Semester Two Examinations, 2022 FINM7405 Finance
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School of Business
Semester Two Examinations,
2022 FINM7405 Finance
Question 1 (10 Marks)
XYZ shares are currently trading at $23. There are two options written on XYZ shares available in the market with the same strike of $24 and maturity of 18 months. Information regarding these two options is as follows:
- Call options trading at $3.32. You calculate the fair price of this call option is $3.68.
- Put options trading at $3.20. You calculate the fair price of this put option is $2.94.
The risk-free rate is 5% compounded continuously.
a. Prove that an arbitrage opportunity exists using put and call parity. (5 Marks)
b. Describe a trading strategy to exploit the above arbitrage opportunity. The table below may be useful. (5 Marks)
Strategy |
Cost |
PAYOFF |
|
ST > X |
ST < X |
||
|
|
|
|
Net |
|
|
|
Question 2 (10 Marks)
Consider the following information on the options available on stock ABC. You intend to write one Jan maturity call option on company ABC’s stock with exercise price $105 and write one Jan maturity put option on the same underlying asset with strike price $100. The information of the options on the stock of company ABC is as follows:
|
|
Call |
Put |
||
Strike |
Expire Date |
Volume |
Price |
Volume |
Price |
90 |
Jan |
45 |
14.875 |
206 |
0.125 |
95 |
Jan |
216 |
9.625 |
741 |
0.25 |
95 |
Feb |
10 |
12.375 |
261 |
1.875 |
100 |
Jan |
911 |
5.25 |
2021 |
0.75 |
100 |
Apr |
29 |
11 |
319 |
4.75 |
100 |
Jul |
5 |
13.375 |
225 |
6.625 |
105 |
Jan |
3109 |
1.75 |
2357 |
2.25 |
105 |
Feb |
358 |
5 |
339 |
5.25 |
105 |
Apr |
231 |
7.75 |
527 |
6.5 |
110 |
Jan |
1986 |
0.375 |
80 |
5.75 |
110 |
Feb |
1025 |
2.9375 |
27 |
7.5 |
110 |
Apr |
421 |
5.375 |
21 |
9.25 |
a. Graph the payoff as well as the profit/loss of this portfolio at option expiration. (2 Marks)
b. At what price range will you break even on your investment based on the payoff? (3 Marks)
c. What will be the payoff and profit/loss on this portfolio if company ABC trades at $102 on the option maturity date? (3 Marks)
d. Given the portfolio that you have constructed, what is most likely your view of the future for the price of ABC’s stock? (2 Marks)
Question 3 (10 Marks)
As an Australian investor, you have just bought a 3-year EuroPound bond in SGD dollar which is priced at par $1000 SGD. Given your knowledge with respect to derivatives trading, you have decided to hedge your position using a ‘fixed-for-fixed’ currency swap. You observe the following current information:
• Spot foreign exchange rate is $0.95 AUD for $1 SGD
• The tenor of the swap is 3 years
• Interest is repaid every half a year
• The inferred market yield of an equivalent 3-year AUD bond is 4% pa
• The inferred market yield of an equivalent 3-year SGD bond is 6% pa
a. With respect to the currency swap, how much are you lending and borrowing and in what currency for each, and what would be the possible reason(s) for taking this hedging position? (3 Marks)
b. Three months have passed. The swap now has 33 months to maturity. The market yield of an equivalent 33-months to maturity AUD bond is 4.5% pa. The market yield of an equivalent 33-months to maturity SGD bond is 5% pa. Today’s spot exchange rate is $0.99 AUD for $1 SGD. If you and the swap counterparty decided to terminate the swap today via ‘mutual agreement’, how much do you have to pay or receive to settle the swap termination? (4 Marks)
c. Now, 2 years have passed since the initiation of the swap and the swap now has 1 year to maturity. The market yield of an equivalent 1-year AUD bond remains at 4% pa. Likewise, the market yield of an equivalent 1-year SGD bond remains at 6% pa. What is the value of the swap for the counterparty if the current spot exchange rate remains at $0.99 AUD = $1 SGD? If the current spot exchange rate changes to $0.8 AUD = $1 SGD? If the current spot exchange rate decreases to $1.1 AUD = $1 SGD? (3 Marks)
Question 4 (10 Marks)
Read the following article:https://www.economist.com/finance-and- economics/2022/10/13/credit-default-swaps-are-an-unfairly-maligned-derivative
Given your understanding of credit default swaps and the content above answer the following:
a. What is/are the common criticisms of credit default swaps? (2 Marks)
b. Explain the opinion of the author of this article in relation to credit default swaps. (4 Marks)
c. Do you agree with their option? Why or why not? (4 Marks)
2023-06-02