Exam 3 Prep Homework Data File: W1E3PrepData

Exercise #A – Black-Scholes ¡Please practice so that exercises 1-4 do not take very long!

Refer to the OptionFormulae.pdf if you need to.

1. Construct the Black-Scholes model.
2. Convert the interest rates from discrete Act/360 to Act/Act continuous. Interpolate the rates to
get the B-S-compatible interest rate input for 1/21/2022.
3. Compute the offer-side implied volatilities for EMR calls struck at 60-85. Plot both implied
volatilities against strikes on one graph. Option prices are from 11/3/2020.
4. In B-S, price a call struck at 68.25. How do you get the right volatility input?

Exercise #B – Binomial

Refer to the OptionFormulae.pdf.

5. Construct a 180-step binomial.
6. Be brave here. Add one more input into your binomial called American which can take on a
value A or E for American or European, respectively. Add an IF statement to call and put values
at every node in the interior of your binomial tree (but not the last time layer) to enable your
model to value American options. The purpose of the IF statement is to compare the discounted
probability-weighted average of the payoffs from the subsequent nodes (the value we compute
for a European option) to the immediate exercise value which is equal to the current stock price
(at that node) minus the strike price for calls, and the strike price minus the current stock price
for puts. If the latter is greater, overwrite the former with the latter. Don’t give up, keep
thinking how to do it. If you understand my instruction here, then you are ready for the test.

Exercise #C – Corporate Hedging with Option

7. In tab “Payoff” plot the unhedged and the hedged position for the following situation: We are a
U.S. company building a production facility in Britain. We have a £10 million payment due in 6
months. We worry that the $/£ exchange rate may increase. Currently, one pound is worth
$1.30. We would like to hedge by buying 1.40 calls (premium $0.02) and selling 1.20 puts
(premium $0.01). The X axis should run from 1.10 to 1.50.

Exercise #D – LBO Pro-formas and Leveraged Buyout

Debt paid down at the end of the year.

8. In tab LBO, consider the financial statements for Emerson Electric from the end of fiscal 2019.
Use the % sales ratios in col E to construct the 2020 financials. Use the red ratios logically. Solve
for the level of old debt in G34 to balance the financials. Then compute the new debt and
additional goodwill as the result of an LBO. The new debt not only has to cover buying the stock
but also paying off all the old debt. The old debt has a change-of-control put provision. Amend
the statements for 2020. Treasury stock and annual dividend payments are frozen at the 2019
level.
 9. Construct the financials for 2021-2025 using the ratios in col F. Many of these are substantially
lower assuming that the new management squeezes lots of efficiencies. (Use the interest rate in
col F for the new debt). We are not paying dividends or buying back stock. Assume each year we
are paying off the new high-interest debt.
10. Perform the IRR analysis of the LBO in rows 53 through 69.

Instructions

Spend time on this assignment. Save your Excel file as lastname_firstname_E3Prep.xslx. Upload on
Canvas at the end of the quiz.