into a 3-year interest rate swap, with semiannual settlement, to pay a fixed rate of 7.5% per year and receive 6-month LIBOR. The notional principal is $10,000,000. -Refer to Exhibit 14-12. What is the market value of the swap to the Skalmory Corporation?

The creation of the CBOE led to all the following innovations in options except

The standardization of option contracts and the creation of the Options Clearing Corporation are two important results of the opening of the Chicago Board of Options Exchange.

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 arrears at month 6, describe the transaction that occurs between the dealer and Darden.

The issuance of convertibles will ultimately lead to greater dilution than an initial issue of stock.

Exhibit 14-7 USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S) Black Gold Industries (BGI) is an independent oil producer with production capacity of 500,000 barrels per month. Due to the cost structure of the business, BGI needs to receive $56.50 per barrel in order to remain solvent. On the other side of this situation is Petrochemicals Unlimited (PU) which uses an average of 500,000 barrels of West Texas crude oil in its normal production operations. The nature of PU's business is such that they will financially suffer if they have to pay more than an average of $57.80 per barrel for oil over the next six years. To hedge against their exposure to volatile oil prices, BI and PU contact a swap dealer to arrange the six-year oil swap described below: - $\quad$ Settlement is made monthly. - The notional principal is for 500,000 barrels per month. - The monthly WTI index value is determined as the average of the daily settlement prices for the crude oil futures contract traded on the New York Mercantile Exchange (NYMEX). - The swap dealer pays BGI $\$ 57.00$ per barrel. - BGI pays the swap dealer the average NYMEX Oil futures price per barrel. - $\quad$ PU pays the swap dealer $\$ 57.50$ per barrel. - The swap dealer pays PU dealer the average NYMEX Oi futures price per barrel. -Refer to Exhibit 14-7. Describe the transaction that occurs between BGI and the swap dealer if the monthly average oil futures settlement price is $55.50.

In convertible bonds, the value of the common stock price upon immediate conversion is the

Warrants differ from options in a number of ways. Which of the following statements about warrants and options is false?