Chapter 5: Q18I (page 590)
What type of interest rate swap would be appropriate for a speculator who believes interest rates soon will fall?
Answer
Floating rate
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In what ways is owning a corporate bond similar to writing a put option? A calloption?
Suppose you are attempting to value a one-year maturity option on a stock with volatility (i.e., annualized standard deviation) ofσ= .40. What would be the appropriate values for u and d if your binomial model is set up using the following?
a. 1 period of one year
b. 4 sub-periods, each 3 months
c. 12 sub-periods, each 1 month
The Excel Applications box in the chapter (available at www.mhhe.com/bkm ; link to Chapter 17 material) shows how to use the spot-futures parity relationship to find a “term structure of futures prices,” that is, futures prices for various maturity dates.
a. Suppose that today is January 1, 2012. Assume the interest rate is 1% per year and a stock index currently at 1,200 pays a dividend yield of 2%. Find the futures price for contract maturity dates of February 14, 2012, May 21, 2012, and November 18, 2012.
b. What happens to the term structure of futures prices if the dividend yield is lower than the risk-free rate? For example, what if the interest rate is 3%?
An investor buys a call at a price of \(4.50 with an exercise price of \)40. At what stock price will the investor break even on the purchase of the call?
Consider an increase in the volatility of the stock in the previous problem. Suppose that if the stock increases in price, it will increase to \(130, and that if it falls, it will fall to \)70. Show that the value of the call option is higher than the value derived using the original assumptions.
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