The Financial Institution “APOLLON INC” in the sunny State of California is implementing the latest risk HEDGING techniques.
The Financial Institution “APOLLON INC” in the sunny State of California is implementing the latest risk HEDGING techniques. The Treasurer of the institution employs a Binomial Option Model in order to pay its obligations in the good, and the bad state of nature, respectively. However, the Treasurer Dr. “Ding-Dong” suffered a temporary lapse of memory and he forgot how to use this risk hedging technique.
Briefly explain to him what this latest technique is all about.
Employ a call option of 14 dollars, a multiplicative upward factor of 1.4, a multiplicative downward factor of 0.9, a probability of 0.5 in every state of nature, a stock price of $140, and a striking price of $140 dollars respectively and create a PERFECT HEDGE. The Risk-Free Rate is 6%.
What is the Optimum Hedge Ratio?
What is the Optimum Hedge Strategy?
What are the intrinsic values of the option in the good and bad state of nature respectively?
Is the Call Option Overvalued or Undervalued?
Q2. (12.5 points)
Consider the CEO of a U.S. financial Institution “Ajax Inc” who is trying to tailor the needs of a corporate client. Calculate the values of the Call and Put Option given the following economic parameters?
1. S=48, X=47, t= 0.25, r=6%, and the variance σ 2 =0.36.
Show me that Options constitute a zero – sum game in well drawn diagrams.
These options are traded in the NASDAQ Stock Exchange Market at $8 dollars. Are these options overvalued or undervalued?
Q3: (12.5 points)
The President of the “Water-Mellon Bank” is offering you the Vice President position because he admires your knowledge on the determinants that affect the option prices (e.g., the Greeks of the Option). You are all excited from the offer and you try hard to impress him talking about long and short positions and synthetic securities, respectively.
The Treasurer of the bank, however, does not believe you and he think that your knowledge is very limited on these issues. Hence, he is asking you to use an example of option valuation in order to prove your knowledge and mathematical skills..
Use the results that you obtain from Question 2 above in order to value the
following Greeks
Δ, Θ, Λ (with the following values respectively, Stock price=50,
Time horizon=4/12 and Volatility= 0.7 of the Call and Put Options, respectively.
Q4: (12.5 points)
Consider the following Spot Exchange Rate 1 Euro= 1.19 U.S. dollar. The Home country is U.S.A and the Host Country is Greece.
What are the Direct and Indirect Exchange Rates respectively?
Given the Table below calculate the values of the European Call and Put Currency Options, respectively.
Calculate and explain the Greeks of the Currency Options given the following parameter values. Carefully explain your answers.
Δ
Λ
Θ
Κ
S
1.19
1.22
X
1.17
1.19
rD
5%
rf
6%
σ 2
0.49
0.64
T-t
4/12
6/12
CE
?
?
?
?
?
PE
?
?
?
?
?
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