Exam 14: Derivatives: Analysis and Valuation

A major difference between a call option and a warrant is that call options are issued by the company so that any proceeds from the sale of stock go to the issuing firm.

The payment of any compensation for loss is contingent on the actual occurrence of a credit-related event under a

Unlike stock options, futures options require the holder to enter into a futures contract.

Exhibit 14-10 USE THE FOLLOWING INFORMATION FOR THE NEXT QUESTION(S) The WallMal Company has entered into a 4-year interest rate swap, with semiannual settlement, to pay a fixed rate of 8% per year and receive 6-month LIBOR. The notional principal is $50,000,000. -Refer to Exhibit 14-10 Assume that one year later the fixed rate on a new 3-year receive fixed pay floating LIBOR swap has risen to 9% per year. Settlement is on a semiannual basis. Calculate the market value of the FRN based on $100 face value.

The forward rate agreement is the most complicated of the OTC interest rate contracts.

The common stock of BioTech Industries pays a dividend of $1 per share and has a current market price of $27 per share. The convertible bond is selling for $1100. The payback or breakeven time for the bond is

Risk management is the driving force behind the futures options market.

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 Chimichango.

Investors should purchase market index put options if they anticipate an increase in the index value.

Exhibit 14-3 USE THE FOLLOWING INFORMATION TO ANSWER THE NEXT QUESTION(S) The following information is provided in the context of a two period (two six month periods) binomial option pricing model. A stock currently trades at $60 per share, a call option on the stock has an exercise price of $65. The stock is equally likely to rise by 15% or fall by 15% during each six month period. The one-year risk free rate is 3%. -Refer to Exhibit 14-3. Calculate the price of the call option after the stock price has already moved down in value once (C_d).

A(n) _______ contract is an arrangement whereby the coupon rate on a note moves in the opposite direction of some variable rate index.

The minimum price of a convertible bond is

The value of a call option is inversely related to:

Options embedded in real assets owned by firms are known as

The intrinsic value of a warrant = (Market price of common stock + Warrant exercise price) ´ Number of shares specified by warrant.

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.

Convertibles provide the upside potential of common stock and the downside protection of a bond.

Index options are settled by delivery of the stocks that make up the index.

Risk management strategies involving interest rate agreements can be classified as forward-based or option-based.

In the Black-Scholes option pricing model, an increase in exercise price (X) will cause