Chapter 1: Derivative: a contract between two parties providing for a payoff from one party to the other determined by the price of an asset, an exchange rate, a commodity price, or an interest rate. Derivative product is defined as financial contracts with settlement depending on the outcome of the underlying assets in the future. Advantages of OTC: terms can be tailored to specific needs of the parties, private market in which no one needs to know about the transactions, unregulated. Disadvantages of OTC: credit risk is higher, transaction size larger than what normal investors can handle. Chapter 8:Forward vs. Futures: definition: a contract between a buyer and a seller to purchase or sell something (the underlying) at a later date (maturity date) at a price (called forward/futures price) agreed upon today. Forward: unregulated, OTC traded, larger bet each contract, $84T mkt size, margin account usually required. Future: regulated and exchange traded margin account always required. Arbitrageurs attempt to profit from differences in the prices of otherwise identical spot and futures positions. Two rules: do not take any risk do not spend any money. Hedging: A) Long in the “underlying” → when the underlying price goes up, you will be happy, but sad when the price decreases. B) Short in the “underlying” → when the underlying price decreases, you will be happy, but sad when the price goes up. IF current position is type (a), sell forward/futures contracts to hedge. IF current position is type (b), buy forward/futures contracts to hedge. Ways to exit forward/futures contract: submit offsetting trade before or on last trading day. et your contract expire and wait for final settlement right after maturity date. For contracts with cash settlement: last trading date is the settlement date for contracts with delivery settlement: last trading date is the position date. Exchange for Physicals (EFP): the only type of permissible futures transaction that occurs off the floor of the exchange the holders of long and short positions get together and agree on a cash transaction that would close out their futures position. EFP market simply gives parties additional flexibility in making delivery, choosing the terms, and conducting such business when the exchanges are closed. Chapter 2:Call: the holder has the right to buy a specific amount (contract size) of the “underlying” at the predetermined “strike price” on (European Style) or before-or-on the maturity day (American Style). Put: the holder has the right to sell a specific amount (contract size) of the “underlying” at the predetermined “strike price” on (European Style) or before-or-on the maturity day (American Style). A bullish trader can choose to buy a call or short a put. A bearish trader can choose to buy a put or short a call. if your current position is long in the underlying, buy put options to hedge. If your current position is short in the underlying, buy call options to hedge. You cannot hedge by shorting options! Pro’s of hedging with options: Flexibility and profit potential. Chapter 3: Important five factors: S0 current stock price, X Exercise Price, r the applicable risk free rate applied during the duration of the option, St stock price at expiration, T length to maturity. S0 has a POSITIVE effect on CALL value, but a NEGATIVE effect on PUT value. X has a NEGATIVE effect on CALL, but a POSITIVE effect on PUT. R has a positive effect on CALL value, but a NEGATIVE effect on PUT. T always has a non-negative effect on American options,
1. (5 points)
A fellow options investor tells you that he is going to enter an order to “buy to close.” Explain exactly what he means.
2. (2 points)
What is the difference between a European option and an American option?
3. (54 points)
On Friday, Nov. 14, 2014, Alibaba stock (symbol BABA) closed at $115.10 a share, up $.26 on the day. Consider the following chart giving the premium as of close of trading on that day on various options on Alibaba shares:
In the questions…
19-1. A call option is a short-term option to buy a specified number of shares at a stated price within a specified time period.
A right is a corporate-created option to purchase a stated number of shares at a specified price within a specified period of time (usually within a few months).
A warrant is a long-term option created by a corporation that allows the holder to purchase a stated number of shares at a specified price within a specified period of…
• Options contracts
• Pricing of the options contract
• Investment strategies with options
Financial Derivatives Options contracts
BKM: Chapters 20&21
1. Options contract
• Understand the basic terminology with
• Be able to calculate the profit/loss to various
options positions as a function of ultimate
• An option contact gives its holder the right to…
Mechanics of Options Markets
A corporate treasurer is designing a hedging program involving foreign currency options. What are the pros and cons of using (a) the NASDAQ OMX and (b) the over-the-counter market for trading?
The NASDAQ OMX offers options with standard strike prices and times to maturity. Options in the over-the-counter market have the advantage that they can be tailored to meet the precise needs of the treasurer. Their disadvantage…
part or in full,
FMAA MONASH ADVANCED CORPORATE FINANCE
Capital structure theory
Capital structure is the mix of a company’s debt (D) and equity (E). Optimal capital structures, that
maximise company value, exist for companies that operate within imperfect capital markets.
Business risk, or systematic risk, is the risk that arises from the operation of a company’s assets to
generate operating cash flows and it is borne equally by holders of company E…
G= government spending on goods and services
CPI Current Period – CPI Previous Period
CPI Previous Period
Present Value (PV)
Future value of principal
(1 + discount rate)number of compounding periods
Present Value of an C= coupon payment
r= discount rate
n= number of coupon payments
: NAVEEN XAVIER
European versus American options
European options can be exercised only at expiry.
American options can be exercised at any time up to expiry. In-the-Money
Exercising the option would result in a positive payoff. At-the-Money
Exercising the option would result in a zero payoff (i.e., exercise price equal to spot price).
Out-of-the-Money Exercising the option would result in a negative payoff
Call options gives the holder the right, but not the obligation, to…
-GAAP recognizes only legal obligations
-ARO IS NOT reported as a separate asset because it does not provide economic benefit alone
-Under IFRS, accretion expense considered financing cost, recorded as interest expense
1. Find present value of expected retirement obligation
2. Add the ARO cost to the carrying amount of the asset, create ARO liability
3. Amortize and expense the discount on the ARO (accretion expense)
4. Upon settlement, Debit the ARO, Credit Cash and record…
truly comparable large sample of firms. Multiples analysis is backward-looking, reliant on historical/current data to obtain multiples. It reflects relative value rather than the intrinsic value which DCF valuation produces.
DCF analysis generates an intrinsic value as it relies on data specific to the firm. DCF analysis factors in time value of money, and thus is a forward-looking measure. However, there is uncertainty in forecasting future revenues, especially for private firms and those firms…
payment dates Maturity date YTM Coupon rate Cum-interest or Ex-interest? If ex-interest If> 7 days to the next coupon payment-----> cum-interest
YIELD TO MATURITY
The Yield to Maturity (YTM) of a bond is: Interest rate that makes the present value of the bond’s…